The Economic Case for Mergers: Old, New, Borrowed, and Blue
Collins, Grainne, Journal of Economic Issues
Over several years I have worked on a project that looked at the implications for women's work of new technology. (1) Part of this project involved case studies and interviewing female workers every two months for twenty-four months. Even though the project was not directly about mergers, they quickly became a major focus as it became clear how many workers had undergone a merger or takeover during their working life. (2) Time after time I heard stories of how stressful mergers were and how they left workers feeling demotivated and de-skilled. The workers I interviewed told anecdotes about futile control struggles, arbitrary changes of technology or procedures that were often later reversed, lack of clear command lines, and illogical decisions taken with power rather than profits in mind. After the merger they felt their partially situated knowledges had been ignored or destroyed and their trust violated and that it was only after several years that things "settled down." All the women I talked to are close to or at the bottom of their organizations, and from their point of view mergers seemed like corporate suicide.
This article is a discussion of my futile search to find context for their stories within the canon of economics. I looked in particular at three economic paradigms--neoclassical, new institutionalism, and institutionalism--and tried to judge each paradigm's success at explaining the cause, and the success or failure, of mergers. In particular I sought to examine how the three theories coped with knowledge, risk and trust, time lags in moving between organizational forms, and the interaction between the different levels of the firms during the merger that I uncovered in my empirical research.
In many ways mergers do provide a hard case for economic theories. Mergers are a moving target, a state of disequilibrium. Economists of each tradition highlight some features of firms and downplay other aspects. This in turn influences the questions that are posed and the evidence sought for support of their theories. Critical in this selection of features is the stance on methodological individualism on one side and history on the other. However, none of the theories I examine satisfactorily situates the reasons for and the consequences of the major economic phenomenon that is mergers and acquisitions.
Examining the Firm
In a merger or acquisition one firm takes over or joins with another firm to form a new company. The ostensible reason for mergers is the drive to improve shareholder value, profits, or market share. Typically it is argued that mergers are a better and faster way to grow than by organic growth. Julie Froud et al. reported that for some years U.K. companies spent more on buying other companies than they did on plant and machinery (2000). Yet value, however defined, is consistently being destroyed, and mergers fail in more than 50 percent of the cases to increase value (Agrawal et al. 1992; Froud et al. 2000; Hubbard 1999; Scherer 1988).3 Why is this? What happens during a merger that changes a profit into a loss? Given that so often mergers are unsuccessful, why do firms pursue, at an increasing pace, mergers?
The standard neoclassical economic literature does not examine mergers often, but when it does it treats them in one of three ways: a form of economic pathology, a form of cartelism, or a result of the separation of ownership and control of the company. The idea that mergers are a form of economic pathology arises because of an inability to explain mergers under the standard perfectly competitive neoclassical framework. (4) Neoclassical theory conceives the entrepreneur as a person with global rationality, unlimited and costless information, unlimited computational ability, unlimited time at his or her disposal, and clearly defined ordering of preferences for various outcomes. With all these attributes the entrepreneur pursues maximization of profits by comparing all possible alternatives, establishes the most profitable, and then moves instantly to align structure and strategy. …