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Week 4 Team A DQ Response STR/GM581

WEEK 2 TEAM A DQ RESPONSE Week 4 Team A DQ Response An important difference between internal and external capital markets is that in an internal market, corporate headquarters owns the business units to which capital is allocated, while in an external market, the bank does not own the business to which the money is lent

(Gertner, 1994). When agreement exists in the internal capital market the corporate headquarters have the power to control the firms assets. Internal capital markets have more control because the corporate headquarters can monitor the distribution and allocation of company funds and have more to gain from monitoring and distributing to specific business units. The internal system works best when a corporation has a distribution of products and business units. The advantage is the ability to cover poor performing assets with another. Because of the ability of a corporation to cover other business units there may be some substance to the amount of information a corporation may distribution about individual business units. In the scenario the external capital market undervalue this type of businesses because they know investors will prefer businesses, which offer differentiation products distinguished from competition. Businesses applying diversifying strategies will reduce the investment and imitation risk of the products created by their business. If no bidding firms exist, competition is not present; therefore this scenario is very different from the scenario described in Question 1. A firm can select to post economic earnings in one of two ways. The luxury of a corporation with multiple product line and business units, the business can distribute information as a corporation, a business unit, or a specific product. Using a multidimensional company like General Electric, within their health care division, there are several ways to distribute information and what the public observes by what the company decides. If the newly acquired Ultrasound business unit is failing, internally the

WEEK 2 TEAM A DQ RESPONSE health care division will be aware but business unit would appear to the public as either GE

corporate profits for which Ultrasound would be a very small component of the corporate report. Even at the Healthcare business unit where the headquarter group would tie it into imaging modalities, and again Ultrasound would only be slightly visible. Internal capital markets can decide what the public sees. Internally, a firm can expect to see profit of an acquired business immediately because even a low profit is better than losing it to the competition as they were prior to the competition. A firm that acquires a strategically related target may earn an economic profit from this sort of acquisition if there is potential for superior profits. Although many bidding firms profit less than expected in merger and acquisition transactions, some firms can gain sustained competitive advantage as a result of unexpected valuable economies of scope between the bidding and target firms (Barney, 2007). Managerial hubris is "the unrealistic belief held by managers in bidding firms, that they can manage the assets of a target firm more efficiently than the target firm's current management can" (Barney, 2007, p. 455). Some individuals suggest that acquisitions take place oftentimes motivated by managerial hubris, Bidders may have an underlying motive of reaping efficiency gains but hubris leads to overbidding (McCannn, 2004, p. 3). Acquisitions and mergers based primarily on hubris are likely to be a waste of time. Even if the acquisition or merger does not completely reduce the economic value of the bidding firm, it is likely not to provide much benefit to the bidding firm in the end, if any. In a competitive market, managerial hubris should be completely cast aside so managers can think clearly and carefully about acquisitions and mergers prior to formulating a bidding strategy. In personal opinions, hubris should be entirely left out of the equation when considering a merger or acquisition. Reasoning in support of the

WEEK 2 TEAM A DQ RESPONSE bid bases on other factors - not on how easy it would be to run the other company or how much better the bidding company's management could lead the other company. The fact is that in many cases organizations are not aware of what is happening with the other company, and to think they know everything and could do better is certainly not reason enough to risk losing economic value, and waste time trying to "prove" this at stakeholder

expense. If the acquisition or merger will indeed benefit the company, and the projection to yield superior profits or give the company a competitive advantage it would not be otherwise able to achieve, perhaps to justify the bid, but hubris should be completely cast aside. Apparently, these scenarios are a case of "the grass is greener"; companies management affirms to see the whole picture and the ego takes over. The truth is that they are not in a position to be aware of the factors and challenges facing the other organization until after the acquisition. This may be why many of them fail at the end. As there are several reasons a firm may acquire other firms, such as to gain a larger market share, compete with other growing business. Whatever the reason may be, there is always a potential gain associated with any acquisition. It is important to note that economic cost is revenue minus both the explicit cost (monthly bills) and the implicit cost (opportunity cost) and that a firm can have earn zero economic cost and still be profitable. With this, the team opinion is that an acquired firm does necessarily have to be the one to gain economic profit; the strategy may be aimed at allowing acquiring company to gain economic profit. Therefore, the reason for the acquisition would determine whether it will earn an economic profit.

WEEK 2 TEAM A DQ RESPONSE References Barney, J. (2007). Gaining and Sustaining Competitive Advantage (3rd ed.). New Jersey: Pearson-Prentice Hall. Gertner, R., Scharfstein, D., & Stein, J. (1994) Internal versus external capital markets. Quarterly Journal of Economics. Retrieved from McCann, M. (2004). Motives for Acquisitions in the UK. Retrieved from