Inefficient Strategies of Serial Acquisition : Glamour, Earnings Management, Financial Engineering and Industrial Concentration

Meeks and Meeks (2022, MM for short)* has a question in its subtitle, Why spend ever more on mergers when so many fail? There are three interwoven strands in the book’s answer:First, contracts (explicit and implicit) often reward key players in the M&A market — executives and advisers — for deals that result in zero or negative operating gains.Second, accounting rules and practice often offer rich opportunities for acquirers to mislead the market about the prospective operating gains from merger, and to flatter performance measures following merger.Third, legal and taxation arrangements often enable acquirer executives, as well as shareholders in these cases, to extract economic rent from other stakeholders in deals that yield no operating gains.This paper extends that analysis for one important category of M&A activity: serial acquisition. It explores ways in which these three characteristics can lead to a sequence in which one inefficient merger facilitates a further inefficient merger, which then aids a further inefficient merger, and so on. ‘Inefficient’ in this sense means that the merger yields insufficient operating gains even to recoup the transaction costs of the deal, or that any operating gains are outweighed by costs to other stakeholders.Each of the devices we discuss causes acquisition to boost conventional performance measures such as earnings per share (EPS), facilitating the funding of further bids. One device we explore creates ‘glamour’ through share-financed acquisition of less ‘glamorous’ firms - the semblance of growth in EPS without any change in the operating profit of the merging firms. A second device – accounting manipulation – not only creates illusory extra accounting profit ahead of an acquisition, inflating the price of acquirer shares offered in exchange for the target, but also can then be used in the course of integrating the target to boost reported post-merger profit. A third device – financial engineering, exploiting moral hazard and tax avoidance – utilises debt finance for acquisitions to create a higher rate of return on equity without any increase in operating profit. A fourth device uses horizontal mergers to build dominant positions in product markets, securing monopolistic profits and undermining allocative efficiency. Again the acquirer becomes more attractive to suppliers of finance for further deals.The final section of the paper turns to the other side of the M&A market – the targets. It explores the curious cases where the same company is bought and sold by a series of acquirers, or even where the acquirer subsequently ‘sells it to itself’. Possible motives for such series of deals, which seem to offer no benefit to the economy, are found in the incentive schemes employed by private equity.Illustrations are provided from a range of industries in the US and UK.*The Merger Mystery (digital version available free at https://www.openbookpublishers.com/books/10.11647/obp.0309 )