Understanding Mergers and Acquisitions in the 21st Century

A Multidisciplinary Approach

K. McCarthy, W. Dolfsma

• Publisher: Palgrave Macmillan
• Year: 2012
• Print ISBN: 9781349340514, 9780230336667
• eBook ISBN: 9781137278074
• Topic: Business
• Subtopic: Business General
• Index: Business

The first volume to explore mergers and acquisitions in the 21st century. The authors systematically introduce, characterize and evaluate these mergers, and discuss the methodologies that can be employed to measure them. They also consider a number of factors relevant to the performance of mergers and acquisitions.

1

Introduction

Understanding Mergers and Acquisitions in the 21st Century: A Multidisciplinary Approach

Killian J. McCarthy and Wilfred Dolfsma

1. Introduction

Mergers and acquisitions (M&As) are big business.

Some 289,254 M&A deals were announced and completed in the first ten years of the 21st century, at a combined cost of $18,721,100,000,000 (or $18.72 trillion). At its height, “the value of M&A averaged $10 billion a day” (The Economist, 8 April 2006). And so large was the expenditure that, at 2010 levels, more than three times the annual gross domestic product (GDP) of China – the world’s shining beacon of economic growth – was spent on mergers, acquisitions and corporate restructurings.

A merger is thought to create:

– cost synergies, as labour forces are reduced, and administration and production costs are streamlined (Carey, 2000);

– market power gains, as a reduction in the level of competition allows for wealth to be transferred from the firms customers and suppliers to its shareholders (Chatterjee, 1986)

– financial gains, as a merger produces a company with a reduced tax profile (Devos et al., 2008); and

– scale and scope economies, as firm exploits the opportunity to expand and diversify into new products and regions (Besanko et al., 2006).

Together these are referred to as ‘synergies’. And because synergistic savings – and thus the creation of value – are amongst the most commonly cited reasons for merger activity (Gaughan, 2010), an increasing number of mergers and acquisitions, one would imagine, is to be welcomed.

But positive as this may at first appear, the fact that the impact of M&A activity on the performance of a firm is thought to be, at best, “inconclusive” (Roll, 1988; Haspeslagh & Jemison, 1991; Sirower, 1997), and at worst “systematic[ally] detrimental” (Dickerson et al., 1997), is troubling. Some studies have reported that the combined average returns – that is, the average net change in value, accrued to the shareholders of both the acquiring and target company, caused by the M&A event – are positive but small (Campa & Hernando, 2004). And others still occasionally find no significant effects on performance (Stulz et al., 1990). The “overwhelming majority”, however, find that “M&A activity does not positively contribute to the acquiring firm’s performance” (King et al., 2004) or its profitability, as variously measured (Ravenscraft & Scherer, 1987; Bühner, 1991; Berger & Humphrey, 1992; Simon et al., 1996; Rhoades, 1998). A consensus of estimates, in fact, places the M&A failure rate somewhere in the range of 60–80% (Puranam & Singh, 1999; Moeller et al., 2005; McCarthy, 2011). In a study of 4,136 U.S. deals, Moeller et al. (2005) concludes that: “shareholders would [be] better off if management [just] burned the cash [that was] used to make these deals”. This finding – the finding that mergers remain, and have in fact become increasingly popular, despite the overwhelming odds against them – is a genuine paradox, the ‘merger paradox’.

Much research has been done to explain why mergers perform poorly; and a number of firm- and deal-specific explanations have been put forward to explain why mergers fail. The relative size of the acquirer, for example, its status as a public or privately listed firm, and the ‘degree of relatedness’ between the target and the acquirer are some well-known indicators of merger performance. Because ‘free cash’ (or excess liquidity) liberates the firm from the so-called ‘discipline of debt’, the method of payment affects merger performance; as does anything that increases the size of the deal, such as the number of bids, the hostility of the bidding process and the level of the premium paid – that is, the payment of a sum on top of the firm’s market value. Bigger deals do less well. And as mergers concluded in the exuberance of a merger wave are typically concluded for a larger price, timing also matters when predicting success.

Merger performance is a well-researched topic. But the list of explanatory variables currently considered by the literature is far from complete. It is illustrative of the high quality of research that typifies this field. But, given the nature of the complex and dynamic M&A industry, it is widely recognized that much work still needs to be done. King et al. (2004), for example, suggest that the current understanding is still “too nebulous” to be useful. And Andrade et al. (2001) have called for a disaggregation, to better understand performance moderation.

The aim of this volume is to answer these calls. To understand performance in the 21st century, we claim that there is a need to look beyond the usual theoretical and methodological suspects for insight; we claim that a more multidisciplinary approach is needed. By introducing a number of new performance moderators, we believe that this volume offers a starting point to that end and in doing so, we hope to add a 21st-century perspective to the discussion.

2. Understanding mergers and acquisitions

This volume attempts to achieve its aim in three main parts.

In Part I, two contributions set the scene for a discussion of 21st century M&As. The first paints an economic picture, the second a legal one.

Chapter 1 begins therefore by profiling 21st-century M&As, pointing to new trends and recent developments, and contrasts the activity with that of the last century. Large-scale M&A activity has no precedent before the 20th century. Throughout the 20th century, M&As, as we will explain, have increasingly come in waves in the 21st century, as the time between waves decreases, a Gestalt Switch might be needed; 21st-century M&A activity is perhaps best understood as a period of ongoing frenzy, with the occasional lull. In it, it is shown that while mergers began as a uniquely US growth phenomenon, in the late 19th century the practice soon spread, to become the norm of the Anglo-Saxon world, then the norm of the Western world, before finally, in the last two merger waves, becoming the global norm. Prior to 1990, mergers were unknown in mainland China. In 2000, Chinese companies invested $1bn on overseas acquisitions by 2011, this figure had increased 47-fold.

With the increasing importance of cross-border activity, and in the face of the sombre reality that regulatory battles can take years, and cost hundreds of millions in litigation fees, Chapter 2 sets the scene with an overview of the legal frameworks of many of the more important merger destinations. The legal systems of the USA, Europe (at both national and supranational levels) and China are discussed, in both procedural and substantive terms. The result is a discussion which not only points to convergences and diverging attributes, but also provides the reader with an understanding of the relevant laws in 34 legal environments.

In Part II, ‘Performance Moderation’, a number of contributions discuss those features that have been found to have an impact on M&As in the 21st century.

Part II is divided into two sections. The first presents a number of contributions from the fields of economics and business on the ‘harder-side’ of performance; that is, the firm- and deal-specific factors which have been found, of late, to impact on performance. Here firm size, ownership, merger motive, merger finance and shareholder power are each discussed in turn.

Chapter 4 begins with a discussion of firm size, and in doing so makes two contributions. Firstly, and because the existing theory flows from studies of large, publicly listed acquirers, this chapter considers how the theory must be modified to describe M&As involving small and medium enterprises (SMEs). In the European context, SMEs are not only thought to represent about 99% of all firms, but to employ between them about 65 million people and to drive innovation and competition. At a global level, SMEs may even be responsible for between 40% and 50% of world GDP (European Commission, 2005). Yet SME M&As are rarely studied by the literature. Secondly, using a unique data set of 17,137 M&As completed by US and Western European acquirers, we show that small deals perform above average; confirming, from the other side, the literature which shows that larger deals perform below average.

Chapter 5 discusses merger motive and merger finance. And again, it makes two contributions. Firstly, some authors suggest that ‘financial slack’ frees the firm from the ‘discipline of debt’, and predicts poor performance. Others claim that financial slack provides the firm with a ‘cushion of liquidity’, which should allow the firm to experiment in new areas. Using unique data on 3,257 deals, this chapter tests both suggestions. However, not all mergers are the same, and the second contribution of this chapter is to distinguish between M&As aiming to ‘strengthen market share’, ‘diversify in products’, ‘cross-borders’ and ‘cut costs’, while accounting for the presence or absence of financial slack. In doing so, it reports that the average deal announces 1.5 merger motives, and that expansionary motives dominate (86% of deals announce expansionary merger motives). This chapter shows, however, that shareholders do not support expansionary deals, unless the firm has the necessary financial resources. Thus, the chapter concludes in favour of the literature that advocates the accumulation of internal cash.

Chapter 6 provides Part II’s final contribution to our economic perspective on merger performance, with a discussion of shareholder expectations and aspirations. And in doing so, it offers a new explanation of value-reducing mergers and stock-market-driven takeovers. In a theoretical contribution, it suggests that if market valuation constitutes an aspiration level for managers, they may be tempted to seek riskier mergers to meet shareholder optimism. Such merger-seeking behaviour increases bidder overvaluation, which is known to destroy value, and can also favour acquisitions when the expected value of takeovers is lower than alternative investments. In doing so, the chapter provides support for several empirical findings.

Although economic in orientation, Chapters 4, 5 and 6 indirectly discuss some social or psychological performance moderators; agency, motive, and expectation are social constructs. In the second section of Part II, we move to make a more explicit discussion of the human element. Drawing upon a number of contributions from the fields of psychology and sociology, we present an overview of the ‘softer side’ of merger performance – that is, the human, cultural and psychological indicators of success – which encompasses the psychology of power, the influence of personality types (and their interactions), as well as the effects of culture.

Chapter 7 begins the second section of Part II with a discussion of culture. ‘Culture’ is a long-neglected explanatory variable. Both scholars and academics have long had a ‘Day 0’ focus. And result, the focus has been on getting the pre-deal economic, financial and strategic aspects inline, assuming that the rest – namely the integration – will take care of itself. This chapter attempts to provide the reader with a better understanding of the influence of culture on performance. An analytical framework is proposed, flowing from the cultural distance paradigm, to define strategies for managing culture. It is argued that culture can be either an asset or a liability, depending on the way it is handled. And by pointing to the importance of managing culture, this chapter paves the way for future research on ‘actionable prescriptions’ for cross-border merger integration.

From this, Chapter 8 moves to present a discussion of managerial power. The manager, it suggests, occupies a position of power within the firm; the manager can influence the organizational strategy of the firm, as well as its human and business components. Psychologists show, however, that ‘empowering’ individuals in this way has some behavioural consequences. In the context of a merger, ‘empowered’ or ‘powerful’ managers, it is suggested, make for better negotiators, in the pre-deal stages, and their lack of emotional empathy is said to aid their objectivity in restructuring the organization. Powerful managers, however, are also prone to risk-taking, are more likely to make deals on the basis of fuzzy concepts, such as ‘instinct’ and ‘gut feeling’, and have a strong ‘Day 0’ focus: powerful managers are disinterested in the detail, they are unable to communicate day-to-day plans, and will not invest in the nitty-gritty of integration planning. All are important contributions to our understanding of the manager in M&As, and illustrate, in a very real way, the need to manage the manager in mergers.

This discussion in Chapter 8 considers the effect of power on the behaviour of the manager. Chapter 9 completes Part II with a consideration of the managerial personality type, and the effects of their interaction. Again, this chapter draws upon developments in psychology. This time, however – in claiming that mergers are, in the corporate world, the equivalent of marriages in the world of human interaction – the chapter draws upon the literature on romantic relationships, and in particular attachment theory. This literature identifies four patterns of human attachment. And in this chapter, and using experimental data, the existence of these distinct personality types is confirmed. How these personality types will interact is reflected upon, but the message from this contribution is again clear: mergers are not solely economic or financial events, but human events with human influences.

Finally, in Part III, ‘A View to the Future’, we move to the topic of methodology.

The research presented in Parts I and II, and indeed in the literature in general, is theory driven: potential performance influencers are identified by the theory, and tested empirically. Chapter 10 takes a different approach. Using models developed in other academic disciplines, most notably in computer sciences and artificial intelligence, Chapter 10 introduces a number of data-driven tools for understanding which factors affect merger performance. These, we explain, ‘learn’ from experience, and thereby point to performance-impacting factors which may otherwise be missed by the theory. In so doing, Chapter 11 not only adds another dimension to our existing understanding of performance, but adds another tool to our methodological arsenal for estimating and understanding which mergers work and why.

3. Contribution

In three interlinked discussions, this volume:

1. provides an overview of the business and legal environments within which 21st-century M&As are embedded;

2. profiles the economic, financial, cultural and psychological factors which together contribute to the performance of 21st-century M&

3. introduces some new methodological tools to better understand 21st-century M&As.

It draws upon recent developments, not only in the more famil...

Table of contents

• Cover
• Title Page
• Copyright
• Contents
• List of Tables
• List of Figures
• Notes on Contributors
• 1. Introduction – Understanding Mergers and Acquisitions in the 21st Century: A Multidisciplinary Approach
• Part I: Setting the Scene – A Perspective from Economics and Law
• Part II: Explaining M&A Performances – A Perspective from Economics and Business
• A Perspective from Psychology and Sociology
• Part III: Moving Forward – A Perspective from Computer Science
• Index