M&A theories

Question 1

What are the 3 theories behind M&A

Answer 1

-Value creation
-Value reducing
-Hubris

Question 2

What is Value creation theory

Answer 2

The Value Creation Theory in mergers and acquisitions (M&A) is rooted in the premise that M&As are strategic decisions aimed at generating additional value that could not be achieved by the firms operating independently. This theory assumes that the combination of two firms creates synergies—efficiencies, cost savings, or revenue enhancements—that exceed the transaction costs and acquisition premiums.

Question 3

What are synergies

Answer 3

The combined entity is greater than the individual firms

Hard synergies - Reduction in operating costs through economies of scale or elimination of redundancies (e.g., shared infrastructure, consolidated operations).

Soft synergies - Enhanced market power, cross-selling opportunities, or complementary product/service offerings.

Question 4

What are the implications for the target (Value creation)

Answer 4

Target shareholders typically receive significant positive returns because acquirers offer premiums to secure the acquisition.

These premiums reflect the expected value from synergies and the competition among potential acquirers.

Question 5

What are the implications for the bidder (Value creation)

Answer 5

Positive Returns: Occur when the acquirer captures synergies effectively and pays a reasonable price.

Neutral or Negative Returns: Arise if the acquirer overpays for the target or fails to realize anticipated synergies.

Question 6

Implications of combined returns (Value creation)

Answer 6

Expected to be Positive: Combined value creation through synergies should outweigh the costs of the merger, including the premium and integration expenses.

Positive combined returns are the hallmark of successful M&A under this theory.

Question 7

What are value reducing theories

Answer 7

Value-reducing theories argue that certain mergers destroy value due to misaligned motivations, poor execution, or external market conditions.

Question 8

Implication of returns for target (value reducing)

Answer 8

Target shareholders typically experience positive returns, as bidders still offer premiums to gain control.

However, these premiums may be inflated or poorly justified, reflecting overvaluation or managerial overconfidence rather than genuine synergies.

Question 9

Implications of returns for bidder (Value reducing)

Answer 9

Bidders often experience significant negative returns under value-reducing theories.
Drivers of these losses include:

Overpayment: Bidders overestimate the value of synergies or the target’s intrinsic value.

Diversification Discount: Mergers aimed at diversification often destroy value, as shareholders can diversify their portfolios independently without incurring acquisition costs.

Question 10

implications for combined returns (Value reducing)

Answer 10

Combined returns are often zero or negative due to value destruction during the integration process.

Poorly executed deals, cultural mismatches, and excessive premiums offset any potential benefits.

For instance, Shleifer and Vishny (2003) noted that overvalued bidders often destroy combined value by paying inflated prices for targets.

Question 11

What is the Hubris theory

Answer 11

The hubris hypothesis (Roll, 1986) suggests that mergers are often driven by managerial overconfidence or arrogance rather than rational economic considerations.

Question 12

Implications on target returns (Hubris)

Answer 12

Similar to value creation theories, target shareholders benefit from acquisition premiums driven by the bidder’s overconfidence.

The premium may even exceed rational valuations due to the bidder’s overestimation of synergies.

Question 13

Implications on bidder returns (Hubris)

Answer 13

Similar to value creation theories, target shareholders benefit from acquisition premiums driven by the bidder’s overconfidence.

The premium may even exceed rational valuations due to the bidder’s overestimation of synergies.

Question 14

Implications on combined returns (Hubris)

Answer 14

Hubris-driven deals may not create net value, as the overpayment offsets any potential synergies.

Combined returns often align with the realization that the premium paid was excessive and synergies were overestimated.

Question 15

Empirical results for combined returns (Value creation)

Answer 15

1. Positive Combined Returns:
   o Bradley, Desai, and Kim (1988):
    Analyzed 236 tender offers from 1963 to 1984 and found positive combined returns.
    Average combined wealth gains ranged from 7% to 10%, highlighting the value created by synergies.

o Jovanovic and Rousseau (2002):
 Mergers transfer resources to better-managed firms, creating significant positive value for the combined entity.
 Strong evidence of efficient resource allocation in industries undergoing technological advancements or deregulation.

o Harford (2005):
 Combined returns are most positive in industries experiencing consolidation, such as deregulation in utilities or technological disruptions in telecommunications.

Question 16

Empirical results for combined returns (Value reducing)

Answer 16

1. Negative Combined Returns:
   o Roll (1986):
    Highlighted that overpayment due to managerial overconfidence (hubris) often leads to value destruction for acquirers.

o Shleifer and Vishny (2003):
 Found that mergers driven by market overvaluation tend to destroy value for combined entities.
 Overvalued bidders use inflated stock as currency to acquire targets, transferring wealth from their shareholders to target shareholders without creating net value.

Question 17

Empirical results for combined returns (Hubris)

Answer 17

1. Negative Bidder Returns:
   o Roll (1986):
    Found that bidder returns are often neutral or negative, supporting the idea that overconfident managers overpay for targets.
    Even when synergies exist, the overpayment erodes most of the potential value for bidders.

o Hayward and Hambrick (1997):
 CEOs with high media attention and compensation relative to their peers were more likely to overpay in acquisitions, leading to poorer post-merger performance.