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A merger is said to occur when two or more companies
combine into one company. One or more companies may
merge with an existing or they may merge to form a new

Motives of Mergers:

• Limit competition.
• Utilize under-utilized market power.
• Overcome the problem of slow growth and profitability in
one’s own industry.
• Achieve diversification.
• Gain economies of scale and increase income with
proportionately less investment.
• Utilize under-utilized resources such as human, physical
and managerial skills.

Types of Mergers:

1. Horizontal Merger: This is a combination of two or more

firms in similar type of production, distribution or area of
business. Examples would be combining two book publishers
or two luggage manufacturing companies to gain dominant
market share. Example: Glaxo Wellcome Plc. And SmithKline
Beecham Plc. Mega merger. The two British pharmaceutical
heavyweights merged resulting in the largest drug
manufacturing company globally.

2. Vertical Merger: This is a combination of two or more

firms involved in different stages of production or
distribution. The basic reason is to eliminate costs of
searching for prices, contracting, payment collection and
advertising and may also reduce the cost of communicating
and co-coordinating production. For example, joining of a
TV manufacturing (assembling) company and a TV
marketing company or the joining of a spinning company
and a weaving company. Vertical merger may take the form
of forward or backward merger. Forward merger takes place
when a raw material supplier finds a regular procurer of its
products while backward merger takes place when a
manufacturer finds a cheap source of raw material supplier.
Example: Merger of Usha Martin and Usha Beltron. The
merger enabled both companies to pool resources and
streamline business and finance with operational efficiencies. It also
helped in cost reduction and development of new products.

3. Conglomerate Merger: This is a combination of firms

engaged in unrelated lines of business activity. Firms
that plan to increase their product lines carry out these
types of mergers. Firms opting for conglomerate merger
control a range of activities in various industries that require
different skills in the specific managerial functions of
research, applied engineering, production, marketing and so
on. Example: L&T and Voltas Ltd are conglomerate
Conglomerate mergers have been subdivided into

a. Managerial Conglomerates: These conglomerates

provide managerial counsel and interaction on decisions
thereby, increasing potential for improving performance. When
two firms of unequal managerial competence combine, the
performance of the combined firm will be greater than the sum
of equal parts that provide large economic benefits.
b. Concentric Conglomerates: The primary
difference between managerial and concentric conglomerate is
its distinction between respective general and specific
management functions. The merger is termed as concentric,
when there is a carry-over of specific management functions.

The term acquisition means an attempt by one firm,
called the acquiring firm, to gain a majority interest in another
firm, called the target firm. An acquisition may be defined as
an act of acquiring effective control by one company over
assets or management of another company without any
combination of companies. Thus, in an acquisition two or more
companies may remain independent, separate legal entity, but
there may be a change in control of companies. There are
broadly two kinds of strategies that can be employed in
corporate acquisitions. These include
• Friendly Takeover: The acquiring firm makes a financial
proposal to target firm’s management and board. This
proposal might involve the merger of the two firms, the
consolidation of the two firms or the creation of
parent/subsidiary relationship.
• Hostile Takeover: A hostile takeover may not follow a
preliminary attempt like a friendly takeover. A hostile takeover
is a takeover that is restricted by the management of the
target company.

Factors behind Expansion:

 Sales Enhancement and Operating Economies

An important reason for some acquisitions is the
enhancement of sales. By gaining market share, ever-
increasing sales may be possible through market dominance.
The acquisition will also bring technological advances to the
product table. It may also fill a gap in the product line, thereby
enhancing sales throughout
Operating Economies can often be achieved through a
combination of companies. A combined firm may avoid or
reduce over-lapping functions and facilities. It can consolidate
the management functions such as manufacturing, marketing,
R&D and reduce operating costs. For example a combined firm
may eliminate duplicate channels of distribution or create a
centralized training center or introduce an integrated planning
and control system.

 Accelerated Growth
Mergers and Acquisitions help to accelerate the pace of a
company’s growth in a convenient and inexpensive manner.
The company can acquire production facilities as well as other
resources from outside through mergers and acquisitions. To
launch a new product the company may lack technical skills
and may require special marketing skills and/or a wide
distribution network to access different segments of markets.
The company can acquire existing company with requisite
infrastructure and skills and grow quickly.

 Diversification of Risk
By acquiring a firm in a different line of business, a
company may be able to reduce cyclical instability in earnings.
Since investors in a company’s stock are averse to risk and are
concerned only with the total risk of the firm, a reduction in
earnings instability would have a favorable impact on share
price. For example an investor who holds one percent of
shares of company X and one percent of shares of company Y,
could achieve the same share of earnings and assets if
companies X and Y merged and he held one percent of shares
of the merged company. The risk from his point of view has
been diversified by his acquiring shares of the two companies.

 Managerial Effectiveness
One of the potential gains of merger is an increase in
managerial effectiveness. This may occur if the existing
management team, which is performing poorly, is replaced by
a more effective management team. Often a firm plagued with
managerial inadequacies, can gain immensely from the
superior management that is likely to emerge as a sequel to
the merger.

 Tax Shields
When a firm with accumulated losses merges with a profit
making firm, tax shields are utilized better. The firm with
accumulated losses may not be able to derive tax advantages
for a very long time. However, when it merges with profit-
making firm, its accumulated losses can be set off against the
profits of the profit making firm and tax benefits can be quickly
 Utilization of Surplus Funds
A firm in a mature industry may generate a lot of cash
but may not have opportunities for profitable investment. Such
a firm ought to distribute generous dividends and even buy
back its shares. However, most management has a tendency
to make further investments even though they may not be
profitable. In such a situation, a merger with another firm
involving cash compensation often represents a more efficient
utilization of surplus funds.

 Lower Financing Costs

The consequence of larger size and greater earnings
stability is to reduce the cost of borrowing for the merged firm.
The reason for this is that the creditors of the merged firm
enjoy better protection than independent firms. If two firms A
and B merge, the creditors of the merged firm are protected
by the equity of both the firms.

 Strategic Benefit
If a firm has decided to enter or expand in a particular
industry, acquisition of a firm engaged in that industry, rather
than dependence on internal expansion, may offer several
strategic advantages
i. It can prevent a competitor from establishing a
similar position in that industry.
ii. It enables a firm to ‘leap frog’ several stages in the
process of expansion.
iii. It may entail less risk and even less cost.
iv. In a saturated market, simultaneous expansion and
replacement makes more sense than creation of additional
capacity through internal expansion.

 Complementary Resources

If two firms have complementary resources, it may make

sense for them to merge. For example a small firm with an
innovative product may need the engineering capability and
the marketing reach of a big firm. With the merger of the two
firms, it may be possible to successfully manufacture and
market the innovative product.

Corporate Failure

It can be defined in several different ways –financially if a
company owes more than it earns over significant periods of
time and can no longer trade this is the serious example of
corporate failure.It can also means institutional failure where
a group of key managers fail to address key policy issues.Eg
Banks lending to those with a poor credit history as in our
present credit crunch.

Corporate failure is a natural component of the market

economy, facilitating the recycling of financial, human and
physical resources into more productive organizations.
Nonetheless corporate bankruptcy can impose significant
private costs on many parties including shareholders,
providers of debt finance, employees, suppliers, customer,
Manager and audit.All of these stakeholders have an interest
in being able to identify whether a firm is on a trajectory
which is lending towards corporate failure.Early
Idendification of such a trajectory could facilitate successful
intervention to avert disaster.

Corporate failure may arise for many reasons.It may result

from a single catastrophic event or it may be the terminal
point of a lengthy process of decline.Under the second
perpective, Corporate failure is a process which is financial
rooted in management defects ,resulting in poor decisions,
leading to deterioration and finally corporate collapse.

Frequent causes of Failure

Although causes of business failure vary from firm to firm,We
can identify several common ones.The predominant cause of
failure is managerial incompetence.Also , the following key
structural problems within management may appear .
1. An imbalance of skills within the top echelon.A manager
tends to attract other managers of similar skills. For
Example , the corporate management may consist
principally of individuals having a
background in sales ,without anyone having production

2. A chief Executive who dominates a firm’s operations

without regard for the inputs of peers.

3. An inactive board of directors. The board of directors’

lack of interest in the financial position of the company
may lead to insolvency.

4 .A deficient finance function within the firms

Management .Not
Infrequently , the only substantial input provided by
the financial
Officer occurs when the budget is submitted to the
board.A company
may have an effective financial information system,
however this
information is of no avail if it does not flow to the
board through a
strong financial officer

5 The absence of responsibility for the chief executive

All other managers with a company are responsible to
the superior ,
the chief executive seldom must account of his
this person is responsible to the shareholders, the link
is tenuous or
even missing altogether.

Symptoms of Bankruptcy

As a company enters the final stages prior to failure, a

pattern may develop in terms of a changing ratios have
proven to be useful indicators of impending disaster.A study
by Altman developed a statistical model that found the
financial ratios best predicting bankruptcy.Based upon
Altman’s sample of bankruptcy firms, the study yielded annn
equation that used five ratios to predict bankruptcy.
Bankruptcy score
Where X1 =(Net working capital / total assets)
X2 =(Retained earnings/total assets )
X3 =(Earnings before Interest and taxes /total
X4 = (Total market value of stock/book value of total
X5 =(Sales/total assets)

With this equation, the criterion for separating firms with a

strong likelihood of bankruptcy from those that probably will
not fail should be as follows.If the score exceeds 2.99 no
concern should exist that the company is facing bankruptcy
in the foreseeable future.On the other hand, a score less
than 1.81 suggests that the firm is a likely candidate for
failure.Values between 1.81 and 2.99 are difficult to assign
to either a “ successful’’ or a “failure ‘’ classification.
However, although a firm in this “ gray area” can easily be
misclassified in terms of the final outcome, the best way to
set up a dividing line is to predict that a company will fail if
its score is less than 2.675.Alternatively a score exceeding
2.675 may be used as an indicater that success is more
likely than failure.These guidelines are shown in table

Altman’s Bankruptcy Criterion

(Bankruptcy score)
Less than 1.81 Between 1.81 and Greater than 2.99
Probability of Probability of Probability of
failure is high failure is difficult to failure is remote
Predict Failure Predict success
Less than 2.675-
predict failure
Greater than
2.675- predict

We may conclude that a potentially failing corporation

begins to invest less in current(X1). Since X2 is a cumulative
indicator of profitability relative to time, the findings suggest
that younger companies have a greater chance of
bankruptcy.Variable X3 reflects the firms’s general earnings
power.Deterioration in this factor was shown to be the best
single indicator that bankruptcy may be
forthcoming.Variable X4 depicts the firms’s financial leverage
position.Finally,X5 the assets turnover ratio, measures
management’s ability to generate sales from the firm’s

Although the financial information flowing from a firm helps

us identify problems, the predications we make with it
certainly are not perfect.Owing to factors unique to the firm,
as well as to the tendency for managements of problem
firms to do some “ Window dressing” of the financial
statements , the ratios will not always effectively identify
corporations that face bankruptcy within the near
future.Even so, they will help us assess the likelihood of


Many quantitative factors are used in predicting corporate failure, including:

 Low cash-flow-to-total-liabilities ratio

 High debt-to-equity- ratio and high debt-to-total –

assets- ratio

 Low return on investment

 Low profit margin

 Low retained-earnings-to-total-assets ratio

 Low working-capital-to-total-assets and low working-

capital-to-sales ratio

 Low fixed-assets-to-noncurrent-liabilities ratio

 Inadequate interest-coverage ratio

 Unstable earnings

 Small company size measured in sales and/or total

 Sharp decline in stock price, bond price, and earnings

 A significant increase in beta(beta is the variability in

the price of company’s stock relative to market index)

 Large gap between market price per share and book

value per share

 Reduction in dividend payments

 A significant rise in the company’s weighted-average

cost of capital

 High fixed-cost-to-total-cost-structure(also called high

operating leverage)

 Failure to maintain capital assets(e.g., a decline in the

ratio of repairs to fixed assets)

 The qualitative factors that predict failure includes

 Poor financial reporting system and inability to control


 Newness of company

 Declining industry

 High degree of competition

 Inability to obtain financial and significant loan

restrictions on any financing obtained

 Inability to meet past-due obligations

 Poor management

 Ventures into areas in which management lacks

 Failure of the company to keep up-to-date, especially in
a technology oriented business

 High risk, such as a positive correlation in the product

line, meaning that for all the company’s products
moves up or down together, or susceptibility to strike

 Inadequate insurance coverage

 Fraudulent actions

 Cyclical business operations

 Inability to adjust production to meet consumption


 Susceptibility to stringent government regulation

 Susceptibility to energy shortage

 Susceptibility to unreliable suppliers

 Renegotiated debt and/or lease agreements

 Deficient accounting and financial reporting system


Companies have many financial and quantitative to minimize the potential

for failure. Liquidity and solvency problems may be minimized by:
 Avoiding heavy debt. If liabilities are excessive, finance
with equity.

 Disposing of losing divisions and product lines.

 Managing assets for maximum and minimum risk

 Using quantitative techniques such as multiple
regression analysis to compute the correlation between
variables and the likelihood of the business failure

 Ensuring that there is a safety buffer between actual

status and the compliance requirements (e.g., working
capital) in connection with loan agreements

 Having a negative correlation in products and

 Lowering dividend payouts


potential for failure

 Vertical and horizontal diversification of product lines and

 Financing assets with liabilities of similar
 Diversifying geographically
 Having adequate insurance
 Enhancing the marketing effort
 Engaging cost of reduction programs
 Improving productivity
 Minimizing the adverse effect of inflation and recession on
the entity
 Investing in multipurpose, rather than single purpose,
assets, because of their lower risks
 Avoiding entering industries that have historically had a
high failure rate
 Having many projects, rather than only few, significantly
affect operations
 Introducing product lines that are only slightly affected by
the business cycle and that posess stable demand
 Avoiding going from a labor-intensive to a capital-
intensive business, since the latter has a high operating
 Avoiding long term fixed-fee contracts to customers and
instead incorporating inflation adjustment and energy-cost
indices in contracts
 Avoiding markets that are on the downturn or that are
already highly competitive
 Adjusting to changes in Technology.