Merger wave

THE FIRST WAVE, 1897-1904

The first merger wave occurred after the Depression of 1883, peaked between 1898 and 1902, and ended in 1904. Because the first wave involved predominantly horizontal acquisitions, this caused a surge in industrial stocks and resulted in the creation of monopolies. Some of today's huge industrial corporations originated in the first merger wave, including Du Pont, Standard Oil, General Electric, Eastman Kodak, and American Tobacco (Gaughan, 1996).

THE SECOND WAVE, 1916-1929

The second merger wave was termed “merging for oligopoly,” whereas the first wave was termed “merging for monopoly.” The second wave occurred from around 1925 to the end of decade, and most mergers from this period were characterized as horizontal or vertical integrations (Jemison & Sitkin, 19861). An abundant availability of capital was fueled by favorable economic conditions and lax margin requirements. The antitrust law force of the 1920s was stricter than the period of the first merger wave. With a more strict environment, the second merger wave created fewer monopolies, but more oligopolies and many vertical integrations (Gaughan, 1996).

The Third Wave, 1965-1969

The 1960s, which have been termed the decade of conglomerates, saw the most controversial of the acquisition activities. The conglomerates, such as Textron, ITT, and Litton, or “empire builders,” acquired many unrelated business firms in order to reduce cyclical risks. Conglomerates not only grew rapidly, but also profitably, and top executives of these conglomerates were perceived as breaking new ground. According to Judelson (1969), these management skills facilitate a necessary unity and compatibility among a diversity of operations and acquisitions. For example, ITT acquired a variety of business firms, such as rental cars, insurance, wood pulp, and bread companies. Harold Geneen, a chaiman & CEO of ITT, used a system of detailed budgeting, tight financial control, and face-to-face meetings among his general managers to build ITT into a highly diversified, but well-functioning conglomerate (Geneen, 1984). In the third wave, the most typical payment method was in stocks. The most important notion for diversified firms is the argument that the top executives of these firms possess general management skills that aim at contributing to the overall performance of the firm. According to Andrews (1969), there has been a continuous growth of management talent in America, equal to the task of managing diversity. The divisionalized structure of large companies provides the opportunities for younger managers to gain the requisite experience. Andrews (1951) further argued that general management skills contributed to diversification, helping to create “successful diversification—because it always means successful surmounting of formidable administrative problems—develops know-how which further diversification will capitalize and extend” (p. 98). Goold & Luchs (1993) stated that, “The idea that professional managers possessed skills that could be put to good use across different businesses rested on the assumption that different businesses nevertheless required similar managerial skills” (p. 8). During the 1960s, most research focused on identifying the basic management principles valuable to all kinds of managers and corporations (Goold & Luchs, 1993). Drucker (1955) argued that “intuitive” management was no longer competitive. Drucker further advocated that managers should cultivate management principles, acquire knowledge, and analyze their performance systematically. Koontz (1961) outlined the management process school, which aimed to identify universal management principles, and held the greatest promise for accelerating management practices. Both Drucker's and Koontz's arguments “naturally emphasized the issues and problems which were common across different types of businesses, since their aim was to help all managers improve their skills and the performance of their businesses” (p. 8, Goold & Luchs, 1993). Berg (1969) stated that merger and acquisition strategies based upon improving the performance of a diverse collection of business would have important implications for management practices, and also for public policies. Goold & Luchs (1993) stated that, “There was little reason to question the belief that general management skills provided a sufficient rationale for diversified companies while such corporations were performing well and growing profitably” (p. 10). However, by the late 1960s, conglomerates began to experience performance problems. In early 1969, the share prices of such conglomerates, including Litton, Gulf &Western, and Textron, fell almost 50 percent from their hey days, compared to a 9 percent drop in the Dow Jones Industrial Average over the same period. Even ITT's consistent record of increased quarterly earnings over 58 quarters during the 1960s and 1970s was broken in 1974 (Bonge & Coleman, 1972). Goold & Luchs (1993) pointed out the causes of the decline of the conglomerates era as “What became apparent was that sound principles of organization and financial control, coupled with a merger and acquisition objective of growth, were not, alone, sufficient to ensure satisfactory performance in highly diversified companies” (p. 10). Further, Goold & Quinn (1990) stated that even General Electric realized by the early 1970s what it called a “profitless growth.” That is, GE's sales increased 40 percent from 1965 to 1970, whereas its profits actually dropped. The era of the conglomerates ended with ITT's 1995 spin-off into three different companies (Sikora, 1995). It can be said that most of the conglomerates' merger strategies failed, and they jettisoned their unrelated or under-performing companies in order to maintain their strengths in today's stiff competition. According to Sadtler, Campbell, & Koch, the combined value of firms jettisoned from their parent companies substantially increased from $17.5 billion in 1993, to more than $100 billion in 1996 in the U.K. (Economist, 1997). In the lodging industry, in 1954, the historical merger between Hilton and Statler stunned the entire lodging industry. The lodging industry also experienced turbulent changes in the 1960s. Following the trend of conglomerates' acquisitions of unrelated businesses, some banking firms became the prey of empire builders. For examples, TWA acquired Hilton International, which operated in 42 countries outside of the United Kingdom, and ITT took over Sheraton Corporation's 160 banks. Also, with acquiring 576 Big Boy Franchises in 1967, Marriott became the nation's largest commercial food and lodging firm, with sales of approximately $383 million in 1968. It executed its initial public offering (IPO) in the same year. One of the most important trends of the 1960s was that many international airline companies had already acquired or were trying to take over banking firms (The Cornell HRA Quarterly, 1968).


The number of merger and acquisition transactions in the 1970s fell dramatically (See Table 4). As a consequence of the problems by conglomerates experienced showed in the 1970s, there was increasing attention paid to the effectiveness of the concept of general management skills. One of the emerging concepts during the 1960s and 1970s was the need for top executives to focus their attention on the long-term goals of their firms. As Chandler (1962) said, strategy is the determinator of the basic long-term goals of an enterprise, and the adoption of courses of action and the allocation of resources necessary for carrying out these goals. Further, Christensen (1965) argued that the concept of strategy made it possible to simplify the complex tasks of top executives. It was increasingly emphasized that the top management tasks are to identify and set up their firms' long-term objectives, rather than the control of the day-to-day operations of their strategic business units. More and more CEOs accepted that strategy must be their primary and unique task. Andrews (1971) defined the primary task of merger and acquisition strategy as identifying the businesses in which the firm would compete, an idea that became a generalized understanding of merger and acquisitionstrategy. However, merger and acquisitionstrategy did not provide practical guidance to some of the problems faced by diversified firms. Specifically, Goold & Luchs (1993) stated that, merger and strategy “did not help them decide how resources should be allocated among businesses, especially when investment proposals were being put forward by a large number of disparate businesses, each with its own strategy. This problem was exacerbated when the aggregate demand for resources exceeded what was available” (p. 11). Bower (1970) argued that investment decisions should not be made on a project-byproject basis, but had to be integrally related to a business's strategic product and market decisions. In the 1970s, portfolio planning was developed by Boston Consulting Group, and then widely accepted as a solution to solve practical problems of resource allocation in the context of an overall merger and acquisitionstrategy. Portfolio planning provided managers with a common framework to compare many different businesses. During the 1970s, many firms adopted portfolio planning as their fundamental management principle. For example, one survey showed that by 1979, 45 percent of the Fortune 500 companies used some form of portfolio planning (Haspeslagh, 1982). Goold & Luchs (1993) stated that, :the key concept here was the idea of a balanced portfolio: made up of businesses whose profitability, growth, and cash flow characteristics would complement each other, and add up to a satisfactory over merger and acquisitionperformance” (p. 11). However, as time passed, problems associated with portfolio planning emerged. In search for solutions to the problems of portfolio planning, Haspeslagh (1982) found that firms made few changes in their formal merger and acquisitionsystems, but merger and acquisitionmanagers in successful firms did make informal attempts to adapt these systems to their business strategies. Furthermore, Hamermesh & White (1984) found that administrative context was an important factor in explaining business performance, and that many firms were taking the wrong approach to some of their businesses. Goold & Luchs (1993) pointed out these identifications as “The recognition that different types of businesses had to be managed differently undermined the argument that general management skills, buttressed by the common frameworks of strategy and portfolio planning, provided the rationale for diversified companies” (p. 13).

THE FOURTH WAVE, 1981-1989

In the 1980s, another merger wave occurred in the UK business world. Sikora (1995) expressed this phenomenon as “A highly skilled service infrastructure of investment bankers, lawyers, tax experts, due diligence probers, valuation mavens, and even environmental specialists developed to skipper buying and selling through the gritty M&A process. Shareholder value motivations leaped to the forefront, triggering both acquisitions and sell-offs” (p. 50). The total value of the mergers of the 80s was approximately $1.3 trillion. In the 80s, merger deals were larger and more frequent than ever. Some driving forces behind this phenomenon were: financial shoppers, equipped with substantial support from lenders and investors, were able to acquire a variety of larger deals than ever; globalization facilitated foreign companies' pouring their money into the UK market; enough funds were available to support a number of buyout deals; and, the antitrust law was lenient (Sikora, 1995). Moreover, previous researchers identified the causes of the fourth merger wave as excess capacity (Jensen, 1993), agency problems (Jensen, 1988; Lichtenberg & Seigel, 1989), market failure (Shleifer & Vishny, 1991), and tax and antitrust law changes (Bhagat, Shleifer & Vishny, 1990). During the 1980s, there was almost unanimously skeptical agreement about diversified firms' capacity to create value. As Goold & Luchs (1993) expressed, “The takeover activity of the 1980s prompted a re-thinking of both the role of merger and acquisitionmanagement in large companies, and of the kinds of strategies which were appropriate for diversified companies” (p. 13). In the 1980s, in order to survive, UK companies cut costs and downsized their staffs, but this was not sufficient to create value for their firms. Porter (1987) found that the diversification strategies of many U. S. firms had failed to create value. More importantly, during the 1980s, American CEOs changed their fundamental goals from building empires to creating shareholders' value. Goold & Luchs (1993) stated that, “Managers were encouraged to evaluate merger and acquisitionperformance in the same terms as the stock market (and raiders), using economic rather than accounting measures, and to take whatever actions were necessary to improve their company's stock price” (p. 14). Rappaport (1986) and Reimann (1987) argued that value-based planning, through adopting the financial tools of discounted cash flow, ROE spreads, and hurdle rates, provided business managers with a different perspective on the link between competitive advantages and stock prices. Both Rappaport and Reimann's assertion is that a firm's share price is determined by the value of a firm's level of competitive strategies. However, some flaws of value-based planning were revealed in its use as for a framework to merger and acquisitionstrategy. As Goold & Luchs (1993) pointed out “It can help merger and managers to focus on the goal of increasing shareholder wealth and to understand the criteria that must be met to do so. It does not, however, provide much insight into the kind of merger and strategies that should be pursued to meet these criteria. A higher stock price is a reward for creating value. But the key question remains: how can corporations add value to a diverse business portfolio?” (p. 14). During the 1980s, the primary underpinning concept of successful merger and acquisitionstrategy was based upon core business, or “stick to the knitting.” According to Peters & Waterman (1982), successful firms did not diversify into various businesses. They tended to specialize in their core businesses and focused on improving their knowledge, including their expertise and management skills in the areas they knew best. Moreover, Hayes & Abernathy (1980) argued that most American companies were being run by professional managers, who specialized in finance and law, but were lacking in technological expertise or in-depth particular industry experience. The authors cautioned that portfolios of diversified firms across dissimilar industries and businesses were fit for stocks and bonds, but not for corporations. Mintzberg (1989) also attacked the concept of a portfolio planning matrix by stating the need for “focused corporations that understand their missions, ‘know' the people they serve, and excite the ones they employ; we should be encouraging thick management, deep knowledge, healthy competition and authentic social responsibility” (p. 373). The growing attention of specialized firms to these concepts clearly contrasted with the existence of diversified firms' ability to create value from their portfolio of businesses. In order to survive, many huge American companies had to adopt a restructuring strategy. Restructuring involved the disposal of merger and acquisitionassets, and was regarded as a salutary correction to the excesses of extensive diversification. Jensen (1989) argued that merger and acquisitionbreak-ups, divisional sell-offs, and LBOs are crucial developments that can prohibit the unproductive use of capital by managers of large firms. Since the 1980s and to the present, there has been a trend towards increased specialization. Denis, Denis & Sarin (1997) identified the causes of this refocused strategy as “decrease in diversification is typically prompted by external control threats, financial distress, and management turnover suggesting that, in general, firms do not voluntarily refocus in order to adapt to environmental change. Rather, refocusing appears to be the result of external monitoring of managerial behavior” (p. 80). In the lodging industry, some notable leveraged buyout (LBO) transactions occurred during the 1980s. According to Moncarz (1991), in February 1985, Kohlberg, Kravis, Roberts, and Company (KKR) and a new management team converted Motel 6s public firm to a private one, with the exchange of some $881 million (including $125 million in equity and $756 million of debt). However, in July 1990, Accor S.A., a French lodging giant, acquired Motel 6 for 1.3 billion in cash, a very high rate of return. Moreover, in 1990, Days Inn agreed to be acquired by Tollman Hundley Corporation for $765 million ($90 million in cash and the assumption of $675 million of debt). However, the new owner experienced a difficult time due to the enormous amount of debt, because of the high burden of its interest rate. As a summary of the merger activities of both the 1960s and the 80s, it can be assumed that diversification and conglomeration were the dominant acquisition trends in the 1960s, whereas consolidation and specialization were the most common phenomena of the 1980s. Shleifer & Singh (1994) stated that: “The fact that diversification of the 1960s did not, on average, lead to profitability improvements and was, to a substantial extent, subsequently reversed, is clear evidence of a failure that was not expected in the 1960s,” (p. 406) and, “In the 1960s, conglomerates were created; in the 1980s, many of them were destroyed” (p. 408).


The predominant M&A deals of the 1990s are carefully designed to secure a strategic fit between merging firms. In the 1990s, the merger wave was shaped very differently than that of the 1960s, the decade of the “conglomerates,” and that of the 1980s, the decade of the “leveraged buyouts” (LBOs). Lipin (1997) pointed out that, “Except that it isn't really like those eras. It is bigger, for one thing. And the forces behind it are different” (p. A1). For example, in 1996, for the first time, each of the top 100 deals was a megadeal, worth more than $1 billion or 53.5 percent of the total transactions (Sikora, 1997). Compared to the 60s and 80s, it could be said that the 1990s is the decade of ‘consolidations'. Consolidation means the combination of two firms' operating and management resources, as well as their assets, debt, and stocks (Watson, 1960). Most acquirers have employed acquisition as expansion strategies within their unique industries. These appear to be less risky acquisitions because they were paid for with stock, which is recognized as being less risky than cash, compared to the 80s when payments were made with cash rather than stock. It is generally believed that consolidation tends to be a means of reducing costs and achieving scale economies from acquisitions. There are several driving forces that have facilitated the current merger-mania syndrome. Lipin (1997) claimed that, “the current merger boom, fueled as it is by executives' drive for market share, efficiency, and pricing power in core businesses, bears similarities with an earlier merger wave, at the end of the last century” (p. A1). Further, the continuation of a stable economic environment, relatively favorable antitrust law enforcement, a low cost of capital, and the stock market's good condition are the catalysts of the current acquisition trend. However, there were still many acquiring companies who failed to generate shareholder value. According to a merger study done by Mercer Management Consulting Inc. (1997), “among all mergers in the 1990s, 48 percent still fail. That compares with 57 percent in the 1980s. But among the largest mergers - when the target company is at least 30 percent of the acquiring company, measured by revenues - the failure rate jumps to 75 percent.” Acquirers have been fueled by the notion that firms had to collect larger and larger pools of assets either to survive or to grow. According to Goold & Luchs (1993), the primary issues for merger and acquisitionstrategy in the 1990s are how to identify the businesses that should form a core portfolio for a firm, and how to discover ways of creating value for those businesses. Goold & Luchs (1993) identified three alternative answers to the above questions. First, diversification must be limited to those businesses with synergy potential. Synergy can be achieved when the performance of a portfolio of businesses adds up to more than the sum of its parts. The most compelling concept of synergy is based in part upon scale economies and the cost saving structure of a portfolio of businesses. Porter (1985) argued that without synergy, a diversified company is nothing but a mutual fund. Moreover, Kanter (1989) also argued that a diversification strategy's only justification is the achievement of synergy. However, both Porter and Kanter acknowledged that firms found it is hard to gain synergy benefits, and therefore there is a high rate of failure. Chatterjee (1992) points out that synergies are hard to achieve and that most acquisition gains arise from asset disposals and restructuring, rather than from anticipated synergistic benefits. Synergy remains a fundamental rationale for acquisitions, but it is difficult to agree that it is the only way to create value in a diversified company. Goold & Luchs (1993) stated that, “The assumption that synergy is the only rationale for a group of companies does not fit the available evidence, and this suggests that not all corporations need to focus their efforts on constructing and managing portfolios of interested businesses” (p. 17). Second, the merger and acquisitionstrategy must be focused on exploiting core competencies across different businesses and/or industries. Hamel & Prahalad (1990) argued that the merger and portfolio should be considered as a portfolio of technological competencies, rather than a portfolio of businesses. Itami (1987) emphasized building a company's “invisible assets,” such as a particular technological expertise, brand names, reputation, or customer information. Itami argued that such assets can be utilized throughout the firm without being used up, and they are the most valuable source of sustainable competitive advantage. Haspeslagh & Jemison (1991) defined core capabilities as managerial and technological experience accumulated primarily through a resource-based view of a firm. Such capabilities can be utilized across a firm's businesses and can make a critical contribution to customer benefits. Haspeslagh & Jemison (1991) also proposed three generic types of acquisition: (1) Domain strengthening; (2) Domain extension (building on existing business); and (3) Domain exploring (going into new markets or technologies). Moreover, Kietel (1988) stated that, “To the extent that such skills can be exploited by each of the company's businesses, they represent a reason for having all those businesses under one merger and acquisitionumbrella—a much better reason, the experts add, than the fabled synergies that multibusiness companies of yore were supposed to realize but seldom did” (p. 20). However, a core competence approach also has flaws. Goold & Luchs (1993) stated that, “It can be difficult to judge when an investment in a business is justified in terms of building a core competence, particularly if it means suspending normal profitability criteria and if the investment is in an unfamiliar business area” (p. 18). Furthermore, Goold & Luchs (1993) stated that, a “competence approach to merger and acquisitionstrategy is that businesses may require similar core competences, but demand different overall strategies and managerial approaches” (p. 18). Goold & Luchs (1993) further stated that, “Merger and acquisitionexecutives are concerned not only with building skills and competences in their businesses, but also with allocating resources to them, approving their plans and strategies, and monitoring and controlling their results” (p. 19). Third, building a collection of businesses which fit with the managerial “dominant logic” of managers and their management style is one of the best ways to diversify successfully. Prahalad & Bettis (1986) argued that, “A dominant general management logic is defined as the way in which managers conceptualize the business and make critical resource allocation decisions—be it technologies, product development, distribution, advertising, or in human resource management” (p. 490). When a manager's dominant logic does not fit the requirements of the business, problems and frustrations can arise. Goold & Luchs (1993) stated that, “Dominant logic may help explain why conglomerate diversification can succeed, and also why diversification based on synergy or core competences can fail. If conglomerate diversification, such as that of Hanson, is based on businesses with a similar strategic logic, then it is possible for merger and acquisitionmanagement to take a common appproach and to add value to those businesses. On the other hand, businesses with opportunities for sharing activities or skills, or ones requiring the same core competences, may nonetheless have different strategic logics. This makes it difficult for merger and acquisitionmanagement to realize synergy or exploit a core competence across the businesses” (p. 20). It was identified that firms are inclined to utilize a specific management style, and that it was difficult to for executives to deal with a wide variety of approaches and styles (Goold & Campbell, 1987). Moreover, Prahalad & Doz (1987) argued that the successful firms in global competition will be those firms that can develop differentiated structures, and management processes and systems appropriate to the wide range of their businesses.

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