Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

VIII. Topics in Corporate

Finance

25. Mergers and
    Acquisitions

© The McGraw−Hill^889

Companies, 2002

1. Anticipated merger gains may not be completely achieved, and shareholders thus
   experience losses. This can happen if managers of bidding firms tend to
   overestimate the gains from acquisition.


2. The bidding firms are usually much larger than the target firms. Thus, even though
   the dollar gains to the bidder may be similar to the dollar gains earned by
   shareholders of the target firm, the percentage gains will be much lower.


3. Another possible explanation for the low returns to the shareholders of bidding
   firms in takeovers is simply that management may not be acting in the interest of
   shareholders when it attempts to acquire other firms. Perhaps it is attempting to
   increase the size of the firm, even if this reduces its value per share.


4. The market for takeovers may be sufficiently competitive that the NPV of acquiring
   is zero because the prices paid in acquisitions fully reflect the value of the acquired
   firms. In other words, the sellers capture all of the gain.


5. Finally, the announcement of a takeover may not convey much new information to
   the market about the bidding firm. This can occur because firms frequently
   announce intentions to engage in merger “programs” long before they announce
   specific acquisitions. In this case, the stock price for the bidding firm may already
   reflect anticipated gains from mergers.

SUMMARY AND CONCLUSIONS

This chapter has introduced you to the extensive literature on mergers and acquisitions.
We touched on a number of issues, including:

1. Forms of merger. One firm can acquire another in several different ways. The three
   legal forms of acquisition are merger or consolidation, acquisition of stock, and
   acquisition of assets.


2. Tax issues. Mergers and acquisitions can be taxable or tax-free transactions. The
   primary issue is whether the target firm’s stockholders sell or exchange their shares.
   Generally, a cash purchase will be a taxable merger, whereas a stock exchange will
   not be taxable. In a taxable merger, there are capital gains effects and asset write-up
   effects to consider. In a stock exchange, the target firm’s shareholders become
   shareholders in the merged firm.


3. Accounting issues. Accounting for mergers and acquisitions traditionally involved
   either the purchase method or the pooling of interests method. In 2001, pooling was
   eliminated as an option. As a result, a merger or acquisition will generally result in
   the creation of goodwill, but, under the new guidelines, goodwill does not have to
   be amortized.


4. Merger valuation. If Firm A is acquiring Firm B, the benefits (V) from the
   acquisition are defined as the value of the combined firm (VAB) less the value of the
   firms as separate entities (VAand VB), or:

CONCEPT QUESTIONS

25.8a What does the evidence say about the benefits of mergers and acquisitions to

target-company shareholders?

25.8bWhat does the evidence say about the benefits of mergers and acquisitions to

acquiring-company shareholders?

CHAPTER 25 Mergers and Acquisitions 865

25.9