Objectives and General Principles of Mergers Finance Essay

The panel of mergers and takeovers was established in 1968, in U.K, and since then has worked as an administrating body of the city code on mergers and takeovers. The fundamental objective of this body is to ensure that all the shareholders are treated fairly, on an equal basis, in cases of mergers and takeovers. The panel of takeovers and mergers is a chief body in U.K who acts as a regulator on these issues. The pillars/ proposition on which the code rests are: Equal treatment of all the shareholders belonging to the same class of shares. Basically, this proposition ensures the fair treatment of all the shareholders involved To enable the shareholders to make the best decision for themselves, the code ensures that they have timely information which is accurate and relevant, and may influence shareholder decision for their best interest The code also ensures that true market mechanisms are the only reflective of the prices of the security and no artificial factor affects them i.e. no false markets The board will not take any decision without prior knowledge of the shareholders.

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General principles

The six general principles are the pillars on which the code rests upon. These general principles are basically the ‘statements of good standards of commercial behavior’. Besides, the general principles are further branched out into 38 rules, which are elaborated by their respective notes. The notes serve both to expand and explain the respective rule. The following figure highlights some of the vital rules of the code: rrrr.bmp [1] Adapted from General principles and rules, the Takeover Panel.

Economic reasons for acquisitions and mergers

There may be many motives behind the merger or acquisitions of companies. Each company may have its own set of unique reasons for going for either merger or acquisition. However, the reasons that may be common to all cases include: One possible reason behind merger or acquisition may be the consolidation of markets. The products most firms today are similar in nature, differentiated only to slight extents. The merger or acquisition may be a possible option in face of competing markets that would reduce the number of firms competing in the market and make them more consolidated. Merger or acquisition is a quick way of increasing the capacity of the firm. In addition, the acquired or merged firm both is from the same industry, and therefore would have similar expertise. No costs are incurred on training or obtaining machinery etc. Mergers and acquisitions also present the advantage of decreasing long run average cost as it begins to realize the economies of scale due to large scale production. A firm may feel that a gap exists in its existing portfolio and it is not catering fully to the market needs. A firm may sometimes want to counter a decline in sales of one industry by acquiring a firm in another industry. A firm may also wish to counter seasonal trends. All this can be achieved through mergers and acquisitions. A firm may merge with, or acquire another firm in a different industry, or selling products that the firm’s existing portfolio lacks. Another motive behind mergers and acquisitions is the forward and backward integration, towards the distribution channels, or backwards towards the sources of raw materials. In both cases, the motive is to have a stronger hold on the stages of the value chain, and may also be to restrict the supply to competing firms. Firms may also wish to have a greater access to technology, skills or sources of finances. The amalgamated firms of course have more vistas of opportunity when they operate as a single entity. Tax aversion may be another motive. Most countries’ laws levy more tax on idle cash than on operating businesses/assets. A merger or acquisition would not only enhance the operations of a firm and provide more sources of income, but would also provide tax exemptions.

Reasons why expected economic benefits may not be achieved

The potential advantages of mergers and acquisitions presented above may not offer the same benefits to all the stakeholders, and therefore a conflict of interest may not lead to benefit of all. The mergers and acquisitions are mostly from the organization’s perspective, seeing only its economic gain, and therefore may overlook other stakeholders such as the customers and employees. One issue that must be addressed is that whether the management will be able to run both businesses simultaneously. Also, there remains a question whether the combined entity will be a as efficient as the two businesses operating independently. The clash of organizational cultures, structure and design further aggravate the problem and the economic benefits may not materialize. The change in the work environment, management and employee behavior might stop the firm from gaining the desired benefits. The firm must, therefore, try to arrive at a compromise which addresses the interests of all stakeholders. To sum up, the probable reasons which might stop the merger or acquisition to deliver the economic benefits that the firm may be expecting are: Human factor Difference in cultures Lack of integration Transition carried out without regarding employees’ sensitivity Lack of productivity due to unhappy workforce The company must have an integration plan in place for the post-merger or post- acquisition situation, to smoothly lead the transition from being a single entity to a combined one. Failure to incorporate an integration plan may cause the potential benefits of the amalgamation to transform into drawbacks and losses. To say in a nut shell, “any decision to carry out a merger or acquisition should consider not only the legal and financial implications, but also the human consequences – the effect of the deal upon the two companies’ managers and employees. It is upon them, ultimately, that the fate of the newly-merged company will depend”.

Arguments for and against foregoing distribution of dividends and investing the funds saved

The dividend policy always has some tradeoffs. Sometimes paying dividends means retaining little from the income. Conversely, as proposed by the director, not paying the dividends means that the profit is retained and invested. This means a lesser reliance on externally generated funds. The tradeoff should be made keeping in mind the firm’s objectives, whether paying dividends to the shareholders is more important, or whether investment would be more beneficial in long run.The two cases are a tradeoff between shareholders receiving dividend in short run, and the value of their stock increasing due to the investment. The residual dividend theory states that dividends should only be paid when there are residual earnings after investment purpose. However, if the shareholders are not happy with the ‘no-payment’ policy, they may sell their shares to obtain an income. The arguments against the nonpayment of dividend are that shareholders are not usually pleased when they are not paid dividends. However, if it is communicated to them that the income would then be used to finance investments projects, they might as well support the nonpayment as the investment ultimately improves the value of the firm and its shares. According to the corporate document repository [2] , the major reasons for using retained earnings to finance new investments, rather than to pay higher dividends and then raise new equity for the new investments, are as follows: “The management of many companies believes that retained earnings are funds which do not cost anything, although this is not true. However, it is true that the use of retained earnings as a source of funds does not lead to a payment of cash.” (Basic finance for marketers, 1997) “The dividend policy of the company is in practice determined by the directors. From their standpoint, retained earnings are an attractive source of finance because investment projects can be undertaken without involving either the shareholders or any outsiders.” (Basic finance for marketers, 1997) “The use of retained earnings as opposed to new shares or debentures avoids issue costs.” (Basic finance for marketers, 1997) “The use of retained earnings avoids the possibility of a change in control resulting from an issue of new shares.” (Basic finance for marketers, 1997)

Alternatives to cash dividends

Dividend may be paid out in the form of stocks, and therefore is not a true dividend as it is not paid out in cash. This has the effect of diluting the share value by increasing the number of outstanding shares. Dividend reinvestment policy, DRIP, is another alternative to cash dividends. DRIP gives shareholders a chance to reinvest the money they would receive as cash dividend into additional shares of stock. DRIP is attractive as shareholders do not have to pay brokerage commission on stock purchase. Spin off shares are also referred to as property dividends in which a corporation gives out some valuable property to shareholders instead of cash dividends. The spin off shares may be shares of a subsidiary that the company owns. Past trends show that mostly spin offs are better than the parent company in terms of performance, and hence shareholders are better off. Shareholders may go for a ‘no-dividend’ or ‘low-dividend’ policy when it is communicated to them that for company’s health and stock price, they may have to forgo cash dividends.

Advantages

There is no additional tax imposed on share repurchases, and therefore it is a good way to increase the capital of shareholders. The equity/ownership of the shareholders increases and this means a greater potential of profits and dividends on shares. The share repurchases basically reduce the number of outstanding shares of the company. This is favorable as it reduces the dilution of the shares. Share repurchases reduce the number of outstanding shares. This means that a greater proportion of company’s retained earnings are attributable to each outstanding share. Therefore, the EPS(earning per share) increases. Share repurchases reduces the fear from the corporate raiders. Undervalued shares of a profitable company are very attractive to companies seeking to acquire that company. Share repurchases, in effect, reduces this risk as the company repurchases its own shares. Furthermore, the future profit from these shares also goes to the company itself. Share repurchase may give out a positive signal to the public, as they may think management is repurchasing the shares because it thinks it is undervalued. Income received from share repurchases is the capital gain for a company. The repurchased stock can be resold to raise money when needed. Stock repurchases provide an internal investment opportunity to the corporation. If a firm wants to alter its capital structure, stock repurchase is an available option. Buybacks also has the advantage of eliminating minority group of stockholders. Also, it reduces the costs incurred by the firms in servicing small stockholders.

Disadvantages

There is an opportunity cost for every decision made by businesses today. The money used in buying back of shares could have been invested to a more optimal use, which perhaps would generate return on assets. Different financial metrics have different results of share repurchases. A buy back could result in a higher debt ratio. If the stock buybacks are issued to the company’s management, the number of outstanding shares would remain the same and therefore no positive impact on EPS. If the public perceives that company is buying back its shares because it does not have any investment opportunity, this may be unfavorable for the company. Firm may have to pay penalties if the regulatory authorities such as the IRS think that buyback was to avoid taxes. A firm may end up paying a higher price for its own share if it has to bid up the prices of the shares.

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Objectives And General Principles Of Mergers Finance Essay. (2017, Jun 26). Retrieved November 27, 2022 , from
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