Businesses Engaged in the 'Transfer Term Paper

  • Length: 13 pages
  • Sources: 20
  • Subject: Economics
  • Type: Term Paper
  • Paper: #83618278

Excerpt from Term Paper :

In contrast with the mutual funds, 'Mutual funds trade hundreds of stocks in many unrelated industries, with very little of the total portfolio in any single stock. By contrast, when a company expands into a new area, its portfolio consists of two stocks, typically 90% in the core operation and 10% in the new businesses' (Tirole, 2005). The diversification in majority of the cases is responsible for lower return and maximal risk factor. Researchers have observed that there is possibility of higher failure rates and lower returns for unrelated acquisitions than for related acquisitions. When the company acquires businesses in their own industry, it is observed that lowest failure rates and highest returns phenomenon occur. The reason why the diversification into unrelated business is considered to be risky is that the corporate is unfamiliar about the industry itself, and therefore the corporate is likely to overlook critical risk factors during due diligence. The corporate is expected to pay more towards the acquisition of strange industry, and will experience trouble to monitor the performance of the new acquisition. It is therefore important that the company conduct the process of due diligence in comprehensive and thorough manner, and the entire proceedings should be flawless. Often the company has appointed non-technical and irrelevant people to monitor the task force, and different departments after the alliances, such appointments will affect the performance and growth of the business, and therefore the shareholder's investment is expected to be at stake. Diversification is popular and common practice in the American market. The responsibility of the manager is to increase the wealth of the shareholders, and therefore if the diversification efforts are consistent it is expected that the shareholders will be able to benefit (David, 2002).

It is expected that the diversification of the firms is responsible for the growth of sales i.e. To be considered less vulnerable to the business conditions, therefore the diluting volatility will support and enhance the performance and initiatives of the management, and it is expected that ultimately the shareholder will enjoy the benefits of such efforts. Diversification is responsible for the diminishing the volatility of the profits, and therefore the expected profit remain consistent. Diversification also have an impact size of the firms, the size of the firm is expected to increase after it diversify through acquisition of other firms, and it is believed that such acquisitions offer hidden payoffs to the top management on the basis of the company's size and magnitude. It is not always necessary that the diversification is profitable for the shareholder. There is no difference 'between the diversification of the portfolio of shares and diversification by the firms, and the shareholders' (Tirole, 2005) investment is at risk. Considering the example of developing countries, the steel company has diversified its operation into telecommunication, and therefore there is equivalent portfolio of shares in telecommunication and steel company separately. Therefore the diversification carried through portfolio is proper course to lower the volatility in a diversified firm, 'this alternative is readily available to the owners directly, and hence managers do not add value by doing firm-diversification if the only gain is a reduction in the risk factor of profits and sales'. The firm diversification is not responsible for the addition of value, rather it reduce the value, the reason because alliance activities are considered to be expensive, and therefore it require great deal of managerial efforts for the execution of an exercise centered at entrance into a new industry, also 'buying out an existing company in the target industry but assimilating the taken-over company is still an onerous and time consuming task where failures are not uncommon' (Tirole, 2005).

Trend for R&D Alliance

It is argued that the degree of diversification is the measure for the size of benefits likely to be achieved by the shareholders. The small benefit is achieved by the shareholder involved in the diversified project; therefore such investors are poorly inclined towards IPO of such diversified firms. The reduction in the likelihood of an IPO is linked with the increase in the degree of diversification, therefore IPO is mainly preferred by such investors who are strange to diversified companies, and as such investors have the potential to make profit from diversification of their portfolios. The firm is likely to go public if the stakeholders are diversified, and possess equal shares. The banks are likely to avail the opportunity for the increasing the value of deposits insurance, therefore, 'an acquisition policy designed to maximize the value of deposit insurance may be shareholder-wealth maximizing if an increase in the value of deposit insurance increase shareholder wealth'. It was believed that the possibility that banks seek to become larger to increase the probability is possible provided that the FDIC will cover 100% of the bank's deposits, the "deposit insurance put-option-enhancing" hypothesis predicts the pursuance of the growth under social suboptimal conditions, the alliances of banks equity also improve the pursuance of growth in terms of increase in salary, perquisites, and personal prestige. The deposit-insurance hypothesis is based on the assumption that the 'acquirers would be willing to pay more for riskier, more profitable organizations whose returns are highly correlated with the acquirer's returns' (William, 2005).

The managerial-interest hypothesis is constant and consistent, and has no relationship with purchase price and exposed risk. It is expected that corporate in particular banks through maximizing risk fail to maximize the shareholder wealth; it is because the regulatory will defy any such risk exposure associated with funding of shareholders, and also in the case of failure the expected loss will be greater than the deposit insurance. Therefore the wealth of the shareholder can be increased through alliances that diversify earnings. The earnings diversification hypothesis is based on the fact that higher levels of cash flow for the same level of total risk can be achieved through acquiring banks i.e. seek earnings diversification, 'the reductions in business risk are offset by increases in financial risk'. The analysts are of the opinion that acquisition of firms can offset the reduction in equity value, which can be achieved through issuance of additional debt; such measures diminish the probability level of bankruptcy to the previous level, there have been strong evidence that leverage is increased as a result of alliances and acquisitions between the non-financial firms. It has been observed that banks acquired by bank holding companies have reduced their capital ratios after acquisitions, and reduction has been incorporated at significant level, 'the increased leverage increases the tax shield due to debt and, hence, after-tax net cash flow' (Tirole, 2005). The acquired banks reduce their holdings of low-risk securities to a greater level, and also improve their holdings of loans, this correspondingly increase the earnings (Karl, 1999).

Features and Disadvantage of Joint Venture

The revenue enhancement and cost cuttings are the major reason behind alliances and acquisition activities. The exploitation of the potential costs and revenue is achieved through alliance activities, in 1996, the alliance of Chase Manhattan and Chemical Bank created largest banking organization in U.S.A, the assets of the company after alliance stood at $300 billion, it was reported that the alliance was responsible for the annual savings of more than $1.5 billion, which was achieved through 'consolidation of certain operations and elimination of redundant costs' (Tirole, 2005) which was based on the removal of 12,000 positions from combined staff of 75,000. The alliance was responsible for expansion of the operations, and the corporate had its branches in more than 39 states of American, and was present in another 5 countries across the world. The Ban cone purchased First Chicago in 1998 for $30 billion; the acquisition was responsible for the annual cost savings of more than $930 million, additional $275million was saved through integration of credit card and other retail and commercial services. The Firstar acquired Bancorp for $18.7 billion in late 2000, it was expected that the alliance will reduce the expenses by $206 million on annual basis. The acquisition of Summit Bancorp by Fleet Financial's for $7 billion in 2001 was responsible for the annual savings of $275 million.

It is expected that acquisition of the bank is likely to increase the revenues in the growing market. The alliance of J.P-Morgan and Chase Manhattan in 2000, and the establishment of J.P-Morgan-Chase was responsible for cost savings of $1.5 billion; the alliance was performed to increase the revenue growth. The alliance combined 'J.P. Morgan's greater array of products with Chase's broad client base, the alliance added substantially to many businesses such as equity underwriting, equity derivatives, and asset management', which previously both the firms failed to launch in a comprehensive manner individually, both the corporate mutually were able to develop their own presence through deals, and were able to achieve presence in Europe, 'where investment and corporate banking were fast growing businesses' (Tirole, 2005). The assets and liability portfolio of the institution offer different credit, interest rate, and liquidity risk characteristics which is based on the stability of…

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