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Chapter 24:Mergers, Corporate

Control, and Corporate Governance

Corporate Finance, 3eGraham, Smart, and Megginson

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Overview of Corporate Control Activities

A takeover is any transaction in which the control of one entity is taken over by another.

An acquisition is the purchase of additional resources by a business enterprise. Resources may come from purchase of new

assets, purchase of some of assets of another company, or purchase of another whole business entity, which is known as a merger.

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Corporate Control Transactions

Statutory merger: Acquired firm is consolidated into acquiring firm with no further separate identity.

Subsidiary merger: Acquired firm maintains its own former identity.

Consolidation: Two or more firms combine into a new corporate identity.

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LBOs, MBOs, and Dual-Class Recapitalization

Going-private transactions transform public corporations into private companies through issuance of large amounts of debt used to buy up the outstanding shares of the corporation.

In a dual-class recapitalization, management commonly buys all the shares of a newly issued class of stock carrying “super” voting rights.

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Methods of Acquisition

Negotiated MergersOpen Market PurchasesProxy FightsTender Offer

Open market purchases, tender offers, and proxy fights could be combined to launch a “surprise attack” on a target firm.

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Divestitures and Spin-Offs A divestiture occurs when the assets and/or

resources of a subsidiary or division are sold to another organization.

In a spin-off, a parent company creates a new company with its own shares by spinning off a division or subsidiary.

A split-off is similar to a spin-off, but ownership of the newly independent company is transferred to only certain existing shareholders in exchange for their shares in the parent.

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Mergers by Business Concentration

Horizontal: between former intra-industry competitors

Vertical: between former buyer and seller Conglomerate: between unrelated firms

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Other Concentration Classifications

Degree of overlapping business Change in corporate focus Herfindahl Index (HI)

Computed as the sum of the squares of the proportion of revenues derived from each line of business

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Returns to Security Holders

Target firm stockholders almost always experience substantial wealth gains.

Acquirer returns are generally much less than those for target shareholders and are sometimes negative.

Combined returns vary across studies but generally reflect an overall synergistic gain.

Bondholders also experience significant wealth changes in mergers.

Clear evidence supporting a co-insurance effect

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International Mergers and Acquisitions

Countries differ not only with respect to how frequently takeover attempts are launched, but also how often these are friendly versus hostile

bids,how often these are cross-border deals

(involving a bidder and a target firm in different countries),

the average control premium offered, andthe likelihood that payment will be made

strictly in cash.

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Value-Maximizing Motives for Mergers and Acquisitions

Geographic (both domestic and international) expansion in markets with little competition may increase shareholder wealth.

Internal expansion into a new market, also known as greenfield entry, involves acquiring and organizing all resources required for each stage of the investment.

External expansion is acquisition of a firm with resources already in place.

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Operational Synergies Economies of scale: Merger may reduce or

eliminate the need for overlapping resources. Economies of scope are other value-creating

benefits of increased size. Resource complementarities: Merging firms

have operational expertise in different areas.

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Managerial Synergies and Financial Synergies

Managerial synergies are effective when management teams with different strengths are combined.

Financial synergies occur when a merger results in less volatile cash flows, lower default risk, and a lower cost of capital.

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Cash Flow Generation and Financial Mergers

Acquirer sees target as undervalued. Tax-considerations for the merger

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Non-Value-Maximizing Motives

Agency problems: Management’s (disguised) personal interests are often driver of mergers and acquisitions. Managerialism theory of mergers Hubris hypothesis of corporate takeovers Agency cost of overvalued equity

Diversification Coinsurance of debt Internal capital markets

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History of Merger Waves First wave (1897-1904)

Ended with the stock market crash of 1904 Second wave (1916-1929)

Ended with the 1929 crash Third wave (1965-1969)

Push for conglomeration Fourth wave (1981-1989)

Spurred by the lax regulatory environment of the time

Fifth wave (1993 – 2001) Characterized by friendly, stock-financed mergers

Sixth wave (2007-2008)16

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Major U.S. Antitrust Legislation

Legislation (Year) Purpose of Legislation

Sherman Antitrust Act (1890)

Prohibited actions in restraint of trade, attempts to monopolize an industry

Violators subject to triple damage Vaguely worded and difficult to implement

Clayton Act(1914)

Prohibited price discriminations, tying arrangements, concurrent service on competitor’s board of directors

Prohibited the acquisition of a competitor’s stock in order to lessen competition

Celler-Kefauver Act(1950)

Eliminated the “stock acquisition” loophole in the Clayton Act

Severely restricts approval for horizontal mergers

Hart-Scott-Rodino Act(1976)

FTC and DOJ can rule on the permissibility of a merger prior to consummation.

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Determination of Anticompetitiveness

Since 1982, both DOJ and FTC have used Herfindahl-Hirschman Index (HHI) to determine market concentration.

HHI = Sum of squared market shares (in percentage form) of all participants in a certain market (industry)

Elasticity tests (“5% rule”) is an alternative measure used to determine if merged firm has the power to control prices.

1000 1800 HHI Level

Not Concentrated Moderately Concentrated Highly Concentrated

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The Williams Act (1968) Ownership disclosure requirements Tender offer regulations Sarbanes-Oxley Act of 2002 Laws Affecting Corporate Insiders

SEC Rule 10-b-5 Rule 14-e-3 The Insider Trading Sanctions Act (1984) Section 16 of Securities and Exchange Act

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State Antitrust Laws Include anti-takeover and anti-bust-up

provisions Provisions usually used in conjunction with

each otherInternational Regulation European Commission (EC) Microsoft case

Other Legal Issues

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Corporate Governance Law and Finance: Capital Markets and

National Legal Systems Efficient capital markets promote rapid

economic growth.

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