ECON 3420 Notes 7 [M&A]

ECON 3420 Notes 7 [M&A] - Mergers and Acquisitions...

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Mergers and Acquisitions In this chapter we study a special type of financial activity – mergers and acquisitions. M&A attracts much attention of financial economists because they utilise a vast amount of financial resources. Economists in general are intrigued by these activities and wonder if they are justified by real gains to society. In the beginning, economists had a sympathetic view on M&A, thinking that they were activities that discipline ineffective managers and improve efficiency of the economy. More recent findings suggest that this view is too simplistic. Modern thinking is that M&A benefits the managers of the acquirers mainly. In the following, we will see why. (I) Background In the U.S., thousands of companies change hands every year. In constant dollar terms, the 1960s and the 1980s marked two separate waves of heavy M&A activities. The former wave saw massive conglomeration activities in which big firms diversified into new lines of business. The latter wave was essentially a reverse of the first, in which conglomerates sold off their non- core divisions to concentrate on their main businesses (core competencies). There are three ways in which the control of a company can be obtained. First, the management of two companies can negotiate a mutually agreed price for shares of one of the companies. This is called a friendly takeover. Frequently, rather than being cash transactions, shares of the two companies are exchanged. After the exchange, the shares of the smaller company will not be traded any more and the larger company in effect acquires the smaller company. The shareholders of the smaller company become the shareholders of the merged company. Second, a bidder makes an offer to the public to buy a certain number of shares of the target company at a certain price. If the offer is made without the consent of the target's management, such an offer is a hostile attempt to take over the target, hence the name hostile takeover. Third, voting power at the annual general meeting can be obtained by collecting proxies from shareholders, without actually purchasing shares. As this option does not change company ownership, it falls outside the scope of mergers and acquisitions. One common form of acquisition is management buy-out (MBO) in which the managers of a company buy up a substantial portion of the shares to control the board of directors, and so the company. Many acquisitions involve massive capital, and one way to obtain financing is by issuing bonds. These acquisitions fall into the category of leveraged buy-outs (LBO), in which the earnings capability and the assets of the target are utilized to back up the loans. Many MBOs are also LBOs. In the context of LBOs in the U.S., junk bonds, which are bonds rated as below investment quality by rating agencies, carry special importance. The success of the junk bond market in the 1980s made the acquisitions of even the largest corporations possible.
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ECON 3420 Notes 7 [M&A] - Mergers and Acquisitions...

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