theories merger

mergers

1. Theories of merger Presented by : Roja M.V Nanaiah T.G Nandish H.M Madhu S.A

2. Efficiency theories Differential managerial efficiency Inefficient management Synergy Pure diversification stratergic Realignment to changing environment Hubris (winner curse) Q-ratio

3. Cont.… Information and signaling Agency problem Market share/power Managerialism Tax consideration

4. DIFFERENTIAL EFFICIENCY It is also called managerial synergy or managerial efficiency . According to this theory if the management of firm A is more efficient than the management of firm B and after firm A acquires firm B the efficiency of firm B is brought upto the level of efficiency of firm A .Efficiency is increased by merger. Basis for horizontal merger It may be social gain as well as private gain. Lastly level of efficiency in the economy will be increased

5. INEFFICIENT MANAGEMENT THEORY  This is similar to the concept of managerial efficiency but it is different in that inefficient management . Basis for mergers between firms when unrelated business i.e., conglomerate merger. The management in control is not abl e to manage asset efficiently ,mergers with another firm can provide the necessary supply of managerial capabilities . In this replacement of inco mpetent managers were the sole motive for mergers and also manager of the target company will be replaced

6. SYNERGY Synergy r efers to the type of reactions that occur when two substances or factors combine to produce a greater effect together than that which the sum of the two operating independently could account for.  The ability of a combination of two firms to be more profitable than the two firms individually. In this companies can create great shareholders value than if they are operated separately.  There are two types of synergy: Operating synergy Financial synergy

7. Operating synergy Operating synergy is improved by Economies of scale and Economies of scope . Economies of scale : it means reduction of average cost with increase In volume or production. Because of fixed overhead expenses such as steel ,pharmaceutical, chemical and aircraft manufacturing . In that merging of company in same line of business such as horizontal Merger it eliminates duplication and concentrate a great volume of activity in a available facility . In vertical mergers com expands forward towards the customer or backward towards the source of raw material (suppliers). By acquiring com control over the distribution and purchasing bring in economies of scale .

8. Cont.….. Economies of scope: Using a specific set of skill or an asset currently employed in producing a specific product or service . Operating synergy arise from improving operating efficiency through E/C’s of scale and scope by acquiring a customers ,suppliers ,and compititors .

9. Financial synergy Impact of merger on cost of capital of acquiring firms or the newly formed firm . Cost of capital can be reduced with financial synergy. Financial synergy occurs as a result of the lower costs of internal financing versus external financing. A combination of firms with different cash flow positions and investment opportunities may produce a financial synergy effect and achieve lower cost of capital. Tax saving is another considerations. When the two firms merge, their combined debt capacity may be greater than the sum of their individual capacities before the merger. The financial synergy theory also states that when the cash flow rate of the acquirer is greater than that of the acquired firm, capital is relocated to the acquired firm and its investment opportunities improve.

10. PURE DIVERSIFICATION Diversification through mergers is commonly preferred to diversification through internal growth, given that the firm may lack internal resources or capabilities requires. It may be done including demand for diversification by managers and other employees ,preservation of organizational and reputational capital, financial and tax advantage. It is undertaken to shift from the acquiring com core product line or market into those that have higher growth prospect . Research reveals that investors do not benefited from diversification . Investors perceive com diversified in unrelated areas as riskier because they are difficult for mgt to understand.

11. STRATEGIC REALIGNMENT To CHANGING ENVIRONMENT . It suggests that the firms use the strategy of M&As as ways to rapidly adjust to changes in their external environments in regulatory framework and technological innovation . When a company has an opportunity of growth available only for a limited period of time slow internal growth may not be sufficient. Technical changes contributes to new products ,industries , market . The use of IT technology is likely to encourage mergers which are less expensive and faster way to acquire new technology and owner knows that how to fill a gap in current offering or to entering new business .

12. HUBRIS HYPOTHESIS Hubris hypothesis implies that managers look for acquisition of firms for their own potential motives and that the economic gains are not the only motivation for the acquisitions.  This theory is particularly evident in case of competitive tender offer to acquire a target. The urge to win the game often results in the winners curse refers to the ironic hypothesis that states that the firm which over estimates the value of the target mostly wins the contest.

13. Q-ratio The ratio relates the market value of shares to replacement value of asset. Inflation and high interest rate can depress share prices will below the book value of the firm , high inflation may also raise replacement cost above the book value of asset . Mergers are undertaken when market value of com is less than replacement cost of its asset

14. Information and signaling The announcement of mergers negotiation or a tender offer may convey information or signals to market participants that future cash flows are likely to increase and that future will increase in future values

15. Agency problem Takeover and mergers would be a threat because of inefficiency or agency problem . When it takes place where there is a divergence between the goals of management and owners

16. Market power /share Mainly mergers are undertaken to improve ability to set and maintain prices above competitive level . Increase in the size of the firm is expected to result in market share . The decrease in the number of firm will increase recognized interdependence

17. Managerialism Managers may increase the size of the firm through mergers in the beliefs that their compensation is determined by size but in practice management compensation is determined by profitability

18. Tax consideration Unused net operating loss of the target com and the revaluation or writing up of acquired asset and the tax free status of the deal influence M&A . Loss carryforward can be setoff against the combined firm taxable income.