MERGERS AND ACQUISITIONS ALTERNATIVES TO INCREASE SHAREHOLDER WEALTH

MERGERS AND ACQUISITIONS: ALTERNATIVES TO INCREASE

SHAREHOLDER WEALTH

Introduction

Increased merger and acquisition activity in the banking industry is driven by changes in

economic conditions. According to Berger et al. (1998) there are five main changes in the

economy that encourage the rise of merger and acquisition activities, namely technological

advances, improving financial conditions, excess capacity / financial failure, international

market consolidation and deregulation.

Mergers and acquisitions have become a contemporary business practice in an effort to

improve shareholder welfare. This business practice invites many researchers to conduct

research. Many articles have been produced from research related to mergers and acquisitions.

Various aspects have been studied, such as motivation, impact on the company that are

involved and their characteristics.

A number of researchers have examined the impact of mergers and acquisitions on

shareholder welfare. The findings show that there are different results on the impact of

mergers and acquisitions on shareholder welfare. Findings stating that mergers and

acquisitions result in The increase in shareholder welfare was carried out by Benston et al.

(1995), Damsetz and Strahan (1995), Akhavein et al. (1997), Rhoades (1998), Hughes et al.

(1999). The research on mergers and acquisitions impacting on the decline in stock welfare

was conducted by Bradley (1980), Asquith (1983), Limmack (1991), and Bradley (1980).

Gregory (1997).

The finding that mergers and acquisitions fail to improve shareholder welfare is an

interesting topic for further study. This is because it contradicts the economies of scale theory,

which means that in business practice there are diseconomies of scale. In the economies of

scale theory, it is explained that increasing the scale of operations will obtain various

economic benefits, such as increased efficiency, increased revenue and lower risk (Hunter and

Wall, 1989; Spiegel and Gart 1996).

The failure of merger and acquisition capabilities in improving shareholder welfare is

explained by several researchers, among others: Roll (1986) with the hubris hypothesis which

states that mergers and acquisitions will not increase shareholder welfare because the

motivation for mergers and acquisitions is based on manager error in estimating the

acquisition value, which is too high. With the high value of acquisitions, shareholder welfare

decreases. Second, the decline in shareholder welfare is due to the opportunity for agency

problems among organizational participants (Jensen and Meckling, 1976). The inability to

manage conflicts will result in decreased organizational performance, which in turn will have

an impact on the decline in shareholder welfare.

From the description above, the question arises: how can mergers and acquisitions

improve shareholder welfare?

School of Thought: Motives for Mergers and Acquisitions

Various studies have been conducted to explain the reasons for conducting mergers and

acquisitions, both in terms of their advantages and disadvantages. The following will outline

important concepts related to mergers and acquisitions from various schools of thought,

namely:

Industrial Organization Economics (IO Economics)

In IO economics, there are two schools of thought, namely the market power school and

the efficiency school. Research in the market power school is research that explains that

mergers are conducted on the basis of monopoly motives (Stigler, 1950; Scherer, 1970).

However, subsequent research conducted by Eckbo (1983), Stillman (1983), and Jensen

(1984) showed that monopoly is no longer the main reason for mergers.

The efficiency school explains that the main reason for mergers and acquisitions is the

increase in economies of scale (Hopkin, 1983) and economies of scope (Boumol, et al., 1988).

The magnitude of merger and acquisition activity in the banking industry may be explained

through efficiency by market expansion.

Financial Theory

In financial theory, mergers and acquisitions are described as being undertaken to

diversify risk (Lewellen, 1971), however, this view has changed with the belief that risk

reduction by diversification is no longer valuable to investors. Equity and debt holders can

diversify risk in efficient capital markets at lower costs and with more flexibility (Chang and

Thomas, 1989). However, if the arguments in finance theory are accepted then firms should

pursue a conglomerate strategy to reduce cash flow variance and failure risk.

Managerial Economics

Managerial Economics uses agency theory to explain the motives for mergers and

acquisitions. Managers have discretionary freedom in public companies, which they can use

for their own interests (Jensen and Meckling, 1976). The occurrence of mergers and

acquisitions is due to top managers wanting increased influence, power, prestige and status

(Mueller, 1969). Mergers and acquisitions are not driven to increase share value, but rather to

increase managerial profits (Roll, 1986). Managers often use resources in an inefficient

manner. In fact, inefficient companies are the main target of investors to become more

efficient (Jensen, 1984). Investors' motivation for investment is to find companies whose

stock value is lower than the value of the assets sold. The investor's rationality is to buy the

company at a low price and sell it at a high price.

Stratergic Management

The strategic management literature has attempted to extend the ideas developed by

economists by explaining the reasons for valuable acquisitions (Chatterjee and Wernefelt,

1991). This study has included the resource base perspective which is the result of research

by Chatterjee (1986), Barney (1986, 1988). These studies have discussed synergies, which

showed that strategic relatedness is not sufficient to generate positive abnormal returns for

shareholders. shareholders (Harrison et al., 1991), Other research results emphasize the

importance of mergers and acquisitions as a way to improve performance (Bowman and

Singh, 1993). Other researchers focus on the consequences of unfavorable acquisition

strategies, such as a decrease in developing innovation capabilities (Hitt, et al., 1996). There

is also evidence to consider that acquisitions allow companies to improve their performance.

Companies exchange specific resources that cause market failure (Hennart and Park, 1993).

Most recent research on the resource base suggests that the use of mergers and acquisitions to

gain ways to improve performance (Capron and Pastre, 2002).

Different Ways to Meet Resources and Capabilities

Company that Having identified its resource and capability gaps, the company will

decide how to fulfill them to obtain new resources. According to Capron et al. (1998) to fulfill

resource and capability gaps, companies can choose (1) factor markets, (2) internal

development, and (3) internal development. internal developments (2) internal developments,

(3) cooperation, (4) mergers and acquisitions. There are three conditions Strategic resources

and capabilities allow for the development of sustainable competitive advantage, these

resources and capabilities are rare, difficult to imitate, unsustainable and not perfectly free to

move (Barney, 1991). (Strategic resources and capabilities allow for the development of

sustainable competitive advantage, these resources and capabilities are rare, difficult to

imitate, unsustainable and not perfectly free to move (Barney, 1991). The distance between

resources shows the main differences between resources and capabilities and will be followed

by differences in the next path (Teece, 1986). Uncertainty Environmental uncertainty

indicates market and technological uncertainties that if not handled properly, resources and

capabilities will become question marks (Liberman and Montgomery, 1988).

Factor Markets

Company Companies that Companies that seek to improve their resources and

capabilities in a dynamic business environment, will then focus on strategically valuable

resources and capabilities that facilitate the development of new competitive advantages

(Eisenhard and Martin, 2000; Helfat and Pateraf: 2003). Strategically valuable resources and

capabilities are nebulous, specific, and complex (McEvily and Chakravarthy, 2000).

Resources and capabilities will face factor market uncertainty because they are in a process

that cannot be achieved in isolation (Teece, 1986a). And to transfer vague knowledge, the

recipient must have knowledge of communication codes (Dietrich, 1994) by means of face-to-

face communication.

Market imperfections for strategically valuable resources may also stem from logical

and idiosyncratic transaction costs. Specific high-value resources are characterized by high

monitoring and other transaction costs, making them difficult to trade (Chi, 1994). According

to Amit and Schoemaker (1993) strategic value resources are difficult to buy and sell in factor

markets. Even factor markets may not exist, such as reputation markets (Dierikx and Cool,

1989). Therefore, factor markets cannot meet the needs of strategic value resources (McEvely

and Chakravethy, 2000). Only low strategic value resources can be met from factor markets.

Internal Development

Fulfilling resources and capabilities through internal development will be problematic.

This is because: First, internal development may not be suitable due to time constraints in a

dynamic business environment (D'Aveni, 1994). In order to capitalize on new business

opportunities, there are usually only specific strategies available that are The period is limited

(Abell. 1978). Also, the vague, specific and complex nature of existing resources may indicate

development stemming from innovation (Teece, 1986b). The isolation mechanism, especially

in the dependency flow, may protect the firm from imitation for some time allowing its

resource position to generate economic rents. However, this protection implies that firms that

want to create true resource innovations will be constrained by the isolation mechanism.

The internal development of new resources and capabilities is limited by existing

resources and capabilities. To develop new resources and capabilities quickly, the difference

between existing and new resources must be relatively small (Tripass and Gavetti, 2000). So

the new resources and capabilities can be developed internally. Consequently, to add new

resources and capabilities, access is required through sources other than factor markets and

internal development. Another alternative is inter-firm cooperation (Capron and Mitchel,

2004).

Cooperation

Joint ventures and other forms of cooperation can facilitate the exchange of resources

between two or more firms and provide additional advantages (Hogedoorn, 1993). However,

from the perspective of the resource base, joint ventures have two limitations in meeting

resource shortages, first, entering into a joint venture carries the risk of dispersing know how

(Bresser, 1988). The idea of entering into a joint venture is due to the special advantages that

the partners have in a new combination. The resulting interaction of resources and capabilities

in a joint venture gives partners access to original and transformed resources. Second, joint

ventures allow for increased conflict between partners. Differences in knowledge are the basis

for individual collaboration in joint ventures, which may result in different assessments and

expectations.

Despite the drawbacks joint ventures may provide a useful alternative to full integration

because of the flexibility they provide. If joint venture is considered a real option, it can be

interpreted as a strategy to develop new resources in situations of high uncertainty. Joint

ventures can help generate information about the likely future value of new resource

combinations (Folta and Miller, 2002). To the extent that market and technological

uncertainty about resources is high, joint ventures will provide value. Joint ventures will be

appropriate for filling resource gaps when market and technological uncertainty are high.

Mergers and Acquisitions

Acquiring new resources and capabilities through factor markets, internal development

and cooperation is difficult due to restrictive circumstances. Mergers and acquisitions provide

possibility (Tsoukas, 1996) which results in unity of control (Nelson and Wintcr, 1982).

Acquisition of resources and capabilities provides to The acquisition of resources and

capabilities gives the acquirer full control within the unitary institution whose information

dissemination provides an advantage. The exchange of information and skills within a single

firm is easier to organize and will be more effective than a joint venture (Teece, 1986b)

Compared to other alternatives, strategically valuable resources and capabilities are relatively

easier to transfer through mergers and acquisitions.

Resources obtained from mergers and acquisitions have the advantage of not being

limited by existing resources and capabilities (Krishnan, et al., 2004). And there is no

limitation to expand even if the new resources acquired are different from the current ones.

Value Gains From Mergers And Acquisitions

The use of mergers and acquisitions to fulfill resource shortages does not generate

positive abnormal returns to the shareholders of the acquiring company. Empirical studies

that show such results are Bradley (1980), Asquith (1983), and Limmack (1991). Before

explaining the condition of shareholders who get positive abnormal returns due to mergers

and acquisitions, we will explain the relationship between resources and value.

Resource, synergy, complementary and Value.

When mergers and acquisitions are used to acquire resources they are intended to realize

synergies from the combination of firms that have related strategic resources. Synergies can

be created if the resources and capabilities of the merging firms can be transferred and

deployed between entities (Capron and Mitchell, 2000). Synergies can be achieved if the

combination of resources and capabilities is complementary. The complementary combination

of new and old resources may result in a set of resources that meet external needs. This is

better than before the merger. Therefore, firms that undertake complementary combinations

will be able to fulfill resource shortages (Barney, 1988). If the combination of resources and

capabilities is not complementary, the transaction cannot be expected to create value.

Therefore, complementary resource combinations will increase economic value. However, not

all complementary types are strategically valuable.

Teece (1996b) describes innovation and alliances. In this explanation, complementary

resource types are divided into three, namely: generic, specialized and cospecialization.

Generic complementary resources are not specific to match other resources. These resources

are commodities that are easily replaced because they are abundantly available and

combinations of this type do not create unique value. Specialized resources are dependent on

other resources. When these specialized resources are paired with independent resources, they

create value, and when they are separated, they lose value. Cospecialized resources are

characterized by bilateral dependencies that will generate economic value if combined and

will decrease in value if separated. Thus, strategic value can be generated only from a

combination of specialized and specialized resources.

Economic Value of Acquiring and Acquired Companies

Various studies have shown that the acquiring firm's holders do not gain the economic

value that the acquired firm gains (Sirower, 1997). This inequality of profit distribution can be

explained for situations involving multiple homogeneous bidding firms. Homogeneity of

bidders will lead to homogeneity in valuing the firm to be acquired, which in turn will lead to

zero abnormal returns for the acquiring firm (Barney, 1988). Homogeneity of bidders allows

entry in the bidding auction, which ultimately becomes a problem for the winner because it

pays a very high price (Oster, 1994).

To achieve economic value, the acquiring firm must seek imperfect markets. In an

imperfect market, the position of the acquiring company will be different from other

companies (idiosyncratic). Hence, heterogeneity, which is the basic assumption of resource

base theory, will provide a logical argument for the success or failure of mergers and

acquisitions. Only heterogeneity between existing companies can differentiate companies to

achieve different synergies. This is because the acquired company will show different values

with different acquiring companies. If the acquiring firm can achieve synergies that are not

available to other bidding firms, this advantage may not be lost to competition and

shareholders of the acquiring firm can expect to receive economic value from mergers and

acquisitions (Baghat et al., 1990).

Barney identified three situations in imperfect markets that give the acquiring company

a unique position. These situations are are: (1) cash flow synergies that provide

individualized and unique value, (2) cash flow synergies that provide inimitable and unique

value and (3) cash flow synergies that provide unanticipated value (Barney, 1988).

Sources Of Potential Benefits From Mergers And Acquisitions

Merger and acquisition strategies are intended to benefit from increased shareholder

wealth or to increase value for managers, which is explained by the management self-interest

hypothesis. However, the question of whether mergers and acquisitions have value in

achieving operational and financial gains is still a topic of discussion in the mergers and

acquisitions literature. The following will outline the sources of potential benefits derived

from mergers and acquisitions.

Synergistic Advantage

The synergy hypothesis explains that two companies will benefit more when they merge

than when they operate independently. The combination of assets from two companies will

increase the aggregate market value (Dodd & Ruback, 1977). The synergy effect comes from

increasing efficiency due to economies of scope or economies of scale (Mueler, 1980).

Testing of the synergy hypothesis was carried out by Seagall (1968) which showed that

there was a decrease in costs due to mergers. Mueller (1980) in his research showed no

support for the synergv hypothcsis. Another researcher, Bedingfield, Rockers and Stagliano

(1984) also failed to show any synergy from bank mergers. The previous decade also tested

the synergy hypothesis which also failed to show any synergy from mergers and acquisitions

(Hogarty, 1970).

Monopolistic Advantage

The monopoly hypothesis explains that market power and associated market profits will

increase due to the merger of two or more firms in one industry. Eckbo's (1983) conducted a

study to test this hypothesis and his findings showed no support for the monopoly hypothesis.

Managerial Efficiency

The Inefficiency Hypothesis explains that mergers and acquisitions will be able to

improve poor management performance due to the merger of companies with poor

management (Hannan et al., 1992). From various studies (Dodd and Ruback, 1977; Manne,

1965; and Mualler, 1969), the concept of managerial efficiency is the basis of the mechanism

for replacing incompetent managers. Berger, Hunter and Timme (1993) say that the potential

gains derived from scale and scope economies are dominated by the gains derived from the

elimination of incompetent management.

Diversification

One of the reasons for conducting mergers and acquisitions is to diversify either

geographically or financially. Hannan and Wolken (1989) explain that the loss of

geographical boundaries geographic boundaries allows banks to realize the benefits of

geographic diversification that were previously unavailable. Cornett and Tehranian (1992)

find that there is a significant increase in cash flow returns for shareholders realized through

mergers. Liang and Rhodes (1988) in their study found that risk is reduced by geographic

diversification. Benston, Hunter and Wall (1995) explain the earning diversification

hypothesis which suggests that acquiring firms seek diversification benefits in an attempt to

generate higher levels of cash flow for a given level of risk.

Conclusions

Mergers and acquisitions are appropriate to fulfill resource shortages if the required

resources have high strategic value. In addition to this, there is also a requirement for a strong

divergence with existing resources, and moderate or low market and technological

uncertainty. Mergers and acquisitions will result in shareholder welfare by obtaining positive

abnormal returns for both the acquiring and acquired companies, if both companies have

strategic value resources that are cospecialized.