Mergers and acquisitions (M&As) arouse public and researchers interest. The latest ones are trying to assess if there is evidence of increased performance resulting from these risky operations. Most empirical studies have concluded that M&As create value for target stockholders, but the outcome for initiating entities is contradictory. Despite disappointing results, this business strategy still generates market enthusiasm. This article presents the concept of M&As, with four different phases, their evolution (waves) and a summary of the criticisms of the performance of the concept.
M&A operations regularly make the headlines in the media. The size of the amounts involved, the concerns for social issues (synergy or rationalization are often synonyms for job cuts (Lehto, Böckerman, 2008)), and governments involvement due to fear of social plans or loss of control of strategic enterprises make them major events. M&A is perceived as CEOs preferred strategy (Ferreira et al., 2014). According to Katz, Simanek, Townsend (1997, p.32) “Mergers and acquisitions are the primary means of rapid external growth.” Ultimately, it is opened to question whether theses operations are positive for the enterprises, shareholders, employees and consumers (Healy, Palepu, Ruback, 1990).
The term M&A combines two realities; even if they have things in common, they have different impacts. A merger operation is characterized by the fact that the entire assets of one or more companies are transferred to another in return for an allocation of shares or cash of the absorbing company.
“Acquisition” is a very broad concept. An acquisition involves the property of economic activity being transferred in total or in part; the selling company continues to exist at the end of the operation.
We can establish a very simplified definition, trying to include all the concepts: “An M&A is a transfer of activity between two distinct entities through a transfer of property.”
M&As can be classified according to legal criteria, size of transaction, type of approach (hostile vs. friendly, domestic vs. cross-border). Researchers distinguish four families of operations (Walter and Barney, 1990). Horizontal acquisitions consist of purchasing competitors in the same sector of activity to increase market coverage, to gain in size or play on the complementarities, but sometimes only to eliminate a competitor. Rahman and Lambkin (2015) underlines the fact that horizontal M&As represented 80% of the deals in the world in the 1990s and 2000s. Vertical integration consists of purchasing customers or suppliers; the idea of this type of acquisition is to eliminate intermediaries in the same economic chain. Concentric M&As involve enterprise combinations which have close or complementary activities; the objective is to increase market share, the type of offer or the technology. The fourth one, conglomerate M&As, is based on the constitution of a group of enterprises for motives of financial consideration or diversification.
Several macroeconomic fundamentals are explaining why M&A strategies are highly regarded. The first macroeconomic catalyst is the globalization and liberalization of exchanges (Mitchell and Mulherin, 1996); a broader market pushes concentrations to obtain a critical size, stay competitive or increase geographic area. Entering new markets is then often easier through the purchase of a competitor that is already well established (Wang, 2009). Another catalyst is the influence of public policies: privatizations that are implemented put large industrial groups on the market, with the objective of helping them to develop internationally. Finally, the economic environment is also an important external factor (Gort, 1969); for example, financial bubbles naturally favour M&As due to easier access to credit leverage.
M&As represent a way for enterprises to continuously improve their performance in the competitive environment in which they evolve. On an organizational level, the motives of M&As are usually to achieve synergies. The primary motives can be classified into three categories (Trautwein, 1990) that can be interdependent.
In the first place we think of operating synergies. The increase in market power (raising prices) or market share are the motives put forward most (Farrel and Shapiro, 1990). When an M&A intends to achieve increasing power on the market, its objective is to increase the negotiating strength towards suppliers or exclude competitors. Revenue enhancement consists of economies of scope when increasing the range of products, and production is based on shared factors of production. Economies of scope are reached if the average cost of producing two products separately declines when the products are produced jointly (Rahman and Lambkin, 2015). And synergies related to technical innovations (Röller, Stennek, Verboven, 2000) can be the absorption of dynamic SMEs, patents, proprietary technology (policy of Google, Microsoft, the pharmaceutical industry). Economies of scale is a decrease of the production unit cost and an increase of the total output (Rahman and Lambkin, 2015).
The second type of synergies are financial synergies. These synergies can be better access to finance as concentration gives improved visibility and provides easier access to funding (Trautwein, 1990), or lowering of the risk through diversification, or tax gains and use of tax losses. There are two types of diversification (Rumelt, 1982), related and non-related. In a related diversification, the purchaser aims to enlarge product range without diversifying in other non-related sectors. The second type consists in expanding in other areas or industries in high-growth sectors (portfolio theory). Corporate restructuring models like spinoffs, carve-outs, break-ups or divestitures can be attractive options as well, for example, getting merger clearance from regulators or raising equity funds. Mulherin and Boone (2000) found that both divestitures and acquisitions can increase shareholder wealth.
In third we have the managerial synergies. The acquirer’s managers may possess special management capabilities and know how to improve the target business operations and performance and as a result create cross-business synergy. The capabilities can be briefly described as corporate functional skills (to improve the performance of the business), corporate strategic capabilities (to improve competitive positioning), and corporate organization design capabilities (to formulate and execute the strategies).
Martynova and Renneboog (2008, p.2149) explain the reasons why M&As occur by waves: “Takeovers usually occur in periods of economic recovery. They coincide with rapid credit expansion, which in turn results from burgeoning external capital markets accompanied by stock market booms”. Harford (2005, p.530) states “Mergers waves occur in response to specific industry shocks that require large scale reallocation of assets.”
M&As coincide with the existence of companies. Lipton (2006) establishes six main waves with the evolution of the concept. Since the financial crisis of 2008 a seventh can be distinguished.
From 1897 to 1904, horizontal M&As and the creation of the first monopolies (Martynova and Renneboog, 2008). This wave takes place mostly in the USA and enables the emergence of empires that still exist nowadays. These groups have acquired leading positions in a sector of activity and can, therefore, dictate their position (monopoly).
From 1916 to 1929, vertical mergers, the formation of oligopolies (Stigler, 1964). After implementation of first anti-trust laws in the USA which cause monopolies to explode but lead to the formation of oligopolies.
From 1955 to 1969, conglomerate wave and portfolio management. Anti-trust laws are strengthened, which encourages groups to diversify. “A typical acquisition in the 1960s was that of a larger firm acquiring a smaller one outside of its main line of business” (Katz, Simanek, Townsend, 1997, p.34).
From 1980 to 1989, the formation of pure-players. This wave leads to the dismantling of conglomerates for the benefit of focusing on core businesses. Hostile OPAs increase, financial resources diversify, both against a background of growing globalization. “Transactions were more often within related industries or lines of business…” (Katz, Simanek, Townsend, 1997, p.35).
From 1993 to 2000, the decade of deregulation (Andrade, Mitchell, Stafford, 2001). This is the market’s most notable period due to globalization and deregulations of all kinds.
From 2004 to 2007, credit bubble, LBOs and big deals. LBOs describe a leveraged operation. Investment funds become major actors but regulatory requirements, the stock market, accounting and financial constraints, make transactions more lengthy and expensive.
From 2008, opportunistic market and recovery after the financial crisis (Kengelbach and Roos, 2011). Moschieri and Campa (2014) report that global M&A activity has increased, particularly in Asia and Europe. UNCTAD (2016, p.2) states that: “A surge in cross-border M&As…was the principal factor behind the global rebound.”
Launching an M&A is a strategic operation that commits the enterprise in the long term (Capron and Pistre, 2002). There is no consensus in the literature about the pre- and post-M&A processes (Gomes et al., 2013), but one can highlight four essential phases that may or may not be sequential.
A strategic phase where the enterprise has to choose external growth through an M&A as opposed to another form of organic growth like a partnership (Garette and Dussauge, 2000). This decision is based on an analysis of the company and its potential targets. Then, the needs regarding resources must be presented, followed by a presentation of the inherent risks. The enterprise has to prepare a complete diagnostic of its situation, identify its strengths, weaknesses, opportunities and threats; and on the basis of this diagnostic, can set an acquisition plan.
The second phase concerns selection of the strategic partner (Gomes et al., 2013) according to its compatibility with the objectives of the M&A and assessment of the target and the possible premium. It is necessary to ensure compatibility between both entities and the potential for value creation that the instigator expects to generate.
The third step is the negotiation phase which includes a careful assessment of the target. During this phase, the buyer has to choose his strategy (friendly or hostile operation). The need for very acute due diligence is underlined by Perry and Herd (2004, p.12) “A handful of due diligence best practices can reduce the risk…”. The buyer also has to formulate the appropriate financial package as the purchase can be settled by several ways. We can mention the exchange of shares, cash, issuance of shares, and issuance of bonds.
The last phase is the most critical: the post-acquisition integration process (Angwin and Meadows, 2015). This step consists in implementing the integration at all levels, the purpose being to make the value creation potential as quickly as possible. Timing is essential, spending time to know the other partner, realizing the difference between methods and cultures; speed can have a negative impact (Angwin, 2004).
Studies considering the impact of M&As on the wealth of shareholders of the acquiring company have presented contradictory results. Bower (2001) suggests that most M&As fail. Healy, Palepu, Ruback (1990) found improvements in cash flow returns. Performance is always used as a justification of M&As, and this is paradoxical; literature tries to determine another method to calculate the performance in order to understand this paradoxical situation better. Measurement of performance of M&As relies on two main approaches: stock exchange performance and economic performance. The first one is based on market reactions to evaluate the opportunity presented by the operation. The second has recourse to accounting data to make the estimate. Researchers’ conclusions are not unanimously agreed, a majority of studies recognize that on the long term M&As are a source of value impairment for the purchaser, (Agrawal, Jaffe, Mandelker, 1992; Gugler et al., 2003; Ghosh, 2001), others end up with positive results (Healy, Palepu, Ruback, 1992; Yilmaz, Tanyeri, 2016 ) or note 50% average success (Schoenberg, 2006).
In general, researchers on post-acquisition performance reveal that diversification had a negative impact (Healy, Palepu, Ruback, 1997). The fact that the purchase and target enterprises are related increases the chances of success of a successful transaction and supports performance. Singh and Montgomery (1987) have demonstrated that shareholders earn more when the purchaser and the target belong to same business sector.
There are many different reasons for M&As failures; they can be strategic, political, cultural or managerial. The main scenarios where a cooperation resulting from a merger fail are the lack of identification in the new structure and the risk of conflicting cultures or unrealistic potential synergies.
Schuler and Jackson (2001) show the need to address a variety of human resource issues since social factors are not of equal importance to leaders or employees. Even in enterprises which give priority to the social dimension, leaders do not make it a priority when conducting a merger. The process of change acceptance shows that individuals go through a more or less extended period of resistance to change (Schuler and Jackson, 2001). The primary psychological factor in resistance is mostly based on a feeling of fear – by nature, employees have a tendency to prefer the status quo and stability. Sources of difficulties can be primarily broken down as resistance to others people’s methods. Taking into account the factor of resistance behaviours is of particular importance adapting communications and structuring the action plan.
Mergers are often experienced as cultural clashes. Domestic cultural differences are often more prominent than organizational cultural differences (Stahl and Voigt, 2008). Appelbaum, Roberts, Shapiro, (2009) argue that the culture issue is the single most decisive factor that can make or break a deal. Here the notion of culture should not be understood in this context as purely civilizational but refers to the concept of corporate culture. Shared values are a key factor in the success of a merger when it means professional values, of the same professional ethics, or when there is the same perception of corporate social responsibility (Ahern, Daminelli, Fracassi, 2015).
Identification of the issues of the new structure refers to the concept of organizational identification, which can be defined as the feeling of being part of an organization leading to the assignment of a certain number of characteristics, in other words, a particular identity. Employees’ organizational identification in a merger depends on of being part of the dominant company or dominated company. For a long time, the recommendation was that enterprises should rush in to structure the machine within a hundred days at most. But most complex synergies, those concerning values, culture, and identification, require more time (Meglio, King, Risberg, 2016). Academics have shown the role that communications could play to encourage employees to have a positive attitude toward the merger.
It is evident that if we try to combine two organizations that have very different cultures, organizational methods, and work methods we could have major problems. According to Lee, Kim and Park (2015) risks are enhanced in cross-border operations due to organizational difficulties which make the integration process particularly challenging. The difficulty is increased by cultural differences between players who emphasize differences between organizational cultures and influence management practices. Chatterjee et al. (1992) have demonstrated that management culture compatibility issues have an impact the results of mergers.
The effect of the payment method on performance is certainly one question that has most interested researchers. Paying an excessive amount is a major reason for failure, in this case, the value can be destroyed as depreciation of the transaction is longer and more complicated. Often external reasons are attributed to the failure of mega M&As not to mention that too much has been paid for the transaction. This could be avoided with prices correlated to the success of the merger (Kohers and Ang, 2000).
There could be a conflict of interest between shareholders (principal) and managers (agents), these merger drivers are called agency motives (Jensen and Meckling, 1976). The motive called empire building (Mueller, 1969) states that managers seek to maximize their compensation as it is directly related to the size of the entity they manage. Moreover, managers sometimes have a tendency to overestimate the chances of success of the M&A; they have the feeling that they control the result and the M&A will be favourable in all case. This exaggerated over-optimism comes from an overestimation of capacities and professional skills, Roll (1986) describes this as managerial hubris.
According to the above, one can figure out that there is quite a lot of criticisms of the strategy in the literature. Therefore, this strategy should not be used without combining it with further strategical constructs, in order to reduce the risks and achieve a better post-M&A performance.
One of the major characteristics of the strategic action is that it is going on in uncertain future. Transforming the addition of two enterprises into one coherent, efficient and homogeneous player is a process that takes time and demands a great deal of efforts to create value over time for shareholders and employees.
Yves Reichenbach (April 2017)
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