9 - Internal Capital Markets vs Agency

Question 1

in takeovers who gains when there is:

• efficiency/ synergy
• Hubris (overpay/no value added)
• Agency problems or mistakes

in regards to total society, target and bidder?

Answer 1

efficiency/ synergy
everyone gains

Hubris (overpay/no value added)
society breaks even, target gains and bidder looses

Agency problems or mistakes
society and bidder loose money, target gains

Question 2

who gets the value dead from a takeover?

Answer 2

premium paid by bidder is usually equal to the value it adds, therefore target shareholders capture value added by bidder

Question 3

what is the free rider problem?

Answer 3

• assumes take overs are for synergies
• bidder can add value to firm

shareholder that refuse to tender gain from acquisition when price increases, however this may mean deal doesn’t go through.

the only way to get shareholders to tender is to offer post acquisition value for shares, which removes all profits for bidder. target shareholders don’t invest time or effort but still receive gains.

Question 4

how can the free rider problem be overcome?

Answer 4

toehold

buy initial 4.99% at market value then make intentions clear to market, saves money.

Question 5

why to acquirers pay premium during a takeover?

Answer 5

because there is strong competition in the takeover market, other firms submit their bids and only target wins in hubris (overpay)

Question 6

what is the target returns on single bidders and mutilple bidders?

Answer 6

single - 25-30%

multi - 35-40%

Question 7

what does STIEN 1997 discuss?

Answer 7

Internal Capital Markets - a reason for mergers and acquisitions

Question 8

what 5 assumptions does STEIN’s 1997 MODEL make?

Answer 8

• entities are credit contained
• managers are self-interested
• compensation and debt can not be costlessly issued
• CF outcomes are costlessly verifiable
• HQ has control rights and acts as an intermediary between division managers and shareholders

Question 9

What is HQ’s role?

Answer 9

have overview of segments, reduce underinvestment through winner picking (ranking investments). maximise entity value

Question 10

why is HQ better at picking where funds should be allocated compared to a bank or the divisional managers?

Answer 10

• bank treats each NPV project on it’s own merits, HQ can allocate funds to the best NPV project
• managers are self interested, have expertise in own segment and will never say no to extra funding

Question 11

how is HQ and management compensated differently?

Answer 11

HQ compensated through value created by winner picking/ stock price
Managers compensated on performance of accounting data or equity anaylsis

Question 12

is there not a risk of empire building is a HQ exists?

Answer 12

no HQ prefer valuable to big empires

Question 13

how does the interest of HQ and shareholders conflict?

Answer 13

HQ prefers lots of separate unrelated segments, reduces risk and increases finance/reduces credit constraint.

Shareholders prefer fewer segments, more related, reduces monitoring costs and lessens impacts of mistakes due to allocating funds correctly

Question 14

what are arguments against internal capital markets? 3

Answer 14

• inefficient segments are supported by efficient segments- deadweight kept alive longer
• separation of segments doesn’t always work, i.e. oil shock: investment in oil and non-oil segments reduced
• Duchin & Sosyura 2013, division managers with closed social ties to CEOs receive more funds that other divisional managers

Question 15

What are 4 AGENCY explanations against diversification?

Answer 15

• Empire building - Jenson 1990 and Stulz 1990
• Entrenchment - Shleife & Vishny 1989
• Protection for managers - Aminud & Lev 1981
• Cross-subsidisation of unprofitable segments Rajan Servaes & Zingles 1999

Question 16

What do Denis, Denis & Sarin 1997 argue? 3

Answer 16

• external markets monitor managers and CEOs
• higher ownership of management lower levels of diversification
• management only have focus businesses due to market disciplining functions

Question 17

what do Gertner, Scharfstein and Stein (1994)?

Answer 17

2 benefits and 1 cost of ICM

• HQ monitors more than banks
• better asset redeployment if performing poorly
• less incentives for management entrepreneurialism as they don’t control capital issue

Question 18

what does Stein 1997 discuss?

Answer 18

HQ resource allocation within internal cap markets

i.e. winner pickings

Question 19

What assumptions does Stein 1997 make? 5

Answer 19

a. credit constraints → not all +ve NPV projects can be financed but can’t go to the market to increase funds as needed
b. only divisional managers know about future sales
c. managers are self-interested (prefer more resources to less)
d. cash flow outcomes are costlessly verifiable
e. HQ has control rights; acts as a non-owner intermediary between shareholders and divisional managers

Question 20

according to Stein 1997, when to shareholders benefit and when do debt holders benefit in regards to projects and firm structure?

Answer 20

• shareholders
  prefer, related projects and un-diversified firm structure

-debtholders
prefer unrelated projects and diversified firm structure

Question 21

according to Stein 1997 can ICM solve over and under investment?

Answer 21

Yes can solve the problem or over- and underinvestment as they have control rights and can redistribute the credit constrained capital between projects to maximise value