Mergers and Acquisitions

How do Mergers and Acquisitions affect Shareholders?

When two companies decide to combine in order to increase their market share, reduce competition, diversify or expand and improve the current market price it is known as merger and acquisition. In simple words, mergers and acquisitions mean when a company merges with another company or acquires another company. An acquiring company is one which buys shares and assets of another company whereas a target company is one whose shares and assets are bought by the acquiring company or it is a company which has been chosen by the acquirer as an attractive option for merger and acquisition. 

Mergers and acquisitions are quite common in present times than we realize as mergers and acquisitions usually do not make it to the headline unless the companies involved in it are big and famous. There can be various reasons for companies to opt for mergers and acquisitions. One important aspect to understand is the impact that mergers and acquisitions have on the shareholders of the companies. Let’s understand how they are affected.

What are Mergers and Acquisitions?

When two or more companies combine to form a single company it is known as a merger. It generally involves two companies of roughly equivalent size.  Mergers are more ‘friendly’ as compared to acquisitions. Merger often takes place to boost the shareholding value by entering new markets or gaining greater market share in which they already compete. Generally, mergers do not require shareholder’s approval as there is limited regulation when it comes to governing small private companies in mergers and acquisitions however if a company has been publicly listed in the last ten years before the merger takes place then the Code of Takeovers and Mergers will apply which requires the shareholders approval. 

An acquisition means when a company having more influence in the marketplace takes over or purchases another company. Acquisitions are also known as ‘takeovers’ and they are not necessarily a mutual decision. In acquisition, the company acquiring is generally a larger entity and it purchases the smaller entity for cash considerations.

Often mergers and acquisitions are considered as one but they are two different concepts. The merger of two companies forms a new company and is different from one company acquiring/taking over another company. In simpler words, a merger is different from an acquisition as generally a larger company is purchased for cash considerations in acquisition but in a merger, there is an agreement between the two companies to combine into a single entity.

What is the Impact of Mergers and Acquisitions on the Share Prices?

The impact of a merger on share prices varies every time. It depends upon the specifics of the deal and the market understanding of the transaction value. If the merger is done by exchange of shares, then the exchange ratio determines whether the company will receive a premium above its share price before the announcement of the deal. Share prices of the company generally rise but it may be limited if the share price of the merging partner drops which erodes the initial premium. The risk of erosion can be limited by including a collar agreement increasing the exchange ratio to meet the risk of the situation where a stock to be exchanged falls below a certain level. The collar agreements limit the downside of a company’s shareholders at the expense of its merging partner and the merging company’s shareholders^[1]. Even the market discounts the proposed merger premium if the deal faces a significant setback which may be for regulatory approval or for other reasons. On the other hand, if the investors believe that the deal announcement may lead to higher bids from new suitors, then shares of the company could be traded above the proposed merger premium.

In addition to this, the impact of the acquisition on the company’s shares is that it rises. At the time of acquisition, the share prices may fall somewhat to meet the cost of acquisition. However, if a merger is presumed by the market to be beneficial then both companies’ share prices go up. If the market feels otherwise, then the share prices may fall.

What is the Impact of Mergers and Acquisitions on Corporate Governance?

The impact of mergers on corporate governance is that shareholders of both companies have a stake in the resultant company irrespective of their exchange ratio. Shares that are not exchanged get diluted in the larger company by the issue of new shares to the other company’s shareholders. Based on the terms and conditions of the deal, merger announcements specify the percentage that each group of shareholder will own in the resultant company. Companies negotiating a merger also mutually decide who will lead the resultant company and the manner of integration of the board of directors, management teams and business. Sometimes, the control of the resultant company is the motivation for the merger and how it is apportioned affects the deal’s financial terms. In some cases, the senior managers are paid bonuses on the merger by inserting a change-of-control provision in the compensation agreements.

What is the impact of merger on the voting power of the shareholders?

The shareholders of the resultant company have less voting power as compared to the parent companies. This can often lead to disputes and genuine shareholders might end up leaving the company. To mitigate this risk, it is necessary to communicate the benefits of mergers and acquisitions and ensure that every shareholder understands how their influence will be impacted.

What is the Impact of Mergers and Acquisitions on the Target company?

Mergers and acquisitions take place at a cost known as the premium. The acquiring company has to pay a premium for building the company from scratch so the stock prices of the target company often tend to rise due to the premium received from the acquiring company.

What is the Impact of Mergers and Acquisitions on the Acquiring company?

The impact of Mergers and Acquisitions on the Acquiring company is different from that of the target company. Stock prices of the acquiring company go down as the acquiring company has to pay a premium to the target company. Sometimes it leads to a heavy debt burden on the acquiring company but it is not the same in all cases. If the acquisition is genuine and proper then it can have a profound effect on the competitors and the market. In such cases, individuals prefer buying stocks of such companies as the price of shares rise.

Conclusion

Mergers and Acquisitions affect stock prices to a great extent. It impacts different parties differently. In summation to what we have discussed above, the impact of mergers and acquisitions on shareholders is different depending on the genuineness and success of the deal. The impact of mergers and acquisitions on the shareholder varies depending upon the company they belong to whether it is the acquiring company or the target company. These are the factors that can impact the shareholders in mergers and acquisitions but there are no hard and fast rules as to how a particular merger and acquisition will respond so it is important to properly analyze the deal before entering into it.

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