Introduction to Corporate Finance

ONLINE CHAPTERS

December 2015) it seems that activity has fallen in 2015. Since the US market accounts for such a large

part of the global market, it is not surprising that global M&A activity seems to have followed similar

patterns to the US. The European market, which is the next biggest M&A market, also benefitted from

major growth in the 1990s, although it peaked slightly earlier than the US (in 1999 rather than 2000).

The European market also recovered over the early to mid 2000s, before recession hit in 2008–2009.

However, as European economic growth performance would suggest, the European M&A market has not

been able to recover as well as the US market. In contrast, although it is a smaller market, the Asia Pacific

M&A market has grown dramatically since the 1990s; recovering relatively quickly from the internet/

technology bubble and growing quite rapidly over the next couple of decades.

Three economy-wide explanations for the ebbing and flowing of overall merger activity have been

put forth. The first explanation suggests that changes in technology, such as the growing importance of

Internet commerce in the 1990s, often lead to numerous alliances and acquisitions, as companies seek to

strategically position themselves in the new economy. Economic or regulatory changes also can lead to a

flurry of merger activity. For example, the relaxing of the Glass–Steagall banking regulations in the 1990s

opened the door for commercial banks to enter sectors such as insurance and security issuance that had

previously been off limits. This naturally also led to mergers between companies in these various industries.

A second explanation of merger waves suggests financial market conditions, such as the ease with

which companies can obtain funding for acquisitions or the relative strengths of currencies, will either

encourage or discourage M&A activity. Merger waves often occur when the share market is near a

recent high (because when share prices are high, companies often find it easier to issue new equity at a

reasonable price) and when debt markets are very liquid (at which time the cost of debt is often relatively

low). Foreign acquisition of assets in a given country also increases following a drop in home country

currency values, since the foreign currency is able to buy more in domestic currency terms. For example,

more US companies became targets when the dollar depreciated in 2007, but this trend waned as the

dollar grew stronger in 2008 and 2009.

A third explanation of merger waves is related to behavioural finance. When targets or entire industries

are believed to be undervalued (that is, current share price is below its true value), these companies

become attractive targets, under the assumption that the valuation will eventually correct itself. Note that

this explanation implies that the market is at least sometimes inefficient and therefore incorrectly prices

target shares. Conversely, companies that believe their shares are overvalued by the market may attempt

to use their shares as currency to purchase the assets of another company. For example, if a share’s true

value is $10 but it temporarily trades at $15, if managers can purchase a fairly valued asset with their

shares, the company can, to some extent, lock in the $15 value. The behavioural explanation implies

that arbitrage activity does not swiftly eliminate inefficient mispricing of ordinary shares. Consequently,

one must be cautious when considering this explanation of merger waves. However, AOL’s acquisition of

Time Warner in 2000 provides a merger example that suggests this occurs in some cases.

Figure 21.2 shows the recent trends in M&A activity in Australia, both by transaction value and

by number of transactions. Comparing the market to the US data, we see that the Australian market is

substantially smaller. Nevertheless, both markets experienced a dip in M&A transaction value in 2010.

The Australian market rallied in FY2011, but suffered a reduction in both transaction volumes and

values in FY2012. It is interesting to note, however, that although transaction numbers remained around

2000 in FY2012, FY 2013 and FY 2014, the value of transactions during that period fell substantially,

suggesting that average transaction values were dramatically reduced.

thinking cap

question

What conditions contribute to a

robust M&A environment?

thinking cap

question

Why did M&A activity shrink so

dramatically in 2007–08, during

the financial crisis?