Value Increasing Theories

3.3.1. Efficiency theory

Motive for merger according to value increasing theories is that merger will be benefi-cial for both the acquirer and the acquired company. This is strictly aligned with basic idea behind finance theory that firm’s most important goal is to increase the value of its shareholders. Efficiency theory suggests that merger will increase company’s and its shareholders’ wealth through operative synergies. Main point in efficiency is that com-bination of two entities can perform more efficiently because for example the admin-istration of the new entity can be handled by one entity’s workforce. In general the idea is that one plus one is more than two in the case of synergies of efficient. (Weitzel 2011.) Efficiency theory also supports the idea that poorly working firm led by poor management is very likely to be purchased and hence the efficiency of old firm will be improved through merger and by new owner (Scherer 1988).

Because mergers and acquisitions are multidimensional transactions, source of wealth creation is not always easy to find out. Expected efficiency increase of the combined entity is one very likely reason for value increase but alternative suggestions are for example increased power through monopoly power and even market mispricing. These mentioned aspects are studied by Banerjee & Eckard (1998) and they concluded that expected efficiency related outcomes were the primary source of value creation after merger. They rejected the monopoly power alternative because they did not find any

“free-rider” reaction which is typical in monopoly behavior. They neither found any support for market mispricing alternative. Supporting evidence for efficiency theory can be found from study by Avkiran (1999). According to their study inefficient banks were more likely to become merged. Their conclusions support the theory that efficiency in-crease is the main motive for merger. In addition studies by Devos, Kadapakkam &

Krishnamurthy (2009) and Mukherjee, Kiymaz & Baker (2004) support the efficiency related theory. Primary source of effectivity according to these studies is cost cuttings.

Savings of expenditures are considered more important source of effectivity than even increased revenues.

3.3.2. Market Power Theory

Market power theory is another explanation why mergers increase shareholders’ and other stakeholders’ value. Primary target of the benefits are however shareholders. If efficiency theory suggested that wealth increases by more cost effective organization, market power theory suggests that wealth increase comes from higher prices. Higher prices are wealth transfers from customers and it is possible because increased market power enables firms to ask higher prices. Wealth link in market power theory is also synergies and these synergies are results from increased market power. (Weitzel 2011.) Horizontal mergers and acquisitions are proved to increase market concentration at least in some level. In the light of market power theory, concentration of the market leads to higher prices and hence the increased market power is the primary source of wealth gains. Market power gains and benefits from more concentrated markets get support from the study by Prager (1992). Prager investigated railroad industry in the U.S. and his conclusions support market power theory but diversification and antitrust enforce-ments have impact on wealth gains. Empirical support for market power theory and the significant role of market concentration can be found also from study by Kim and Singal (1993). Their study investigated mergers’ effects in airline industry and accord-ing to their findaccord-ings mergers had positive impact on shareholders wealth and the prima-ry source of wealth gains was higher prices. Interesting finding was also that poorly performing firms ask lower prices but after merger they rose their fares and it helped them to perform more profitable. That is quite genuine but it supports the theory that mergers lead to market power and it enables asking of higher prices.

In contrast with horizontal mergers, market power theory can be applied with vertical mergers also. According to empirical evidence market power theory explains the mer-gers and acquisitions when target company is operating in relatively competitive mar-kets. On the other hand firms already operating in highly concentrated industries do not have significant incentives to take part in mergers and acquisitions. In conclusion the concentrated market position is one strategic goal of firms and mergers are considered as an appropriate alternative for achieve it. (Chatterjee 1991).

Market power hypothesis seems to be strongly related to the size of the acquirer, be-cause empirical evidences state for example that big banks which acquire, achieve more market power. Conclusion is that the larger mergers result in higher interest rates. In-creased market power enables banks to ask higher interest rates similar to inIn-creased

market power enables firms from other industries ask higher prices (Sapienza 2002).

Significance of size of the acquiring firm is considered also in the study from Chatterjee (1991) and the conclusion is that bigger acquirer results in bigger gains in market pow-er. In addition Chatterjee however states that market power theory and efficient theory must be considered simultaneously sometimes and motives must be investigated case by case.

3.3.3. Corporate Control Theory

The third theory in the group of value increasing theories is corporate control theory.

According to this theory the management’s primary task is to run the firm so that the wealth of shareholders will be maximized. If management and company underperform there will always be eager firms to purchase this underperforming firm. In a result of merger this poorly operating management will be replaced and firm will start maximize shareholders’ wealth again. Corporate control theory includes some kind of circular effect where new management will maximize firm’s profit until there emerge new firm and management which is able to earn even higher profits with firm’s assets. Corporate control theory is slightly related to efficient theory but significant differences arise at least in two issues. First, value increasing is not a result of combined assets of two firms but the acquirer firm’s management and underutilized assets of acquired firm. Second, corporate control theory often includes hostile takeovers because incumbent manage-ment is likely to resist the takeover. Typically bidders in these occasions are private investors or corporate riders which will bring in more sufficient management teams. In conclusion shareholders’ wealth is increased by net gains through managerial synergies.

(Weitzel 2011.)

Market power theory has been criticized by many authors and lawyers that mergers are harmful for society and customers because of risen prices. In contrast with this approach Manne (1965) has concluded that merger markets are important part of the markets be-cause profitable assets of the poorly managed organizations must be fully utilized and here markets for mergers are important. From economical point well-functioning firms are beneficial for the whole society. However if organization’s assets are not utilized fully because of poor management, the firm does not increase the wealth in the society.

According to corporate control theory well-functioning merger markets result in wealth increase of the shareholders and the whole society.

Supporting evidence for corporate control theory is also suggested by study of Jensen and Ruback (1983). According to their findings mergers increase the wealth of share-holders. They state that previous studies reject the hypotheses that increased market power is not the source of wealth gains. Their conclusion is somehow combining result of better performing management and increased efficient. According to their study the source of wealth increase is not explicitly the new management or cost effectiveness but the combination where competent management enables the firm to be profitable and efficient in the future.