Synergy Theory of Merger and Acquisition
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Published: Tue, 20 Mar 2018
1 Description of the research problem
Merger means combining of two business entities under common ownership. Synergy means the potential ability of individual organizations or groups to be more successful or productive as a result of a merger, just like to achieve “1+1>2”. Mergers and acquisitions (M & A) is an important way of the enterprise’s external development in modern economic life, and it is an important aspect of enterprise capital management. Through mergers and acquisitions, companies can effectively achieve the rational allocation of resources, expand production scale, decrease transaction costs and achieve synergies, to the purpose of maximizing shareholder value.
Merger and acquisition as a product of the market economy development, it has become prevalent and important economic phenomenon in Western countries. In today’s developed market economy countries, companies are increasingly relying on the means of mergers and acquisitions to expand operations, concentrate production and capital to achieve business growth targets. The Nobel economics laureate, American economist George. J. Stigler said, throughout the United States-known large companies, which almost no one is not a certain way, to some extent the application of mergers and acquisitions and developed.
In the context of China accession to World Trade Organization (WTO), more intense competition among enterprises, the current monopoly industries such as electricity, civil aviation, railway and so on will gradually opening up. Sooner or later will face the industry challenges and the impact of multinational corporations, many companies may are merged by domestic or foreign companies. In recent years, the number of listed companies which are in the form of the mergers and acquisitions are increase. Chinese auto industry mergers behavior has shown an increasing trend in recent years. Expansion of Chinese auto industry is mainly large enterprises mergers and acquisitions the small enterprises. There are three main Lead restructuring groups in Chinese auto industry; they are China First Automobile Group Corporation, Dongfeng Motor Co. Ltd. and Shanghai Auto Industry Corporation. Three major groups in the policy resources, the overall strength have the advantage of other companies cannot have. Chinese auto industry has formed three groups led to the Guangzhou Honda, Zhejiang Geely, Beijing Hyundai and so on as an important part of the “3+ X” pattern. From China merger and acquisition practice, the successful integration of merger and acquisition rate is low, the most of enterprise cannot be achieved the “1+1>2” synergy after merger and acquisition, some of them Even negative synergistic effect. In this paper, Chinese auto industry mergers and acquisitions as example, analysis the synergy effect of mergers and acquisitions in Chinese auto industry.
1.2 Overall aim and objectives of the research
This article based on the general theory of the synergistic effect, from the theoretical and empirical analysis the synergy effect of merger and reorganization in Chinese auto industry. Purpose of this research is through analysis the results, and obtained the conclusions which are does the merger and acquisition in Chinese auto industry have synergy effects? The merger and acquisition of auto companies create value, whether or not? Added value to shareholders, or damage the interests of shareholders? If value added, it shows that most of the Chinese car companies’ mergers and acquisitions is successful in recent years, and achieved a synergistic effect; If damaged shareholder’s value and there is no synergy effect, this paper will advance useful recommendations of Chinese auto industry how to improve synergies and the realization of synergies after the merger in the mergers and acquisitions process.
Merger and acquisition is a key measure of whether a synergistic effect of merger and acquisition is success. The generation of synergies not only depends on the choice of acquisition targets, but also depends on the size of synergies, the distribution in mergers and acquisitions, and synergy management after merger. At present, China’s auto industry has a series of merger and acquisition, but there are still many small enterprises. Therefore, this article from the synergistic perspective of Chinese auto companies’ merger and acquisition, and to have an in-depth comprehensive study has important theoretical and practical significance.
3 Literature review
3.1 Synergy theory of merger and acquisition
Ansoff, H.I. (1987) was studied from the perspective of corporate strategy synergistic effect. He believes that strategy consists mainly of four elements: Market scope, development, competitive advantage and synergy. Among them, the synergy shows that how companies identify their capabilities and opportunities through the matching relationship to development new business successfully. He established the economic meaning of synergy, which is why the value of the whole enterprise may be greater than sum the value of each part. Not only include the land, equipment, plant and other tangible assets shares, but also include the sharing of intangible assets such as technology, company image, etc.
Japan’s strategy experts Itami Hiroyuki (1987) made a more stringent definition of Synergistic effects. In his book “Mobilizing invisible assets” (1991), he broke down Ansoff’s synergy definition into complementary effect and synergy effect these two parts. Itami advanced the company’s strategy should cooperate of five areas, three external fields are user, competition and technology, two external fields are the resources and organization. He discussed the five areas and analysis synergy in each area. The goal is use of all the company resources in the most effective way, while creating enough resources. The company must make all the resources have the greatest performance; one way to do this is to increase the utilization of resources. By increasing efficiency to save costs or increase sales approach, Itami called this is complementary effect. While complementary effect is valuable, but it is very easy to follow by other companies, and cannot provide lasting advantages for the company. Therefore, he believed that complementary effects are not the real source of synergy. Only when the company began using its unique resources, that is, invisible assets, it can be possible to have a real synergy. As Itami said that, the invisible asset which is locally developed from the company can be used for other areas, and will not be wearing out. He point out that, many companies because of overlooked the invisible assets, and lost opportunity to earn profit of synergies.
Barney, J. (1991) said that, the company resources include three parts: tangible capital, human capital and organizational capital. These three types of capital are containing the skills, abilities, organizational factors, values, and the tangible assets such as land, plant, equipment and so on of the company. While each company has a lot of resources, but one of the most important is that the resources can generate competitive advantage. This resource will not be imitating by competitors, and no available substitute can replace, but it has great market value. Through mergers and acquisitions get these resources can achieve significant synergies.
Buzzell, R. and Gale, B. (1987) considered that, synergistic value mainly have four ways: First is the sharing of resources or business conduct. Second is the spread of benefits of marketing and research development. Third is the similar of enterprises. Fourth is the sharing of the company image.
Porter, M.E. (1985) in his book “How information gives you competitive advantage” used “associate” conducted a study on the synergistic effect. He believes that there are about three types of the possible association between the business units: Tangible association, intangible association and competition associated. Tangible association is due to mutual customers, channels, technology and other factors, this is an opportunity for the relevant business unit to share the activities of the value chain. Intangible association involved the communication of management skills between different value chains. Competitive association is because of actual competitors or potential competitors exist in different countries. Three types of associate are very important for the effects of the competitive advantage, although these associates are different, but not exclusive from each other.
Weston, J.F. (1998) in his book “Takeovers, restructuring, and corporate governance” believes that the factor of mergers and acquisitions’ total value increase are including: Firstly, management synergy. The companies which have different management level combinations can bring efficiency improvements. A relatively efficient bidder may acquire a relatively low efficiency as a target company, and value can be improved by improving the efficiency of the target company. Secondly is operating synergies. It includes the theory which is based on the synergy effects, and assuming exist the transaction costs savings of various forms in the industry. Thirdly is financial Synergy. One source of financial synergies is the lower cost of internal financing and external financing. The companies which have a large number of internal cash flow and less investment opportunities will hold excess cash flow. The companies which have lower production capacity of internal capital and large number investment opportunities will need for additional financing. The merger of these two kinds of company may get the advantage which is lower cost of internal funds. Fourth is undervalued effect. Undervalued level generally uses ratio q to reflect. The definition of q is the ratio of Stock Market Value divided by Replacement cost. Fifth is information effect. The information of acquisition will lead to value increase of the business. It includes two aspects, one is the acquisition will spread the information of the target company is undervalued, and Acquisition will enable the market to re-evaluation of these shares. The other is the acquisition will encourage the manager of target company implementation more effective strategies in the company.
3.2 Merger and acquisition motivation theory
Merger and acquisition is not the result of a single motive pushed. Therefore, some scholars studied from different research aspect. They made a lot of theory or hypothesis; include Free Cash Flow Hypothesis (Jensen, M.C. 1986), Hubris Hypothesis (Roll, R. 1986), Efficiency Theory (Weston, J.F. 1971), Market Power (Meeks, G. 1975), Tax Consideration, Agency Problem, Information and signaling, and so on. The following will introduce several theories about:
Based on Weston, J.F. (1971) Efficiency Theory said that, merger and acquisition is to improve the effectiveness of corporate management, Increase social welfare. The theory considers that mergers and acquisitions activity has the potential social benefits. Business MERGER AND ACQUISITION motivation is to get through the acquisition of a synergistic effect, i.e., “1 +1>2”. This kind of effect may come from management, business, finance and so on.
3.3 Evaluation theory of synergy
A number of scholars have done a lot of empirical research on the performance of the company’s acquisition. The empirical research basic carried out in accordance with two main lines, which are through contrast the income approach and the evaluation of financial indicators, test stock market performance of merger and acquisition and the company’s operating performance effect of merger and acquisition. Research the stock market reflection of company’s merger and acquisition is actually examining stock price reflects of the listed companies’ merger and acquisition event. Through research and study Jensen and Ruback (1983) found that target company’s shareholders can receive 30% of the excess rate of return in merger and acquisition. Dennis and Sihan (1988) analysis the market reaction of thirty-one large equity transfer notice. They found that in the day before the announcement, shares rose to 7.3%, and shares rose by 12.8%.before and after the announcement. Gregg Jarrell and Poulsen (1989) analysis 663 successful cases of merger and acquisition between 1960 and 1985, and they found the average excess rate of return of the target company is over 20%, but the purchaser’s average excess rate of return is only 1.14%.
Healy, Palepu and Ruback (1992) research and studied the 50 largest mergers and acquisitions cases in U.S. from 1979 to 1984, and they found that the company’s assets return is significantly improved. This kind of increase is due to the improvement of management efficiency, and it is not through dismissing workers to generate the labor cost savings. Langtieg (1978) hold the same industry companies as control sample, and he found that the performance of the company did not significantly increase after the merger and acquisition. Bradley and Jarrel (1988) use different theory to check Magenhein’s simple, however has not get the evidence of the company’s declining performance after the merger and acquisition.
Gregor Andrade, Mark Mitchell and Erik Stafford (2001) research and studied about 2,000 mergers and acquisitions cases in U.S. from 1973 to 1998. The result shows that, before the mergers and acquisitions’ activities, the target company’s and acquired company’s operating profit relative to the expected industry’s average profit is very high. After the merger and acquisition, the target company’s and the acquired company’s operating profit has increased slightly. Through analysis the company’s un-normal profit rate in different period by the regression analysis theory, they found that more than half of the mergers and acquisitions can increase the profit sustained. Therefore, merger and acquisition really can improve the operating profit of business.
4 Methodology and theoretical framework
There is little research of Chinese merger and acquisition synergies in specific industries. In this paper, the automotive industry as an example, make a detailed synergy analysis of the mergers and acquisitions, it is include manager synergy, financial synergy, operating synergy and synergy of intangible assets. There are four evaluate methods of synergy in this paper, they are free cash flow model, dividend growth model, event-based method and the direct recursion model. In this paper, author will use the event-based method to examine the synergy effects of mergers and acquisitions in Chinese auto industry from 2001 to 2003. Author will base on the research result to analysis the factors (macroscopic and microcosmic factors) which are affect synergy of mergers and acquisitions in Chinese auto industry. At last, author will put forward some suggestions to improve the synergy effects of mergers and acquisitions in Chinese auto industry. The aim of this research paper is by collecting relevant data and case of the Chinese auto industry mergers and acquisitions synergies for analysis, then find the result which is the synergy effects of mergers and acquisitions in the Chinese auto industry.
4.1 Proposed methodology
The appropriate calculation method of Synergies is the key issue to make a correct decision for merger and acquisition. Sudarsanam, P.S. (1995) believes that using discounted cash flow method to calculate the difference between before and after mergers and acquisitions is a good way. Xinping Xiao (1999) believes that merger and acquisition synergies calculation includes two aspects: Internal model and external market model. The internal model of synergy means that M & A company business decision makers through the past and current data of their own and the company which they merged to predict the future data. Then, through analysis and calculate the Net increase profits, get the estimates result of synergy. According to principles of market efficiency, use the change of stock prices, shares types and circulation before and after mergers and acquisitions, then sum of net profit of the Merger parties and merged party to get synergy value. Xuanneng Hu (2002) consider that merger and acquisition synergies calculation theory mainly have The total value remaining theory of mergers and acquisitions and increase discounted cash flow method of mergers and acquisitions.
4.11 Cash flow valuation method
This kind of method is investigated the differences in cost and benefits between have M & A event and do not have M & A event. This difference is caused by the merger event, the effect is synergistic. In theory, this method also can be divided into two types: the first one is the synoptic way. This is an indirect method, by estimating the value of the enterprise after merger and the value of the enterprise after merge, subtract the two values to get synergy value. The other one is the incremental way, which is by predicting increases in cash flow of mergers and acquisitions, directly derived the value of synergies.
4.12 Direct regression model
The principle of this model is relatively simple, by selecting a set of merger samples, and a set of associated variables about synergy, and regression method used to determine the coefficient between them, then derived empirical model. The model is to study the effects’ factors and the significance impact of synergy. Niden (1993) proposed the linear model to calculate the relative value of successful merger’s synergy effect as follows:
In this formula, α is coefficient, WK, HOST, CASH, MIX, MULT and TNDOFR are dummy variables. Niden (1993) conclude that: for all samples, if do not considering the two factors which are several competitors and the bid, the first four variables (WK, HOST, CASH and MIX) are significantly positively correlated.
To get regression model, first is to determine the size of synergy, then can regression analysis the other relevant variables. Because of this, the model needs to be used with the other synergies of r evaluation methods.
4.13 Stock price movement model
Compared with the internal calculation, calculation model for stock return is standing on shareholders’ position. According to principles of market efficiency, calculate the share price and trading volume changes of merger and acquisition. Use the change of stock prices, shares types and circulation before and after mergers and acquisitions, then sum of net profit of the Merger party and merged party to get synergy value.
In this formula, SAi and S’Ai is the company A’s the number of shares i in stocks issued, and PAi , P’Ai is the corresponding price. SBi and S’Bi is the company B’s share I in stock issued, and PBi, P’Bi is the corresponding price. eRAi and eRBi means the final value of the coefficient during merger and acquisition. RAi and RBi means The corresponding returns by continuously compounded calculated. There are three ways to calculate this kind of stock rate of return: Average Adjusted Returns method, Market model method and Market Adjusted Returns method. Stock price movement model is suitable for merger parties and merged parties are both listed companies, however, this kind of case is little in China, lead to this paper do not use this kind of method.
4.14 Event profit model
This method is used widely in empirical research. This method attempts to make the merger and acquisition as a single event. Through the stock price changes in the capital market to analysis the economic impact of mergers and acquisitions. It assumes that capital markets are efficient, stock price will react to events merger sooner or later. There are mainly three ways to calculate the normal rate of return:
First is Market adjustment method. It assumes the market index returns is the expected rate of return of each shares during the event day. I.e. Rit=RMt
Second is Average adjustment method. This method need to select a “clean period”, which means the period without incident. The “clean period” can before the merger and acquisition event, or after merger and acquisition event, but it cannot include event period.
Third is Market model method. This method is based on the security asset pricing theoretical model (such as CAPM) to calculate the expected rate of return. This method also needs to select a “clean period”. Through the data of market rate of return and the stock real rate of return to calculate:
Rit= αi + βiRMt + εit
In this formula, RMt means market rate of return in t day. Through calculate the market index change rate in day t and t-1 can get the RMt.
In above three methods, the first and second method is simple and intuitive; however they all have some theoretical shortcomings. In theory, the market model method is more complete. This kind of method takes into account the market associated risks and average income, and it is one of the most widely used methods in academic research. This paper also use this kind of method to analysis the synergy effect of merger and acquisition in Chinese auto industry.
4.2 Hypotheses and Sampling frame
China’s auto industry had happen the merger and acquisition events frequently in recent years. Whether these mergers and acquisitions have brought positive synergies? Whether to give shareholders a significant excess returns? In this paper, use the merger and acquisition events of current listed auto company in China as a sample, using the market model method, from the perspective of shareholder wealth changes to analysis, does synergistic effect of merger and acquisition is produced in Chinese auto industry? This kind of theory is from the price changes to measure the changes in corporate wealth. That is because in the case of the securities market in full force, companies to obtain synergies through mergers and acquisitions, which led to the improved performance necessarily reflected on the volatility of the stock.
The study of this paper is the synergy effects of mergers and acquisitions in Chinese auto industry. The research of this paper is about Chinese auto industry aspects, and the main scope of this research paper is in China, questionnaire survey and interviews were not appropriate. Therefore, secondary research is more appropriate than primary research in this concept. This research paper used data from academic articles and official government Web site. In this way, the secondary data is more accurate and more precise than the primary data, and the secondary data which is research by the economists out of, and it is more convincing.
4.4 Data collection
The main methods used to gather information on this document were through reading journals, books and fact sheets. The research method for this topic used second data from some academic journals, and these data can be cited for academic purposes, because it would suggest that the information available is reliable. The journals which were analyzed in this paper were mainly through the University of Winchester’s online journal database and some official web sites, such as State Administration of Foreign Exchange official website, National Bureau of Statistics of China website, The Central People’s Government of the People’s Republic of China website and Ministry of Education of the People’s Republic of China website etc.
4.5 Time plan Ethical considerations
Author use Gantt chart makes a time plans (see Appendices), and will follow this time table finish the paper step by step. In this paper, Microsoft Excel has been used to analysis the secondary data and makes these data more structured. This paper does not involve any discrimination and ethical issues, the article used secondary data only for academic research.
Merger and acquisition is a kind of distribution and redistributing of resource, and it is important to development of the enterprises. Many enterprises would like to merger and acquisition. Even though however the rate of failure is high, merger and acquisition popular in the world, by the lack of synergy or the limited synergy is the most important reason. Especially in China, pursuing the hotness industry and do not consider the phenomenon of synergy is very common. In recent years, Chinese auto industry had increase the speed of merger and acquisition. This paper focuses on the merger synergies and value creation as the main line, combined with merger and reorganization of China’s automobile industry, make an in-depth analysis and research about the theory of synergy, synergy assessment and the key factors of synergy. Attempts to describe the whole framework of the synergistic effect provide a reference for the theory research and the business decision-making.
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