Merger Activity Due in Large Term Paper

Download this Term Paper in word format (.doc)

Note: Sample below may appear distorted but all corresponding word document files contain proper formatting

Excerpt from Term Paper:

Finance-dominated proponents also maintain that boom economic periods generate a more varied divergence of valuations that fuel merger activity (Medlen 2007). In this regard, Medlen concludes that, "Taken collectively, these understandings may explain some of the merger activity in booms, but they involve certain asymmetries that undercut their explanatory power. High stock valuations allow stock to be utilized as currency and collateral for takeovers; yet stock booms also make targets expensive" (p. 202). Moreover, despite the commonly held perception that mergers are a "quick and dirty" way to grow a business and achieve organizational goals, there remains a lack of convincing empirical evidence in support of this perception (Medlen 2007). As Medlen points out, an "anomalous fact about mergers concerns the lack of evidence that mergers are profitable. This fact begs the question: why then are mergers carried out with such frequency and with such large levels of capitalization?" (p. 202). Nevertheless, the synergistic effect that is associated with merger activity and the perceived ability of the merger approach to help organizations grow their market share has fueled increasing interest in determining what factors serve to influence such activity, and several theories of merger waves are discussed further below.

Theories of Merger Waves

Neoclassical Theory of Merger Waves. At present, the theory of merger waves that is most widely accepted is the neoclassical theory of merger waves. This theoretical model holds that these waves are caused by industry-specific shocks that result in reorganizations among companies competing in a given industry (Komlenovic et al. 2011). According to Komlenovic and his colleagues, "These mergers are the most efficient way to reorganize within a particular industry. A number of researchers to date have identified a positive relationship between the number of mergers in an industry and the magnitude of industry shocks that immediately precede the mergers. As a result, mergers are concentrated in a few industries at a time" (2011, p. 240). Likewise, Ahern and Weston (2010) report that, "Traditionally, mergers and acquisitions (M&as) have been defined to be the purchase of entire companies or specific assets by another company. In more general terms, this implies that a new combination of existing assets is formed. Neoclassical economic theory predicts that the new combination will be more productive than the sum of its parts; hence, synergy gains will be realized" (p. 5).

The research to date provides substantial support for the neoclassical theory; however, industry shocks in isolation from other precipitating events may not be a primary cause of merger waves (Komlenovic et al. 2011). Therefore, it is reasonable to suggest that industry specific shocks are positively associated with aggregate industry mergers (Komlenovic et al. 2011). Neoclassical theories, though, do not provide the robustness needed to capture the long-term performance of acquirers, a constraint that is addressed by the behavioral theory of merger discussed further below.

Behavioral Theories of Merger Waves. Although the goal of the behavioral theories of merger waves is essentially the same as the neoclassical model, the behavioral theories differ in that they seek to explain why high market valuation (e.g., high market to book, high price to earnings) coincides with increased merger activity. According to Komlenovic and his associates, "One of the popular behavioral theories, overvaluation theory, asserts that managers of the overvalued firms take advantage of mispricing by acquiring undervalued firms; therefore, merger waves are driven by the relative valuation of firms" (p. 240). Similarly, Ito and Rose (2009) report that, "Stock market overvaluation promotes corporate managers to acquire relatively undervalued firms. This 'behavioral' hypothesis also suggests that higher share prices cause merger waves" (p. 273).

Likewise, the overvaluation theory maintains that stock acquirers are more overvalued compared to cash acquirers, and that cash-acquired targets are less undervalued compared to their stock-acquired counterparts (Komlenovic et al. 2011). The implications of this theory for merger waves is that "dispersion of market valuation are likely to positively influence industry-level merger activity" (Komlenovic et al. 2011, p. 240). In other words, investors with sufficient liquidity to avoid having to resort to cash alternatives for financing will experience less favorable returns on their investments, in general, compared to their cash-flush counterparts. In this regard, Komlenovic and his associates point out that following the announcement of mergers, "acquirers using stock to finance mergers experience negative long run abnormal returns, while acquirers who use cash experience positive long run abnormal returns" (p. 240). The perception of boom times may therefore spur additional merger activity in the expectations that the boom will continue without interruption, but this perception is comparable to the gambler's fallacy but it nevertheless has played out in real-world situations time and again in ways that influence merger waves. As Komlenovic and his colleagues conclude, "In general, overvalued acquirers perform worse regardless of the way that mergers are financed. Acquirers overestimate the targets' value (and synergy) in times when the market is overvalued and underestimate it in times when the market is undervalued. Therefore, is it reasonable to suggest that overvaluation measures will positively affect industry-level merger activity" (2011, p. 240). Likewise, it is also reasonable to suggest that during periods of economic boom, investors may respond in ways that contribute to increased merger activity, a phenomenon that is discussed further below.

Markov-Switching Model

A number of economic activities demonstrate discernible patterns and waves in their behaviors that are associated with corresponding major economic events such as financial crises or unexpected shifts in governmental policies (Hamilton 1989). In response to the need to better understand these correlations, a number of innovative approaches have been developed that can model these correlations in various ways. In this regard, Engle reports that of these, some employ innovative modeling approaches that rely on data sets that are created for the purpose, especially data sets that use intra-daily information (Hamilton 1989). These modeling approaches include those that are based on daily range statistics and realized volatilities and correlations including Gallo and Otranto (2007) use of regime-switching models of correlation.

In the Markov-Switching Model formulated by Hamilton (1989), conditional densities are governed by parameter vectors, the value of which depends on the state (i.e., expansion or contraction), with state transitions governed by a first-order Markov process (Dewatripont, Hansen & Turnovsky 2003). According to Hargreaves (1994), "The Markov switching model is useful because of the potential it offers for capturing occasional but recurrent regime shifts in a simple dynamic econometric model" (p. 283). The use of the Markov-Switching Model for analyzing merger waves, though, also has some constraints. For instance, Hargreaves emphasizes that, "Existing treatments restrict the transition probabilities to be constant over time; that is, the probability of switching from one regime to the other cannot depend on the behaviour of underlying economic fundamentals" (1994, p. 283). These constraints suggest that a more robust model for merger waves might be developed by including an analysis of companies' Q. ratios as discussed further below.

Q-Theory of Merger Waves. The same type of events that precipitated the Great Depression in 1929 and ended a major merger wave in the United States have been the cause of other cyclical changes in merger activity and some economists suggest that these can best be explained in terms of the Q-theory of merger waves. This theory is based on the overvaluation theory and maintains that as a company's Q. ratio increases, its investment rate rise as well as making it more profitable for it to acquire other companies (Komlenovic et al. 2011). According to Medlen (2003), "Tobin argued that stock market booms encourage new investment" (p. 967). This assertion is fairly obvious and intuitive, Tobin suggests, who writes: "It is common sense that the incentive to make new capital investments is high when the securities giving title to their future earnings can be sold for more than the investments cost" (1996, p. 14). In his analysis of major merger wave that took place at the fin de siecle (the third such wave for England but the first such merger wave for the United States as shown in Table 2 below), Medlen reports that, "This ratio of the market valuation of firms to their replacement costs has been dubbed Q. And has been utilized extensively since the late 1950s to model new investment expenditures. It has also been used to explain takeover mania by egregious undervaluations relative to the fundamental value of the underlying assets" (2003, p. 968).

The empirical evidence to date does appear to indicate that changes in companies' Q. ratio has a more profound impact on mergers and acquisitions compared to direct investment, moreover, companies that have higher Q. ratios are typically more inclined to acquire companies that have lower Q. ratios; however, the association of this ratio with unrelated mergers remains unclear (Komlenovic et al. 2011).

A number of additional salient controls may also have varying effects on industry merger activity that are not included in any particular theory;…[continue]

Cite This Term Paper:

"Merger Activity Due In Large" (2012, May 04) Retrieved December 6, 2016, from http://www.paperdue.com/essay/merger-activity-due-in-large-57134

"Merger Activity Due In Large" 04 May 2012. Web.6 December. 2016. <http://www.paperdue.com/essay/merger-activity-due-in-large-57134>

"Merger Activity Due In Large", 04 May 2012, Accessed.6 December. 2016, http://www.paperdue.com/essay/merger-activity-due-in-large-57134

Other Documents Pertaining To This Topic

  • Mergers and Acquisitions the Situation

    06 or 56.1% to $2.95 while Zhone shares fell down to $2.90 or 18%. Yet, of the new company, Zhone shareholders will own 63.2% and Paradyne shareholders will own 36.8%. (Zhone to Buy Paradyne in Stock-Swap Deal, Says 2Q) Even the Paradyne seniors are being retained and the Chairman and Chief Executive as also the Chief financial Officer will remain as consultants for a period of two years. The analysis by

  • Mergers and Acquisitions as a CEO You

    Mergers and Acquisitions As a CEO, you are trying to acquire a foreign firm. The size of your firm will double, and it will become the largest in your industry. What does your firm do and what does the foreign firm you are trying to acquire do? Where are the firms based? Before any M&A proceeding should occur. An analysis of the macroeconomic factors and industry related factors should be conducted. In

  • Mergers and Acquisitions the Case

    Bibliography Amos Web Dictionary, Gloss arama, Merger, http://www.amosweb.com/cgi-bin/awb_nav.pl?s=gls&c=dsp&k=merger, last accessed on February 28, 2007 Wikipedia, the Free Online Encyclopedia, Mergers and acquisitions, Due Diligence, Procter&Gamble, http://en.wikipedia.org/,last accessed on February 28, 2007 CNN Money, Results of Weekly Pole, 2005, Chris Isidore, P&G to buy Gillette for $57B, CNN Money, January 28, 2005, http://money.cnn.com, last accessed on February 28, 2007 Procter&Gamble buys Gillette to Form the World's Biggest Consumer Products Group, FinFacts Ireland, Business&Finance Portal, January

  • Merger One of the Greatest Mergers in

    Merger One of the greatest mergers in the history of computers was recently organized between Hewlett Packard and Compaq Computers. This was a great victory organized by the chief executive of Hewlett Packard, Carleton S. Fiorina. The direct proof has come within one year of the purchase of Compaq computers at a cost of $19 billion. There was a savings of $3.5 billion and this was achieved in one year, when

  • Business Regulation of Mergers and Implications of

    Business Regulation of Mergers and Implications of Government Intervention - the Case of a Potential Merger for Blockbuster When a large firm in a mature industry wants to grow a common strategy will be the seeking of an acquisition or merger. However, large firms in an industry will often be faced with government regulation which may seek to control and limit the way merger activity takes place. For example, if Blockbuster, a

  • Corporate Merger Between Delta and Northwest Airlines

    corporate merger between Delta and Northwest airlines in order to find out the possible reasons why it was necessary. We evaluate the merits associated with corporate mergers and the challenges that might be faced in the process. A recommendation on how mergers should be carried out is also provided Mergers and acquisitions form a very integral part of the contemporary corporate landscape. Kolker (2010) points out that initial six months

  • AT& T & T Mobile Merger In Order to

    AT&T & T-Mobile merger. In order to analyze this move properly, we will compare this merger with a case study of the merger of Frito-lay and Pepsi to create PepsiCo. At that time, the federal government of the United States was much more supportive of corporate mergers than currently. Without such hostility at the time to hinder it, the PepsiCo company has grown into a very competitive, innovative and healthy


Read Full Term Paper
Copyright 2016 . All Rights Reserved