Overview of Theories in M&A

Merger and acquisition has brought forth a total of seven different theories (Lubatkin, 1983).

Gort‘s (1969) disturbance theory and those approaches that view mergers as process outcomes belong in the second category. Firstly, the category most theories focus on shareholders‘

interests while one group focuses on managers‘ interests and their deviations from shareholder value maximization as showed in Figure 15.

Merger as

Merger as process outcome Process theory

Merger as macroeconomic phenomenon Disturbance theory

Source: Trautwein, 1990

Figure 15 Theories of M&A motives

Lubatkin lists M&A motivation into seven main theoretical areas such as Monopoly,

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Efficiency, Valuation, Empire Building, Process, Raider and Disturbance theory. Later a

systematic summary of the motives was provided by Trautwein (1990) and Cox (2006).

Besides, Foerster and Fortier describes information theory as one of M&A theories. The motivations for merger and acquisition activity seem reasonable of study as has been the case in the past (Berkovitch and Narayanan, 1993, Markides & Oyon, 1998 & Trautwein, 1990).

3.2.1 Efficiency theories

Efficiency Theories are the most optimistic views about the potential of mergers for social benefits. This theory argues that there are indifferences in the effectiveness of managements between companies. This theory also involves the possibility of achieving three forms of synergy such as financial synergies result in lower costs of capital, operational synergies can stem from combining operations of hitherto separate units for example a joint sales force or from knowledge transfers (Porter 1985), Managerial synergies are realized when the bidder‘s managers possess superior planning and monitoring abilities that benefit the target‘s performance. This theory makes the assumption that economies of scale do exist in the industry and that prior to the merger, the firms were operating at a level of activity that fell short of achieving the potentials for economies of scale in accordance with three types of synergies.

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3.2.2 Monopoly theory

This theory describes merges as being planned and executed to achieve market power.

Conglomerate acquisitions may allow a firm to embark on three types of advantages. Firstly, the firm could cross-subsidizes products. For example, STX have set up the greatest vertical integration in order to sustain a fight for market share in another market ranging from ship components, engine, shipbuilding, sipping and energy & power plant. STX allegedly did this after M&A. Secondly, the firm could target at simultaneously limiting competition in more than one market. One way to do so is tacit collusion with competitors it meets in more than one market (Edwards, 1955). A practical example is building a foothold in a competitor‘s main market who in turn possesses such a foothold position in the firm‘s main market (Porter, 1985). Lastly, the firm could aim at deterring potential entrants from its markets. One possible way of achieving this is concentric acquisition by a market leader (Steiner, 1975). These kinds of advantages have been referred to as competitor interrelationships (Porter, 1985) or collusive synergies (Chatterjee, 1986).

3.2.3 Valuation theory

This approach argues that mergers are planned and executed by manages who have better information about the target‘s value than the stock market (Steiner, 1975; Holderness and Sheehan, 1985; Ravenscraft and Scherer, 1987). Bidder‘s managers may catch an undervalued company, or they have unique information about possible advantages to be obtained from

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combining the targets with their own. Like the financial synergy argument this hypothesis conflicts with that of an efficient capital market. In the common sense an efficient market does not preclude the existence of undervalued target firms, but only the possibility of capitalizing on revealed private information (Wensley, 1982).

3.2.4 Empire-building theory

In this theory, mergers are planned and executed by managers who maximize their own utility instead of shareholders‘ value (Berle and Means, 1933). Recently, Rhoades (1983) and Black (1989) have developed related merger explanations. In Baumol‘s model (1933) managers maximize revenues subject to a minimum profit requirement. Marris‘ model (1964) overcomes this static perspective and instead postulates the financially sustainable growth rate of assets as the goal pursued by managers. An empire-building argument is not necessarily confined to the motive of growth maximization (Rhoades, 1983). Rhoades connects the profit motive and the power motive as possible explanation of business behavior.

3.2.5 Process theory

This theory describes strategic decisions not as comprehensively rational choices but as outcomes of process governed by one or more of the more of the following influences: firstly organizational routines, secondly political games played between an organization's sub-units and outsiders, and lastly individuals' limited information processing capabilities. The evidence

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on the process theory can best be described as ambiguous. The available evidence is largely supportive (Trautwein, 1990).

3.2.6 Raider theory

A raider is a person who causes wealth transfers from the stockholders of the companies he bids for in the form of greenmail or excessive compensation after a successful takeover. This theory, however, has two problems such illogic and the completely unfavorable evidence.

Firstly, any extortion scheme would hurt him disproportionately after controlling stockholder of the company, while partially bought-out stockholders might still enjoy a net gain from his activities. Secondly, in many studies initiated by some of the most prominent so-called raiders, Holderness and Sheehan (1985) found target‘s shareholder‘s to gain in all cases.

3.2.7 Disturbance theory

M&A waves are caused by economic disturbances: Economic disturbances cause changes in individual expectations and increase the general level of uncertainty, thereby changing the ordering of individual expectations. Previous non-owners of assets now place a higher value on these assets than their owners and vice versa. The result is an M&A wave. This theory is not reflecting on further for three bases. First, it does not discuss the institutional framework for mergers. Second, most disturbances are of a sectoral nature. Lastly, Gort (1981) explains how disturbances affect individual expectations is not sufficient for his hypothesis that this

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overturns the ordering of expectation.

3.2.8 Information theories

Information theories refer to the revaluation of the ownership shares of firms owing to new information that is produced during the merger negotiations, the tender offer process, or the joint venture planning. This theory is described as two types such as the kick-in-the-pants explanation and the sitting-on-a-gold mind hypothesis. The first shows where management is encouraged to implement a higher valued operating strategy. The latter describes where negotiations or tendering activity may involve the dissemination of new information or lead the market to judge that the bidders have superior information. The market may then revalue previously "undervalued" shares (Foerster & Fortier, 2000).