Megamergers

A merger is a combination of two corporations in which only one corporation survives and the other firm goes out of existence. A consolidation is the combination of two or more companies to form an entirely new company, to the point that the original companies cease to exist. Megamergers simply refer to very large mergers and consolidations. Examples include the mergers of Vodaphone-AirTouch and Mannesman ($180 billion), AOL and Time Warner ($165 billion), and Citicorp and Travelers ($73 billion).

Corporate mergers and acquisitions are important events because they represent massive reallocations of resources within the economy. Over the past century, there were five merger waves, in which a series of high merger activity was followed by a relatively inactive period. The last merger wave, called the “period of megamergers,” occurred from 1992 to 2000. The megamergers during the past decade are just larger than previous ones. The concentration of megamergers in recent years has been in the banking, telecommunications, petroleum, and pharmaceutical industries. Megamergers partially reflect the level of growth in economic activity and globalization of financial markets.

Megamergers occur for numerous reasons, such as synergy, corporate control, tax considerations, diversification, market power, transaction cost efficiency, and purchase of undervalued assets. A common motive for megamergers is synergy, which refers to an increase in competitiveness and resulting cash flows beyond what the two companies are likely to accomplish independently. Thus, the synergy motive suggests that megamergers occur for the efficiency that results from merging the resources of the two firms. Synergies come in various forms, including economies of scale due to cost savings and better capacity utilization, more effective management, improved production techniques, and combining complementary resources.

[Page 575]An important issue is whether megamergers create value. Some contend that megamergers increase value and efficiency and move resources toward optimal uses. Others are dubious of this view. They argue that megamergers do not lead to subsequent performance gains and destroy value. Still others believe that any gains to shareholders simply represent the distribution of wealth from other stakeholders. Thus, value is preserved.

To measure wealth effects, studies use either short-run stock performance of the bidder and target or the long-term performance of the bidder for several years after the transaction. The use of short-run stock performance appears to be more reliable, as it accounts for the changes in stock prices that would incorporate any expected changes in firm value as a result of a merger. Long-term studies focus on relative performance of the acquiring firm compared to non-acquiring peers.

The evidence on wealth gains for acquiring firm shareholders is unclear, because they may earn little, no, or negative wealth gains in the short run. The target's stock usually increases upon the announcement of a megamerger, but often at the expense of the acquiring firm's shareholders. Studies that examine the performance of acquiring firms during the 3 to 5 years after the transactions generally find a negative net wealth effect. Whether megamergers are good for consumers, competition, or society at large remains an empirical question.