Mergers and Acquisitions

Mergers and Acquisitions

Mergers and acquisitions influence business. This influence is realized through sensible and dubious decision-making. Moreover, benefits and costs of cash and stock transactions exist when business mergers and acquisitions take place. Furthermore, evidence of financial risk when merging or acquiring an organization in another country exists; however, these risks can be mitigated.

To make sensible decisions, business must understand how mergers are categorized. The categories are horizontal, vertical, and conglomerate. Horizontal mergers are made up “two similar businesses formed as one” (Brealey, Myers, & Marcus, 2004, p. 591). The vertical merger is “companies at different stages of production” and conglomerate mergers require “companies in unrelated business” (p. 591). The appearance of a merger or acquisition may make sense, but more often than not, management falls short in handling “the complex task of integrating two firms with different production processes, pay structures, and accounting methods” (p. 592). In addition, sensible reasoning takes advantage of unused taxed shelters, more debt capacity, and management control.

Challenges exist that add uncertainty to mergers and acquisitions. For investors, money is easier to diversify instead of mergers. In addition, some doubt cast when firms offer a low price-earning ratio per share that could result in a higher share price instead of increased earnings. Investors expect rapid growth, which is why a company enjoys a high price-earning ratio. A game called “the bootstrap game consists in buying undervalued companies and making the market re-rate them to create value for the shareholders of the acquirer” (Quiry, Dallocchio, Le Fur, & Salvi, 2005, p. 358). This game cannot last forever; eventually, earnings will cease.

Mergers and acquisitions benefit from deregulation and changes in technology. Studies suggest that mergers and acquisitions increase productivity (Brealey, et al., 2004). For example:

Healy, Palepu, and Ruback examined 50 large mergers between 1979 and 1983 and found an average increase in the companies’ pretax returns of 2.4 percentage points. They argue that this gain came from generating a higher level of sales from the same assets. There was no evidence that the companies were mortgaging their long-term futures by cutting back on long-term investments; expenditures on capital equipment and research and development tracked the industry average. (p. 606)

Moreover, mergers and acquisitions can be financed through cash or stock. For example, cash can be used when management and shareholders consent to the purchase of “at least the stand-alone value of their shares” (p. 597). A stock transaction allows firms to safeguard its cash for other investments, which also adds market value. In addition, “the target company shareholders will retain a stake in the merged firm,” this appreciates due to an increase of investments from investors after a merger (p. 599).

If cash is offered, the cost of the merger is not affected by the size of the merger gains. If stock is offered, the cost depends on the gains because the gains show up in the postmerger share price, and these shares are used to pay for the acquired firm. (p. 599).

Financial risk exists when merging or acquiring an organization in another country. For many companies, the risk comes from the internal operations. Cultural differences, business differences, skewed expectations, management head butting, and employee happiness are all causes that lead to low productivity (Brealey, et al., 2004). One way to mitigate these risks is to focus on merging cultures and organizations effectively. Financial risk also happens because of international exchange rates. Exchange rates ebb and flow, as they do “the dollar value of their revenues or expenses also fluctuate” (p. 629).

Companies will run into “two types of exchange rate risk: transaction risk and economic risk”