Chapter 24: Mergers, Corporate Control, and Corporate Governance

1. Chapter 24:Mergers, Corporate Control, and Corporate Governance Corporate Finance, 3e Graham, Smart, and Megginson

2. Overview of Corporate Control Activities • A takeover is any transaction in which the control of one entity is taken over by another. • An acquisition is the purchase of additional resources by a business enterprise. • Resources may come from purchase of new assets, purchase of some of assets of another company, or purchase of another whole business entity, which is known as a merger.

3. Corporate Control Transactions Statutory merger: Acquired firm is consolidated into acquiring firm with no further separate identity. Subsidiary merger: Acquired firm maintains its own former identity. Consolidation: Two or more firms combine into a new corporate identity.

4. LBOs, MBOs, and Dual-Class Recapitalization • Going-private transactions transform public corporations into private companies through issuance of large amounts of debt used to buy up the outstanding shares of the corporation. • In a dual-class recapitalization, management commonly buys all the shares of a newly issued class of stock carrying “super” voting rights.

5. Methods of Acquisition Negotiated Mergers Open Market Purchases Proxy Fights Tender Offer • Open market purchases, tender offers, and proxy fights could be combined to launch a “surprise attack” on a target firm.

6. Divestitures and Spin-Offs A divestiture occurs when the assets and/or resources of a subsidiary or division are sold to another organization. In a spin-off, a parent company creates a new company with its own shares by spinning off a division or subsidiary. A split-off is similar to a spin-off, but ownership of the newly independent company is transferred to only certain existing shareholders in exchange for their shares in the parent.

7. Mergers by Business Concentration Horizontal: between former intra-industry competitors Vertical: between former buyer and seller Conglomerate: between unrelated firms

8. Other Concentration Classifications • Degree of overlapping business • Change in corporate focus • Herfindahl Index (HI) • Computed as the sum of the squares of the proportion of revenues derived from each line of business

9. Returns to Security Holders Target firm stockholders almost always experience substantial wealth gains. Acquirer returns are generally much less than those for target shareholders and are sometimes negative. Combined returns vary across studies but generally reflect an overall synergistic gain. Bondholders also experience significant wealth changes in mergers. Clear evidence supporting a co-insurance effect

10. International Mergers and Acquisitions • Countries differ not only with respect to how frequently takeover attempts are launched, but also • how often these are friendly versus hostile bids, • how often these are cross-border deals (involving a bidder and a target firm in different countries), • the average control premium offered, and • the likelihood that payment will be made strictly in cash.

11. Value-Maximizing Motives for Mergers and Acquisitions Geographic (both domestic and international) expansion in markets with little competition may increase shareholder wealth. • Internal expansion into a new market, also known as greenfield entry, involves acquiring and organizing all resources required for each stage of the investment. • External expansion is acquisition of a firm with resources already in place.

12. Operational Synergies Economies of scale: Merger may reduce or eliminate the need for overlapping resources. Economies of scope are other value-creating benefits of increased size. Resource complementarities: Merging firms have operational expertise in different areas.

13. Managerial Synergies and Financial Synergies Managerial synergies are effective when management teams with different strengths are combined. Financial synergies occur when a merger results in less volatile cash flows, lower default risk, and a lower cost of capital.

14. Cash Flow Generation and Financial Mergers Acquirer sees target as undervalued. Tax-considerations for the merger

15. Non-Value-Maximizing Motives • Agency problems: Management’s (disguised) personal interests are often driver of mergers and acquisitions. • Managerialism theory of mergers • Hubris hypothesis of corporate takeovers • Agency cost of overvalued equity • Diversification • Coinsurance of debt • Internal capital markets

16. History of Merger Waves • First wave (1897-1904) • Ended with the stock market crash of 1904 • Second wave (1916-1929) • Ended with the 1929 crash • Third wave (1965-1969) • Push for conglomeration • Fourth wave (1981-1989) • Spurred by the lax regulatory environment of the time • Fifth wave (1993 – 2001) • Characterized by friendly, stock-financed mergers • Sixth wave (2007-2008)

17. Major U.S. Antitrust Legislation

18. Not Concentrated Moderately Concentrated Highly Concentrated HHI Level 1000 1800 Determination of Anticompetitiveness Since 1982, both DOJ and FTC have used Herfindahl-Hirschman Index (HHI) to determine market concentration. • HHI = Sum of squared market shares (in percentage form) of all participants in a certain market (industry) Elasticity tests (“5% rule”) is an alternative measure used to determine if merged firm has the power to control prices.

19. The Williams Act (1968) • Ownership disclosure requirements • Tender offer regulations • Sarbanes-Oxley Act of 2002 • Laws Affecting Corporate Insiders • SEC Rule 10-b-5 • Rule 14-e-3 • The Insider Trading Sanctions Act (1984) • Section 16 of Securities and Exchange Act

20. Other Legal Issues State Antitrust Laws Include anti-takeover and anti-bust-up provisions Provisions usually used in conjunction with each other International Regulation European Commission (EC) Microsoft case

21. Corporate Governance Law and Finance: Capital Markets and National Legal Systems Efficient capital markets promote rapid economic growth.