The History of Mergers and Acquisitions

The History of Mergers and Acquisitions Two major themes: 1. Each of major merger movements reflected some underlying economic or technological factors 2. Macroeconomic environment is important a. GDP growth b. Interest rate levels c. Interest rate risk premiums d. Monetary stringency 1st Merger Wave – 1897-1904 – ”Merging for Monopoly” Underlying Factors:  Technological developments o Transcontinental Railroads o Electricity o Innovations in production process  Continuous process cigarette machine  Rapid Economic Expansion  Lax anti-trust enforcement  Corporation laws relaxed  Voluntary code of ethical behavior Characteristics of 1st wave mergers:  Horizontal mergers  Heavy manufacturing industry Reasons for ending 1st wave:  Majority of mergers failed – didn’t achieve increase in efficiency  Economic recession in 1903  Stock market crash in 1904  Supreme court ruled in 1904 that Sherman Act could be used to attack anticompetitive mergers 2nd Merger Wave – 1916-1929 – ”Merging for Oligopoly” Underlying Factors:  Post-World War I economic boom  Lax margin requirements  Technological developments o Continued development of railroad o Motor vehicle transportation o Radio  Government encouraged firms to work together during WWI, maintained this policy in 1920s Characteristics of 2nd wave mergers:  Produced fewer monopolies, rather oligopolies, vertical mergers, and conglomerates (usually related)  Primary metals, petroleum products, food products, chemicals, and transportation equipment were the most active M&A industries  Used significant proportion of debt to finance deals  Investment banks played central role in financing (as in 1st wave) Reasons for ending 2nd wave:  October 29, 1929 stock market crash  Great depression 1940s Mergers motivated by tax relief No major technological changes or dramatic development in U.S. infrastructure 3rd Merger Wave – 1965-1969 – ”Conglomerate Mergers” Underlying Factors:  Booming economy  Rising stock prices  High interest rates  Tough antitrust enforcement  Management science developments  Financial manipulations o Price-earnings game o Pooling of interests method of accounting o Bootstrap effect Characteristics of 3rd wave:  Primarily conglomerate mergers  Some bidders smaller than targets   Primarily equity-financed – investment banks did not play central role Aerospace most active industry, while industrial machinery, auto parts, railway equipment, textiles, and tobacco also active  CEOs with vision to create conglomerates Reasons for ending 3rd wave:  Attorney General announced plans to crack down on conglomerates in 1968  Legislation o Williams Act o Tax Reform Act  Market eventually saw through financial manipulations  Many of conglomerates performed poorly 1970s – Precedent-setting mergers   INCO – ESB United Technologies – Otis Elevator  Colt Industries – Garlock Industries 4th Merger Wave – 1981-1989 – ”The Megamerger” Underlying Factors:  Expanding economy  Technological developments  International competition  Deregulation  Increased pension fund assets  Financial innovations  Investment banking industry much more competitive  Failure of conglomerates Characteristics of 4th wave:  Size and prominence of acquisition targets much greater than before  Oil and gas industries dominant in early 1980s, while pharmaceuticals most common in late 1980s; airlines and banking also common  Foreign takeovers became common  Heavy use of debt to pay for acquisitions  Junk bonds  More hostile takeovers o Corporate raiders o Arbitrageurs o Investment banks and law firms active Reasons for ending 4th wave:  Legislation o Financial Institutions Reform, Recover, and Enforcement Act (1989) o State antitakeover legislation  Michael Milken’s indictment (1989) and Drexel Burnham Lambert’s bankruptcy (1990)  Gulf war 5th Merger Wave – 1992-2000 – ”Strategic restructuring” Underlying Factors:  Expanding economy, rising stock prices  Technological developments  Globalization  Deregulation Characteristics of 5th wave:  Emphasized longer-term strategy rather than immediate financial gains  More often financed with equity than debt  Consolidation in the telecommunications and banking industries Reasons for end of 5th wave:  Bursting of stock market bubble  Economic slowdown Merger Trends in the United Kingdom Peaks in 1968, 1972, 1989, and late 1990s Increase in takeovers in late 1980s due to rising stock prices, laissezfaire governmental attitude towards mergers, financial innovations Merger Trends in Continental Europe Uncommon before 1990s, especially hostile takeovers Takeovers increasing, despite antitakeover legislation Firms making transition from sunset to sunrise industries Deregulation Changes in Corporate Governance in 1980s and 1990s Prior to 1980s:  External corporate governance mechanisms rarely used  Institutional shareholding modest  Boards provided weak monitoring of management o Large boards of directors o Low percentage of directors’ compensation is equity-based  Management stock ownership modest  Performance plans based on accounting measures Changes in the 1980s:  Predominance of debt financing – provided strong financial discipline o Leveraged acquisitions o Leveraged buyouts (LBOs)  Managers receive substantial equity stakes  LBO sponsors or investors closely monitored and governed firms they purchased  Small boards of directors  Directors tend to own large equity stakes  IPOs could lead to big payoffs for LBO investors o Management buyouts (MBOs) o Stock repurchases  Institutional shareholders’ stakes increased Results:  Cross-subsidization of poorly-performing divisions stopped  Excess capacity eliminated Changes in the 1990s – public companies mimicked LBOs  Managers received generous stock-option plans  New measures of managerial performance  Closer monitoring by institutional shareholders  Smaller boards of directors  Directors’ compensation more equity-based  Trend toward decentralization within firms Market vs. internal allocation of finance   Firms are experts at particular technologies, products, processes Firms may not be good at producing products in new industries  Firms’ transition to new industries may be slow  Markets may be better at identifying new investment opportunities  Markets can redirect capital to new industries quickly  Management of independent firms in the new industry is likely to be more knowledgeable about the industry Public Criticism of M&A and Market-based Corporate Governance  Corporate raiders use their control to strip assets from the target, make a quick profit, destroying the company in the process, throwing people out of work  Raiders shouldn’t have the right to buy up firms they have no idea how to run – the employees who have spent their lives building up the firm should be making the decisions  Raiders become filthy rich without producing anything, at the expense of hardworking people who do produce something  The management and board of directors can best judge whether a takeover offer is in shareholders’ interests    M&A damages the morale and productivity of firms Markets are far from efficient Markets are short-sighted (especially institutional investors) o Managers pressured to forego long-term investment in favor of short-term profit o Market penalizes firms heavily investing in R&D o M&A market discourages managerial risk-taking  Divestitures (bustups) destroy firm value  Corporate debt levels have risen to dangerous levels  High-yield (junk) bonds do not adequately compensate investors for risk  Golden parachutes are excessive Jensen’s defense of M&A and Market-based Corporate Governance:  Only natural that CEOs would oppose this system  Incumbent management may be unable/unwilling to make difficult restructuring decisions    M&A can lead to more orderly liquidation of assets than bankruptcy Divestitures (bustups) involve reallocation of assets to more productive uses – the assets don’t disappear Takeover and divestiture market provides a market constraint against bigness for its own sake  M&A can discipline managers even without going through with the merger  Markets are close to being efficient  Markets are not short-sighted o Institutional investor shareholding not associated with increased takeovers, decreased R&D expenditures o Firms with high R&D spending not more vulnerable to takeovers o Stock prices respond positively to announcements of increased R&D expenditures  High-yield bonds are fairly priced by the market  Corporate debt level not abnormally high  Properly structured golden parachutes are value-enhancing  Poison pills should be banned