MERGERS AND ACQUISITIONS

Mergers and acquisitions (M&A) are often the means chosen by company boards of directors to meet strategic goals such as expansion of products, services, or revenues. As the terms imply, a merger is a combination of two existing businesses; an acquisition is a purchase of a company by another company. Since both processes legally unite companies, the transactions are called consolidations. Since the two processes are similar, the term mergers and acquisitions is the typical reference used for consolidations in the United States. The detailed differences of such transactions, though, influence the accounting treatment in the company's records. The Financial Accounting Standards Board (FASB) has promulgated rules and practices for the accounting treatment for each of the four variations of consolidations recognized in U.S. accounting standards.

The sections that follow include: consolidation movements in the United States, motivations for M&A, the process, accounting for M&A, and after the merger or acquisition. The range of strategies used by companies to undertake cooperative ventures is not discussed here. Furthermore, the potential tax effects of consolidations are beyond the scope of the discussion provided in this article.

CONSOLIDATION MOVEMENTS IN THE UNITED STATES

Distinct periods for consolidations have been identified in the United States. J. Fred Weston and Samuel C. Weaver, for example, identified four periods with the circumstances that initiated each:

1. 1893–1903—Fueled by consolidation of railroads and industrial enterprises
2. 1920s—Motivated by interest in vertical consolidation to control the entire supply chain
3. 1960s—Spurred by interest in diversification, the building of conglomerates
4. 1980s—Stimulated by availability of junk-bond financing

Writers in the early twenty-first century identified a fifth wave that began in the mid-1990s. For example, Patrick Gaughan noted that by "1993 we were once again in the throes of a full-scale merger wave" (2002, p. 3). The literature about events since 2000 has demonstrated mixed judgment, with some writers indicating that the fifth wave was continuing (as of 2006).

CONTEMPORARY MOTIVATIONS FOR M&A

Consolidations that began in the 1990s have had common motivations identified in the press and in empirical reviews of M&A activity in the United States.

To Enhance Market Position Quickly

The board of directors, viewing a high level of cash reserves and high market value for the company stock, may determine that acquiring a company that has a particular product line or customer base will heighten its position in the market. For example, ConocoPhillips, formed through a series of mergers, continued to grow through mergers through 2005. As of November 2005, it realized that it could become the third-largest oil company with the contemplated purchase of one of the largest independent oil companies in the United States. The target of their interest, Burlington Resources, was attractive owing to Burlington's use of new drilling technologies and because of the possibilities of expanding internationally by gaining access to this company's inroads in countries such as Canada and Ecuador. The outcome of a possible acquisition is seldom clear because other interested parties could appear before the completion of the process.

Larger Size Can Meet Perceived Demand

Businesses such as banks, accounting firms, law firms, and management consulting firms have all experienced mergers and acquisitions during the economic development of the United States. Banks, for example, undertake mergers and acquisitions as customers and potential customers required larger pools of funds than available in a bank with limited resources.

Technological Shifts

A period of intense technological changes encourages mergers and acquisitions. It is not uncommon for a mature company to identify the innovation of an emerging company as a good match to extend their product lines or provide new services. In December 2005 the New York Stock Exchange (NYSE), a traditionally functioning stock exchange that began operations in 1792, concluded that expansion of services electronically was critical for its future. Thus, their acquisition of Archipelago, an electronic trading network, is illustrative of this motivation. As of early 2006, the newly formed NYSE Group Inc. was scheduled to shift from a not-for-profit organization to a publicly owned entity with extended services for clients.

Growth in Revenues

Sometimes competitors realize that they can achieve far more together than separately. The extensive number of mergers and acquisitions during the final decade of the 1800s and the first years of the 1900s is often cited as a key factor in the establishment of a national economy in the United States.

THE PROCESS

There are many aspects to the achievement of a successful merger or acquisition. The process may take a relatively brief period or an extended period of several years. The nature of the initial interest influences the initial process. Experts in the field of M&A who are able to meet the reporting phases mandated by legal requirements in the United States are generally needed. Company charters and bylaws provide policies and procedures that must be met in the event of a sale or merger. For certain types of mergers or acquisitions, the shareholders have the right to cast a vote to support or reject the bid.

Initial Attitudes of Participants

Interested parties—the target company executives and the potential buyer—may be friendly or hostile to each other. If friendly, the leaders of two companies may engage in informal discussion that leads to a more serious assessment of the advantages to each if their company resources were combined.

If the company executives of the target company do not find the efforts of the potential buyer appealing, strategies to undermine the potential takeover may be introduced. The use of poison pills (securities issued to shareholders that become available if purchases of stock reach a specified level) raises the cost of acquisition. Changes in the company bylaws and charter, including the issuances of gold or silver parachutes—high payouts to current executives of target companies—impede progress in hostile takeover efforts. The business press often reports the types of strategies in use by major companies facing hostile takeovers.

The potential buyer, to overcome the reluctance of the target company, may make a tender offer, which is to advertise its interest in buying the target company stock from current stockholders at an attractive price.

Need for Expert Assistance

Companies that engage in mergers and acquisitions on a relatively regular basis may have professional staff members in house that participate in the process. Even with in-house staff, however, the engagement of outsiders is common. Investment bankers are frequently engaged to serve as the key drivers of the total process. Additionally, the companies involved seek the guidance of lawyers, accountants, and proxy solicitation companies, as well as public relations firms.

Review by Regulatory Agencies

Companies with publicly traded securities participating in mergers or acquisitions must submit documents to relevant governmental agencies at the federal and state levels. All such companies must meet federal securities laws that deal with adherence to provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934, which deal with disclosure requirements and the regulation of tender offers. The U.S. Department of Justice and the Federal Trade Commission are responsible for enforcing antitrust laws. Regulated industries, such as banking, insurance, communications, utilities, airlines, and railroads, must meet special regulatory requirements beyond the general rules.

The purposes of such review reflect the interest of the U.S. government in ensuring that the business environment in the United States is favorable to an open, competitive, fair style of behavior by business entities. Furthermore, such reviews include gaining assurance that laws related to employee benefits and environmental requirements are honored by participants in a merger or acquisition.

ACCOUNTING FOR M&A

Mergers and acquisitions fall under the general technical description of "business combinations" in accounting terminology. Two financial accounting standards govern the accounting for business combinations. They are the Statement of Financial Accounting Standards No. 141, "Business Combinations," and the Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," both of which were issued by the FASB in 2001.

The definition of a business combination from FASB Statement No. 141 is: "a business combination occurs when an entity acquires net assets that constitute a business or acquires equity interests of one or more other entities and obtains control over that entity or entities."

The most frequent method for entering into a business combination is acquisition of an equity (common stock) interest of over 50 percent of the outstanding stock of the acquired company. The acquired company does not go out of business. The acquiring company (now called the parent) usually has complete control of the acquired company (now called the subsidiary). Because of this controlling relationship, accounting standards require that consolidated financial statements be prepared for the parent and subsidiary as if they were a single entity. The parent may have many subsidiaries, in which case all would be consolidated with the parent in the consolidated financial statements.

Commonly, the parent acquires the stock of the subsidiary with cash, exchange of stock, and/or debt. The total paid (the cost) is then compared to the book value acquired. Normally, there is an excess of cost over book value acquired for two reasons—book value of long-lived assets is based on historical cost less accumulated depreciation, and intellectual assets are not permitted to be on the balance sheet of the newly acquired subsidiary according to generally accepted accounting principles.

An appraisal of the subsidiary is made and a part of the excess of cost over book value acquired is allocated to all identifiable assets. Nevertheless, because intellectual assets—such as value of employees—are not permitted to be recorded as assets, there is generally a residual value of the excess of cost over the book value acquired after the allocations to bring net assets of the acquired subsidiary to fair value. This residual value is called goodwill. When consolidated statements are prepared, both the fair values of the subsidiary's assets and the goodwill are shown.

There are three other methods for achieving business combinations. One method is for one company to acquire the assets of another. The other two methods use statutory mergers and statutory consolidations. Note that although in common language mergers and acquisitions are used as synonymous terms for consolidations, in accounting these are technical terms. A statutory merger occurs when Company A acquires Company B and dissolves Company B. A statutory consolidation occurs when Companies A and B create Company C and dissolve companies A and B. The accounting for business combinations achieved via asset acquisitions, statutory mergers, and statutory consolidations is similar to the accounting for a business combination via equity acquisition.

AFTER THE MERGER OR ACQUISITION

After the legal functions have satisfactorily concluded, the new entity has the demanding task of integrating the components of the new entity so that the goals anticipated at the time of consolidation are realized. The evidence on the success of mergers meeting their goals is ambiguous. In a summary of several empirical studies, Günter Stahl and colleagues noted, "Despite their popularity and strategic importance, the performance of most M&A has been disappointing" (Stahl, Mendenhall, Pablo, and Javidan, 2005, p. 1).

There are many instances of earlier mergers and acquisitions being spun off. For example, First Data Corporation, which acquired Western Union in 1995, announced in January 2006 that it planned to spin off its purchase of more than a decade earlier. This decision was made even though Western Union had been a fast-growing money-transfer business for the acquirer.

Both Cendant and Tyco, which expanded through mergers and acquisitions over a decade, announced plans to split their companies. In October 2005 Cendant reported it would become four independent companies. In early January 2006 Tyco International reported plans to split itself into three publicly traded companies.

Reconsideration of company strategy leads to mergers and acquisitions as well as to the undoing of earlier mergers and acquisitions. The dynamic characteristic of contemporary business is clearly reflected in these two seemingly contradictory processes that are evident in the economic environment at the same time.

bibliography

Dash, Eric (2006, January 27). Western Union, growing faster than its parent, is to be spun off. The New York Times, Section C, p. 3.

DePamphilis, Donald M. (2003). Mergers, acquisitions, and other restructuring activities (2nd ed.). Amsterdam: Academic.

Gaughan, Patrick A. (2002). Mergers, acquisitions—Corporate restructuring (3rd ed.). New York: Wiley.

Stahl, Günter K., Mendenhall, Mark E., Pablo, A. L., and Javidan, M. (2005). Sociocultural integration in mergers and acquisitions. In Günter K. Stahl and Mark E. Mendenhall (Eds.), Mergers and acquisitions: Managing culture and human resources. Stanford, CA: Stanford Business Books.

Statement of Financial Accounting Standards No. 141. (2001). Business combinations. Stamford, CT: Financial Accounting Standards Board.

Statement of Financial Accounting Standards No. 142. (2001). Goodwill and other intangible assets. Stamford, CT: Financial Accounting Standards Board.

Weston, J. Fred, and Weaver, Samuel C. (2001). Mergers and acquisitions. New York: McGraw-Hill.

Bernard H. Newman

Mary Ellen Oliverio