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December 05, 2005

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Paddy Carter

One problem I have with all the research I have seen that demonstrates M&A tends to produce poor returns is the lack of counterfactual. As ever this is, in some respects, a pointless criticism, because we never do have counterfactuals in such cases, but nonetheless ... some M&A moves are defensive. The idea being that without them, the company would wither, sooner or later. So even though the calculated return is rubbish, the alternative (not-merging) may have been worse. No, hang on, that is a rubbish criticism, because we it works in both directions: we don't know that life might not have actually been better without the merger. That's the point. Duh.

It is, though, an argument that is sometimes put. For example, Microproceser company Arm recently bought a company called Artisan, in what looks like a text book example of a deal that will not create returns (over priced, no synergies). However, Arm executives argue that in the future, they will need to have the technology Artisan has given them, and there was no cheaper means of acquiring it. Or something like that. Or perhaps sometimes companies want to stop a rival getting their hands on an asset (Oracle recently bought a company called Retek to stop SAP getting it, and paid well over the odds). In a game theory way of looking at things, they'd argue that every alternative move was worse, even though the financial maths make the deal look like a bum move. Is this feasible, or hogwash? I'm just thinking aloud here.

Robert Schwartz

Mergers will remain popular as long as executives who promote them continue to get raises and bankers continue to collect fees.

AJE

"I mention all this because I suspect the taste for mergers is an example of the salience heuristic - the gains to mergers seem obvious, whilst the costs of them (difficulties in managing larger firms) are more hidden."

Great point. Would you also say that this is some kind of "planners bias" where people overestimate the extent to which they can plan economic activity? Solution being to read more Hayek!

dearieme

Put aside the general points: those of us who are NTL customers know that its management suffers from alcoholic conviviality in a brewing facility organisational dysfunction syndrome.

Innocent Abroad

Dearieme, I'm an NTL customer too and while I might have agreed with you six months ago they've got a lot better and frankly I expect things to get worse under the mad balloonist's régime... although if he can get Test Cricket on a proper PPV basis all will be forgiven...

chris

AJE - I certainly would say that. We cannot over-emphasize the parallels between centrally planned economies and centrally planned companies.

Kevin Carson

I totally agree with what you say about diseconomies of scale (with the research I'm doing on organizational behavior, btw, I've got stacks of Canback articles out the wazoo).

I would add this caveat, though. Bureaucratic diseconomies don't necessarily lead to poor market performance. If an industry is largely cartelized by state regulations, and made up of a handful of oligopoly firms that share the same pathological organizational culture, then they're largely insulated from the ill effects of inefficiency.

Kevin Carson

Very interesting post. I touched on some of the same issues on my blog today. It's nice to see Canback cited, because he's done some excellent work. His biggest influence was Oliver Williamson; he argued that the main reason for preferring internal hierarchy over market contract, despite bureaucratic diseconomies, was the need for a governance structure for dealing with asset specificity. One thing he neglected, though, is the fact that asset specificity is a dependent variable. Whether specialized or general-purpose capital equipment is more efficient, for example, depends on the volume of demand. Government policies that promote artificially large market areas also promote higher levels of asset specificity. In a decentralized economy of small-scale production for local markets, asset specificity would be a lot less severe.

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