The History of

Mergers and
Acquisitions
 Two major themes

• Each of major merger movements

reflected some underlying economic
or technological factors
• Macroeconomic environment is
important
– GDP growth
– Interest rate levels
– Interest rate risk premiums
– Monetary stringency
 1st Merger Wave – 1897-1904 –
”Merging for Monopoly”
Underlying Factors:
• Technological developments
– Transcontinental Railroads
– Electricity
– Innovations in production process
• Continuous process cigarette machine
• Rapid Economic Expansion
• Lax anti-trust enforcement
• Corporation laws relaxed
• Voluntary code of ethical behavior
 Characteristics of 1st wave
mergers:

• Horizontal mergers
• Heavy manufacturing industry

US Steel founded by J P Morgan

These resulting industrial merged with Carnegie Steel
consolidations led to creation of large founded by Andrew Carnegie. The
monopolies. merged firm US Steel also acquired
several other smaller steel
producers and the resulting giant
captured 75%of the steel market of
Standard Oil owned by John D
United States.
Rockfeller commanded 85% of the
market share.
 Reasons for ending 1st
wave:
The era of easily availability of
finance, a basic ingredient for
• Majority of mergers failed – didn’t
takeover, ended resulting in the
achieve increase in efficiency halting of the first wave.
Further the application of anti-trust
legislations, which was hitherto lax,
•become
Economic recession in 1903
more rigorous.
The federal Government under the stewardship of
Some President
of current corporate
Theodore leaders
Roosevelt (nick named like
‘trust buster’)
• General
Stock market Electric
crash
and subsequently (GE),
under in Du
1904
President Pont,
William Taft made a
major crackdown
Eastman Kodak,on large monopolies.
Navistar International are products of
• Supreme court ruled in 1904 that
Standardthe first
Oil was wave.
broken into 30 companies such as Standard Oil of New
Sherman Act* could be used to attack
Jersey (subsequently renamed Exxon), Standard Oil of New York
anticompetitive
(subsequently mergers
renamed Mobil), Standard Oil of California (subsequently
renamed Chevron) and Standard
*Mudit, Oil of
Ankur and Indiana
Ankit - to(subsequently renamed
find out the salient features
Amoco) of this Act.
2nd Merger Wave – 1916-1929
– ”Merging for Oligopoly”
Underlying Factors:
George Stigler , a winner of the Nobel
• Post-World War I economic boom has contrasted the
prize for economics,
• Lax margin requirementsfirst wave as “ merging for monopoly”
and the second wave as “ merging for
• Technological developments oligopoly”.
– Continued development of railroad
– Motor vehicle transportation
– Radio
• Government encouraged firms to work
together during WWI, maintained this policy
in 1920s
 Characteristics of 2nd wave
mergers:
• Produced fewer monopolies, rather
oligopolies, vertical mergers, and
Ford Motors (usually
conglomerates became related) a vertically
• Primaryintegrated metals, petroleum company. It
products,
foodmanufactured
products, chemicals, its own tyres and for
transportation the cars equipment
from the rubber were the
mostproducedactive from M&A its industries
own plantations
• Used in significant
Brazil. Further proportion
the bodies of debt for to
finance deals
the car were made from the steel,
• Investment banks played central role
produced
in financing (asfrom in 1st itswave)
own steel
plants.
The anti-trust The
environment steel
was stricter with plants
the passing ofin turn
Clayton Act,
1914. This resulted in several vertical mergers, wherein firms involved did
got the
not produce iron
same ore
productfrom Ford’s
but had similar own
product lines.
mines and shipped on its own
 Reasons for ending 2nd wave:

• October 29, 1929 stock market crash

• Great depression
corporate The giants
wave endedlike
with the stock market

1940s General Motors,

crash on the “Black Thursday”. On 29th
October, 1929, the stock market witnessed
International
• Mergers motivated by tax relief Business
one of the steepest stock price fall in
history.

• NoThemajor
Machine(
technological
IBM), Union
changes
crash resulted in a loss of business confidence, curtailedor
dramatic Carbide,
spending development
and investment, John
thereby Deere,
worsening in U.S.
a sharp etcafter
decline

infrastructure product of this

are the the crash.

era.
Firms were focusing on basic survival and maintaining their solvency
rather going for the fresh acquisitions.
 3rd Merger Wave – 1965-1969
– ”Conglomerate Mergers”
Underlying Factors: This wave featured a historically high
level of merger activity. One of the
• Booming economy reasons for this factor is that this wave
occurred in the background of a
booming American economy
• Rising stock prices

• High interest rates

• Tough antitrust enforcement

• Management science developments

3rd Merger Wave – 1965-1969
– ”Conglomerate Mergers”
The bull market in the 1960s drove stock prices higher
and higher. This resulted in the shares of certain
companies getting high price/earning multiple. Potential
acquirer realized that acquisitions through stock swaps
• Financial manipulations
(shares of the acquirer given in exchange for the shares
of the target company) was an innovative way to
increase earning. This led to famous boot strap game.
– Price-earnings game
– Pooling of interests method of
accounting
– Bootstrap effect
Example to be discussed in class
 Characteristics of 3rd wave:
Reverse Merger
• Primarily conglomerate mergers One of the new trends
started by this wave
was the acquisition of
larger companies by
• Some bidders smaller than targets smaller companies. In
The conglomerate formed the wave prior to this,
during this period were highly the acquirer was
• Primarily equity-financed
diversified and simultaneously – investment
always bigger in size
banks did not play central role than the target.
operated in several unrelated
industries.
• Aerospace most active industry, while
industrial machinery, auto parts, railway
equipment,
e.g. during the sixtiestextiles, andInternational
,ITT (The original tobacco also &active
Telephone Telegraph
was created in 1920 ) acquired such diversified businesses like car rental
firms, bakeries, consumer credit agencies, luxury hotels, airport parking
• CEOs with vision to create conglomerates
firms, construction firms, restaurant chains, etc.
 Reasons for ending 3rd wave:

• Attorney General announced plans to crack

down on conglomerates in 1968
• Legislation
– Williams Act*
– Tax Reform Act
• Market eventually saw through financial
manipulations
• Many of conglomerates performed poorly

*Amit / Anil to discuss the silent features of this Act

in class
 1970s – Precedent-setting
mergers

• INCO – ESB
• United Technologies – Otis Elevator
• Colt Industries – Garlock Industries
4th Merger Wave – 1981-1989
– ”The Megamerger”
Underlying Factors:

• Expanding economy
• Technological developments
• International competition
• Deregulation
• Increased pension fund assets
• Financial innovations
• Investment banking industry much more
competitive
• Failure of conglomerates
 Characteristics of 4th wave:

• Size and prominence of acquisition

targets much greater than before

• Oil and gas industries dominant in early

1980s, while pharmaceuticals most
common in late 1980s; airlines and
banking also common

• Foreign takeovers became common

 Characteristics of 4th wave:

• Heavy use of debt to pay for acquisitions

• Junk bonds

• More hostile takeovers

– Corporate raiders
– Arbitrageurs
– Investment banks and law firms active
 Reasons for ending 4th wave:

• Legislation
– Financial Institutions Reform, Recover, and
Enforcement Act (1989)
– State antitakeover legislation

• Michael Milken’s indictment (1989) and Drexel

Burnham Lambert’s bankruptcy (1990)

• Gulf war
5th Merger Wave – 1992-2000
– ”Strategic restructuring”
Underlying Factors:

• Expanding economy, rising stock prices

• Technological developments

• Globalization

• Deregulation
 Characteristics of 5th wave:

• Emphasized longer-term strategy rather

than immediate financial gains

• More often financed with equity than

debt

• Consolidation in the telecommunications

and banking industries
 Reasons for end of 5th wave:

• Bursting of stock market bubble

• Economic slowdown
 Merger Trends in the United
Kingdom

• Peaks in 1968, 1972, 1989, and late

1990s

• Increase in takeovers in late 1980s due

to rising stock prices, laissez-faire
governmental attitude towards mergers,
financial innovations
 Merger Trends in Continental
Europe

• Uncommon before 1990s, especially

hostile takeovers

• Takeovers increasing, despite

antitakeover legislation

• Firms making transition from sunset

to sunrise industries

• Deregulation
 Changes in Corporate
Governance in 1980s and
1990s
Prior to 1980s:
• External corporate governance mechanisms
rarely used
• Institutional shareholding modest
• Boards provided weak monitoring of
management
– Large boards of directors
– Low percentage of directors’ compensation
is equity-based
• Management stock ownership modest
• Performance plans based on accounting
measures
 Changes in the 1980s:

• Predominance of debt financing – provided

strong financial discipline
– Leveraged acquisitions
– Leveraged buyouts (LBOs)
• Managers receive substantial equity stakes
• LBO sponsors or investors closely monitored
and governed firms they purchased
• Small boards of directors
• Directors tend to own large equity stakes
• IPOs could lead to big payoffs for LBO
investors
 Changes in the 1980s:

• Management buyouts (MBOs)

• Stock repurchases
• Institutional shareholders’ stakes
increased
• Results:
• Cross-subsidization of poorly-
performing divisions stopped
• Excess capacity eliminated
 Changes in the 1990s – public
companies mimicked LBOs

• Managers received generous stock-option plans

• New measures of managerial performance
• Closer monitoring by institutional shareholders
• Smaller boards of directors
• Directors’ compensation more equity-based
• Trend toward decentralization within firms
 Market vs. internal allocation
of finance

• Firms are experts at particular

technologies, products, processes

• Firms may not be good at producing

products in new industries

• Firms’ transition to new industries

may be slow
 Market vs. internal allocation
of finance
• Markets may be better at identifying
new investment opportunities

• Markets can redirect capital to new

industries quickly

• Management of independent firms in

the new industry is likely to be more
knowledgeable about the industry
 Public Criticism of M&A and
Market-based Corporate
Governance
• Corporate raiders use their control to strip
assets from the target, make a quick
profit, destroying the company in the
process, throwing people out of work

• Raiders shouldn’t have the right to buy up

firms they have no idea how to run – the
employees who have spent their lives
building up the firm should be making the
decisions
 Public Criticism of M&A and
Market-based Corporate
Governance
• Raiders become filthy rich without
producing anything, at the expense of
hardworking people who do produce
something

• The management and board of

directors can best judge whether a
takeover offer is in shareholders’
interests
 Public Criticism of M&A and
Market-based Corporate
Governance
• M&A damages the morale and
productivity of firms
• Markets are far from efficient
• Markets are short-sighted (especially
institutional investors)
– Managers pressured to forego long-
term investment in favor of short-
term profit
– Market penalizes firms heavily
investing in R&D
– M&A market discourages managerial
risk-taking
 Public Criticism of M&A and
Market-based Corporate
Governance

• Divestitures (bustups) destroy firm value

• Corporate debt levels have risen to dangerous

levels

• High-yield (junk) bonds do not adequately

compensate investors for risk

• Golden parachutes are excessive

 Jensen’s defense of M&A and
Market-based Corporate
Governance:
• Only natural that CEOs would oppose this
system
• Incumbent management may be
unable/unwilling to make difficult
restructuring decisions
• M&A can lead to more orderly liquidation of
assets than bankruptcy
• Divestitures (bustups) involve reallocation
of assets to more productive uses – the
assets don’t disappear
 Jensen’s defense of M&A and
Market-based Corporate
Governance:

• Takeover and divestiture market

provides a market constraint against
bigness for its own sake

• M&A can discipline managers even

without going through with the
merger

• Markets are close to being efficient

 Jensen’s defense of M&A and
Market-based Corporate
Governance:
• Markets are not short-sighted

– Institutional investor shareholding

not associated with increased
takeovers, decreased R&D
expenditures
– Firms with high R&D spending not
more vulnerable to takeovers
– Stock prices respond positively to
announcements of increased R&D
expenditures
 Jensen’s defense of M&A and
Market-based Corporate
Governance:

• High-yield bonds are fairly priced by the

market

• Corporate debt level not abnormally high

• Properly structured golden parachutes are

value-enhancing

• Poison pills should be banned