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^867

Companies, 2002

In our discussion, we will frequently refer to the acquiring firm as the bidder.This is
the company that will make an offer to distribute cash or securities to obtain the stock
or assets of another company. The firm that is sought (and perhaps acquired) is often
called the target firm.The cash or securities offered to the target firm are the consider-
ationin the acquisition.

Merger or Consolidation

Amergeris the complete absorption of one firm by another. The acquiring firm retains
its name and its identity, and it acquires all of the assets and liabilities of the acquired
firm. After a merger, the acquired firm ceases to exist as a separate business entity.
Aconsolidationis the same as a merger except that an entirely new firm is created.
In a consolidation, both the acquiring firm and the acquired firm terminate their previ-
ous legal existence and become part of a new firm. For this reason, the distinction be-
tween the acquiring and the acquired firm is not as important in a consolidation as it is
in a merger.
The rules for mergers and consolidations are basically the same. Acquisition by merger
or consolidation results in a combination of the assets and liabilities of acquired and ac-
quiring firms; the only difference lies in whether or not a new firm is created. We will
henceforth use the term mergerto refer generically to both mergers and consolidations.
There are some advantages and some disadvantages to using a merger to acquire
a firm:

1. A primary advantage is that a merger is legally simple and does not cost as much as
   other forms of acquisition. The reason is that the firms simply agree to combine
   their entire operations. Thus, for example, there is no need to transfer title to
   individual assets of the acquired firm to the acquiring firm.


2. A primary disadvantage is that a merger must be approved by a vote of the
   stockholders of each firm.^1 Typically, two-thirds (or even more) of the share votes
   are required for approval. Obtaining the necessary votes can be time-consuming
   and difficult. Furthermore, as we discuss in greater detail a bit later, the cooperation
   of the target firm’s existing management is almost a necessity for a merger. This
   cooperation may not be easily or cheaply obtained.

Acquisition of Stock

A second way to acquire another firm is to simply purchase the firm’s voting stock with
an exchange of cash, shares of stock, or other securities. This process will often start as
a private offer from the management of one firm to that of another.
Regardless of how it starts, at some point the offer is taken directly to the target firm’s
stockholders. This can be accomplished by a tender offer. Atender offeris a public of-
fer to buy shares. It is made by one firm directly to the shareholders of another firm.
Those shareholders who choose to accept the offer tender their shares by exchanging
them for cash or securities (or both), depending on the offer. A tender offer is frequently
contingent on the bidder’s obtaining some percentage of the total voting shares. If not
enough shares are tendered, then the offer might be withdrawn or reformulated.
The tender offer is communicated to the target firm’s shareholders by public an-
nouncements such as those made in newspaper advertisements. Sometimes, a general

CHAPTER 25 Mergers and Acquisitions 843

merger

The complete absorption

of one company by

another, wherein the

acquiring firm retains its

identity and the acquired

firm ceases to exist as a

separate entity.

consolidation

A merger in which an

entirely new firm is

created and both the

acquired and acquiring

firms cease to exist.

tender offer

A public offer by one firm

to directly buy the shares

of another firm.

(^1) Mergers between corporations require compliance with state laws. In virtually all states, the shareholders of
each corporation must give their assent.
What’s new in mergers
and acquisitions? Visit
http://www.advisor-alliance.com
to find out.