Things To Consider Before Mergers And Acquisitions-

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A merger includes a decision taken by two organisations to integrate their operations on a relatively equal basis.

A merger is negotiated directly between the management of an acquiring company and the management of a target company, and the proposals are approved by the separate boards of directors before shareholders vote on them.

If the target company directors resist the merger, then the acquiring firm would make a public tender offer directly to the acquirer’ shareholders. If this takeover is for part or all of the equity, then a hostile takeover bid is launched, which if accepted by the target company shareholders, results in an acquisition. We have seen Microsoft wanted to launch a hostile takeover bid on Yahoo in February-March 2008.

An acquisition, on the other hand involves one organisation buying a controlling interest in another organisation. The acquired company often becomes a subsidiary of the acquiring firm operating within its portfolio of other business units. During this kind of acquisition, no hostile takeover bid is launched.

Mergers activities happen much more often in the Anglo-Saxon countries and this is reflected in their respective stock markets‘ activities. This is because of their corporate governance mechanisms.

In Continental Europe (UK non-included), M&A is not as developed as it is in the UK and the US, although cross-merger activities are in the rise because of rapid privatisation programmes foster by the EU. Another reason is that Europe sees mergers as a way to compete against vast American conglomerates and institutional shareholders are encouraging top managers to adopt M&A as a strategy of rapid growth.

M&A are important for growth strategies for the following reasons:
Market power
Transaction costs
Resources and capabilities
Diversifications

1. Market power
M&A can increase an organisation market power through horizontal integration. If the firm is not dominant enough, M&A could help in achieving market share that was not otherwise possible. Merging firms can either increase prices, or decrease prices by increasing productions. Also, merger firms could achieve scale economies from operating multiple plants.

An organisation may achieve entry into a new market, either because it possesses excess resources it cannot profitably use in its own market, or because its existing market is declining and revenue growth is slowing.

However, regulatory concerns will restrict M&A unless it benefits consumers. Therefore Market power has its own limitations.

2. Transaction costs

M&A may spread an organisation’s exposure to risk across a variety of industries. We have witnessed the approach of Microsoft to merge with Yahoo in order to take advantage of the online advertising market dominated by Google.

Merger would create value by reducing transaction costs concerned with setting up contracts, management structure costs, market exchange, etc. M&A could help minimise these transaction costs from an organisation point of view-when entering new foreign markets.

3. Resources and capabilities

M&A may help secure resources and capabilities not currently possessed by the acquiring firm. M&A can be source of competitive advantage by providing two organisations with complementary resources and expertise. This will help the acquiring firm achieve and sustain a competitive advantage over its competitors by reconfiguring its tangible and intangible assets in the way that is difficult to imitate, and by having resources and skills that are durable and not appropriable or replicable.

4. Diversifications

Relying on one or two activities is risky. Merging companies tend to diversify in order to reduce their dependence on some activities, hence reducing the organisations cost of capital.

From shareholders point of view a merger is a good thing, for a merger allows them to exert control over managers and only firms who maximise value will survive. The threat of takeover hanging over they heads, will push managers to use resources at their disposals efficiently.

Next time we will go over the limitations of M&A, recent M&A failures and what was going to happen if Microsoft were able to acquire Yahoo!

The Importance Of Corporate Governance

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Corporate governance refers to the rules, procedures, and administration of the firm’s contracts with its shareholders, creditors, employees, suppliers, customers, and sovereign governments. Governance is legally vested in a board of directors who have a fiduciary duty to serve the interests of the corporation rather than their own interests or those of the firm’s management.

With this simple definition, we assume that directors and managers are motivated to serve the interests of the corporation by incentive pay, by their own shareholdings and reputational concerns, and by the threat of takeover.

The operation of the board and the remuneration of the Executive Directors are vital in maintaining and protecting the interests of the different stakeholder groups. If we accept that the shareholders collectively own the business and they have invested in it to maximise their wealth, then their main aim is to grow the overall value of their share capital and maximise returns in the form of dividends.

However, there are potential conflicts of interest between this ambition and the managers/employees of the group who are looking to maximise their own wealth. Managers are appointed as agents on behalf of the shareholders of the company who have delegated this responsibility to them.

In the UK and the US, corporate governance mechanisms emphasise the relationship between shareholder and management. In countries such as France, Germany and the Netherland, the corporate governance mechanisms take a stakeholders’ approach to governance, aiming to balance the interests of owners, managers, major creditors and employees.

The main mechanisms for understanding corporate governance are the following:

1. The market for corporate control (i.e. a hostile takeover market and the market for partial control).

2. Large shareholder and creditor monitoring.

3. Internal control mechanisms, i.e. the board of directors, non-executive committees and the design of executive compensation contracts.

4. External mechanisms, i.e. product-market competition, external auditors and the regulatory framework of the corporate-law regime and stock exchan

How governance affects firm performance? Do firms perform better when shareholders’ interests are likely to be dominant? Answering these questions, will lead us to evaluate the folowing points:

*Corporate control

Changes in control due to takeover or insolvency bring dramatic changes in firm personnel and strategy. CEO and board member turnover increases radically in the event the firm goes into financial distress. Managers will avoid being taking over by either increasing the firm’s cash flows or by some less productive avenue.

*Board, Remuneration Committee, Pay and incentives

A research has found that the appointment of non-executives directors is associated to a company stock price increases. An Executive that wants to take the company in a direction that might be more in its personal interests could be sacked. Another research has found a positive relationship between the percentage of shares owned by managers and board members and firms’ market-to-book values.

The remuneration committee is made up of non-execs, so this creates a natural control to stop the executive directors awarding themselves unjustifiable salaries and benefits. The remuneration of the Directors should be in line with other similar companies, to remain competitive and retain its top executives.

The remuneration packages are intended to align the interests of Director and Shareholders by linking cash and share incentives to performance.

However, some argue that the increase in share price was also associated with a decline in the value of the firm’s outstanding debt. And corporate performance cannot be reliably increased simply by adding outsiders to the board of directors or by increasing the CEO’s stockholdings.

*Recent Corporate Scandals
Corporate governance failures can lead to disastrous consequences beyond anyone expectations.
Parmalat- a world leader in the dairy food business, entered bankruptcy protection in 2003 when investors least expected it. How the Italian group so much praised siphoned away billions of euros without its shareholders, nor its top managers suspecting it?

One of the problem at Parmalat was due to its ownership and control structures-There was a limited presence of shareholders and mainly linked by family ties. Parmala was a holding company with all the other companies within the group controlled by the Tanzani family. The family had the majority if not ‘all’ of the voting rights. As this happens, other shareholders had limited control over the activities of the group-hence limited power to block any decisions. Managers had also limited power to influence decisions taken by the family shareholders.

In that case, the family managed to siphoned away almost millions of euros to other
companies owned by the family.

In summary, the demise of Parmalat was a failure to fully implement the corporate governance mechanisms listed above.

*Statutory auditors
Some thought that the Parmalat case was country-specific, however, Enron the
giant American Energy failed victim to corporate governance problems with the help of Arthur Andersen-the US accounting firm.