Nowadays, businesses around the world have to comply with the trend of growing economies and globalization that cause a huge increase of competition in all industries. Such integration also reduces the opportunities of companies to get the optimal market share in the home country and outside it.
The topicality of this article is stipulated due to the fact that these common tendencies have resulted in a rise in the number of mergers and acquisitions (M&A), making them a global trend. This “new strategy” affects the businesses around the world and significantly influences management decisions, causing not only positive, but also a number of negative impacts on the companies and employees.
In recent years, the international market of mergers and acquisitions has increased by several times. According to Deloitte M&A trends report 2016, 23 percent of respondents anticipate a huge increase in M&A deal volume; in 2017 — slightly more on the corporate side (24 percent) than private equity investors (20 percent). Prospectively, 60 percent of respondents said they closed at least six deals in the past 12 months, and 21 percent closed more than 11 deals. The aggregate value of the deals closed in the past year exceeded $1 billion for about three in ten respondents (29 percent).
The goal of this article is to study the nature of mergers and acquisitions, their role in the modern business world and particularly the influence of the conflict of interest on business environment.
To achieve the posed goal it is necessary to solve the following aims:
- To identify the nature of mergers and acquisitions;
- To consider some real-life examples of M&As;
- To examine the advantages of M&A strategy;
- To consider the drawbacks of M&A strategy;
M&A deals are the most widespread in the oil and gas sector, chemical, automotive and pharmaceutical industries, banking and telecommunications sectors, and in the energy sector.
For instance, in October 2016 British American Tobacco offered $47 billion in cash and stock for full control of Reynolds American. BAT already owned 42 % of Reynolds, so it wanted to buy the remaining 58 %. Besides, in 2016 German pharmaceutical and Chemicals Company Bayer said it would buy U. S. seed and agricultural chemical company Monsanto. The new company would control over 25 % of global supply of seeds and pesticides.
One of the factors that enhance M&A are an ongoing process of concentration of capital, the growing globalization of firms, and the liberalization of access to the national markets.
In the XXI century one of the most important goals, businesses possess today, is achieving a sustainable growth. Usually, every business wants to gain the optimum market share over their competitors, using the strategy of mergers and acquisitions.
Modern companies try to maximize profits for its owners and satisfy all the stockholders. M&A provide businesses with a potentially bigger market share and open a more diversified market. Currently, it is the most commonly used method for the growth of companies.
Overall, the concept of M&A is very similar to marriage, where two individuals start living together. In the same way, two companies become one “family” in mergers and acquisitions strategy. In mergers, two almost “equal” firms cooperate with each other and create a new entity. The acquisition happens, when one big company makes a deal to buy another organization and become its owner. Usually, both these strategies start with a process of some informal discussions between firms’ representatives. The next steps are formal negotiation, the issuance of a letter of intent, due diligence, entering into a purchase or merger agreement, and the execution of the deal.
Undoubtedly, M&A occur among different functional areas among different industries. And this is exactly the reason, why firms should adequately estimate the main pros and cons of M&A strategy, forecast the consequences (both positive and negative) for every company involved.
Through structural and operational benefits secured by the merger, the mutual business can potentially reduce costs and increase the profits, boosting stockholder values for each group of shareholders. Broadly speaking about M&A’s advantages, it is worth mentioning that this strategy enables companies to create huge network economies, which facilitates significant economies of scale. Simply put, the biggest advantage of achieving economies of scale is decreased costs per unit of production. Logically, it allows businesses’ profits to go up with unchanged level of prices. For example, when T-Mobile merged with Orange in the UK, the companies’ decision was justified as follows: “The ambition is to combine both the Orange and T-Mobile networks, cut out duplication, and create a single super-network. For customers it will mean bigger network and better coverage, while reducing the number of stations and sites — which is good for cost reduction as well as being good for the environment.”
Moving further, today, almost all firms aim at investing money in research and development (R&D) in order to come up with new products and technological decisions. As we have already mentioned, a merger helps the firm to achieve greater financial results, and consequently, allocate more money for R&D. And in the era of huge competition, this opportunity is crucial for success of almost every company.
It is also worth mentioning that M&A help companies avoid duplication. For instance, two quite big taxi companies could be competitors, because have the same everyday route. In case, these companies merge and make a single entity, passengers will definitely win thanks to lower costs. Besides, getting rid of duplication will help to reduce congestion and traffic jams.
There exist even more advantages and benefits of mergers and acquisitions, but undoubtedly, such a strategy has its own cons, as well.
First and foremost, there is a probability that a new entity will gain a power of monopoly and limit fair competition on the market. It goes without saying that this consequence may have a negative impact on the customers and other firms, which offer the same services as two merged companies.
Secondly, in case of creating one big organization, instead of several small and medium sized businesses, people lose the variety choice. Market turns out to be incapable of giving consumers alternatives that is also considered as a shortage of M&A strategy.
One of the most commonly adverse influences of M&A is job loss of many workers of one of the companies. Basically, when one firm acquires another one, it aims at decreasing staff and getting rid of under-performing sectors of the acquired organization.
Besides, workers who face the necessity of working in a new environment may encounter many conflicts that will negatively influence the performance of the entity. If employees feel that they are undervalued, and the success of the company does not depend on them, they may become less motivated to work hard and achieve great results.
What is more, making such important decision is quite difficult in conditions of instability and uncertainty in the modern economy. The causes of uncertainty may lie in the lack of information. The more information available to the market entity, the more prediction and evaluation can be made. In addition to objective reasons lack of information (poor knowledge of market, suppliers, borrowers), there are objective, unavoidable reasons related to the uncertainty of the future (future interest rates, the movement of the stock). And all these issues should be taken into account before making a decision to merge or acquire.
The next negative point relates to the conflict of interest, the issue that deserves a special attention. Starting from the basics, four groups with opposing interests are shareholders of the acquiring firm, management of the acquiring firm, shareholders of the target firm, and management of the target firm. The process of M&A deal’s negotiation might result in a bigger compensation for the target manager for sacrificing his private benefits while mitigating the agency conflict in the bidder firm at the same time. Target shareholders, on their turn, might accept the lower payoffs in a negotiated merger to ensure that a merger actually occurs. Also, a common case is when bidder shareholders allow the bidder manager to make final decisions quite independently when the deal is small and to be compensated for that. Hence, the bidding manager would prefer working on smaller targets to operate freely and be awarded. All the facts mentioned above are exactly what is called a conflict of interest under M&A deal and are the major constraints against fair and effective M&A negotiations.
Bidding firm shareholders, leaving the fact of ethics, moral and legality, exploit the ”conflict of interest” concept by giving side payment to the target manager in exchange for a larger share of the synergistic gains for bidders. However, shareholders of the bidder firm should control the activity and motives of the management of their own company: prevent the management from receiving side payments and approving mergers that will not generate substantial profits in the future. Although the problem is urgent and commonly known, taking care of managers is not the priority of the shareholders that is why there is a space for “internal cheating” and the conflict of interest takes place widely. Analyzing the logic behind the target shareholders’ behavior is also critical. Target shareholders must approve the negotiated merger. In case blocking a merger is more expensive rather than approving it, shareholders tend to agree for the deal that is a value-decreasing move.
Furthermore, there is a concern stating that CEO’s interests may not be fully aligned with those of shareholders, thus the CEO might struggle for his/her own benefits when negotiating the M&A deal (e.g. retention, at the expense of a higher premium for the shareholders). The conflict of interest hypothesis predicts that CEOs are more likely to be retained when the conflict of interest is more acute, to be more precise, when the interests of the target CEO and shareholders diverge more.
In order to provide more visibility on the subject, let us go through a Daimler-Benz purchase of Chrysler Corp. in May 1998 that eventually came to end in 2008. The purchase of Chrysler, America’s third-largest car company, by the Stuttgart-based Daimler-Benz was the biggest acquisition by a foreign buyer of any American company in history. In spite of the fact that initially the deal was positioned to investors as an equal partnership, it resulted in Daimler being the dominant partner (Daimler’s stockholders held the majority of the new company’s shares). The merger led to the emergence of a company, ranked 3d in the world in terms of revenues, market capitalization and earnings, and 5th in the globe considering the number of units sold. So, a new impressive leader in the automobile industry emerged, that was exactly the motive of the Daimler-Benz shareholders when purchasing the Chrysler Corporation.
However, a couple of years after the acquisition were marked with unstable profit from Chrysler product line that resulted in big losses for the entity. Instead of gaining competitive advantage, the merger rushed the two car producers even deeper into crisis and did not provide the companies with the necessary tools to overcome the recession. The main cause of such an unfruitful collaboration was a conflict of interest. The major problem concerned a huge differences between the European and American style of doing business, organizing negotiations, treating employees. Through the time, Germans occupied a leading position in the company, many American top managers were fired, and hence, the internal working environment became chaos. Since Daimler’s managers were driven by possible gains from the merger, paying not enough attention to the possible conflicts arising from different corporate culture, the company ended up with unattractive public image and deteriorating sales. Daimler-Chrysler announced it was selling 80.1 % of Chrysler to the private-equity firm Cerberus Capital Management for $7.4 billion. In the end, Chrysler applied for bankruptcy protection in April 2009.
To put it in a nutshell, M&A strategy has both pros and cons and it definitely may have both positive and detrimental effect on both companies, which are going to make a deal. A strategic merger or acquisition may be one of the crucial means for successful growth of the business, or may cause some negative consequences for one of the companies. Considered strategy offers a solution to various business problems. For instance, an acquirer or merged enterprises can grab a new product line, enter new markets, or gain some expertise and innovations. But at the same time, M&A can cause internal conflicts among shareholders, employees and management, and have an adverse effect on the performance of the business in both short-term and long-term perspective. The significance of the conflict of interest should not be underestimated as it can lead to financial losses, legal suits, restructuring, reputation damage and even full decomposition of the business entity. That is why management of two organizations should take into account all the factors before making such an important strategic decision.
References:
- V. V. Garipova, “Corporate conflicts and their solutions”/URL: https://bgscience.ru/lib/2554/
- Deloitte M&A trends report 2016/ URL: https://www2.deloitte.com/content/dam/Deloitte/us/Documents/mergers-acqisitions/us-ma-mergers-and-acquisitions-trends-2016-year-end-report.pdf
- Economics Help/ Pros and Cons of M&A/ URL: http://www.economicshelp.org/blog/5009/economics/pros-and-cons-of-mergers/
- Tyrone Callahan “Who’s Cheating Whom in Mergers and Acquisitions?”, URL: http://www.thomasmoeller.net/thomasmoeller/research_files/Merger_Theory.pdf
- Leonce L. Bargeron, Frederik P. Schlingemann, René M. Stulz, Chad J. Zutter/ “Are Acquisition Premiums Lower because of Target CEOs’ Conflicts of Interest?” / April 2010/ URL: https://fisher.osu.edu/supplements/10/9860/201008.pdf
- CNN money New/ URL: http://money.cnn.com/1998/05/07/deals/benz/
- Fortune Finance/ URL: http://fortune.com/2016/12/28/mergers-and-acquisitions-donald-trump/
- Perepelitsa D. G. / The problem of making an investment decision under conditions of lack of information./ URL: http://naukovedenie.ru/PDF/35EVN315.pdf
