Due diligence

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Introduction:

When people discuss regarding acquiring another firm, the phrase "due diligence" comes up earlier or afterwards. Usually, authentic definitions of due diligence say a little such as: "Due diligence is a measure of prudence, activity or assiduity, as is properly to be expected from, and ordinarily exercised by, a reasonable and prudent person under the particular circumstances" (E. Gattiker, 2007).

According to the G. Andrade, M. Mitchell Mergers signify massive reallocations of assets within the economy, both inside and outside industries, in 1995, the value of acquisitions and mergers about equally 5 percent of GDP and was equivalent to 48 percent of non-residential investment. From the firm’s perspective, mergers describes as a quite unusual events, often enabling a firm to double its size in a matter of months. As a result, measure value creation (or destruction) resulting from mergers and determining how this incremental value is scattered among merger participants are two of the vital objectives in finance and business merger research.

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Merger and acquisition has a very significant role in the financial management and the corporate finance. For number of organisation it is a one of the source of the extended development through the external growth when the organic growth is not possible, on the other hand to other organisation it is signify as a steady danger to their progressing independent survival. According to the Watson and Head 2007, merger is defined as a reorganisation of assets into new organisation i.e. A and B merge to become C, a new company, with the agreement of both sets of shareholders.

M & A is not only the simple merger and acquisition, whereas it combination of the strategic alliance and the joint venture of the participating firms. It includes carves- out, pin offs, divestitures, tracking stocks and the restructuring activities. In merger and acquisition there is change in the ownership of the firm occurs through the repurchasing of the shares, leverage buyouts, leverage recapitalisation and the dual class recapitalisation. Merger and the acquisition activities are not substitution activities for the internal improvement rather it is an addition.(J. Fred Weston, Samuel C. Weaver 2001)

J. Fred Weston, Samuel C. Weaver 2001 describes mergers as a horizontal, vertical and conglomerates, in Horizontal merger two firms which were operating in same industry, in vertical merger where two firms are operating in different production operation and in conglomerates mergers it is occurs in two different unrelated businesses.

In last century there was great deal about the characteristic change in merger and acquisition. The studies conducted show that the mergers create the wealth of the share holders, by most of the gains accruing to the target organisation. This paper shows the evidence on merger and acquisition on stock liquidity. The study conducted by the economist shows that the merger and acquisition has many causes, to increase the economies of scale, to increase the market value, to create the market power, it helps to reduced the inefficient management, it helps to expand the business, it is chance to diversify the capabilities from one business to other business. The theories shows that the some merger in last century and shows the understanding of the what are measure for the acquisition. From above it is clear that merger is better sometimes than that of other options.

"Since 1940s active enforcement & antitrust laws has make the merger power difficult to achieve. The diversification merger in 1960s and studies shows that these mergers where comes under the failure category. Till 1980 mergers as one the key financial measure not much utilised by the companies, but the takeover was the one the key financial instrument on that time (G. Andrade, M. Mitchell, and E. Stafford 2001).

Studies conducted by Mulherin & Mitchell in 1996 has explained that the mergers take place by building through the two important empirical features of mergers since last century 1) it is occurs in waves 2) it is (mergers) strongly cluster by industries. This above features shows that the mergers are occurs due to the unexpected experience felt by the industry structure. This ground is a potentially productive one to discover from both a academic and experiential point of view.

It is seems that the experience of the persons who were working in those field and analyst that industries tend to re- formed their structure and try to consolidate in concentrated duration of that era, that those changes happened suddenly and very difficult to visualize. Although identify industry shock and document their outcome were challenging. study shows that merger as a instruments in 1990s, as a last decades is heavily clustered by industry.

In this activity of merger and acquisition, industry shocks explain a big portion of merger activity does not really make clear the mechanism involved, which bring the issues least about, 1) the long-term effects of mergers, 2) what make some successful as compared to others.

Merger is always seems to be creation of total value for shareholders but the during announcement time earning from the M & A is an entire target of an individual shareholders, but by acquiring firm shareholders become visible to come dangerously close to actually subsidizing these transactions. However, the picture is not quite complete. The results hide an important distinction based on the financing of these transactions. In, mergers finance with stock, at least partially, has different value effects from mergers that are financed without any stock. From the acquiring firm’s point of view, stock-financed mergers can be view as simultaneous transactions: an equity issue and merger. On average, equity issues are associated with reliably negative abnormal returns throughout the few days adjoining the announcement. Various models have developed to describe this finding, mostly focus on information differences between managers and outside investors (Myers and Majluf, 1984).

Decision regarding the merger and acquisition majorly affects the firm’s vision for future endeavours. The past studies shows the valuable information regarding the effects of mergers and acquisition, but these information is still very less for the effects of M & A on stock liquidity on big corporate events. In our study we try to find out the M & A effects on the stock liquidity of different organisation in pre-merger and acquisition 120 days data and post M & A. 120 day’s data.

In financial studies it is shows that the stock liquidity is directly related to the equity price. Study conducted by the Amihud and Mendelsons in 1986 shows that the increased liquidity decreases the cost of equity capital by decreasing the reward required by the investor in trade difficulties. In another study by the Amihud & Mendelsons in 1988 shows that the managers find out different ways to enhance liquidity of their stocks for the benefit of the share-holders liquid securities. There are only few evidences shows that the direct evidence that stock liquidity is important from the corporate or finance managers. The purpose of our study is to find out the relationship between the stock liquidity and before 12o days of merger and 120 days post merger and acquisition activity. As shown by Amihud and Mendelsons in 1986 and 1988 a lower cost of capital will not only increase the present value of existing assets but also widen the profitable investment opportunity.

References:

  1. Watson Denzil and Antony Head 2007, Corporate Finance Principle and Practice Fourth Edition, Prentice Hall, ISBN-10: 0-273-70644-6. Chapter11, pp. 312.
  2. J. Fred Weston and Samuel C. Weaver,2001, Mergers and Acquisitions, Mc Graw Hill, ISBN 0-07-143537-9 (PKB)
  3. G. Andrade, M. Mitchell, and E. Stafford 2001, Journal of Economic Perspectives-Volume 15, Number 2-Spring 2001-Pages 103-120
  4. E. Gattiker, 2007 Merger and Acquisition: Effective Information Security Depends on Strategic Security Metrics, Information systems control journal , volume 5.
  5. Myers, Stewart and Nicholal S. Majluf, , June 1984 "Corporate Financing and Investment Decisions when Firms have Information that Investors Do Not Have", Journal of Financial Economics, Vol. 13, No. 2, pp. 187-221.
  6. Amihud Y.and H. Mendelsons in 1988 ”Liquidity and Assets Prices: – Financial Management Implication” Finaancial Management 17, (1988) 5-15.
  7. Amihud Y.and H. Mendelsons in 1986, ” Assest Pricing and the bid ask spread”. Journal Of Financial Economics 17 (1986) 223-249.

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