In this blogpost, Sudhi Ranjan Bagri, Student, National Law Institute University, Bhopal, writes about the pros and cons of mergers and acquisitions

Introduction

Mergers and acquisitions (M&A) are two different concepts, however, over the period of time, the distinction has blurred, and now they are often used in exchange for each other.  In mergers, two similarly sized companies combine with each other to form a new company. The acquisition, on the other hand, occurs when one company purchases another company and thus becomes the new owner. The process which is generally followed in both these concepts usually starts out with a series of informal discussions between the companies by their representatives, which is followed by formal negotiation, then the issuance of a letter of intent, the process of due diligence, entering into a purchase or merger agreement, and finally, the execution of the deal and the transfer of payment.[1]

The next question which comes into our mind is that why do these companies enter into such transactions.

Pros of Mergers and Acquisitions

Some of the most common reasons for companies to engage in mergers and acquisitions include-

To become bigger Most of the companies enter into M&A agreements to increase their size and to eliminate their rivals from the market. In the normal circumstances, it can take many years for a company to double its size, but the same can be achieved much more rapidly through mergers or acquisitions.

To eliminate competition M&A deals are usually done so as to allow the acquirer company to eliminate the future competition by gaining a larger market share in its product’s market. However, there is a con attached to it, which is that a large premium is usually required to convince the shareholder of the target company to accept the offer. In such cases, the shareholders of the acquiring companies get disappointed by the fact that their company is issuing huge premiums to another companies shareholder’s, and thus the shareholders of the acquiring company sell their shares which further results in decreasing their value. [2]

Synergies and economies of scale This is usually one of the primary motivating factors for small companies as they have limited resources and usually deal with financial constraints. Companies merge to take advantage of synergies and economies of scale. Synergies occur when two companies who deal with the similar type of business combine with each other, as they can then consolidate or eliminate duplicate resources like a branch and regional offices, manufacturing facilities, research projects etc. Every amount of money which is saved goes straight to the bottom line, boosting earnings per share and making the M&A transaction an “accretive” one.[3]

Tax purposes Companies also enter M&A agreements for tax purposes, although this may be an implied rather than an overt motive. For instance, countries like U.S., have a huge corporate tax rate, so to avoid payment of these taxes, some American companies have resorted to corporate “inversions”. This involves a U.S. company buying a smaller foreign competitor and moving the merged entity’s tax home overseas to a lower-tax jurisdiction, in order to substantially reduce its tax bill.[4]

Cons of Mergers and Acquisitions

Substantial Increase in Prices A merger reduces competition and thus can give the acquiring company the monopoly power in the market. With less competition and greater market share, the new firm can increase prices of the products for consumers. For example let’s consider a hypothetical situation, where some major automobile companies merge with each other, the probable outcome is that they will substantially increase the prices of their product, because of the fact that the consumers will not do not have many options to choose from thus leaving them with no other option but to purchase those products at the increased prices. Thus, this is one of the biggest drawbacks of the M&As, wherein the market is highly disrupted, and the consumers are the ultimate sufferers.[5]

Job Losses:  A merger can lead to a situation wherein the employees have to lose their jobs. Usually, while a merger or acquisition takes place, the companies tend to reduce and remove those assets which will not be resulting in their profiting rearing process. This is a particular reason for concern if it is an aggressive takeover by an ‘asset stripping’ company. An asset stripping company is a company, which seeks to merge and get rid of under-performing sectors of the target company.[6]

Diseconomies of ScaleThe new company may experience diseconomies of scale from the increased size. After a merger, since the size of the company is increased, it may lack the same degree of control and thus may struggle to motivate workers. If workers feel they are just part of a big multinational, they may be less motivated to try hard.[7]

Loss in productivity In cases where the small companies are being merged or acquired by big companies, the employees of the small companies may require exhaustive re-skilling. Thus, the time during which is required for such re-skilling, the company will have to suffer the non-productivity of those employees, which indirectly would cast a burden on the capital of the company. [8]

Author’s comment

Just like a coin has two faces, the same applies to the case of mergers and acquisitions. On one hand, it enables a firm to expand its area of business and eliminate competition, on the other hand, the concept of mergers and acquisitions often creates monopoly of a company thereby increasing the prices and often reducing the productivity of the company.

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[1] See http://www.investinganswers.com/financial-dictionary/economics/mergers-acquisitions-ma-366

[2] R Renaud, Why do companies merge with or acquire other companies?, available at http://www.investopedia.com/ask/answers/06/mareasons.asp

[3] E. Picardo, How Mergers and Acquisitions Can Affect A Company, available at http://www.investopedia.com/articles/investing/102914/how-mergers-and-acquisitions-can-affect-company.asp

[4] Ibid

[5] T. Pettinger, Pros and Cons of Mergers, available at http://www.economicshelp.org/blog/5009/economics/pros-and-cons-of-mergers/

[6] Ibid

[7] Supra 5

[8] Y. Kumar, Advantages And Disadvantages Of Mergers And Acquisition Economics Essay, available at http://www.ukessays.com/essays/economics/advantages-and-disadvantages-of-mergers-and-acquisition-economics-essay.php