Mergers
Mergers
A merger is the combination into a single business enterprise of two or more previously independent enterprises. The combination may take a number of forms. Among these are the outright purchase of the assets of one company by another for cash or for the stock or debt of the acquiring company. A holding company may be created, with the stock of the combining companies exchanged for that of the parent company. The stock of the merging companies may be held in trust, though this has been generally superseded by corporate arrangements. Combinations have been effected by long-term lease. The legal and financial forms the merger takes are governed largely by tax, corporate charter, and other legal provisions that introduce unique elements in each case. While such factors are of some influence in shaping the broad pattern of mergers, they are probably much less important than underlying forces of economic change and competition.
Mergers represent a formal, as against an informal, form of combination. Independent and competing enterprises may pursue a common course of action by various arrangements falling short of outright merger. These range from conscious parallelism of action to contractual agreements governing prices, production, conditions of sale, marketing, and other major business policies. Many of these less formal arrangements may achieve the same purpose as a merger in organizing an industry. However, their effects are likely to be less permanent, enforceability is less absolute, and they are vulnerable to the charge of conspiracy.
Probably only a small fraction of all mergers, certainly of recent mergers, have had the reduction or elimination of competition as a principal motive. Other reasons for merging are to achieve a more efficient integration of successive stages in production and marketing, to diversify into new products and markets, to take advantage of a favorable investment opportunity, to minimize taxes when liquidating a business, and to acquire a talented person or a promising patent. In the case of many mergers of very small enterprises, the purpose may be simply to gain the benefits of specialization in management, one partner to the merger becoming responsible for production, the other for marketing and sales.
The great variety of objectives in mergers suggests that convenient generalizations about their underlying causes may not be easy to find. Certain patterns in mergers have been observed, however, which offer some guides to promising lines of inquiry. The following discussion must be confined largely to the United States because of the lack of statistical information about other countries.
Merger movements
One outstanding characteristic of mergers in the United States is the highly episodic nature of their occurrence. In three periods—1898 through 1902, 1926 through 1930, and 1957 through 1961—industrial mergers occurred on so extensive a scale that they are best described as waves or movements (see Figure 1). This tendency of a fundamental form of enterprise expansion to show vast and widely separated peaks of activity has probably interested students more than the examination of individual mergers.
The first recorded merger movement of major proportions occurred as the United States entered the twentieth century, its peak years being 1898 through 1902. For a number of industries it represented the formal consolidation of companies that had already achieved a certain degree of policy coordination through agreements to avoid active competition, agreements that had shown distressing tendencies to break down. For a few important companies it represented merely a change in legal form, from trust to holding company, of an earlier merger. Most importantly, however, it involved the consolidation of companies in a large number of previously dispersed industries into single companies in which control was tightly centralized. It transformed many industries formerly characterized by many small and medium-size firms into those in which one or a few large corporations occupied dominant positions. During the first merger wave such industrial giants as U.S. Steel, American Tobacco, International Harvester, DuPont, Anaconda Copper, Corn Products, American Smelting and Refining, Otis Elevator, Allis-Chalmers, and American Sugar Refining were created.
The second large movement took place in the last half of the 1920s, its peak years being 1926 through 1930. To some degree it represented consolidation in the important new industries that had
appeared since the first merger wave. It also reflected attempts in some industries to restore the levels of concentration achieved three decades earlier by firms whose leading positions had been eroded in the meantime. Among the prominent companies created by merger in this period were National Steel, National Dairy Products, United Aircraft, Owens-Illinois, and Caterpillar Tractor.
As Figure 1 indicates, the third large movement was probably underway in the early 1960s. There was a short merger revival immediately following World War II, which was confined mainly to the two years 1946 and 1947. However, merger activity did not return to sustained high levels until the mid-1950s. The pattern of recent mergers has been more varied, with product diversification and tax minimization playing a more prominent role than in the earlier movements (Butters et al. 1951).
The current revival of merger activity, while large, is not as large as the earlier merger movements. In the five turn-of-the-century years, 1898 through 1902, at least 2,700 firms disappeared into the manufacturing and mining mergers reported in the financial press—and reporting was not as comprehensive as it has since become. In the peak years of the late 1920s, 1926 through 1930, mergers claimed 4,800 firms. By contrast, in the five years 1957 through 1961 there were about 2,900 disappearances. Since the number as well as the size of industrial firms has grown considerably in the past six decades, the most recent levels of merger activity are relatively lower than suggested by the absolute comparisons.
Mergers and competition
The three merger movements have had varied effects on the intensity and form of competition in markets. The turn-of-the-century movement, as indicated above, succeeded in consolidating thousands of small and medium-size companies into relatively few large ones. In literally dozens of cases the merged firm attained a dominant share of its industry. The avowed goal of many mergers was monopolistic control of a market, and this goal was realized in many instances. The effect was to transform competition from that among many firms into that in which one firm was large enough, through force of size, to maintain orderly, and profitable, conditions in a market. The result was a major reduction in the amount of competition as it had been known in the nineteenth century.
The merger wave of the late 1920s, superimposed on an industrial structure still showing the effects of its giant predecessor wave, had a necessarily different effect on competition. Some observers have speculated that its pattern was influenced by judicial interpretation. Antitrust policy, while generally permissive toward mergers in this period, may have made the largest companies in an industry less eager to engage in mergers which would markedly increase their leadership of an industry [seeAntitrust legislation]. Such action might be considered predatory and lay the company open to the charge of being a “bad trust.” Since well-behaved colossi were generally free from antitrust attention, an industry’s largest company might think twice before taking action which might jeopardize its reputation. The second- , third- , or fourth-ranking companies might have felt less restricted. This may have accelerated the formation of industries in which the leadership was shared by several large firms. However, until direct evidence on the number and size of mergers in this period becomes available, such an interpretation must remain largely speculative.
The pattern of several-firm leadership of industry—oligopoly—is now characteristic of many of our leading industries[seeOligopoly]. It is still a much-debated question whether the oligopolistic industry is competitive enough, though there is more general agreement that the existence of several big firms in an industry signifies more active competition than that of one huge, dominant firm. Certainly the merger wave of the 1920s produced an increase in industrial concentration, if by this is meant simply the centralizing of the control of markets into a smaller relative number of enterprises. It remains to be established, however, whether the more common result was the substitution of oligopoly for industries having only one clear leader or its substitution for decentralized industries having many firms and the more classical variety of competition.
The most recent merger revival has been even more complex in its effect on competition. Unlike the two earlier merger waves, the goal of most re-cent mergers has not been the union of two or more firms producing the same product at the same stage of fabrication. This type—the horizontal merger—has the immediate effect of reducing the number of independent firms selling the product in question. A study by the Federal Trade Commission suggests that horizontal mergers may be accounting for about two-fifths of recent merger activity (U.S. Federal Trade Commission 1955, chapter 3). They amounted to about three-fourths of the turn-of-the-century merger activity (Nelson 1959, p. 103) and probably much more than half of that of the 1920s.
The over-all effect on competition of recent horizontal mergers has therefore been considerably less than the horizontal mergers of three and six decades earlier. It would be difficult to see how it could be greater. Given the existing levels of concentration, established in no small part in the earlier movements, the recent merger movement could only maintain or slightly increase this level. To change it greatly would mean the creation of monopolies or near-monopolies in many industries, and this is clearly contrary to public policy.
The strengthening of major oligopolies by merger has recently received greater discouragement from antitrust authorities. In 1958 the courts ruled against the proposed merger of the Bethlehem and Youngstown steel companies, whose effect would have been to make the second largest steel company, Bethlehem, more nearly equal to the largest company, U.S. Steel. Bethlehem, with 15 per cent of the industry, would have had 19 per cent had it acquired Youngstown, thus bringing it closer to U.S. Steel’s share of 30 per cent. A comprehensive study by the National Industrial Conference Board has characterized recent antitrust orientation as follows:
The Board’s study finds that, contrary to popular impression, enforcement has focussed, not on the size of the acquiring or acquired company, as such, but on market effects. Indeed, only 2% of the acquisitions recorded for 1958 and 1959 for the 300 largest manufacturing corporations had resulted in a merger case by March, 1960.
... up to the present time, a merger has been most vulnerable if the acquiring corporation’s sales and assets exceed $10 million and it is one of the first companies in its field, if the acquired unit is also one of the major organizations in its field, and if a high percentage of the output of the products or services in question is concentrated in relatively few companies. Vulnerability is greatest if the two companies operate in the same field. (Bock 1960, pp. 9-10; italics added)
Approximately one-fifth of recent merger activity has involved the combining of firms at successive stages in the production and distribution of a particular product—the vertical merger. The effect of a vertical merger on competition is not likely to be great, unless it provides the merged company with a stranglehold on one of the stages of production. If this is the result, then the relevant combination is fundamentally a horizontal one. The relatively crude evidence available suggests that it is unlikely that the latest vertical mergers have produced any appreciable diminution in competition.
Finally, about two-fifths of recent mergers have had the diversification of products or production processes as a goal. In the first movement, by contrast, there were virtually no mergers for diversification. Diversification objectives cover a broad range. Some companies hope to achieve economies in marketing through production of a broader line of products. Others seek economies in production by acquiring products capable of being produced by the company’s existing production facilities. Still others diversify simply to avoid having their fortunes dependent on a single product or industry. The competitive effects of a diversified merger are not likely to be great. If the merged products did not directly compete with one another before the merger, the fact that they are now produced by the same company can have only indirect effects on competition in their separate markets.
The above general review of the competitive consequences of the three merger movements should amply illustrate that we continue to possess only the crudest notions of the effect of mergers on competition. Considerable work remains to be done in classifying mergers; the simple horizontal-vertical-diversified taxonomy is only a beginning. Beyond this, however, lie challenging conceptual problems for which the tools of economic analysis are appropriate. Many problems are related to the appropriate economic sector in which to measure competition and have relevance to other factors in the structure and performance of industries. Many, however, have their basis in the unique characteristics of the merger and the role that considerations of competitive factors play in the merger decision.
Mergers and business cycles
Although merger history has been dominated by the three large waves, mergers have occurred in measurable amount in every year. One of the periods of lowest activity observed in the twentieth century was the decade from 1905 through 1915, following the huge turn-of-the-century wave. Even during this period there were important mergers. In 1908 General Motors was formed, and in 1911 what is presently International Business Machines. Both were consolidations of several prominent firms in their fields. The great depression of the 1930s saw mergers at probably their lowest ebb; yet even then there were some important chemical and electronics mergers.
The historical pattern of merger activity is notable, therefore, not only for its great waves but also for the presence of cycles in mergers. The cycles are most pronounced as part of the great movements, but they also may be observed during the two-to-three-decade intervals of lowered activity. For the six-decade period from 1895 through 1954 12 clear merger cycles have been identified. During the same period the National Bureau of Economic Research identified 14 cycles in general economic activity, and the merger cycle conformed to the general business cycle in 11 of the 12 cases. When it did not conform, the cycle in general business was either very short, very mild, or both (Nelson 1959, chapter 5).
The cyclical responsiveness of mergers to business activity raises a number of questions. One set relates to the role of mergers as a form of business investment. The balancing of the cost of the firms to be acquired with the discounted expected value of the future earnings of the merged firm involves the same kind of calculation required when deciding to organize a new business or build another plant. Like private investment, merger activity has been shown to respond in a positive and sensitive fashion to the business cycle.
Both merger activity and private investment in new plant and equipment reach their highest points before the peak in general business activity. Both seem to bear a fairly close relationship to movements in stock prices, which suggests that an important factor is the possibility of financing the purchase of either a new plant or another company under conditions favorable to the issuance of new equity securities. Firms expanding by merger, as in other forms of firm growth, frequently turn to public sources for the needed extra funds. The issuance of new securities is most necessary when the acquired firm is purchased for cash; however, when the purchase is made by exchange of stock, new securities may be issued to increase working capital. Even when there is only the exchange of stock, the organizers of the merger are likely to be sensitive to the recent trend of the stock market, because ratios of exchange are often based on the relative market prices of the two securities.
Although both are generally responsive to stock price rises and other manifestations of economic expansions, merger activity and plant and equipment investment are not wholly synchronous. One examination has found that merger activity reaches its peak earlier in a cyclical expansion than do contracts for industrial and commercial construction and orders for manufacturers’ durable equipment (Nelson 1966, p. 58). This pattern of timing refutes the theory that businesses turn to mergers only after other profitable forms of investment have been exhausted.
What might explain the earlier peak in mergers than in internal expansion? One hypothesis might be that, although nothing in the basic decision to invest in merger or new plant would predict when in an expansion each is more likely to occur, delays in the construction of new plants may result in merger plans coming to fruition sooner than plant-building programs. Indeed, delays encountered in plant-building may encourage firms to accelerate merger efforts in order to achieve growth targets on schedule.
Mergers by large firms
In the histories of a majority of the largest industrial corporations there has been at least one merger important enough to have had a significant effect on the subsequent rate and direction of company growth (Nelson 1959, p. 4). Some mergers have made companies leaders in their traditional industries, while others have created diversified enterprises. Some have given large companies commanding leads in expanding new industries, while others have consolidated into fewer firms the control of stationary or declining industries. One could claim that the attrition of time has nullified the effects of at least the earlier of these mergers, so that the structure and performance of these companies is now little different from what it would have been had no mergers taken place. This may have been true, almost by definition, of the least successful mergers, but it strains credibility to argue that the forces molding industry structures have been so pervasive as to make it generally true. Assuredly the structure of the aluminum industry from 1900 through 1940 would have been different had not early patent mergers succeeded in making Aluminum Company of America the only company in the field at that time.
A problem that continues to need solution is that of measuring with some precision the part that mergers have played in the growth of firms. Recent studies provide some idea of its magnitude, and evidently it has not been small. The most comprehensive examination made to date has been that of J. Fred Weston. Investigating 74 large industrial firms, he found that, at a minimum, 22.6 per cent of the 1900-1948 growth of these companies could be assigned to merger (1953, p. 14). Weston regards this as a minimum estimate because he explicitly counted as growth by merger only the addition of the acquired firm at the time of the merger. This assumes that the part of the now-enlarged company representing the new acquisition did not continue to grow after the merger, and so contributed nothing to the postmerger growth of the combined firm. While necessary in setting a lower limit to the range of estimates, the assumption leads, among other things, to the unlikely inference that mergers are organized by pessimistic men.
It is difficult to measure the growth-enhancing effects of any major restructuring of an enterprise, and that produced by a merger is no exception. One approach to measurement might be to com-pare observed growth with that predicted by simple models of firm growth. One such model might assume that, for the merger to have been neutral in its effect on growth, the acquired firm would have grown at the same rate as its industry. Alternatively, one might assume that merging firms (acquiring and acquired) each would have grown at the same rate as the merged firm. Perhaps most plausible would be the assumption that the merging firms would have grown at the same rate as other similar firms that did not merge. Other models could be developed, and much could be learned of the effects of mergers in the process of developing and testing them. None has yet been used on a comprehensive scale to measure the merger component in large-firm growth.
The interest of many students has been in the role of mergers in producing high concentration in major industries, for this is where the implications for antitrust policy have greatest relevance [seeIndustrial concentration]. To study the role of mergers in concentration, one must focus on the firm’s share of its industry and on horizontal mergers that directly affect this share. For 25 of his 74 companies Weston presented measures of mergers’ effects on industry shares. In this formulation he assumed that, in the absence of merger, the acquiring firm would have maintained its pre-merger share of the industry, that is, it would have been able to grow as fast as the industry. This assumption probably assigns too little of post-merger growth to the acquired firm, for enhancement of growth potential must be a primary reason for acquiring a rival firm. Despite this bias toward understatement, the calculated contribution to growth was impressive. He found that, under the above assumption, most of the companies’ increase in market share was assignable to merger. Indeed, for 11 of the 25 companies, mergers accounted for more than their increase in market share, that is, the companies witnessed a decline in the shares of markets that mergers had initially given them. These findings led Stigler, in his review of the Weston study, to conclude: “He [Weston] lends support to the opinion that merger has been the basic method by which individual firms have acquired high shares in major industries in the United States” (1956, p. 40).
International comparisons
Though crude and incomplete, merger statistics for the United States are incomparably more abundant than those for other countries. The only comprehensive time series on mergers known to the writer is that for Great Britain during the large wave of amalgamations it, too, experienced at the turn of the century (Macrosty 1907). Reasons for the paucity of merger statistics in other countries are not hard to find. Absence of antitrust laws, especially those directed at mergers, means that government agencies have had no need to collect data on which to base policy. Also, cartelization rather than amalgamation seems to have been the more common form of combination in European industry, and merger activity may not have been sufficiently large or widespread to engage the interest of economists.
With the acceleration of European economic integration, mergers may begin to receive more attention. The creation of a tariff-free market as large or larger than that of the United States may compel major changes in the firm-structures of industries, and it seems probable that mergers should emerge as important instruments for effecting any such change. The experience of the United States suggests that availability of data provides no sure guarantee that public policy toward mergers will always be enlightened. However, there are some indications that lags in assembling merger data have made the evolution of policy more tortuous, erratic, and probably less successful. An early beginning to the assembling of data on Common Market mergers could aid considerably in the development of appropriate public policies toward mergers; policies, one hastens to add, that may be expected to depart in significant respects from the United States example.
Ralph L. Nelson
BIBLIOGRAPHY
Current data on the number, size, and industry of mergers are available from the Office of Information of the Federal Trade Commission. Comprehensive lists of mergers may be found in National Industrial Conference Board,Conference Board Record (see Bock 1960, pages 107-119 for a discussion of these data).
Bock, Betty 1960 Mergers and Markets: An Economic Analysis of Case Law. Studies in Business Economics, No. 69. New York: National Industrial Conference Board. → See especially pages 107–119, “Data on Merging Companies.”
Butters, John K.; Lintner, John; and Cary, William L. 1951 Effects of Taxation: Corporate Mergers. Boston: Harvard Univ., Graduate School of Business Administration, Division of Research.
Macrosty, Henry W. 1907 The Trust Movement in British Industry. London: Longmans.
Markham, Jesse W. (1955) 1966 Survey of the Evidence and Findings on Mergers. Pages 141-182 in Universities-National Bureau Committee for Economic Research, Business Concentration and Price Policy: A Conference. National Bureau of Economic Research, Special Conference Series, No. 5. Princeton Univ. Press.
National Industrial Conference BoardConference Board Record. → Published since 1944. Previously published under the titles Conference Board Business Record and Conference Board Business Management Record.
Nelson, Ralph L. 1959 Merger Movements in American Industry: 1895–1956. National Bureau of Economic Research, General Series, No. 66. Princeton Univ. Press.
Nelson, Ralph L. 1966 Business Cycle Factors in the Choice Between Internal and External Growth. Pages 52–70 in William W. Alberts and Joel E. Segall (editors), The Corporate Merger. Univ. of Chicago Press.
Stigler, George J. 1956 The Statistics of Monopoly and Merger. Journal of Political Economy 64:33–40.
Thorp, Willard L. 1941 The Structure of Industry. U.S. Temporary National Economic Committee, Investigation of Concentration of Economic Power, Monograph No. 27. Washington: Government Printing Office. -→ See especially pages 227–234, “The Merger Movement.”
U.S. Federal Trade Commission 1955 Report on Corporate Mergers and Acquisitions: May 1955. Washington: Government Printing Office.
Weston, J. FRED 1953 The Role of Mergers in the Growth of Large Firms. Berkeley: Univ. of California Press.