Theories of Mergers

GARIMA SINGH MBA 4TH SEMESTER ROLL NO.
- 51
EFFICIENCY THEORIES
Differential efficiency theory.
Inefficient management theory. Synergy.
Pure diversification.
Strategic realignment to changing environment. Undervaluation.
According to this theory if the management of firm
A is more efficient than the firm B and if the firm A acquires firm B, the efficiency of firm B is likely to be brought up to the level of the firm A. The theory implies that some firms operate below their potential and as a result have below average efficiency. Such firms are most vulnerable to acquisition by other more efficient firms in the same industry. This is because firms with greater efficiency would be able to identify firms with good potential but operating at lower efficiency.
This is similar to the concept of managerial efficiency but
it is different in that inefficient management means that the management of one company simply is not performing up to its potential. Inefficient management theory simply represents that is incompetent in the complete sense.
Synergy refers to the type of reactions that occur when two
substances or factors combine to produce a greater effect together than that which the sum of the two operating independently could account for. The ability of a combination of two firms to be more profitable than the two firms individually. There are two types of synergy: Financial synergy. Operating synergy.
Diversification provides numerous benefits to managers,
employees, owners of the firms and to the firm itself. Diversification through mergers is commonly preferred to diversification through internal growth, given that the firm may lack internal resources or capabilities requires.
It suggests that the firms use the strategy of M&As as ways
to rapidly adjust to changes in their external environments. When a company has an opportunity of growth available only for a limited period of time slow internal growth may not be sufficient.
The acquiring firm has information about the acquired
firm which leads it to believe that the latter in undervalued.
The tender offer sends a signal to the market that the
target companys shares are undervalued.

The offer may signal information to the target
management which motivates them to become more efficient.

The target managements response to the offer and the
means of payment may also have signaling value.
Agency problems may result from a conflict of interest
between managers and shareholders and between shareholders and debt holders .
Takeovers are viewed as the last resort to discipline
self serving managers.
Takeovers are a manifestation of the agency problem,
not its solution.

Self serving managers embark on mergers to expand
their empire and improve their own career prospects.
Takeovers take place because of the conflicts between
managers and shareholders over the payout of free cash flows.

Free cash flows should be paid out to shareholders
thereby reducing the power of management and subjecting managers to the scrutiny of the public markets more frequently.
Debt-for-stock exchange offers are viewed as a means
of bonding the managers promise to pay out future cash flows to stakeholders.
Acc . to Jensen- Free cash flow is the cash flow in excess of the amounts required to fund all projects that have positive net present values when discounted at the applicable cost of capital.
Such free cash flow must be paid out to shareholders if the firm
is to be efficient and to maximize the share prize.

The payout of free cash flow reduces the amount of resources
under the control of managers and thereby reduces their power.

In addition, they are then more likely to be subject to
monitoring by the capital markets when they seek to finance additional capital investments with new capital.
This theory states that the merger occurs to increase
the market power of an organization.

(But the market power can also be achieved by the
internal expansion of the firm.)

To acquire a larger volume of operations sooner. Market gains are the results of increased concentration
leading to collusion and monopoly effects.
Tax minimizing opportunities. Carry over of net operating losses, tax credits and the
substitution of capital gains for ordinary income are among the tax motivations for mergers.
Looming inheritance taxes may also motivate the sale
of privately held firms with aging owners.
Acc. To this theory, the source of the value increases
in mergers is redistribution among the stakeholders of the firm

Gains from a merger may come at
the expense of
other stakeholders in the firm.

Expropriated stakeholders may include bond holders,
government and organized labour.

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What are some of the efficiency theories discussed in the document?

What are some of the efficiency theories discussed in the document?

What does synergy refer to according to the document?

What does synergy refer to according to the document?

GARIMA SINGH MBA 4TH SEMESTER ROLL NO.

According to this theory if the management of firm

This is similar to the concept of managerial efficiency but

Synergy refers to the type of reactions that occur when two

Diversification provides numerous benefits to managers,

It suggests that the firms use the strategy of M&As as ways

The acquiring firm has information about the acquired

firm which leads it to believe that the latter in undervalued.

The tender offer sends a signal to the market that the

target companys shares are undervalued.

management which motivates them to become more efficient.

means of payment may also have signaling value.

Agency problems may result from a conflict of interest

self serving managers.

Takeovers are a manifestation of the agency problem,

not its solution.

their empire and improve their own career prospects.

Takeovers take place because of the conflicts between

managers and shareholders over the payout of free cash flows.

is to be efficient and to maximize the share prize.

under the control of managers and thereby reduces their power.

This theory states that the merger occurs to increase

the market power of an organization.

internal expansion of the firm.)

leading to collusion and monopoly effects.

of privately held firms with aging owners.

Acc. To this theory, the source of the value increases

in mergers is redistribution among the stakeholders of the firm

other stakeholders in the firm.

government and organized labour.

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