Competitive parity for bidding firms from acquiring related targets

Strategic relatedness between bidding and target firms, as defined in equa- tion (10.1), is not a sufficient condition for the shareholders of bidding firms to earn competitive advantages from mergers or acquisitions (Jensen and Ruback 1983; Lubatkin 1983). If the value of the combined cash flow of target and bidding firms is publicly known, if several potential bidding firms can all obtain this cash flow, and if semi-strong capital market efficiency holds (Fama 1970), then shareholders of bidding firms will, at best, gain only competitive parity from acquisitions. In this setting a ‘strategically related’ merger or acquisition may create economic value, but this value will be distributed in the form of superior returns to the shareholders of target firms. This conclusion follows directly from the equilibrium expected in perfectly competitive markets (Hirshleifer 1980), in this case the market for corporate control (Jensen and Ruback 1983).

The price of a target firm in such markets will rapidly rise to its NPV in creating synergies with bidding firms, that is, k will tend to 0. The price of a target will not be less than this level, for if it were, another bidder, seeing an opportunity for superior returns, would drive the price up (Barney 1986a).2 Bidding firms that complete a merger or acquisition in this setting will not obtain superior returns, even if they are completely successful in exploiting anticipated relatedness with a target, for the value of that relatedness will be reflected in the price of a target (Barney 1986a), and thus distributed as superior returns to the shareholders of acquired target firms.3

Different bidding firms may have different types of relatedness with tar- get firms, and these competitive dynamics still unfold. All that is required is that these different bidding firms value targets at the same level. However, in real markets for corporate control, it seems likely that when different bidding firms value the acquisition of targets at the same level, the type of relatedness that exists between one bidder and targets is likely to be quite similar to the type of relatedness that exists between other bidders and targets.4 This homogeneity in relatedness leads to a homogeneity in the valuation of targets, which in turn leads to zero economic profits for bidders on acquisition.

The frequency with which markets for corporate control are perfectly competitive in this manner is ultimately an empirical question. However, in general these conditions seem at least plausible. It is not difficult to imagine a set of similar firms pursuing the same strategy in an industry all becoming interested in a particular type of acquisition to implement that strategy. In this setting, perfect competition dynamics are likely to unfold, and firms that successfully acquire a target are likely to earn zero economic profits for their shareholders. In all likelihood the manager who successfully ‘snatches’ a target from several competing firms will have paid a price for that target that fully anticipates any competitive advantages associated with that acquisition. Such acquisitions cannot be expected to generate superior returns for the shareholders of this successful bidding firm.

Empirically, Ruback’s analysis (1982) of DuPont’s takeover of Conoco suggests that this acquisition probably occurred in a perfectly competitive market. Also, Singh and Montgomery’s research (1987), which showed that strategically related acquisitions created more economic value than unrelated acquisitions, but that this value was captured by the shareholders of acquired firms, suggests that these acquisitions occurred in perfectly competitive markets.

Source: Barney Jay B., Clark Delwyn N. (2007), Resource-Based Theory: Creating and Sustaining Competitive Advantage, Oxford University Press; Illustrated edition.

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