Hubris

Richard Roll (1986) suggested that the urge to merge is driven by pride, or hubris, in the face
of evidence suggesting that earning supernormal profits from acquisitions is difficult. Roll
suggests that the drive to merge stands on an irrational belief that the deal will succeeds,
despite similar ones failing/

 Common motives for corporate restructuring

Form of acquisition

Form of Payment: Financial and private bidders generally do not engage in large
M&A using stock as deal currency.

Tax considerations.

Accounting considerations

Acquisition Vehicle

Post-closing organisation

Legal form of selling entity

 Alternative forms of corporate restructuring strategies.

 Friendly vs Hostile Deals

o In a friendly deal, the target’s board of directors approve the deal and
recommend the shareholders to accept it. It is likely management teams will
not be fired, as would be the case in a hostile takeover and deal premium is
normally lower than in hostile deals. In a hostile deal there are two common
bid strategies: tender offer and proxy fight. The target’s management teams
normally will be fired, and deal premium is a lot higher. From 2000 to 2014,
the number of hostile bids has dropped significantly due to poison pills
legislation.

 Strategic Bidder vs Financial Bidder

o An acquirer may be interested in the target due to strategic fit between the two
companies and they are attracted to the target’s potential synergies. The target
may also align with the acquirer’s long-term business plans.
 o A financial bidder is attracted to takeover because of the potential return they
could generate soon by buying the target, improving its operational
performance and then selling it.
 Financial bidders typically raise cash, source bids depending on market
trends, acquire companies using a mix of equity and debt, incentivise
the target’s management team by giving them a larger segment of any
shareholder wealth they successfully create. The board is replaced with
the private equity firm’s GPs and operational managers.

Motivations of M&A Transactions

Synergy

1) Economics of Scale - Horizontal Merges

 Central services such as office management, accounting,
financial control, executive development, and top-level
management can be shared.
 As production increased, the average unit cost of production
goes down.
2) Economics of Vertical Integration
 Takes control of the whole production process by taking
over companies inside their supply chain – such as those that
produce raw materials and companies that are the consumer
– retails stores.
 This allows for more flexible coordination and
administration of business activities.

Reaction to Changes (Neoclassical Theory, Nelson, 1959)

1) Regulation changes
2) Technology changes
3) Macroeconomic policy changes

Valuation

1) Overvaluation of the acquirer – the acquirer may have stocks that are
overvalues which can be used to pay for the target and make a profit
(Shleifer and Vishney 2003). However, when the value drops, the target
shareholders undergo a loss.
2) Undervaluation of the Target – acquirer believes the target’s share price
does not reflect its true value. Typically, these deals occur during
macroeconomic downturn situations – high inflationary, interest rate
environments and low stock prices.
Market Power

1) Increasing their market power post-merger by having greater market

share and leverage when negotiating with suppliers/retailers

Diversification

1) Related Diversification: Acquirers may buy businesses in the same

supply chain to benefit from a reduction in costs.
2) Unrelated diversification: acquirers invest in unrelated areas with high
growth potential than its original business. This form may harm firm
valuation.

Complementary Resources

1) Many small firms are acquired by larger ones that can provide the
missing ingredient missing in a small firm’s business (Brealey, 2010).
For example, increasing the marketing budget/ using the larger firms
market power and image to sell products
2) Pharma companies may acquire smaller firms with a pipeline of patented
medicines instead of investing in R&D
3) Talent acquisitions

Management Overconfidence and Self- Interest

Please illustrate in detail what is the difference between managerial self- interest
and managerial hubris in the motivation of mergers and acquisitions.