Why Firms Merge And The Problem They Cause

Introduction:

According to Fairburn and Kay (1989) mergers can be dated back in the 1920’s, from the past it is evident that mergers may cause more harm than bring the advantages they bring to the merging firms, the merging and acquisition activities have increased in the past and firms merge because they think by doing so various advantages will be realized and therefore increase the profits of the firm. This paper focuses on the motivating factors toward mergers and the problems caused by these mergers.

Why firms merge:

In this section we discuss why firms merge, some of the reasons why firms merge include the effort to gain market power, tax advantages of gaining a loss making firm, efficiency, increasing market share and diversification among other factors.

Efficiency:

Ravenschaft and Scherer (1987) state that firms will merge because they think that this will result into an increase in efficiency in the new firm formed after merging. Efficiency is expected to rise after the increase in capital, sharing of expertise, elimination of duplicate processes in production and the realization of economies of scale. All these advantages associated with mergers will influence firms to merge, however according to Hughes (1989) mergers may not lead to the realization of efficiency and they may lead to even increased inefficiencies in the firm.

 Market power:

Firms will merge in order to gain market power, market power increases where firms that merge are in the same industry and produce the same products in the market and when they merge they form a monopolistic firm which controls the prices and the quantity produced. The firms will also merge as a way to increase their competitive advantages over their rivals and this makes the new firm a market leader, however this may not be the case where government policies may restrict firms to form monopolistic market forms where the firms controls the prices and quantity produced.

Increased market share:

Firms have different levels of market share in the market, when the firms merge they form one big firm those market share is equal to the sum of both firms market share, as a result the market share increases and this acts as a motivating factor for firms to merge. The reason why a larger market share is preferred is because a firm will realize economies of scale, increase sales volume, increase sales revenue and therefore increase profits earned.

Tax advantages:

Firms will also merge in order to gain a tax advantage, all firms will pay tax to the government depending on the level of profits they have acquired, and firms will therefore merge with loss making firms as a way of reducing their tax burden. However in most countries this has been discouraged where policies have been put in place to limit the act of profit making firms shopping for loss making firms to gain tax advantages.

 Diversification:

According to Henry (2000) firms will also merge as a way to smooth earnings, smooth earning results into a smooth stock price over time and therefore investors are attracted to invest in the companies stocks. When two firms merge their earnings and stock prices are more stable and this increases investor confidence and therefore realize increased capital base from investors equity.

Increasing geographical coverage:

Firms will merge as a way of increasing their geographical coverage, example two law firms namely the Battle and Booth company and the Mack and McLean company merged in order to increase their geographical coverage and therefore offer their services to a larger population, this is because when firms merge they form a larger com-any and the large company is able to invest more and diversify than a small company.

Sharing of expertise and technological integration:

Firms will gain expertise and gain from mergers, managers and other experts share ideas and this helps in improving the efficiency and also the productivity of a firm, this sharing is made possible when firms merge but this would not have been possible when the firms operated individually. Therefore the sharing of technology and ideas will lead to higher productivity and profitability of a firm.

Increase firm size:

It is evident that firms will merge for the reason of increasing their size, larger firms are known to compete better in the market than smaller firms, and therefore firms are motivated to merge due to the fact that formation of a larger firm will result into better competitive position. The merger of these firms will create a larger firm that is more visible to consumers and investors, therefore the larger firm will attract more consumers and investors and therefore improve the firm’s performance and profitability, and however from past mergers firms that merge due to this reason still retain their previous operation problems in the market.

Problems caused by these mergers:

Mergers will cause problems in the market and also to the employees and investors, these problems include loss of jobs, demoralization of employees, loss of investor confidence and a decline in the market area and other problems which are discussed below, from various scholars it is evident that mergers often will cause more problems than advantages gained.

Effect on employees:

Planned mergers adversely affect employees of the merging companies, the merge process is a slow process and affects the employees of both firms, when announcements are made about the merge of companies the working climate in those companies change, workers are confused and anxious about what will happen when the merge takes place and this reduces productivity of these workers, employees also feel betrayed and therefore mergers will result into reduced employee loyalty. Both companies will therefore report poor performance due to reduced productivity and efficiency during the merger negotiation process. This is evident from a report by Totenbaum (1999) who reported that the productivity of firms after a merge dropped 25% to 50%; this is a significantly large drop in productivity which will adversely affect the performance of the company in the market.

 Job losses:

Mergers involve major restructuring of the firms structure of the new company to be formed, this is due to the fact that merging firms will eliminate duplicate processes as a way of cutting down on production costs, as a result of this employees will loose their jobs because of this restructuring, according to Appelbaum (2000) the merge process leads to uncertainty among employees regarding the impact of merger on their career and job, for this reason therefore employees spend more time thinking about their career and job rather than their jobs and this will reduce the productivity of the employees in both companies.

Effects on managers and other top ranking employees:

Managers and other top ranked employees in both companies may be deprived of their authority after the merger. This is a painful process and may affect their performance after the merger. This process demoralizes such employees and performance of the new company formed may be even worse, an example is the case of the merger between Carton and Granada where the top executive employees namely Charles Allen and Michael Green were forced to have joint responsibilities after the companies merged, this definitely will have a negative effect on them and consequently affect the companies performance.

Slow negotiation process:

Mergers involves a process that takes time to complete, much time and resources are spent in the process which may adversely affect the performance of the company, managers concentrate on the negotiation process rather than the firms operation and this will result into poor performance of both companies. During this negotiation process the workers in both firms will spend most of their time gossiping and speculating on what will happen in after the merger and for this reason there will be reduced performance in the company.

Conclusion:

From the above discussion it is evident that mergers do not always lead to advantages they anticipated, many research reports show that there has been a reduction of companies performance after merging. Some of the motivating factor to mergers includes formation of larger companies, larger market size, economies of scale, diversification, larger geographical coverage, attraction of investors and consumers, larger capital base and sharing of ideas and expertise.

Mergers also pose major problems that may lead to failure of these mergers, some of these problems include demoralization of workers, loss of resources and time, reduced employee loyalty because employees feel betrayed, low productivity as employees spend more time speculating about the future and finally poor performance of both companies during the negotiation process.

For this reason therefore firms should be much more careful when merging, there should be proper communication with the employees about the reasons why the company is merging, a firm should select the most appropriate partner and the negotiation process should take the shortest time possible so that it does not affect the productivity of the firms. Therefore merging of companies is not a simple task and requires taking into consideration many factors that may lead to failure after the merger.

 References:

A. Hughes (1989) The Impact of Merger: a survey of empirical evidence for the UK, McGraw Hill Press, New York

Appelbaum S. and Yortis H. (2000) Anatomy of a merger, Management Decision, Volume 38, 9

Ashkenas Ronald and Lawrence J. (1998) Making the Deal Real; How GE Capital Integrates Acquisitions, Harvard Business Review, Volume 76 Issue 1D. Ravenscraft and Scherer F (1987) Mergers, Sell-offs and Economic Efficiency, McGraw Hill Press, New York

D. Henry (2002) Mergers; Why Most Big Deals Don't Pay Off, McGraw Hill Press, New York

Fairburn J. and Kay (1989) Mergers and Merger Policy, Oxford University Press, Oxford

Reish David (1988) the Impact of Taxation on Mergers and Acquisitions, UniverSity of Chicago Press, Chicago