Assignment 3 ca
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This document discusses various efficiency theories for mergers and acquisitions. It outlines theories such as differential efficiency, inefficient management, synergy, pure diversification, and strategic realignment. It also discusses undervaluation as a factor for M&As. Additionally, it covers agency problems that can arise between managers and shareholders, and how acquisitions can help address these issues. Finally, it outlines the hubris hypothesis, where managers may commit errors of overoptimism when evaluating merger opportunities due to excessive pride.
![This is called as the managerial synergy hypothesis as per which a a firm whose
management team has greater competency than is actually required by the
current responsibilities in the firm may seek to utilize the surplus resources by
acquiring and improving the efficiency of a firm which is less efficient due to
lack of resources Merger creates synergy since the surplus managerial resources
of the acquirer combine with the non-managerial organizational capital of the
acquired firm. So surplus resources can be optimally used. So even if a firm has
no opportunity to expand can diversify and enter new areas.
2. INEFFICIENT MANAGEMENT THEORY.
This is similar to the concept of managerial inefficiency but it is different in that
inefficient management means that the management of one company simply is
not performing up to its potential. Another control group is in a position to
manage the assets of the firm more effectively. Inefficient management simply
represents management that is incompetent in the complete sense. Under
differential efficiency theory the management seeks to complement the
management of the acquired firm and has experience in the particular line of
business of the acquired firm. Hence it is more likely that the horizontal mergers
may take place. On the contrary inefficient management theory could be the
basis for conglomerate mergers.
3. SYNERGY
It refers to the type of reactions that occur when the two substances or factors
combine to produce a greater together than that which the sum of the two
operating independently could account for. It refers to the phenomenon that 2+2
=5. I.E
In anticipation of such synergistic benefits acquirer firms incur expenses of the
acquisition process and still pay premium for the shares of the target shareholders
it allows the combined firm to have a positive nav. Nav=vab –[va + vb] – premium
for b – expense for acquisition.](https://image.slidesharecdn.com/assignment3ca-160318162640/85/Assignment-3-ca-3-320.jpg)
Assignment 3 ca
- 1. ASSIGNMENT 3 CR & MA SUBMITTED TO SUBMITTED BY PROF. GOPINATH SIR ROHAN FARMANIA 14MBA63172 SEC: - D
- 2. 1. GIVE AN ACCOUNT OF VARIOUS EFFICIENCY THEORIES ? EFFICIENCY THEORIES: This suggests that M & A’s provide a mechanism by which capital can be used more efficiently and that the productivity of the firm can be increased through economies of scale. According to these theories m & a’s have the potential for social benefits. The theories can be:- EFFICIENCY THEORIES DIFFERENTIAL EFFICIENCY THEORY. INEFFIECIENT MANAGEMENT THEORY. SYNERGY. PURE DIVERSIFICATION. STRATEGIC REALIGNMENT TO CHANGING ENVIRONMENT. UNDER VALUATION. 1. DIFFERENTIAL EFFICIENCY THEORY If the management of firm “A” is more efficient than firm “B” and if firm “A” acquires firm “B” the efficiency of firm “B” is likely to be brought upto the level of firm “A”. That means the increased efficiency of “B” is due to merger. This implies that firms operate below potential & as a result have below average efficiency. Such firms are most vulnerable to acquisition by more efficient firms. This is because good firms identify firms which have good potential but are operating at lower level of efficiency. They would also have the managerial ability to improve the latter’s potential. But a difficulty would arise when the acquiring firm is over optimistic and over estimates its ability to improve the performance of the acquired firm. This may result in a firm paying too much to acquire a firm or that the acquirer not improving the acquired firms performance.
- 3. This is called as the managerial synergy hypothesis as per which a a firm whose management team has greater competency than is actually required by the current responsibilities in the firm may seek to utilize the surplus resources by acquiring and improving the efficiency of a firm which is less efficient due to lack of resources Merger creates synergy since the surplus managerial resources of the acquirer combine with the non-managerial organizational capital of the acquired firm. So surplus resources can be optimally used. So even if a firm has no opportunity to expand can diversify and enter new areas. 2. INEFFICIENT MANAGEMENT THEORY. This is similar to the concept of managerial inefficiency but it is different in that inefficient management means that the management of one company simply is not performing up to its potential. Another control group is in a position to manage the assets of the firm more effectively. Inefficient management simply represents management that is incompetent in the complete sense. Under differential efficiency theory the management seeks to complement the management of the acquired firm and has experience in the particular line of business of the acquired firm. Hence it is more likely that the horizontal mergers may take place. On the contrary inefficient management theory could be the basis for conglomerate mergers. 3. SYNERGY It refers to the type of reactions that occur when the two substances or factors combine to produce a greater together than that which the sum of the two operating independently could account for. It refers to the phenomenon that 2+2 =5. I.E In anticipation of such synergistic benefits acquirer firms incur expenses of the acquisition process and still pay premium for the shares of the target shareholders it allows the combined firm to have a positive nav. Nav=vab –[va + vb] – premium for b – expense for acquisition.
- 4. 4. PURE DIVERSIFICATION Diversification provides many benefits to managers, employees, owners of the firm and to the firm itself. Also diversification through mergers is better than diversification through internal growth given that the firm may lack internal resources or capabilities required. PURE DIVERSIFICATION BENEFITS:- .Employees:- Employees develop firm specific skills over time which makes them more Efficient in their current jobs. These skills are job specific and they have no Chance to diversify than the shareholders who can diversify their portfolio. So They seek job security, stability and better opportunities for promotion for Higher Compensation. OWNER- MANAGERS:- Owners who are also managers of a firm will be able to retain corporate control Over his firm through diversification and simultaneously reduce the risk Involved. FIRM:- A firm builds up information on its employees over time, which helps it to match employees skills profile with jobs within the firm. This info is not transferred outside. If the firm diversifies these teams can be shifted from unproductive acts to productive ones leading to profitability & growth. GOODWILL:- In due course of its operation a firm develops a reputation with debtors, creditors, customers and others resulting in goodwill. Goodwill is important strategy wise for investment, advertising etc. Diversification helps in maintaining goodwill and reputation.
- 5. FINANCIAL AND TAX BENEFITS:- Diversification through mergers also results in financial synergy and tax benefits. Since diversification helps in reducing the risk it ultimately increases the corporate debt capacity and reduces the present value of future tax liability of the firm. 5. STRATEGIC REALIGNMENT TO CHANGING ENVIRONMENTS. This theory suggests that firms use the strategy of M&A’s as ways to rapidly adjust to changes in their external environment. Strategic planning approach to mergers implies that there is a possibility of achieving economies of scale or using the underutilized managerial capacity of the firm . Adjustment to the environment can be through internal development but the speed of adjustment through external diversification is faster. Timing here is very important. When a company has an opportunity of growth available for a short period of time, slow internal growth may not be sufficient. Competitors may respond quickly and take advantage. In such cases external growth through M&A seems to be a better alternative. Generally the sources of change are many but recently the regulatory and technological changes have been the major forces in growth of companies. 6. UNDERVALUATION: Undervaluation of the target companies can also be one of the motivating Factors leading to mergers. Undervaluation refers to the target being worth More than what it is actually valued at. Undervaluation may be because of the Underperformance of the management.
- 6. 2. What do you understand by Agency Problems and Hubris Hypothesis ? AGENCY PROBLEMS AND MANAGERIALISM. The conflict of interest between the Principal (shareholders) and Agent (managers) in which the agent has an incentive to act in his own self interest because he fears less than the total cost of his actions is called as an Agency Problem. When managers own only a portion of the shares in the firm it causes them to work less vigorously than otherwise and encourages them to take more benefits since they do not bear the cost. AGENCY PROBLEM The agency cost include:- The costs of structuring the contracts between the managers and owners. Costs of monitoring and controlling the behavior of the agents by the principal. Costs of bond to guarantee that the agents will make optional decisions or principals will be compensated for the outcome of suboptimal decisions. Loss experienced by the principal due to the divergence between the agents decisions and the decision to maximize principals interest. ACQUISITIONS AS A SOLUTION TO AGENCY PROBLEMS A takeover through a tender offer or a proxy fight enables outside managers to gain control of the decision processes of the target while avoiding existing managers. There is always a threat of takeover when a firm performs badly either because of inefficiency or agency problems. The agency problems may be efficiently controlled by some organizational and market mechanism. When a firm is characterized by separation of ownership and control, decision system of the firm, separate decision management (initiation & implementation) from decision control (ratification and monitoring) in order to limit the power of individual decision agents to expropriate shareholders interest. Control functions are delegated to a board of directors by the shareholders who retain approval
- 7. right on important matters including board membership, mergers and new stock issues. Compensation can be tied to performance through such devices as Bonuses, and executive stock options. When these mechanisms are not sufficient to control agency problems the market For takeovers provides an external control device of last resort. Mergers as a Threat of takeover. If a firm’s management lagged in performance either because Of ineffiency or because of Agency problems. HUBRIS HYPOTHESIS Managers commit errors of over optimism in evaluating mergers opportunities due To excessive Pride, animal spirits or hubris. In a takeover the bidding firm Identifies potential Target firm and values its assets. When the valuation turn south to be below The market price no offer is made. Only when the valuation exceeds the current Market price a bid is made and enters the Takeover sample. If there is no synergy or Other takeover gains the mean of devaluations will be the current marketprice.Offers are made only when the valuation is Too high. The takeover Premium is a random error a mistake made by the bidder. The hubris hypothesis assumes strong Form efficiency of markets. Stockpricesreflect all (public and no public)information, Redeployment of productive resources cannot bring gains, and management cannot be improved Through reshuffling or combinations across firms. Thus serves the role of benchmark for comparison and is null against which other hypothesis Should be compared. The hypothesis does not require conscious pursuit of self interest by Managers. Managers may have good intentions but can make mistakes in judgment.