Why firms merge and the problem they cause:

Introduction:

According to Fairburn and Kay (1989) mergers can be dated back in the 1920′s, from the past it is evident that mergers may cause more harm than bring the advantages they bring to the merging firms, the merging and acquisition activities have increased in the past and firms merge because they think by doing so various advantages will be realized and therefore increase the profits of the firm. This paper focuses on the motivating factors toward mergers and the problems caused by these mergers.

Why firms merge:

In this section we discuss why firms merge, some of the reasons why firms merge include the effort to gain market power, tax advantages of gaining a loss making firm, efficiency, increasing market share and diversification among other factors.

Efficiency:

Ravenschaft and Scherer (1987) state that firms will merge because they think that this will result into an increase in efficiency in the new firm formed after merging. Efficiency is expected to rise after the increase in capital, sharing of expertise, elimination of duplicate processes in production and the realization of economies of scale. All these advantages associated with mergers will influence firms to merge, however according to Hughes (1989) mergers may not lead to the realization of efficiency and they may lead to even increased inefficiencies in the firm.

Market power:

Firms will merge in order to gain market power, market power increases where firms that merge are in the same industry and produce the same products in the market and when they merge they form a monopolistic firm which controls the prices and the quantity produced. The firms will also merge as a way to increase their competitive advantages over their rivals and this makes the new firm a market leader, however this may not be the case where government policies may restrict firms to form monopolistic market forms where the firms controls the prices and quantity produced.

Increased market share:

Firms have different levels of market share in the market, when the firms merge they form one big firm those market share is equal to the sum of both firms market share, as a result the market share increases and this acts as a motivating factor for firms to merge. The reason why a larger market share is preferred is because a firm will realize economies of scale, increase sales volume, increase sales revenue and therefore increase profits earned.

Tax advantages:

Firms will also merge in order to gain a tax advantage, all firms will pay tax to the government depending on the level of profits they have acquired, and firms will therefore merge with loss making firms as a way of reducing their tax burden. However in most countries this has been discouraged where policies have been put in place to limit the act of profit making firms shopping for loss making firms to gain tax advantages.

Diversification:

According to Henry (2000) firms will also merge as a way to smooth earnings, smooth earning results into a smooth stock price over time and therefore investors are attracted to invest in the companies stocks. When two firms merge their earnings and stock prices are more stable and this increases investor confidence and therefore realize increased capital base from investors equity.

Increasing geographical coverage: