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Introduction

Mergers and acquisitions (M&A) are now emerging as a major influence on contemporary business expansion. They provide a popular means of achieving rapid growth and market entry. It has been reported that there are over 0,000 M&A transactions annually in the new Millennium, which could equivalent to the completion of one deal every 17 minutes. Companies spent $,500 billion US dollars altogether in 000 in all M&A cases, a huge increase despite nearly $500bn in 11 and $1,500bn in 17. These factors could figure out that, from both terms of global cases and investment, merger and acquisition are widely welcomed by chief executives globally.

In spite of the popularity of merger and acquisition, a recent report of Financial Times sounded the alarm and gave a warning between 65 and 75% of all mergers and acquisitions fail. Some other resources reported about one in two merger and acquisition cases fail. Anyway, it seems that M&A activities should be accompanied by a lot of risks. Obviously, chief executives actively pursue this risky method of business expansion because they are confident to handle the problems accompanying their M&A activities.

Why are they willing to take the high risks and pursuit M&A? What benefit can merger and acquisition bring to them? What kind of risk will they face that could be very dangerous if they fail to handle? What critically determine M&A to succeed or fail? This disquisition aims to find answers to these questions.

Literature review on M&A

M&A Concepts

Before going any further analysing mergers and acquisitions, some sort of theoretical background research are to be done. The very first of all what is merger and acquisition?

A merger, in my opinion, can be viewed as a combination of two previously separate organisations rather than a take-over of one by the other. A merger involves two companies, often of approximately similar size, coming together to combine all of their assets. The result of a merger is the formation of a new legal entity that encompasses the combined assets of the two previously independent companies. Shareholders in the two merging companies become the joint owners of the new entity.

In contrast, an acquisition may be defined as one company, the 'bidder', purchases a controlling interest in another company, the 'target'. Typically, the bidding firm offers either cash or its own shares in exchange for the shares of the target company. Once the acquisition is completed, the bidding company controls all of the assets, both tangible and intangible, of the target entity and for this reason acquisitions are often referred to as take-overs.

M&A Performance

There has been a great deal of academic studies about M&A performance. One study by McKinsey & Company reveals that 4 per cent of international acquisitions fail to produce a financial return that meets or exceeds the acquirer's cost of capital; put another way 4 per cent destroy shareholder value for the acquiring firm. (Bleeke and Ernst, 1)

Other studies have adopted broader definitions of performance, typically assessing the outcome of an acquisition against the original objectives set for it, both financial and non-financial. These assessments are usually carried out three to five years following the completion of the acquisition and are conducted using input from the acquiring company. Recent research along these lines indicates that 45 to 55 per cent of acquirers are 'neutral to highly dissatisfied' with the overall performance of their acquisitions.

Approximately 45 per cent of all acquired firms are divested after an average of seven years under the ownership of the acquirer. Divestment has sometimes been taken to signify acquisition failure, but it could also indicate that an acquirer wishes to realise its profits following a successful restructuring of the acquired company. Indeed, research data further show that 40 per cent of divestitures are sold on at a price in excess of their acquisition cost, so this is perhaps not a particularly reliable performance measure. (Kaplan and Weisbach, 1)

Some researchers have investigated the impact of M&A on overall wealth generation, which typically rely on stock market measures of performance. Wealth generation is calculated from the change in the share prices of the bidder and target around the time of the acquisition announcement. Results of such studies reveal that, in general, acquisitions create negligible or only very small wealth gains. However, the distribution of any gain between the shareholders of the bidding and target companies is not even.

One in-depth study of 4 British acquisitions completed between 180 and 10 found that target companies gained approximately 0 per cent in value, while shareholders in bidding companies lost approximately 5 per cent. The acquisitions had produced overall wealth gains of only per cent. A further interpretation of this result is that at the level of the overall economy acquisition activity represents little more than the transfer of wealth from bidder to target shareholders. (Sudarsanam, Holl and Salami, 16)

However, it is interesting to note that while the stock market based studies have tended to show that on average bidders' returns are negative, within this most do report that around 50 per cent of individual bidders show positive abnormal returns. This again confirms the finding that only approximately one in two acquisitions can be classified as successes for the acquiring company.

The Four Value Creation Mechanisms

The ultimate driver of value creation within acquisitions is the ability to leverage the individual resources and capabilities of the combining companies. The value creation could be very important motive for chief executives in making an M&A decision. Relevant arguments have led to a more generalised model of acquisition value creation. (Haspeslagh and Jemison, 11; Porter, 187) There are four generic mechanisms through which value can be created from an acquisition

1. Resource Sharing, in which certain operating assets of the two companies are combined and rationalised, leading to cost reductions through economies of scale or scope. Resource sharing is generally based on the existence of similarities between the two organisations and frequently employed within intra-industry acquisitions.

. Knowledge (or skills) Transfer, where value-adding knowledge such as production technology, marketing know-how, or financial control skills is transferred from the acquiring firm to the acquired, or vice versa. Additional value is created through the resulting reduction in costs or improvement in market position leading to enhanced revenues and/or margins. Knowledge transfer is often a key source of value creation within cross-border acquisitions, in which the opportunities to share operational resources may be limited by geographic distance.

. Combination Benefits, where an increase in market power or a reduction in competitive intensity is achieved, or where financial resources are beneficially combined. A company making a large acquisition within its existing industry, or a series of smaller ones, may succeed in raising profit margins by effecting a transformation of the industry structure. In other instances financially based combination benefits may be available. These may include the use of an acquirer's superior credit rating to reduce the interest charge of an indebted target, the consolidation of a target's losses to reduce tax liability, or the exploitation of various balance sheet positions.

4. Restructuring is applicable when the acquired company contains undervalued or under-utilised assets. Here acquirers seek to exceed their acquisition costs by divesting certain assets at their true market value and by raising the productivity of the remaining assets. The skill of the acquirer is in recognising and being able to realise the true value of the target's assets.

Motives of M&A

Individual firms may have wide range of motives for making an acquisition. But generally the term 'merger' and 'acquisition' do have precise meanings in certain contexts, for example legal structures. They share common motives and criteria for success. The wide range of motives for making an M&A can be classified into three groups strategic motives, financial motives and managerial motives.

Strategic Motives

A firm may undertake a merger or acquisition in order to increase its penetration of an existing product market, to enter a new product market, to enter a new geographical territory or to diversify away from its core business.

M&A may be a particularly attractive means of achieving such strategic developments under certain conditions. Firstly, in mature industries containing a number of established players, expansion or entry via merger or acquisition can avoid the competitive reaction that can accompany attempts to grow by organic growth; rather than intensifying the rivalry by adding further productive capacity, the potential competition is purchased. Secondly, in some industries economies of scale are central to a competitive cost structure and the purchase of an enterprise that is already of the requisite scale can provide entry without the risk of starting at a cost disadvantage.

Furthermore, in consumer goods industries this argument can be extended to securing distribution channels. A frequent barrier to a product range expansion or a move into a new product area is the premium attached to retailers' shelf space. Acquisition of a company that is already operating in the desired product area gives immediate access to an established distribution channel and its valuable shelf space, in addition to its other assets such as manufacturing capacity and brand name. Similarly, the speed with which acquisitions can provide an established market position can be very useful if a firm believes it is a late entrant relative to its competitors into a particular product or geographic market.

Companies may also undertake a merger or acquisition because they wish to strengthen their existing resource base in a specific area or because they lack a particular competence that would be needed to develop their strategy by internal means. For example when AOL merged with Time Warner it gained access to their back-catalogues of books and films, an asset that would have been virtually impossible to develop internally. Similarly, an acquisition might be used to gain a leading-edge product or process technology, an established brand name, access to a distribution channel, or managerial know-how. The latter factor can be especially relevant to cross-border acquisitions there the bidding company often lacks any operating experience in the overseas market and is keen to exploit the local market knowledge of the target firm's management team.

Financial Motives

Organisational growth via merger and acquisition may be particularly attractive to a publicly quoted company if its priceearnings ratio is relatively high compared to that of target companies. Under such circumstances an acquisition funded by shares can provide an immediate earnings per share enhancement to the acquiring firm.

This type of financial logic also extends to the acquisition of companies in order to exploit their accumulated tax credits or high balance sheet liquidity. A company making healthy profits may be attracted to acquire a target firm that has built up losses over a period of time. Once the acquisition is completed, and if the appropriate accounting conditions are met, the accumulated losses of the target can be set against the future profits of the acquirer so reducing the latter's corporation tax liability. Similarly, a firm that possesses a cash-rich balance sheet or is in a highly cash generative business may make an attractive take-over target for a company that has promising investment opportunities of its own. The acquirer is able to raise the rate of return on the target company's cash by investing it in its own business or to extend its own borrowing capacity by virtue of its enhanced cash flow position. This logic can even be reversed where by acquirers with very strong balance sheets and a associated high credit rating take over a highly geared business and subsequently enhance profits by refinancing the debt within the acquired company at a lower interest rate.

Finally, some acquirers are motivated to make acquisitions in the hope that they can purchase a company at a bargain price and later sell it on, either whole or in its constituent parts, at a profit. While few, if any, pure 'asset-stripping' opportunities remain today; a modern variant is the practice of 'unbundling'. This involves acquiring an existing conglomerate, the stock market value of which is less than the sum of the individual constituent businesses. The businesses are then sold off piecemeal, creating a surplus over the acquisition cost

Managerial Motives

It has been suggested that some take-overs be undertaken in the interests of the firm's managers rather than its shareholders. An acquisition can help to advance a manager's own position through a rapid increase in the size of the company that the manager is responsible for, or through an increased dependence on the manager's particular skills via the purchase of a target business which is reliant on those skills. (Berkovitch and Narayanan, 1)

Acquisitions that are motivated primarily by the self-interest of the managers of the acquiring firm are unlikely to be value maximising for its shareholders. This is for two reasons. First, managers driven to make acquisitions for personal reasons may be less concerned to make a careful economic analysis of whether the acquisition has the potential to create shareholder value. Second, they may be prepared to pay a higher price for the acquisition than would be justified on purely economic grounds. Direct research into the 'empire building' theory of acquisitions is very difficult given the natural reluctance of executives to admit that personal motives may have played a role in a corporate decision.

However, there is tangential support available from research, which shows that firms with strong CEOs but weak corporate governance structures tend to pay higher premiums for their acquisitions. Where a strong CEO was also chairman of the board, or where the board of directors contained a low proportion of non-executive (external) directors, the acquisitions made by the firm exhibited higher bid premiums and inferior shareholder returns. Put more positively, the findings do also suggest that the presence of a strong board of directors can limit the ability of executives to pursue acquisitions for their own motives. (Hayward and Hambrick, 17)

Why M&A Fail

There are many reasons that could make an M&A fail. There are two most popular but important reasons that all chief executives have to consider carefully. First, to recover from the bid premium and second, the employee resistance. Any inconsiderateness about any single one of the mentioned possible-failure-causes will lead to disaster of the whole M&A performance.

The Bid Premium

The share price of a target company tends to rise on the announcement of an acquisition, which is because the shareholders of a target company almost always demand a premium over and above the current share price before they agree to accept a take-over offer. This premium is known as the 'bid premium'.

The average bid premium for British take-overs involving publicly quoted companies has been around 5 per cent for friendly (agreed) acquisitions in recent years, whereas hostile acquisitions have attracted premiums of around 45 per cent. The higher premiums paid in hostile take-overs reflect the greater resistance to the bid approach and there may be competition amongst more than one bidder. This is one reason why hostile acquisitions have been found to perform less well than friendly transactions from the perspective of the acquiring company. (Healy, Palepu and Ruback, 17) In a pure merger it may be that no bid premium is required, as managers and shareholders of both parties wish the transaction to proceed and will continue to have a stake in the control and ownership of the merged entity.

Clearly, the need to pay a bid premium puts a major constraint on an acquirer's ability to generate positive returns for its own shareholders as a result of an acquisition. In order to create value successfully, the future cash flow stream of the acquired company has to be increased by an amount that exceeds the bid premium, plus the often-overlooked costs incurred in integrating the acquisition and making the bid itself. Let us have a look at a simplified example a company that has a pre-bid stock market value of £100 million. If the company is subsequently acquired at a 5 per cent bid premium for £15 million, it means that the acquirer must raise the future cash flows by £5 million just to recover the bid premium, which has already paid to the previous owners. In effect, the bid premium is a portion of future value that is paid in advance to the previous owners. The acquisition will only generate value for the acquirer if future cash flows are raised by more than £5 million. Many acquisitions fail merely because insufficient value is created to recoup the bid premium.

Employee Resistance

In many instance Employee Resistance hinders the ability of the acquirer to create the planned value. Employee frequently feel high levels of anxiety and uncertainty when a merger or acquisition is announced as concerns are voiced over issues ranging from changes in management style to possible redundancies. These concerns are often compounded once the acquisition is complete and new reporting hierarchies, management structures, and control systems are actually introduced. Staff and managers within the acquired firm can feel alienated and marginalised by the changes themselves and also by the implications for planned career paths and previously familiar and comfortable working patterns. These negative feelings can manifest themselves as increased employee stress, reduced work performance and commitment acts of non-compliance and in some cases even deliberately disruptive behaviours.

The impact of employee resistance is confirmed by research conducted within newly acquired US firms. Human resource problems, including absenteeism, staff turnover, conflict levels and reduced work quality, rose in line with the degree of change that followed an acquisition. The occurrence of these human resource problems, in turn, had a clear negative impact on the subsequent performance of the affected acquisitions. (Shanley, 14)

Culture clashes can be a major cause of employee resistance. M&A involve the coming together of two separate organisational cultures that had previously defined the rituals and routines of working life within their respective companies. The marriage of different and incompatible cultures can foster feelings of uncertainty and insecurity amongst employees as differences in the philosophies, values and practices of the two companies become exposed in the post-acquisition period. Several empirical studies have found that differences in the national cultures of the bidder and target are associated with inferior acquisition outcome, although the separation of the influences of organisational and national culture is a methodological difficulty faced by such studies. (Schoenberg, 000)

Conclusion

M&A are an increasingly popular means of corporate expansion, motivated by a variety of strategic, financial and managerial objectives. Yet despite their popularity, it has been confirmed by a report of the Financial Times that between 65 and 75% of all mergers and acquisitions fail.

There are two major causes of M&A failures. First, the sufficient additional value must be created within the combined entity to more than offset any bid premium paid and the associated costs of combination. Second, employee resistance to the combination must be minimised in order to avoid long-term human resource problems and the loss of key personnel.

Despite the high failure rate of M&A deals, chief executives still pursue merger and acquisition. This is because of the three major motives, namely strategic, financial and managerial, and the value creation mechanisms. These could be the main reasons why M&A appear set to remain a central component of the corporate strategy agenda. References

Berkovitch E. and Narayanan M. (1). 'Motives for Takeovers An Empirical Investigation'. Journal of Financial and Quantitative Analysis, 8/ 47-61

Bleeke,J. and Ernst D. (1). Collaborating to Compete Using Strategic Alliances and Acquisitions in the Global Marketplace. New York J. Wiley &Sons

Haspeslagh P. and Jemison D. (11). Managing Acquisitions Creating Value through Corporate Renewal. New York Free Press

Hayward M. and Hambrick D. (17). 'Explaining the Premiums Paid for Large Acquisitions Evisence of CEO Hubris'. Administrative Science Quarterly, 4 10-7

Healy P., Palepu K. and Ruback R. (17). 'Which Takeovers Are Profitable? Strategic or Financial?' Sloan Management Review, 8/4 45-57

Kaplan S. and Weisbach M. (1). 'The Success of Acquisitions Evidence from Divestitures'. Journal of Finance, 57/1 107-8

Porter M. (187). 'From Competitive Advantage to Corporate Strategy'. Harvard Business Review, 65/4-5

Schoenberg R. (000). 'The Influence of Culture Compatibility within Cross-Border Acquisitions A Review'. Advances in Mergers and Acquisitions, 1 4-5

Shanley M. (14). 'Determinants and Consequences of Post-Acquisition Change', in G. von Krogh, A. Ainatra and H. Singh (eds.), The Management of Corporate Acquisitions. London Macmillan, 1- 41

Sudarsanam S., Holl P. and Salami A. (16). 'Shareholder Wealth Gains in Mergers Effect of Synergy and Ownership Structure'. Journal of Business Finance and Accounting, 67-8

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