M&A motives

Question 1

why do mergers occur?

Answer 1

Size and returns to scale (e.g. Adam Smith, 1776)

Transaction costs (Coase, 1937)

Question 2

mergers occur due to Size and returns to scale (e.g. Adam Smith, 1776), explain

Answer 2

– Benefits of size are usual source of “synergies”
– Economies of scale
* Average costs decline with larger size
* Lower required investment in inventory
* Large firms more able to implement specialization
– Improved capacity utilization
– Economies of scope – firm can produce additional products due to experience with existing products

Question 3

mergers occur due to Transaction costs (Coase, 1937), explain

Answer 3

– Firms must decide between internal or external production
– Transaction costs within and outside firm determine decision on firm size and merger
– E.g., if supplier can produce input more cheaply due to specialisation gains, will not profit a firm to merge

Question 4

what is the value increasing theory

Answer 4

– Mergers create synergies (e.g. Bradley et al., 1988)
* Economies of scale
* More effective management
* Improved production techniques
* Combination of complementary resources

– Transaction costs – organization of firm is reaction to appropriate balance of internal operations and external markets (e.g. Coase, 1937)

– Takeovers are disciplinary (e.g. Manne, 1965)
* Can be used to remove poor managers
* Facilitate competition between different management teams

Question 5

what is the value reducing theory

Answer 5

– Agency costs of free cash flow (Jensen, 1986)
* Free cash flow (FCF) is a source of value reducing mergers
* Firms with FCF are those where internal funds exceed investment required for positive NPV projects

– Managerial entrenchment (Shleifer and Vishny, 1989)
* Managers hesitant to distribute cash to shareholders
* Investments may be in form of acquisitions where managers overpay but reduce likelihood of their own replacement