An Exploratory Literature Review Mergers And Acquisitions Finance Essay
The main purpose of this paper is to offer a reader a guided tour through the literature written about the mergers and acquisitions (M&As). This is an exploratory study through the field where number of articles is written, often with mixed results. The goal of many successful writers in M&As field of interest is to contribute to understanding of M&As and ultimately understand how mergers and acquisitions can be (more) successful. Number of different sub-area is discussed and the most relevant and interesting articles – according to the author’s opinion - are presented.
Announcement and finalization of the mergers signals often changing times in the particularly industry and affects directly and indirectly people around the world. There is often huge boost for CEO’s and company prestige and economy benefits on the long run, however the performance of the participant companies after the acquisition is debate issue.
Although during the first years of the XXI century, the number and size of acquisitions decreased, large increase in the size and number of mergers was seen, especially during the 1990’s. For example, 60,375 mergers involving a total of over $4.5
Trillion occurred between 1980 and 1996 were conducted in the U.S. alone. Some of the largest recent U.S. mergers (and overall in the world) are those who were advertised on the front covers of the newspapers and business journals like: between America Online and Time Warner (2000; $165 billion), MCI WorldCom and Sprint (1999; $115 billion), Exxon and Mobil (1999; $81 billion); Citicorp and Travelers Corporation (1998; $72.6 billion), and SBC Communications and Ameritech (1998; $60.1 billion).
As earlier mentioned, there is a slowdown in number and size of executed mergers and acquisitions; however, smaller companies seem to be less susceptible to slowdown in activity this year.
“In 2002, the number of deals and their dollar volume dropped 11% and 41%, respectively. This business hasn't been so bad since 1993. One bright spot: mergers and acquisitions of smaller companies with market values of $50 million to $500 million. A recent report by U.S. Bancorp Piper Jaffray notes that through the third quarter 2002, the takeover market for companies in this size range slumped less than the overall market.” (Forbes, 2003)
So, what are really mergers and acquisitions after we talked about? In essence, mergers are union of two or more corporations by the transfer of all assets to a single company; acquisitions are capture of one company (target) by another company (acquirer) by transferring all assets to the acquiring company. Often due to complexities of ownership and other interest it is not sure who is acquiring whom and is it a merger of acquisitions. To avoid potential unproductive traps we are addressing whole field as M&As.
How was the literature review conducted?
This paper encompasses more than 30 research oriented – mostly academic - articles in the M&As field. Over 70 different research oriented-articles was reviewed; number of articles was recommended by Dr. Paul Fouts at Golden Gate University. The main research oriented publications that are reviewed are: Strategic Management Journal, Harvard Business Review, Journal of Finance, Academy of Management Journal, Academy of Management Executive; more popular articles are reviewed from: Forbes, Fortune, Business Week, Business 2.0, Financial Times, Economist and U.S. New& World Report; several books on mergers and acquisitions were reviewed but not used for this paper. From the Golden Gate University’s library articles published in “Strategic Management Journal”, and other journals, were copied from microfiche. The academic literature review was conducted in the Golden Gate University’s library, as well as in the San Jose Public Library (opened in July 2003, the largest library West of Mississippi). The research was conducted during period between June and August 2003, and represents the author’s take on the M&A literature, that can possibly benefit others.
Based on the author’s take on literature in the M&A field, a division into five major branches in this filed was established. Each of these branches is discussed in following chapters.
There are major branches of body of research work in the M&A area:
People in M&A;
Performance and success;
These conclusions were drawn based on literature review mentioned earlier.
The best practices research in the M&As field, is a branch of M&As body of knowledge devoting to communicate valuable lessons from number of planned and executed M&As. The research in this field is usually done in a form of case studies of various companies that were involved in M&As. Quality and depth of the articles in this group varies widely. There is often a repetition of themes; although, often more holistic view –as well as practically applicable results - can be found in this sub-category.
As the international trade is increasing, a valuable M&As research is conducted, related to success and challenges of the cross-border acquisitions. Second important sub-group of International M&As are country and regional M&As. Sometimes the research in International M&As is devoted to one country or a region. however, the conclusions, in this comparative type of the research, could go beyond the country or region subject of the research.
People are often overlooked in the M&A but there is extensive body of research addressing from ethical, organizational learning or more in depth personal issues perspective.
Measuring success of M&A – mostly through quantitative research – is subject of number of articles in the field of finance or economics, or other directly realty fields. This research is ongoing for more than 50 years.
Valuation is often overlooked category in M&As. Valuations are a critical part of every acquisition, and potentially can be very beneficial, not only in pre-acquisition time and during acquisitions, but also after the acquisition is conducted.
Success and Performance
Companies are often conducting a series of acquisitions. In early works in the M&A field there was a thinking that related acquisitions have a better chance of succeeding.
Relatedness, only by itself, does not create abnormal returns for acquiring companies. Synergy is the main factor that leads to success and abnormal returns. Barney (1988) in his research proves that:
“… synergistic cash flows stemming from relatedness will lead to abnormal returns for shareholders of bidding firms when those cash flows are private and unique, inimitable and unique, or unexpected.”
However, later work has proved that there are different ways how companies can be close to each others and, as a consequence, there is a various degree of success based on that. According to Hayward’s work (2002), the acquisitions that tend to be more successful are between the companies that are moderately similar in business characteristics and size to one another (“…not highly similar of dissimilar to one another”). If the prior acquisitions were with small losses - no high gains or high losses – the next acquisitions have a better chance of success. Lastly, the timing of the acquisitions should be such that acquisitions are “not too temporarily close to or distant from the focal acquisitions” (Hayward, 2002). According to the author’s opinion there are larger benefits of acquisitions intervals between 6 and 12 months. If the prior acquisitions are smaller than the interval is shorter and when “involve less intensive integration demands”; and similarly, if the prior acquisitions are larger than the acquisition interval is longer and when involve more intensive integration demands. The author results are closer to evolutionary thinking that firms benefit from variety of experience, experimenting and temporal rhythms (Brown, Eisenhard, 1997).
Mergers create value for acquirers when the acquirer has some unique resources which can be then utilized within the target’s company. The authors conclude (Capron, Pistre, 2002) that on other side “when the source of synergies reside with the target, the market is likely to allocate the full gains to the target because of competition between potential acquirers”. Namely, bidding competition of competent bidders can raise price of the target’s company in a way that would be beneficial for the target’s shareholders but likely would lead to unsuccessful performance of the acquirer firm.
“These results, combined with the observation of continued growth in merger and
acquisition activity, gives rise to the “M&A success paradox.” If we assume that managers are rational, and that corporate governance structures serve as a check and balance on poorly conceived strategic actions, we would expect the level of M&A activity to taper off, which has not been observed. To date, scholars have been unable to unravel the M&A success paradox” (Cording, Christmann, & Bourgeois, 2002).
In his study Chatterjee (1992) was trying to see who is gaining from M&A. This study does not suggest that everyone is gaining in M&A, just that there is a net gain for the economy. Often the acquiring company is researched more. However, the target company is other part that is often under-researched. According to the author, the target company should accept takeover only if the synergistic component is dominant to restructuring component.
In the study - during the period of 11 months before the tender offer until 60 months after the tender offer - cumulative average of abnormal returns (CAAR) is measured. The CAAR, and similar indexes, are a financial measure of success in this and many similar studies. The study was based on sample of 577 tender offers between 1963 and1986. There are number of conclusions that can be drawn from the results of the research. The CAAR after 60 months (and for years 1, 2, 3, 4 before) is negative for unsuccessful bidders, about zero for successful bidder and for the rivals and the target company positive. Next, the restructured target companies have much higher positive CAAR than not restructured targets (positive but close to zero). Restructured targets have better CAAR than the rivals of restructured targets; rivals of not restructured targets have much better CAAR of not restructured targets (Chaterjee, 1992).
External factors influence merger activity in strong and consistent sense as has been proven in the research by Golbe and White (1988). Although this research is based on Industrial Organization theory view, and it is concentrated to industries, conclusions go beyond industries to whole economy. Overall, macroeconomic environments influence merger activity; in time of economic expansion the number of merger increases and during economic slowdown the number of merger decreases. Initial industry group conditions has major influence on number of mergers in the industry, as well as macroeconomics factors.
Companies, like people, tend to continue to do what have they done in past. The M&A researchers Amburgey and Miner (1992) studied effects of companies’ momentum on merger activity. Amburgey and Miner based their conclusions on theories of organizational routines and cognitive decision making patters. They come up with a conclusion that there are three types of strategic momentum:
Repetitive momentum (companies repeat previous strategic measures)
Positional momentum (companies sustain or extend their existing strategic positions)
Contextual momentum (general character of a company determine strategic action in a consistent way)
The research results support for reality of repetitive and contextual momentum; however, there is only partial support for positional momentum.
A majority of studies report that the acquirers underperformed market after the merger. However, that issue s not completely resolved considering that there are number of different ways how the performance can be measured. In the finance arena, number of the researchers conducted after-merger performance studies including Agrawal and Jaffe. Agrawal and Jaffe (1992) conclude that the acquiring companies under-perform for about 10%, in average, during the five years after the merger. However, they conclude that this question is not totally resolved.
Certain studies that have measured post merger success have had a different approach. Instead of trying to look into historical market performance they looked into a survey as a methodology. They surveyed prime stakeholders of the merger activity in order to find out how well the merger satisfied objectives based on the pre-acquisitions objectives. In the Capron’s survey-based work, he states: “…traditionally available financial data are too gross to permit differentiation between the types of fine-grained value-creating mechanisms…” (Capron, 1999: 993). One of the conclusions of the research is to keep top management team of the target’s firm, no matter of whether it is a related or conglomerate merger.
Although these types of the studies could suffer of undue subjectivity of respondents (usually the CEO’s who were part of the merger) it provides a good complement and reality check of the previous financial performance oriented studies.
A number and volume of the cross-boarder acquisition is increasing; for example, only 6% of the cross-boarder acquisition activity in the U.S. from 1985, increased to share of 19% in 1999. As international trade is increasing, even faster the number of local cross-boarder acquisitions is increasing. The study encompassed 100 acquisitions of the U.S. companies by foreign companies between 1981 and 1990. According to the study and previous work, there are three motives for cross-broader acquisitions: synergy-seeking, managerilism and managerial hubris. One of the findings of the study is that in synergy-seeking cross-border acquisitions, there will be a positive relationship between the degree of value creation and 1) asset sharing, 2) reverse internalization 3) market seeking and 4) financial diversification (Seth at al., 2001). The study also provides results for managerilism and managerial hubris types of acquisitions mentioned earlier.
“There are appears to be some association between value creation and he national governance systems that prevail in the home country of the bidder: bidding firms from group group-oriented governance systems (such as Germany and Japan) appear to participate in acquisitions with higher levels of value creation than do bidders from market-oriented governance systems (such as Great Britain)” (Seth at al., 2001).
Although this is an ambivalent conclusion per authors of the study, they, also, suggest that “understanding the role of governance systems in value creation and destruction is a fruitful area for future research (Seth at al., 2001).
Sometimes the research is devoted to one country but the conclusions could be go beyond the country that was subject of the study. Dickerson, Gibson and Tsakalotos (2003) are devoting their research to the U.K. manufacturing companies, they inquire about potential ways to prevent the mergers. Among the many different aspects explored, they established that action using the same means is the best prevention. Specifically, prevention through acquisition, is the best way of defense against potential acquisitions attempt.
Experiences in M&As from one country can be beneficial in another country, especially due that a certain studies prove there are a lot of similarities in M&As ( Gugler at al., 2003). They claim that the post merger patterns look similar across different countries they compared during the last 15 years. According to the study, there are no major differences between mergers in the manufacturing and the service sectors around the world. In addition, there are no differences between domestic and cross-border mergers. The study (Gugler at al., 2003) is using probably somewhat arcane method of measuring performance, in which they were comparing merging firms with etalon groups of non-merging firms basing measurements on profitability and sales.
The number of mergers has been increasing during the last several decades, studying mergers in specific countries provides benefits to both academics and practitioners. China’s companies, performing within a growing economy with over billion consumers, are especially becoming more interesting to researchers and practitioners. The companies under private ownership were most commonly the acquisitions targets in China. It is likely that this trend will continue especially considering that between 40-50% of China’s state owned companies are performing with losses (only 17% of the state owned companies are the targets of acquisitions) (Milman,1999).
Acquisitions from outside of China are increasing although sizes of the acquisitions are relatively small compared to the U.S. acquisitions. The U.S. is only second to Hong-Kong based on the size of the acquisitions (Taiwan was likely included to China classification for political reasons).
Acquisitions and alliances are often way how multinational companies are penetrating into newly emerging markets like Central and Eastern Europe. In post-communist world of Central and Eastern Europe new and old elements of economy are mixed and change is occurring slowly but surely.
“In many Central and Eastern European countries, however, MNC partnerships or acquisitions can be seen as threats by state enterprises, privatized companies, government agencies, or political interest groups that oppose foreign domination of domestic industries. In order to succeed, MNCs must develop alliances or acquisitions as win-win arrangements that benefit not only their own shareholders, but also their host-country counterparts and governments” (Rondinelli, Black, 2000).
There is a mutual benefit for both sides. Central and Eastern European countries are often gaining much needed expertise, product and services which can be additional boost for integration to the rest of Europe and boost for its sluggish economies. For the international companies there is presence of new market and possibilities.
“Among the most frequently reported reasons for investing in Central Europe were the ability of MNCs to exploit their unique products or services in new markets, use their alliance partners' special knowledge of foreign customers and markets, jointly create technology, provide global services, and represent international clients. Firms reported that they also expected to benefit from economies of scale and to take advantage of cheaper labor and supplies” (Rondinelli, Black, 2000).
Cross-national mega mergers are often on the front pages of daily papers and magazines. The multinational M&As deals require a lot of resource to be devoted to acquisition; the results are often mixed. Multinational companies want to maximize profits, trive to establish dominant, and close to monopolistic position on the market, with often serial or huge acquisitions. Mega-mergers on multinational level often are pushed by egos of the leaders of acquiring companies. However, although a number of acquisitions across the borders is increasing, relative degree of industry concentration is much lower now than in 50's, 60's, 70's in the number of industries like Aluminum, auto, oil production and oil refining (Ghemawat, Ghadar, 2000).
Silicon Valley is often area where companies around the world are trying to find partners, alliances, to learn new ways how job is getting done or potentially look for acquisitions targets among emerging startup companies. During the period of Silicon Valley and the U.S. economic and technological expansion of 1990’s number of companies outside of the U.S. were very active in acquisitions; the non-US companies acquired close to $250 billion worth of the U.S. technology companies (Inkpen at al., 2000).
“The various areas critical to M&A activity integration success are: communication, decision making, integration speed, networking and socialization, and clearly delineated structures of authority and responsibility. In the area of corporate governance, stock and option-based compensation, alignment between ownership and control, enhancing the role of M&A in the strategy process (especially at the divisional level) and limiting the role of stakeholding constituencies (such as bankers) are key factors for non-U.S. companies to address.” (Inkpen at al., 2000).
Above mentioned and related summaries could help some of the non-U.S. companies in acquisitions. There are difficulties in successfully managing and integrating acquisitions of Silicon Valley and other related technology based firms and to a large degree is based on difference how business is conducted there.
The results how experience in acquisitions affect success of the acquisitions are mixed, as well as dependant on the types of acquisitions studied. A study (Haleblian, Finkelstein, 1999) shows that an acquirer’s subsequent acquisitions often under-perform initial acquisitions, which implies that leading mangers are possibly not acknowledging sufficiently enough dissimilarities of the subsequent acquisitions.
“These findings suggest that relatively inexperienced acquirers, after making their first acquisition, inappropriately generalize acquisition experience to subsequent dissimilar acquisitions, while more experienced acquirers appropriately discriminate between their acquisitions” (Haleblian, Finkelstein, 1999).
This study was based on research in behavioral learning theory in psychology.
The study (Vermeulen, Barkema, 2001) deals with another side of acquisitions; the acquisition can rejuvenate the acquiring company. Foundations of the study are on the previous research in which is proven that a company tends to become “rigid, narrow and simple owning to the repeated use of their knowledge bases. Only looking to financial aspects of the acquisitions may limit our understanding why acquisitions are so popular as way of growth of the company.
“We found that a focus on internal growth through greenfields diminishes the survival chances of a firm's later ventures. We also found that acquisitions help to prevent and resolve such rigidity. A recognition of these effects on the parts of researchers and shareholders may lead to a less critical stance toward acquisitions than appears to have been in vogue since the 1980s. At the same time, however, our study is not an unconditional plea for making acquisitions. In fact, we suggested various contingencies mediating when acquisitions contribute to a firm's long-term survival.” (Vermeulen, Barkema, 2001)
Another sub-area of research, related to M&A and people within, is ethics of M&A. Often one of the reasons for the mergers is cost-cutting (including target’s customers and synergy). Often in the process of the merger or acquisitions the employees are laid off; consequently, new complex and often conflicting web of relationships is created in the new company.
“The intention of the article is to offer stakeholders affected by mergers a criterion from which moral arguments may be generated for the organization of each individual case. The criterion: "Any operation causing legitimate interests to suffer vital infringement should be avoided in a merger process." A vital infringement of these interests is assumed when the merger undermines unique positive opportunities or considerable impairment in the future, impossible to overcome for the person affected without an unacceptable level of difficulty” (Karitzki, Brink, 2003).
A compensation of executives after the merger as one of the motives of M&As is often speculated although, also, researched area. Some studies are trying to compare prior and post merger compensation packages and some concentrate to only one of these two periods. Lynch and Perry (2002) compared compensation structure prior to the merger in acquiring and target companies and found significant differences; total compensation – expectedly so - is significantly higher for executives in acquiring company compared to executives in target companies. Only in part, the difference in pre-acquisition size and growth opportunities between acquirer and target companies explain the previously mentioned difference in compensation package.
“Failure to reconcile these differences can lead to morale and turnover issues that can lessen possible integration success. In extreme circumstances, integration issues resulting from these disparities can stand in the way of achieving the expected benefits that originally led to the merger. Reconciling the differences will present large challenges for the combined company” (Lynch,Perry, 2002).
Mergers depend on people in both - acquiring and target companies. Employee’s and manager’s opinion about the acquisition can change over time. Sometimes the importance of communication is overemphasized, although it is important. In Schweiger and DeNisi’s study (1991), they found out continual negative consequences of a friendly merger in their longitudinal survey. In their study, they compared employee attitudes of a control group that did not with a unit that received multiple communications. Although the communications helped to some extent the non-control group, three months after the merger was announced, the attitudes of both groups were below pre-merger levels. Consequently, although communication provides improving responses to mergers, the negative attitudinal impacts may nonetheless continue.
Covin and other (1996) in their research, established that acquired employees may face more stressors. Stressors can be factors causing stress, included but not limited to: changes in salary, changes in benefits, loss of power and status, and lack of managerial direction. The authors studied 2,845 employees from a large manufacturing company after the merger. The researchers presented significant differences between acquiring firm and target firm employees in satisfaction with the merger. As possibly expected, acquired company employees experienced high levels of dissatisfaction with the merger, and consequently they felt more stress due to the merger induced changes. Covin et al. (1996) also claim that the hostility and stress may be aggravated if there was direct competition between the acquirer and the target company.
Understanding what makes mergers successful is a problem that has various components. Some components are very hard to enumerate even, let alone fully understand combinations of these components within a given corporate environment that works. Mirvis and Marks (2001) list and explore number of factors that were mentioned in the previous researches but sometimes not at one place: strategic intent, clear selection, search and selection process, thorough screening, diligent due diligence, defining the end state, preservation, transformation aspects, looking for mindset of the buyer, preparation workshops, commitment from the top leadership and others. These aspects are just some to consider in preparation of an acquisition or merger.
“Strategic and psychological challenges afflict all combinations, even the friendliest and most soundly conceived ones. The more these issues are raised and worked through during the pre-combination period, the more prepared people will be to take on the challenges of integration and contribute to mining the strategic synergies in a combination. Pre-combination planning readies people to move forward in their personal and organizational transitions, and establishes the dynamics that endure as the combining teams come together to manage the transition to a unified post-combination organization.” (Mirvis, Marks, 2001)
Psychological aspects of merger activities are often overlooked under different day-to-day activities of human resources. The change that comes with M&A affects people deeply and this article try to address number of areas. Most of the acquisitions are friendly, both companies are working together to make acquisitions successful. According to Aiello and Watkins (2000), all M&A deals pass through five different stages, with unique characteristics:
"1. Screening Potential Deals
Look at all potential deals in your market, not just at the deal at hand.
Don't cast strategy aside in the face of an exciting opportunity.
2. Reaching Initial Agreement
Don't focus on price, yet.
Identify the details critical to the deal's success.
Use early negotiations to foster a sense of trust with the target's top executives.
3. Conducting Due Diligence
Look for the devil in the details.
Deepen your understanding of the target's operating managers.
Link due diligence with business planning
4. Setting Final Terms
Negotiate on several fronts simultaneously
Make sure you have alternatives to this deal
Anticipate the competition
5. Achieving Closure
Oversell to stakeholders.
Close quickly after setting final terms."
As the authors are concluding, following these principals is helpful. In addition firms need to learn how to learn from past experiences; however, "mastery of the art of acquisition can be achieved only through experience" (Aiello, Watkins, 2000). Main reasons for M&As failure could be sometimes different from the main reasons why other M&As have success. Gadish at al. (2001) are looking for reasons for failures and generically summarize reasons for failure in the six different groups:
“Poor strategic rationale, or a poor understanding of the strategic levers.
Overpayment for the acquisition, based on overestimated value.
Inadequate integration planning and execution.
A void in executive leadership and strategic communications.
A severe cultural mismatch.
Setting rationale” (Gadish at al, 2001)
In the researchers opinion getting strategic rationale right is central. The authors also distinguish mergers based on scale consideration from synergistic mergers. In their opinion, the mergers based on scale can rely more on financial data; on other hand, more bolder synergistic mergers rely more on number of other factors including vision for both companies.
High tech companies recently are at the forefront of merging frenzy. As one of the consequences of overcapacity of bubble economy, it is expected that further consolidation is expected in some areas of high tech businesses (some software and telecommunications segments). The results of the acquisition in high tech are also mixed. According to a recent study that encompassed 24 companies in their execution of 53 acquisitions, 11 acquisitions were considered successful by all sides, 9 were failures and remaining 33 provided mixed results (Chaudhuri, Tabrizi, 1999). Pace of changes and introduction of new technologies and releases of the products is increasing. According to the researchers, in order to ensures continues long-term success, high tech company depend on " the sustained ability to build on excellent products - to develop or recognize rising technologies and incorporate them into new versions that satisfy changing markets." Acquisitions that are only short-term oriented seeking for certain products or just a pure market share do not gain competitive advantage. Results of these acquisitions would not be enough to offset premiums of acquisitions. What is necessary is to obtain real capabilities that play well with existing ones. So, the companies should know their own capabilities first and than to understand what capabilities the companies really need (Chaudhuri, Tabrizi, 1999). According to the Chinese strategist, Sun Tzu discussing military strategy, applies this to business strategy: “Know yourself, know your enemy - hundred battles, hundred victories”. The authors are placing especial emphasis on business development units inside of the companies by distinguishing phases of acquisitions:
"Scan market development and available methodology; Identify potential goals; Buffer, make matches, and monitor process" (Chaudhuri, Tabrizi, 1999).
There is often repeated mantra that acquisitions are predominantly unsuccessful. This fact was confirmed in the numerous studies. However, often the environment and conditions are relevant so this claim can’t be used apriori. Some of the studies are failing to communicate that most of the companies fail, especially startups. No one can research what would happen if the two companies continued in their own separate ways so judging the "successfulness" of the mergers could be a tricky endeavor. Ed Libby, a chairman and CEO of AllState, says:
"I 'd like today one more thing about the bad rap on M&A. I think one of the reasons for it is that acquisitions are so visible. When they fail, they draw intense notice. But a lot of things in business fail: we 've all started projects that didn’t work out. The internal failures simply don't get as much attention" (Anonymous, 2000).
There is on one strategy - fits all element in acquisitions. Successfulness of the acquisitions largely depends on three factors chronologically:
How is the acquisition prepared?
How well is the acquisition process conducted?
How well the companies work together after acquisitions?
This seems to be self-obvious but a lot of companies operate in the "shoot, ready, aim" mode in which they mixed phases. Sometimes more cautious and gradual approach is undertaken in which certain investment is placed in company of interest with some mechanism of monitoring development of company and exploring a case for future acquisition in situation arises. Jan Leschly, retired CEO of SmithKline Beecham says:
"We invest small amounts - half a million dollars here and a million there- and we put our people on the boards. Once the companies get going, we can decide whether to buy them out completely or not. With large acquisitions, you are buying an awful lot of problems along with the products and technology they bring (Anonymous, 2000).
Company valuations could be a very tricky endeavor and resulting price can vary. In the company valuations there are several different schools how the valuations are done. Hall suggests three different methods.
“Three different methods are used when estimating the value of a business: the comparable-companies method, a discounted future earnings method, and an asset method. The comparable-companies method involves finding publicly traded companies most like the one being appraised and assigning a similar price-to-earnings ratio derived from the comparable companies to the earnings of the company being appraised. Premiums and discounts are then applied to account for differences in such things as minority versus control value, price to-earnings ratios across different sized firms, etc. The discounted future earnings method involves estimating future earnings and calculating the present value of that future earnings stream. The asset method involves estimating the fair value of the assets and liabilities of the company.” (Hall, 2003).
Usually different methods, like the three above mentioned, are used and then weighting factors are assigned to each valuation to come to a final valuation. The author is arguing that this approach could be very misleading and argues that weighted factors should be much lover for comparable-companies method than for discounted future earning method. Current economic conditions largely affect the public traded companies and therefore valuations can be skewed if rely on comparable-companies method (Hall, 2003). Most of the M&As come with additional premium price that needs to be paid. The price of premium could not be as big of an issue if the intrinsic value of the company is calculated correctly. For valuing the business equation is relative simple; it is a stand-alone value, in addition to the value of synergies, minus the acquisition closing cost and integrating the acquisition. The main challenge lies in incorporating right estimated numbers into the above mentioned equation (Gadiesh, Haas, Cullinan, 2001). Valuations of acquisitions start with projecting the full potential of the stand-alone company and projecting future cash flow of the company. However, the sellers are usually ones to over project there own value. To counter that, the buyers need to offer comprehensive analysis of the company, future possibilities, and the business environment.
“The lesson for buyers? Build your own projections. Standard market multiples do not reflect an individual company's position, and a low price does not necessarily indicate a bargain. In the mid-1990s, value-added computer resellers, such as Vanstar or Entex, looked cheap - market valuations had declined 50 percent. But they were not a bargain: the economic rules of reselling were being rewritten, and valuations tumbled a further 50 percent” (Gadiesh, Haas, Cullinan, 2001).
After projecting the cash flow, the buyers needs to project scale of the merged company, then test related business opportunities:
“…check the fit of acquisitions that increase scope, assess the potential value of transactions that transform the business and negotiate preemptively” (Gadiesh, Haas, Cullinan, 2001).
The price is always an issue with M&As. There is a number of very sophisticated methods to valuate a company. Usually, the final result is based on weighted average of a number of valuations. Often companies don’t realize that there is no single, objective price for an acquisition. In determining the value gap, which is measured s difference between the purchase price and the intrinsic value, it would be good to define present some terminology. Intrinsic value is established on net present value (NPV) of future cash flow without consideration of the acquisition. Purchase price is the value that acquirers anticipate to pays for the target company. Market value is current market capitalization value (based on the current stock price); synergy value represent NPV of the future cash flow of when the target and are combined (Eccles, Lanes, Wilson, 1999). In M&As the target and acquirer are paying the premium that could be higher (or lower) than originally planed purchase price.
"The premium allocates some of the future benefits of the combination to the target shareholders. Absent a premium, most target shareholders would refuse to sell" (Eccles, Lanes, Wilson, 1999).
There are two ways in M&A that the most of companies are trying to add value. One way is through cost saving, with layoffs, elimination of production facilities, and other expenses. It is easier to estimate newly created synergy by estimating the cost savings. The second option is by creation of revenue enhancements. The revenue enhancements are very dependant on the current internal situation of the company and often to a smaller extent to external environment. (Eccles, Lanes, Wilson, 1999). According to the authors, based on the research of successful and unsuccessful M&As in or this research there are two areas that especially needs improvement. The first is external communication. Companies fail to communicate efficiently to their shareholders, market overall, suppliers, customers, regulatory bodies, among others. Companies are generally doing well in informing their own employees but fail to explain to external stakeholders what the merger is all about. Second is risk analysis. Although some risk analysis is often done, usually is not sufficient enough. The most common failure is that the risk analysis does not include the least and the most favorable outcomes (Eccles, Lanes, Wilson, 1999).
The research and interest in M&A did not start recently. However, as the number and size of the M&A increased the importance of the research in this arena grew. I would see that there is necessity for competent integrative, as well as longitudinal, studies in this arena; there is a lot of repetition of already concluded facts. This type of study would summarize already accomplished findings in M&A and could be a stepping stone that would benefit practitioners but also academics. Historically, I expect less research devote to pure financial aspects of the research performance. It would be very interesting if advances in valuation of the companies could help in assessing true success of M&A. Importance of cross-boarder acquisitions research will likely increase as global trade expands and the MNC recognize even further opportunities, and need, to grow internationally.
Source: (Cording, Christmann, & Bourgeois, 2002)
Marks, M., & Mirvis, (May 2001). Aiello, R., & Watkins, M. (November-December, 2000). Gadiesh, O., Ormiston, C., Rovit, S., & Critchlow, J. (2001). Chaudhuri, S, & Tabrizi, B. (September-October, 1999). Anonymous (Discussion Moderated by Dennis Cary). (May-June, 2000).
Seth, A., Song, K., Pettit, R., & Richardson, R. (2001). Ghemawat, P., & Ghadar, F. (July-August, 2000). Inkpen, A., Sundaram, A., & Rockwood, K. (Spring, 2000).
Country and Regional
Dickerson, A., Gibson, H., & Tsakalotos, E. (May, 2003). Gugler, K., Mueller, D., Yurtoglu, R., & Zulehner, C. (May 2003). Milman, C. (Fall 1999). Rondinelli, D., Black, S. (Nov, 2000).
People in M&A
Lynch, L., & Perry, S. (Fall, 2002). Schweiger, D., & DeNisi, A. (1991). Covin, TJ., Sightler, K., Kolenleo, T., & Tudor, K. (1996).
Karitzki, O., & Brink, A. (Mar 2003).
Haleblian, J., & Finkelstein, S., (1999). Vermeulen, F., & Barkema, H. (June, 2001).
Success and Performance
Barney, J. (1988). Hayward, M. (2002). Capron, L. & Pistre, N., (2002). Chatterjee, S. (1992) Golbe, L., & White, L. (1988). Amburgey, T.L., & Miner, A.S., (1992). Agrawal, A., Jaffe F. (1992).
Elements of Success
Capron, L. (1999). Cording, Christmann, & Bourgeois, (2002)
Hall, S. (Jan, 2003). Gadiesh, O., Haas, D., & Cullinan, G. (Jul/Aug 2001). Saha, A., & Simon, (Jul, 2000). Eccles, R., Lanes, K., & Wilson, T. (July-August, 1999).
Branches of M&A and literature
Agrawal, A., & Jaffe F. (1992). The post merger performance of acquiring firms: a re-examination of an anomaly. Journal of Finance, 47, 1605-1621.
Aiello, R., & Watkins, M. (2000). The Fine Art of Friendly Acquisition. Harvard Business Review, November-December.
Amburgey, T.L., & Miner, A. S. (1992). Strategic momentum: the effects of repetitive, positional and contextual momentum on merger activity. Strategic Management Journal, 13, 5, 335-348.
Anonymous (Discussion Moderated by Dennis Cary). (2000). A CEO Roundtable of Making Mergers Succeed. Harvard Business Review, May-June.
Barney, J. (1988). Returns to bidding firms in mergers and acquisitions: reconsidering the relatedness hypothesis. Strategic Management Journal, Summer Special Issue, 9, 71-78.
Brown S, Eisenhard K. (1997). The art of continuous change. Linking complexity theory and time paced evolution in relentlessly shifting organization. Administrative Science Quarterly, 42, 1-34
Capron, L. & Pistre, N. (2002). When do acquirers earn abnormal returns? Strategic Management Journal, 23, 781-794.
Capron, L. (1999). The long-term performance of horizontal acquisitions. Strategic
Management Journal, 20, 987-1018.
Chatterjee, S. (1992) Source of value in takeovers: synergy or restructuring-implications for target and bidder firms. Strategic Management Journal, 13, 4, 267-286.
Chaudhuri, S., & Tabrizi, B. (1999). Capturing the real value in high-tech acquisitions. Harvard Business Review, September-October.
Cording, M., Christmann, P., & Bourgeois, L. J. III.. (n. d. ). A Focus on Resources in M&A. Success: A Literature Review and Research Agenda to Resolve Two Paradoxes. Darden School University of Virginia. To be presented at Academy of Management, August 12, 2002.
Covin, TJ., Sightler, K., Kolenleo, T., & Tudor, K. (1996). An investigation of post-acquisition satisfaction with the merger. Journal of Applied Behavioral Science, 32, 2, 125-142.
Dickerson, A., Gibson, H., & Tsakalotos, E. (2003). Is attack the best form of defense? A competing risks analysis of acquisition activity in the UK. Cambridge Journal of Economics. 27, 3, 337.
Eccles, R., Lanes, K., & Wilson, T. (1999). Are you paying too much for that acquisition. Harvard Business Review, July-August.
Gadiesh, O., Ormiston, C., Rovit, S., & Critchlow, J. (2001). The 'why' and 'how' of merger success. European Business Journal, 13, 4, 187.
Gadiesh, O., Haas, D., & Cullinan, G. (2001). Getting the price right. Strategy & Leadership, 29, 4, 27.
Ghemawat, P., & Ghadar, F. (2000). The Dubious Logic of Global Megamergers. Harvard Business Review, July-August.
Golbe, L., & White, L. (1988). Mergers and Acquisitions in the U.S. economy: An aggregate and historical overview. The University of Chicago Press. Chicago. 25-47.
Gugler, K., Mueller, D., Yurtoglu, & R., Zulehner, C. (May 2003). The effects of mergers: An international comparison. International Journal of Industrial Organization, 21, 5, 625.
Haleblian, J., & Finkelstein, S., (1999). The influence of organizational acquisition experience. Administrative Science Quarterly, 44, 29-56.
Hall, S. (Jan, 2003). Comparable-companies business valuation in the current financial markets environment. Journal of Financial Service Professionals, 57, 1, 9
Hayward, M. (2002). When do firms learn from their acquisition experience? Evidence from 1990-1995. Strategic Management Journal, 23, 21-39.
Inkpen, A., Sundaram, A., & Rockwood, K. (2000). Cross-border acquisitions of U.S. technology assets. California Management Review, Spring. 42, 3, 50.
Karitzki, O., & Brink, A. (Mar 2003). How can we act morally in a merger process? A stimulation based on implicit contracts. Journal of Business Ethics. 43, 1/2, 137.
Lynch, L., & Perry, S. (2002). An examination of pre-merger executive compensation structure in merging firms. Journal of Managerial Issues, Fall. 14, 3, 279.
Marks, M., & Mirvis, (2001). Making mergers and acquisitions work: Strategic and psychological preparation. The Academy of Management Executive, 15, 2,80
Milman, C. (Fall 1999). Merger and acquisition activity in China: 1985-1996. Multinational Business Revie,. 7, 2, 106.
Rondinelli, D., & Black, S. (2000). Multinational strategic alliances and acquisitions in Central and Eastern Europe: Partnerships in privatization. The Academy of Management Executive, 14, 4, 85-99.
Saha, A., & Simon, (2000). Predicting the price effect of mergers with polynomial logit demand. International Journal of the Economics of Business, 7, 2, 149.
Schweiger, D., & DeNisi, A. (1991). Communication with employees following a merger: A longitudinal field experiment. Academy of Management Journal, 34, 1, 110-135.
Seth, A., Song, K., Pettit, R., & Richardson, R. (2001). Value creation and destruction in cross-border acquisitions of foreign acquisitions of U.S. firms. Strategic Management Journal, 23, 921-940.
Vermeulen, F., & Barkema, H. (2001). Learning through acquisitions. Academy of Management Journal, 44, 3, 457.
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