Sunday, August 17, 2014

Mergers and Acquisitions: What about the Stockholders?

Why do companies merge and acquire other companies? Synergy is the textbook answer. Typically, the stockholders of the target company see an appreciation in the value of their stock, while stockholders in the initiating firm see a downtick. The reason why is simple: corporations typically overpay. The value-added of the anticipated synergy must be greater than not only any overpayment, but also the intangible costs in aligning the corporate cultures. Yet another factor—an opportunity cost, really—is frequently overlooked: that of whether the extra cash on hand should be returned to the stockholders as dividends.

During 2014 up to August 15th, merger activity around the world was $2.2 trillion, up from $1.29 trillion in the same period the previous year.[1] Comcast, for example, was buying Time Warner Cable for $5 billion, and Reynolds American was buying Lorillard for $27 billion.[2] The nonfinancial companies in the S&P 500 had a near-record $1.2 trillion in cash in an economic context of low interest rates and a bit of inflation.[3] Buying another company would thus be cheaper than not only expanding from within, but also investing the cash in interest-bearing or tied securities.

In fact, not buying a company under the circumstances could easily be thought of as doing nothing with the cash. As Chris Lee of Fidelity Select Financial Services Portfolio puts it, “Now, the risk of doing nothing seems greater than the risk of doing something.”[4] In spite of the fact that mergers can be very good in the long haul for the stockholders of both companies to a merger or acquisition, a board in touch with its fiduciary duty to the company’s owners would properly consider the alternative of returning the surplus cash to them. Lest too much attention be paid to appreciation in the price of a stock—admittedly of value to those owners who intend to sell—the dividend is a means by which all of a company’s current owners benefit.

To be sure, the decision is not merely a financial one. The return of capital to the providers of equity is an ideological matter as well. To own property, even if most of it is in the form of a concentration of capital, brings with it the right to a share in the profits. This goes beyond the impact of the successive surpluses on the stock’s price. The perspective in which not using extra cash to acquire or otherwise merge with another company is reckoned as doing nothing eclipses the alternative use altogether. Returning excess cash to the stockholders is decidedly not “doing nothing.” The implication that it is intimates a bias in the interest of management that is at odds with its fiduciary duty. 

Put another way, similar to what can easily happen in the political debate over whether to reduce taxes so the citizens will be able to hold onto more of their money or spend the additional revenue on governmental budget items, the tendency of corporate managements, and even boards, to spend excess money rather than return it to the owners may not always be in the best interests of the principals and the principle of property rights.

[1] John Waggoner, “When 2 Companies Love Each Other Very Much . . . “, USA Today, August 15, 2014.
[2] Ibid.
[3] Ibid.
[4] Ibid.