Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionVIII. Topics in Corporate
Finance- Mergers and
Acquisitions
(^866) © The McGraw−Hill
Companies, 2002
- Mergers and acquisitions sometimes involve “unfriendly” transactions. In such
cases, when one firm attempts to acquire another, the activity does not always
confine itself to quiet, genteel negotiations. The sought-after firm often resists
takeover and may resort to defensive tactics with exotic names such as poison pills,
greenmail, and white knights.
We discuss these and other issues associated with mergers in the sections that follow.
We begin by introducing the basic legal, accounting, and tax aspects of acquisitions.
THE LEGAL FORMS OF ACQUISITIONS
There are three basic legal procedures that one firm can use to acquire another firm:- Merger or consolidation
- Acquisition of stock
- Acquisition of assets
Although these forms are different from a legal standpoint, the financial press frequently
does not distinguish between them. The term mergeris often used regardless of the ac-
tual form of the acquisition.
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In Their Own Words...
Michael C. Jensen on Mergers and
Acquisitions
Economic analysisand evidence indicate that
takeovers, LBOs, and corporate restructurings are
playing an important role in helping the economy adjust
to major competitive changes in the last two decades.
The competition among alternative management teams
and organizational structures for control of corporate
assets has enabled vast economic resources to move
more quickly to their highest-valued use. In the process,
substantial benefits for the economy as a whole as well
as for shareholders have been created. Overall gains to
selling-firm shareholders from mergers, acquisitions,
leveraged buyouts, and other corporate restructurings
in the 12-year period from 1977 through 1988 total
over $500 billion in 1988 dollars. I estimate gains to
buying-firm shareholders to be at least $50 billion for
the same period. These gains equal 53 percent of the
total cash dividends (valued in 1988 dollars) paid to
investors by the entire corporate sector in the same
period.
Mergers and acquisitions are a response to new
technologies or market conditions that require a
strategic change in a company’s direction or use of
resources. Compared to current management, a new
owner is often better able to accomplish major change
in the existing
organizational
structure.
Alternatively,
leveraged
buyouts bring
about
organizational
change by
creating entrepreneurial incentives for management and
by eliminating the centralized bureaucratic obstacles to
maneuverability that are inherent in large public
corporations.
When managers have a substantial ownership interest
in the organization, the conflicts of interest between
shareholders and managers over the payout of the
company’s free cash flow are reduced. Management’s
incentives are focused on maximizing the value of the
enterprise, rather than building empires—often through
poorly conceived diversification acquisitions—without
regard to shareholder value. Finally, the required
repayment of debt replaces management’s discretion in
paying dividends and the tendency to overretain cash.
Substantial increases in efficiency are thereby created.Michael C. Jensen is Edsel Bryant Ford Professor of Business Administration at Harvard University. An outstanding scholar and researcher, he is famous for his pathbreaking
analysis of the modern corporation and its relations with its stockholders.