Motives behind M&A The dominant rationale used to explain M&A activity is that acquiring firms seek improved

financial performance. The following motives are considered to improve financial performance:

Economy of scale: This refers to the fact that the combined company can often reduce its fixed costs by removing duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit margins. Economy of scope: This refers to the efficiencies primarily associated with demand-side changes, such as increasing or decreasing the scope of marketing and distribution, of different types of products. Increased revenue or market share: This assumes that the buyer will be absorbing a major competitor and thus increase its market power (by capturing increased market share) to set prices. Cross-selling: For example, a bank buying a stock broker could then sell its banking products to the stock broker's customers, while the broker can sign up the bank's customers for brokerage accounts. Or, a manufacturer can acquire and sell complementary products. Synergy: For example, managerial economies such as the increased opportunity of managerial specialization. Another example are purchasing economies due to increased order size and associated bulk-buying discounts. Taxation: A profitable company can buy a loss maker to use the target's loss as their advantage by reducing their tax liability. In the United States and many other countries, rules are in place to limit the ability of profitable companies to "shop" for loss making companies, limiting the tax motive of an acquiring company. Geographical or other diversification: This is designed to smooth the earnings results of a company, which over the long term smoothens the stock price of a company, giving conservative investors more confidence in investing in the company. However, this does not always deliver value to shareholders (see below). Resource transfer: resources are unevenly distributed across firms (Barney, 1991) and the interaction of target and acquiring firm resources can create value through either overcoming information asymmetry or by combining scarce resources.[3] Vertical integration: Vertical integration occurs when an upstream and downstream firm merge (or one acquires the other). There are several reasons for this to occur. One reason is to internalise an externality problem. A common example is of such an externality is double marginalization. Double marginalization occurs when both the upstream and downstream firms have monopoly power, each firm reduces output from the competitive level to the monopoly level, creating two deadweight losses. By merging the vertically integrated firm can collect one deadweight loss by setting the upstream firm's output to the competitive level. This increases profits and consumer surplus. A merger that creates a vertically integrated firm can be profitable.[4]

However, on average and across the most commonly studied variables, acquiring firms' financial performance does not positively change as a function of their acquisition activity.[5] Therefore, additional motives for merger and acquisition that may not add shareholder value include:

Diversification: While this may hedge a company against a downturn in an individual industry it fails to deliver value, since it is possible for individual shareholders to achieve the same hedge by diversifying their portfolios at a much lower cost than those associated with a merger. Manager's hubris: manager's overconfidence about expected synergies from M&A which results in overpayment for the target company. Empire-building: Managers have larger companies to manage and hence more power. Manager's compensation: In the past, certain executive management teams had their payout based on the total amount of profit of the company, instead of the profit per share, which would give the team a perverse incentive to buy companies to increase the total profit while decreasing the profit per share (which hurts the owners of the company, the shareholders); although some empirical studies show that compensation is linked to profitability rather than mere profits of the company.

Understanding Mergers, Acquisitions, and Other Corporate Restructuring Terminology This article is extracted from the textbook Mergers, Acquisitions and Other Restructuring Activities by Donald M. DePamphilis. 1.0 Mergers and Consolidations Mergers can be described from a legal perspective and from an economic perspective. This distinction is relevant to discussions concerning deal structuring, regulatory issues, and strategic planning. 1.1 A Legal Perspective This perspective refers to the legal structure used to consummate the transaction. Such structures may take on many forms depending on the nature of the transaction. A merger is a combination of two or more firms in which all but one legally cease to exist, and the combined organization continues under the original name of the surviving firm. In a typical merger, shareholders of the target firm exchange their shares for those of the acquiring firm, after a shareholder vote approving the merger. Minority shareholders, those not voting in favor of the merger, are required to accept the merger and exchange their shares for those of the acquirer. If the parent firm is the primary shareholder in the subsidiary, the merger does not require approval of the parents shareholders in the majority of states. Such a merger is called a short form merger. The principal requirement is that the parents ownership exceeds the minimum threshold set by the state. For example, Delaware allows a parent corporation to merge without a shareholder vote with a subsidiary if the parent owns at least 90 percent of the outstanding voting shares. A statutory merger is one in which the acquiring company assumes the assets and liabilities of the target in accordance with the statutes of the state in which the combined companies will be incorporated. A subsidiary merger involves the target becoming a subsidiary of the parent. To the public, the target firm may be operated under its brand name, but it will be owned and controlled by the acquirer. Although the terms mergers and consolidations often are used interchangeably, a statutory consolidation, which involves two or more companies joining to form a new company, is technically not a merger. All legal entities that are consolidated are dissolved during the formation of the new company, which usually has a new name. In a merger, either the acquirer or the target survives. The 1999 combination of Daimler-Benz and Chrysler to form DaimlerChrysler is an example of a consolidation. The new corporate entity created as a result of consolidation or the surviving entity following a merger usually assumes ownership of the assets and liabilities of the merged or consolidated organizations. Stockholders in merged companies typically exchange their shares for shares in the new company. A merger of equals is a merger framework usually applied whenever the merger participants are comparable in size, competitive position, profitability, and market capitalization. Under such circumstances, it is unclear if either party is ceding control to the other and which party is providing the greatest synergy. Consequently, target firm shareholders rarely receive any significant premium for their shares. It is common for the new firm to be managed by the former CEOs of the merged firms who will be co-equal and for the composition of the new firms board to have equal representation from the boards of the merged firms. In such transactions, it is uncommon for the ownership split to be equally divided. The 1998 formation of Citigroup from Citibank and Travelers is an example of a merger of equals. Research suggests that the CEOs of target firms in such transactions often negotiate to retain a significant degree of control in the merged firm for both their board and management in exchange for a lower premium for their shareholders.

1.2 An Economic Perspective Business combinations also may be classified as horizontal, vertical, and conglomerate mergers. How a merger is classified depends on whether the merging firms are in the same or different industries and on their positions in the corporate value chain (see Figure 1 below). Defining business combinations in this manner is particularly important from the standpoint of antitrust analysis in which regulators often use the combined firms market share as a measure of their ability to influence product/ service selling prices. Horizontal and conglomerate mergers are best understood in the context of whether the merging firms are in the same or different industries. A horizontal merger occurs between two firms within the same industry. Examples of horizontal acquisitions include Proctor & Gamble and Gillette (2006) in household products, Oracle and PeopleSoft in business application software (2004), oil giants Exxon and Mobil (1999), SBC Communications and Ameritech (1998) in telecommunications, and NationsBank and BankAmerica (1998) in commercial banking. Conglomerate mergers are those in which the acquiring company purchases firms in largely unrelated industries. An example would be U.S. Steels acquisition of Marathon Oil to form USX in the mid-1980s. Vertical mergers are best understood operationally in the context of the corporate value chain depicted in Figure 1. Vertical mergers are those in which the two firms participate at different stages of the production or value chain. A simple value chain in the basic steel industry may distinguish between raw materials, such as coal or iron ore; steel making, such as hot metal and rolling operations; and metals distribution. Similarly, a value chain in the oil and gas industry would separate exploration activities from production, refining, and marketing. An Internet value chain might distinguish between infrastructure providers, such as Cisco; content providers, such as Dow Jones; and portals, such as Yahoo and Google. In the context of the value chain, a vertical merger is one in which companies that do not own operations in each major segment of the value chain choose to backward integrate by acquiring a supplier or to forward integrate by acquiring a distributor. An example of forward integration includes paper manufacturer Boise Cascades acquisition of office products distributor, Office Max, for $1.1 billion in 2003. An example of backward integration in the technology industry is America Onlines purchase of media and content provider Time Warner in 2000. In 2008, American steel company, Nucor Corporation, announced the acquisition of the North American scrap metal operations of privately held Dutch conglomerate SHV Holdings NV. The acquisition further secures Nucors supply of scrap metal used to fire its electric arc furnaces. Recent research indicates that horizontal, conglomerate, and vertical mergers accounted for an average of 42 percent, 54 percent, and 4 percent of transactions globally since 1981. While pure vertical mergers are rare, studies suggest that about one-fifth of the all mergers during the same period exhibited some degree of vertical relatedness. Figure 1. Corporate Value Chain (note: IT refers to information technology)

2.0 Acquisitions, Divestitures, Spin-Offs, Carve-Outs and Buyouts Generally speaking, an acquisition occurs when one company takes a controlling ownership interest in another firm, a legal subsidiary of another firm, or selected assets of another firm such as a manufacturing facility. An acquisition may involve the purchase of another firms assets or stock, with the acquired firm continuing to exist as a legally owned subsidiary. In contrast, a divestiture is the sale of all or substantially all of a company or product line to another party for cash or securities. A spin-off is a transaction in which a parent creates a new legal subsidiary and distributes shares in the subsidiary to its current shareholders as a stock dividend. An equity carveout describes a transaction in which the parent firm issues a portion of its stock or that of a subsidiary to the public A leveraged buyout (LBO) or highly leveraged transaction involves the purchase of a company financed primarily by debt. While LBOs commonly involve privately owned firms, the term often is applied to a firm which buys back its stock using primarily borrowed funds to convert from a publicly owned to a privately owned company.