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MERGERS, ACQUISITIONS, AND CORPORATE CONTROL

In recent years the scale and pace of merger activity have been remarkable. For example, Table 6.1 lists just a few of the important mergers of 1998 and 1999. Notice that the United States does not have a monopoly on merger activity. In recent years many of the largest mergers have involved European firms.

The mergers listed in Table 6.1 involved big money. During periods of intense merger activity financial managers spend considerable time either searching for firms to acquire or worrying whether some other firm is about to take over their company.

When one company buys another, it is making an investment, and the basic principles of capital investment decisions apply. You should go ahead with the purchase if it makes a net contribution to shareholders`wealth. But mergers are often awkward transactions to evaluate, and you have to be careful to define benefits and costs properly.

Many mergers are arranged amicably, but in other cases one firm will make a hostile takeover bid for the other. We describe the principal techniques of modern merger warfare, and since the threat of hostile takeovers has stimulated corporate restructurings and leveraged buyouts (LBOs), we describe them too, and attempt to explain why these deals have generated rewards for investors. We close with a look at who gains and loses from mergers and we discuss whether mergers are beneficial on balance.After studying this material you should be able to

_ Describe ways that companies change their ownership or management.

_ Explain why it may make sense for companies to merge.

_ Estimate the gains and costs of mergers to the acquiring firm.

_ Describe takeover defenses.

_ Summarize the evidence on whether mergers increase efficiency and on how the gains from mergers are distributed between shareholders of the acquired and acquiring firms. _ Explain some of the motivations for leveraged and management buyouts of the firm.

The Market for Corporate Control

The shareholders are the owners of the firm. But most shareholders do not feel like the boss, and with good reason. Try buying a share of General Motors stock and marching into the boardroom for a chat with your employee, the chief executive officer.

The ownership and management of large corporations are almost always separated. Shareholders do not directly appoint or supervise the firm`s managers. They elect the board of directors, who act as their agents in choosing and monitoring the managers of the firm. Shareholders have a direct say in very few matters. Control of the firm is in the hands of the managers, subject to the general oversight of the board of directors. The separation of ownership and management or control creates potential agency costs. Agency costs occur when managers or directors take actions adverse to shareholders` interests.

The temptation to take such actions may be ever-present, but there are many forces and constraints working to keep managers` and shareholders` interests in line. As we pointed out earlier, managers` paychecks in large corporations are almost always tied to the profitability of the firm and the performance of its shares. Boards of directors take their responsibilities seriously ¤they may face lawsuits if they don`t ¤and therefore are reluctant to rubber-stamp obviously bad financial decisions.

But what ensures that the board has engaged the most talented managers? What happens if managers are inadequate? What if the board of directors is derelict in monitoring the performance of managers? Or what if the firm`s managers are fine, but resources of the firm could be used more efficiently by merging with another firm? Can we count on managers to pursue arrangements that would put them out of jobs? These are all questions about the market for corporate control, the mechanisms by which firms are matched up with management teams and owners who can make the most of the firm`s resources. You should not take a firm`s current ownership and management for granted. If it is possible for the value of the firm to be enhanced by changing management or by reorganizing under new owners, there will be incentives for someone to make a change.

There are four ways to change the management of a firm. These are (1) a successful proxy contest in which a group of stockholders votes in a new group of directors, who then pick a new management team; (2) the purchase of one firm by another in a merger or acquisition; (3) a leveraged buyout of the firm by a private group of investors; and (4) a divestiture, in which a firm either sells part of its operations to another company or spins it off as an independent firm.

We will review briefly each of these methods.