Part 3: Transactions

Question 1

Mergers can be

Answer 1

Horizontal
Vertical
Conglomerate

Question 2

Methods of payment

Answer 2

Stock-swap
Cash
Combination of the two

Question 3

Reasons to acquire

Answer 3

1. Economies of scale and scope
2. Vertical integration (governance, se screetshot)
3. Expertise
4. Monopoly gains
5. Tax saving (take advantage of operating losses)
6. Takeovers as a corporate governance mechanism (adding value by replacing bad management)
7. Empire Building

Question 4

The free-rider problem

Answer 4

Any profit a raider can make in the form of share price increases represents a profit the individual investor can make by not tendering her shares

Question 5

Mitigating the free-rider problem

Answer 5

Dilution
Large Shareholders
Toeholds
Laws and by-laws

Question 6

Takeover gains

Answer 6

Expected additional value created by new management compare to the value created by current management

Question 7

Distribution of takeover gains

Answer 7

• The increased value that follows from the takeover is transferred to the bidder, the target firm’s shareholders, or both
• Most of the value created through a takeover goes to the shareholders of target firms

Question 8

When is due diligence done?

Answer 8

1. Mergers & Acquisitions
2. IPOs
3. Joint ventures
4. Strategic co-operation and long-term contracts
5. Credit
6. Procurement
7. Privatisation

Question 9

What drive due diligence?

Answer 9

1. Screening - adverse selection, DD mitigates this, trade-off between cost and benefit
2. Screening & legal principles - only the buyer know what she wants, responsibility to screen rest on her
3. Matching - question whether the target and buyer are a good match (synergies)
4. Transfer of responsibility - legal and auditing firms used mainly because of liability insurance. Due diligence then becomes a vehicle of risk transfer rather than a tool for screening
5. Fishing expectations - DD information is sensitive, however, it is rare that competitors can use this information without seriously considering buying the firm
6. Unfair contracting - DD is meant to form a basis for negotiating transaction price. A tactical buyer could prefer to use some information until after the transaction and claim damages

Question 10

Forms of due diligence

Answer 10

1. Ordinary due diligence - commercial, financial, and legal
2. Extended due diligence - tax, organisational, technological, environmental, and IT
3. Special due diligence - intellectual property, etc.

Question 11

Commercial due diligence

Answer 11

Can the commercial goals of the transaction succeed? 
Strategic and long-term processes
External factors (market, customers, competition)

Question 12

Financial due diligence

Answer 12

Financial analysis, valuation, auditing

Provide information to the buyer for price negotiation

Question 13

Legal due diligence

Answer 13

An investigation of the legal information and documentation

Question 14

Due diligence and investor performance conclusion (Cumming & Zambelli, 2017)

Answer 14

• In a PE setting, DD is a source of value
• Overall, an extra week of DD results in higher ROA statistically
• Consistent with previous findings that DD is a source of Alpha
• Especially when DD is performed internally in the PE firm -> implying agency costs when delegating DD

Question 15

What is an event? (event studies)

Answer 15

Something that happens and is identifiable in time

Question 16

What does event studies study?

Answer 16

Investors reaction to events, according to EMH, information from events should be incorporated into the price instantly

Question 17

Cross-sectional tests

Answer 17

The most common tests in event studies

Tests how stock price effects are related to firm characteristics

Question 18

Explain how abnormal returns are determined in event studies

Answer 18

The key is to know the normal return, however, what is normal?
There are three models commonly used:
- Constant expected returns model
(abnormal return = return - average return before event)
- Market adjusted returns
(abnormal return = return - market return)
- Market model
(a variation of CAPM)

Question 19

Williamson (1979) characterisation of transactions and what are the governance mechanisms related

Answer 19

Investment characteristic - nonspecific, mixed, idiosyncratic
Frequency - frequent, occasional

Classical contracting - all nonspecific
Neoclassical contracting - for occasional (mixed & idiosyncratic)
Relational governance - for frequent (mixed & idiosyncratic)

Question 20

Takeover defences

Answer 20

Poison pills - give existing shareholders right to buy shares at a discount under certain conditions
Staggered boards - prevent raider to get board candidates
White knights
Golden parachutes
Recapitalization