An economic approach to understand, analyze and improve Merger and Acquisition
In this post, I will talk about Merger and Acquisition (M&A) from an economic standpoint. By definition, M&A refers to the consolidation of firms. For example, the recent event in which Bill Gates’s company acquired Four Seasons can be considered as an M&A deal.
An M&A can be regarded as a game because it always has at least two parties (the sell-side and the buy-side); the parties always need to negotiate, work together and cooperate to settle down with a strategy that works best for all sides (Nash equilibrium – players’ strategies are best responses to each other). M&A is sometimes mistaken for a zero-sum game, which means there are always losers and winners. However, there is technically no “loser” in a successful M&A. As we have learned in Networks about network exchange, a node will withdraw from the exchange if it gets nothing. Similarly, an M&A can only proceed when the two sides are willing to join or when both sides can gain surpluses from the deal. This means that the buyer’s value has to be higher than the deal’s value and the deal’s value has to be higher than the seller’s value. Simultaneously, it is important that neither sides have better outside options, which means the buyer and seller in a deal have to be each other’s best match.
From what I have explained above, it is obvious that economics has a lot to do with M&A. In an M&A deal, we can also apply the concept of the matching market to find the best buy-side – sell-side matches.
Since M&A is sometimes mistakenly considered as a zero-sum game, in which there have to be winners and losers in the games (Ramkumar), people sometimes evaluate the deals’ matchings by looking at the buyers’ willingness and preferences (“Mergers and Acquisitions Matching for Performance Improvement: A DEA-Based Approach”), which is somewhat similar to the type of matching we learned in class. In fact, M&A is a game in which any player can withdraw and therefore, it should be looked into from both sides’ standpoints. In the research article “Mergers and acquisitions matching for performance improvement: a DEA-based approach”, the authors suggested using two-sided matching when approaching an M&A deal. Whether the two players of an M&A are the best match to each other or not is determined by the matching score. The score is calculated based on the scale and technical efficiency of the merged companies if the two players decide to make a deal. The higher the score is, the more compatible the two parties are. In the article, the authors gave an example of a matching problem with 14 sellers and 6 buyers. After calculating the efficiency scores for each matching scenario, they arrived at this combined matching degree table:
From this table, it is very easy to see which matchings work the most efficiently. A great thing about this method is that all players’ abilities and benefits are taken into consideration, which reduces the chances of one side exiting the deal due to dissatisfaction. What’s more, it also evaluates the quality of the matching based on very concrete and measurable variables (scale efficiency is based on the current market of the companies and technical efficiency is based on the current ability of the companies), which helps a lot in decreasing biases in the decision making process.
In conclusion, economics is heavily involved in how M&A is established. If the economic concepts are carefully incorporated when evaluating and proceeding M&A deals, I firmly believe that it will lead to a lot more successful and profitable M&A deals for business firms.
References:
https://www.mwcn.org/2020/07/21/game-theory-in-finance-the-prisoners-dilemma-and-ma/
https://www.tandfonline.com/doi/full/10.1080/1331677X.2020.1775673