21: Mergers, Acquisitions and Corporate ControlIn 2016 (an even year), the company loses $10 million, and ‘carries back’ this loss to get a refund of the
$3.5 million in taxes it paid in 2015. That is, the government sends company A a $3.5 million cheque
in 2016. What A loses by paying taxes in 2015 and getting a refund in 2016 is the time value of money
on $3.5 million for one year (not to mention the hassle of filing taxes and then filing again for refunds).
Assume the discount rate is 10%. A’s ‘tax cost’ is $3.5 million – $3.5 million/(1.1) = 0.318 million –
that is, $318,182. This happens every two years in perpetuity, and A’s two-year discount rate is 21%
(=1.1^2 – 1). Therefore, the present value tax cost to A (as of 2014) is $318,182/0.21 = $1.52 million.
Company B never pays taxes, because it loses $10 million in odd years that it carries forward to the next
year, completely shielding taxes in even years. Therefore, as two stand-alone companies, A and B owe
the government taxes with a present value of $1.52 million. If A and B merge into one company, they
would not owe any taxes (recall the first paragraph). Therefore, expected tax obligations are lower for
conglomerates, as long as the taxable income across divisions is not perfectly, positively correlated.
In some cases, the stability of a conglomerate can result in a better credit rating than would be
possible for the individual divisions to obtain on their own. For example, GE maintained a AA+ credit
rating even during the depths of the late 2000s recession, in large part more because of the stability of
the overall company than because of the stellar performance of each division. Having a high credit rating
reflects the ability to borrow relatively cheaply, including providing access to certain segments of the debt
markets, such as the commercial paper market. Of course, having a high credit rating is not the primary
goal of a corporation, but rather should be viewed in the context of whether it increases company value.
One possible advantage of conglomerate form stems from internal capital markets. That is, if one
division of a company has growth opportunities but would struggle to borrow in capital markets, a
conglomerate can transfer profits from a division that produces excess cash flow. This could especially
be a good thing in developing economies (where the capital markets might not be fully developed), or
when capital markets freeze up, such as during the 2008–09 recession. Thus, internal capital markets
potentially offer the advantage of providing capital to cash-poor, growth-rich divisions. However, internal
capital markets can also lead to inefficient outcomes if, for example, management uses profits from a
healthy division to prop up a failing division that is destroying overall company value. Most evidence
seems to indicate that internal capital markets do not add value in mature, well-functioning economies.
There can also be advantages to conglomerate size, such as economies of scale, as previously
discussed. The stability of conglomerates can also increase employee job security, at least in the short
run. This could be good if it increases employee productivity, but could be bad if the workforce becomes
too complacent or protected from competitive pressures. Moreover, it becomes harder to motivate
employees in individual conglomerate business units, because it is harder to tie share compensation
directly to a given division. Finally, large conglomerates can suffer from slow decision processes.
In most cases, the disadvantages of operating in conglomerate form have been thought to outweigh
the advantages in recent years. Fewer conglomerates are formed now versus several decades ago, and if
anything, existing conglomerates are often broken up.
Managerial Explanations
Sometimes a company will acquire another company in order to acquire a new management team. This
is common when expanding into a new country or new industry. Managerial acquisitions can also occur
within an industry to acquire young talent. For example, when JP Morgan Chase acquired Bank One in
July 2004, one explanation was that it wanted to acquire a young Jamie Dimon, who became CEO and
led JP Morgan Chase through the financial crisis of 2008–09 relatively unscathed. Other managerial