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sense for companies to merge

In what ways do companies change the composition of their ownership or management?

If the board of directors fails to replace an inefficient management, there are four ways to effect a change: (1) shareholders may engage in a proxy contest to replace the board; (2) the firm may be acquired by another; (3) the firm may be purchased by a private group of investors in a leveraged buyout, or (4) it may sell off part of its operations to another company. There are three ways for one firm to acquire another: (1) it can merge all the assets and liabilities of the target firm into those of its own company; (2) it can buy the stock of the target; or (3) it can buy the individual assets of the target. The offer to buy the stock of the target firm is called a tender offer. The purchase of the stock or assets of another firm is called an acquisition.

Why may it make sense for companies to merge?

A merger may be undertaken in order to replace an inefficient management. But sometimes two business may be more valuable together than apart. Gains may stem from economies of scale, economies of vertical integration, the combination of complementary resources, or redeployment of surplus funds. We don`t know how frequently these benefits occur, but they do make economic sense. Sometimes mergers are undertaken to diversify risks or artificially increase growth of earnings per share. These motives are dubious.

How should the gains and costs of mergers to the acquiring firm be measured?

A merger generates an economic gain if the two firms are worth more together than apart. The gain is the difference between the value of the merged firm and the value of the two firms run independently. The cost is the premium that the buyer pays for the selling firm over its value as a separate entity. When payment is in the form of shares, the value of this payment naturally depends on what those shares are worth after the merger is complete. You should go ahead with the merger if the gain exceeds the cost.

What are some takeover defenses?

Mergers are often amicably negotiated between the management and directors of the two companies; but if the seller is reluctant, the would-be buyer can decide to make a tender offer for the stock. We sketched some of the offensive and defensive tactics used in takeover battles. These defenses include shark repellents (changes in the company charter meant to make a takeover more difficult to achieve), poison pills (measures that make takeover of the firm more costly), and the search for white knights (the attempt to find a friendly acquirer before the unfriendly one takes over the firm).

Do mergers increase efficiency and how are the gains from mergers distributed between shareholders of the acquired and acquiring firms?

We observed that when the target firm is acquired, its shareholders typically win: target firms` shareholders earn abnormally large returns. The bidding firm`s shareholders roughly break even. This suggests that the typical merger appears to generate positive net benefits, but competition among bidders and active defense by management of the target firm pushes most of the gains toward selling shareholders.

Mergers seem to generate economic gains, but they are also costly. Investment bankers, lawyers, and arbitrageurs thrived during the 1980s merger and LBO boom. Many companies were left with heavy debt burdens and had to sell assets or improve performance to stay solvent. By the end of 1990, the new-issue junk bond market had dried up, and the corporate jousting field was strangely quiet. But not for long. As we write this material early in 2000, stock markets and mergers are again booming.

What are some of the motivations for leveraged and management buyouts of the firm?

In a leveraged buyout (LBO) or management buyout (MBO), all public shares are repurchased and the company БІАААмgoes private.БІАААн LBOs tend to involve mature businesses with ample cash flow and modest growth opportunities. LBOs and other debt-financed takeovers are driven by a mixture of motives, including (1) the value of interest tax shields; (2) transfers of value from bondholders, who may see the value of their bonds fall as the firm piles up more debt; and (3) the opportunity to create better incentives for managers and employees, who have a personal stake in the company. In addition, many LBOs have been designed to force firms with surplus cash to distribute it to shareholders rather than plowing it back. Investors feared such companies would otherwise channel free cash flow into negative-NPV investments.