No control premium. Because 51 % of the shares are not purchased, the full control premium that is normally associated with 51 % to 100 % stock acquisitions may not have to be paid.
● Control with fractional ownership. As noted, working control may be established with less than 51 % of the target company's shares. This may allow the controlling company to exert certain influence over the target in a manner that will further the controlling company's objectives.
● Approval not required. To the extent that it is allowable under federal and state laws, a holding company may simply purchase shares in a target without having to solicit the approval of the target company's shareholders. As discussed in Chapter 3, this has become more difficult to accomplish because various laws make it difficult for the holding company to achieve such control if serious shareholder opposition exists.
Holding companies also have disadvantages that make this type of transaction attractive only under certain circumstances:
● Multiple taxation. The holding company structure adds another layer to the corporate structure. Normally, stockholder income is subject to double taxation. Income is taxed at the corporate level, and some of the remaining income may then be distributed to stockholders in the form of dividends. Stockholders are then taxed individually on this dividend income. Holding companies receive dividend income from a company that has already been taxed at the corporate level. This income may then be taxed at the holding company level before it is distributed to stockholders. This amounts to triple taxation of corporate income. However, if the holding company owns 80 % or more of a subsidiary's voting equity, the Internal Revenue Service allows filing of consolidated returns in which the dividends received from the parent company are not taxed. When the ownership interest is less than 80 %, returns cannot be consolidated, but between 70 % and 80 % of the dividends are not subject to taxation.
● Antitrust issues. A holding company combination may face some of the same antitrust concerns with which an outright acquisition is faced. If the regulatory authorities do find the holding company structure anticompetitive, however, it is comparatively easy to require the holding company to divest itself of its holdings in the target. Given the ease with which this can be accomplished, the regulatory authorities may be quicker to require this compared with a more integrated corporate structure.
● Lack of 100 % ownership. Although the fact that a holding company can be formed without a 100 % share purchase may be a source of cost savings, it leaves the holding company with other outside shareholders who will have some controlling influence in the company. This may lead to disagreements over the direction of the company.
Chapter 2
History of Mergers
IN MUCH OF FINANCE there is very little attention paid to the history of the field. Rather, the focus is usually on the latest developments and innovations. This seems to be particularly the case in the United States, where there is less respect for that which is not new. It is not surprising, then, when we see that many of the mistakes and types of failed deals that occurred in earlier years tend to be repeated. The market seems to have a short memory, and we see that a pattern of flawed mergers and acquisitions (M&As) tends to reoccur. It is for this reason that we need to be aware of the history of the field. Such an awareness will help us identify the types of deals that have been problematic in the past.
There have been many interesting trends in recent M&A history. These include the fact that M&A has become a worldwide phenomenon as opposed to being mainly centered in the United States. Other trends include the rise of the emerging market acquirer, which has brought a very different type of bidder to the takeover scene. We devote special attention in this chapter to these important trends in recent M&A history.
Merger Waves
Six periods of high merger activity, often called merger waves, have taken place in U.S. history. These periods are characterized by cyclic activity – that is, high levels of mergers followed by periods of relatively fewer deals. The first four waves occurred between 1897 and 1904, 1916 and 1929, 1965 and 1969, and 1984 and 1989. Merger activity declined at the end of the 1980s but resumed again in the early 1990s to begin the fifth merger wave. We also had a relatively short but intense merger period between 2003 and 2007.
What Causes Merger Waves?
Research has shown that merger waves tend to be caused by a combination of economic, regulatory, and technological shocks.15 The economic shock comes in the form of an economic expansion that motivates companies to expand to meet the rapidly growing aggregate demand in the economy. M&A is a faster form of expansion than internal, organic growth. Regulatory shocks can occur through the elimination of regulatory barriers that might have prevented corporate combinations. Examples include the changes in U.S. banking laws that prevented banks from crossing state lines or entering other industries. Technological shocks can come in many forms as technological change can bring about dramatic changes in existing industries and can even create new ones. Harford shows that these various shocks by themselves are generally not enough to bring about a merger wave.16 He looked at industry waves, rather than the overall level of M&A activity, over the period 1981–2000. His research on 35 industry waves that occurred in this period shows that capital liquidity is also a necessary condition for a wave to take hold. His findings also indicate that misevaluation or market timing efforts by managers are not a cause of a wave, although they could be a cause in specific deals. The misevaluation findings, however, are contradicted by Rhodes-Kropf, Robinson, and Viswanathan, who found that misevaluation and valuation errors do motivate merger activity.17 They measure these by comparing market to book ratios to true valuations. These authors do not say that valuation errors are the sole factor in explaining merger waves, but they say that they can play an important role that gains in prominence the greater the degree of misevaluation.
Rau and Stouraitis have analyzed a sample of 151,000 corporate transactions over the period 1980–2004, including a broader variety of different corporate events than just M&As. They have found that “corporate waves” seem to begin with new issue waves, first starting with seasoned equity offerings and then initial public offerings, followed by stock-financed M&A and later repurchase waves.18 This finding supports the neoclassical efficiency hypothesis, which suggests that managers will pursue transactions when they perceive growth opportunities and will engage in repurchases when these opportunities fade.
First Wave, 1897–1904
The first merger wave occurred after the depression of 1883, peaked between 1898 and 1902, and ended in 1904 (Table 2.1). Although these mergers affected all major mining and manufacturing industries, certain industries clearly demonstrated a higher incidence of merger activity.19 According to a National Bureau of Economic Research study by Professor Ralph Nelson, eight industries – primary metals, food products, petroleum products, chemicals, transportation equipment, fabricated metal products, machinery, and bituminous coal – experienced the greatest merger activity. These industries accounted for approximately two-thirds of all mergers during this period. The mergers of the first wave were predominantly horizontal combinations (Table 2.2). The many horizontal mergers and industry consolidations of this era often resulted in a near monopolistic market structure. For this reason, this merger period is known for its role in creating large monopolies. This period is also associated with the first billion-dollar megamerger when U.S. Steel was founded by J. P. Morgan, who combined Carnegie Steel, founded
Jarrad Harford, “What Drives Merger Waves,”
Matthew Rhodes-Kropf, David T. Robinson, and S. Viswanathan, “Valuation Waves and Merger Activity: The Empirical Evidence,”
Panambur Raghavendra Rau and Aris Stouraitis, “Patterns in the Timing of Corporate Event Waves,”
