Thus the existence of bidder and target relatedness, per se, is not a source of superior returns to the shareholders of bidding ﬁrms. However, if a market for corporate control is imperfectly competitive, then bidding ﬁrms may be able to obtain a superior return for shareholders from imple- menting merger and acquisition strategies. Three ways that these markets can be imperfectly competitive—including (a) when private and uniquely valuable cash ﬂows exist between a bidder and target, (b) when inim- itable and uniquely valuable cash ﬂows exist between a bidder and target, and (c ) when unexpected synergistic cash ﬂows exist between a bidder and target—are examined below. The ﬁrst two of these cash ﬂows reﬂect valuable, rare and private and valuable, rare, and costly to imitate resources controlled by bidding ﬁrms.
1. PRIVATE AND UNIQUELY VALUABLE SYNERGISTIC CASH FLOWS
One way such an imperfectly competitive market could exist is when a tar- get is worth more to one bidder than it is to any other bidders—and when no other ﬁrms, including bidders and targets, are aware of this additional value. The price of a target will rise to reﬂect public expectations about the value of a target. Once acquired, however, the performance of this special bidder will be greater than expected, and this will generate superior returns for its shareholders.
Consider, for example, the simplest case where the combined cash ﬂow between bidder A and target ﬁrms has an NPV of $12,000, whereas the combined cash ﬂows of all other bidders and targets have an NPV of $10,000. Suppose also that, while no other ﬁrms are aware of A’s unique status, they are aware of the value of the cash ﬂow of all other bidders combined with targets (i.e. $10,000). If the current cash ﬂow of all bid- ders has an NPV of $5,000, then ﬁrm A will obtain a superior return from acquiring a target if it pays less than $7,000 (P = $12,000 − $5,000), while all other bidders will obtain a superior return from acquiring a target if they pay less than $5,000 (P = $10,000 − $5,000). All publicly available information in this market suggests that a target is worth $5,000. Thus, the price of targets will rise to this level, ensuring that if bidding ﬁrms, besides ﬁrm A, acquire a target, they will not obtain superior returns.
If there is only one target in this market for corporate control, then ﬁrm A will be able to bid $5,000 + ε, that is, just slightly more than any other bidder, to obtain the target. At this level, ﬁrm A obtains a superior return of ($7,000 − ($5,000 + ε)), that is, the added value of the combined cash ﬂow minus the price of obtaining that additional cash ﬂow. No other ﬁrm will bid higher than ﬁrm A because, from these ﬁrms’ point of view, the acqui- sition is simply not worth more than $5,000. If there are several targets in this market for corporate control, then ﬁrm A, along with several other bidding ﬁrms, will all pay $5,000 for a target. While all other successful bidding ﬁrms will not obtain superior returns from their bidding activities, ﬁrm A will obtain a $2,000 economic proﬁt.
For ﬁrm A to obtain this return, the existence of its uniquely valuable synergistic cash ﬂows with targets cannot be known by other ﬁrms, both bidders and targets. If other bidding ﬁrms know about this additional value associated with acquiring a target, they are likely to try to dupli- cate this value for themselves. Typically, this would be accomplished by other ﬁrms duplicating the type of relatedness that exists between A and targets by acquiring the resources and capabilities that create technical economies, pecuniary economies, diversiﬁcation economies, or some com- bination of these types of relatedness between A and targets. Once other bidders acquired the resources and capabilities necessary to obtain this more valuable combined cash ﬂow with targets, they would be able to enter into bidding, thereby increasing the likelihood that the shareholders of successful bidding ﬁrms would earn zero economic proﬁts.
The acquisition of these resources and capabilities would not even have to be completed before bidding began, because bidding ﬁrms can anticipate that they will be able to acquire them at some point in the future, and thus the NPV of the expected combined cash ﬂow with a target for these bidders is the same as for A (Barney 1986a). In this setting the price of an acquisition will rise to the point where k = 0. Firm A is shielded from this perfect competition if other bidding ﬁrms are unaware of the higher synergistic cash ﬂow available to A and the sources of this higher synergistic cash ﬂow (Lippman and Rumelt 1982).
Target ﬁrms must also be unaware of A’s uniquely valuable synergistic cash ﬂow for A to obtain superior returns from a merger or acquisi- tion. If target ﬁrms are aware of this cash ﬂow and its sources, they can inform other bidding ﬁrms. These bidding ﬁrms could then adjust their bids to reﬂect this higher value, and the competitive dynamics discussed previously would reduce superior returns obtained by bidders to a fully competitive level. Target ﬁrms are likely to inform bidding ﬁrms in this way because increasing the number of bidders with a more valuable combined cash ﬂow increases the likelihood that target ﬁrms will extract all the eco- nomic value created in a merger or acquisition (Jensen and Ruback 1983; Turk 1987). Although there may be many diﬀerent managerial motives behind target ﬁrms seeking out ‘white knights’ as alternative merger part- ners after an acquisition attempt has been made, the eﬀect of such actions is to increase the number of fully informed bidders for a target. This, in turn, reduces the superior returns that successful bidding ﬁrms obtain.
Table 10.1. NPV of synergistic cash ﬂows and NPV of four idiosyncratic bidding ﬁrms ($)
Thus far, it has been assumed that only one ﬁrm had a more valuable combined cash ﬂow with targets (in the example, worth $12,000). How- ever, the argument also applies to the more complex case when several ﬁrms have combined cash ﬂows with targets greater than what is publicly known. As long as the number of targets is greater than or equal to the number of ﬁrms with these more valuable combined cash ﬂows, each of these bidding ﬁrms can complete an acquisition, and each can earn varying amounts of superior returns (depending on the value of each of these bidding ﬁrm’s combined cash ﬂows) for their shareholders.
The impact of private and uniquely valuable synergistic cash ﬂows on superior returns for shareholders of bidding ﬁrms even holds when diﬀer- ent bidding ﬁrms all have diﬀerent independent cash ﬂows, and when they all have diﬀerent combined cash ﬂows with targets, that is, where each ﬁrm acting in a market for corporate control is unique. Consider the example outlined in Table 10.1. The NPV of the cash ﬂows of ﬁrms A, B, C, and D in this table vary from $5,000 to $2,000, and the NPV of the combined cash ﬂows with targets range from $12,000 to $9,000. From equation (10.2) it is clear that ﬁrm A must pay less than $9,000 for a target to obtain superior returns, ﬁrm B less than $6,000, ﬁrm C less than $7,000, and ﬁrm D less than $7,000.
If information is publicly available suggesting that ﬁrms with the right resources and capabilities can obtain an incremental growth in cash ﬂow worth $7,000 from acquiring a target, then several things are likely to occur. First, ﬁrm B is likely to add to its resources and capabilities those attributes that allow ﬁrms C and D to obtain a $7,000 NPV increase from acquiring a target. Next, the price of a target is likely to rise to $7,000. If there are sev- eral target ﬁrms available, all the ﬁrms in Table 10.1 will be able to acquire a target, but only ﬁrm A will make a superior return (equal to $2,000). If only one target is available, only ﬁrm A will complete the acquisition or merger, and its abnormal return, though still positive, will be slightly smaller ($2,000 − ε). If there are not enough targets for all bidding ﬁrms, then which ﬁrms (B, C, or D) will complete an acquisition is indeterminate, although whichever of these ﬁrms does will not obtain a superior return. In this case, as well, ﬁrm A will complete an acquisition and still earn a superior return for its shareholders equal, in total, to $2,000 − ε.
Adding a ﬁfth ﬁrm (ﬁrm E) that is identical to ﬁrm A in Table 10.1 highlights the requirement that the number of ﬁrms with a more valuable synergy with targets must be less than or equal to the number of targets in order for these bidding ﬁrms to obtain superior returns. If there are two or more targets, then both ﬁrms A and E can execute an acquisition for such returns. However, if there is only one target, then ﬁrms A and E are likely to engage in competitive bidding, perhaps driving the price of this target up to the point where k = 0 (i.e. to $9,000) and in this process shifting superior returns from their shareholders to the shareholders of acquired ﬁrms.
2. INIMITABLE AND UNIQUELY VALUABLE SYNERGISTIC CASH FLOWS
The existence of a ﬁrm with private and uniquely valuable synergistic cash ﬂows with targets is not the only way that a market for corporate control can be imperfectly competitive. If other bidders cannot duplicate the uniquely valuable combined cash ﬂow of one bidder and targets, then competition in this market for corporate control will be imperfect, and the shareholders of this unique bidding ﬁrm will earn superior returns. In this case the existence of uniquely valuable combined cash ﬂows does not need to be private, for other bidding ﬁrms cannot duplicate these cash ﬂows, and thus bids that substantially reduce returns to the shareholders of this special bidding ﬁrm are not forthcoming.
Typically, other bidding ﬁrms will be unable to duplicate the uniquely valuable combined cash ﬂow of one bidder and targets when the relat- edness between this bidder and targets stems from some nonimitable resources or capabilities controlled by this bidding ﬁrm. Such resources and capabilities tend to be path dependent, causally ambiguous, socially complex, or have other attributes that increase the cost of their imitation identiﬁed in the resource-based literature (Dierickx and Cool 1989; Barney 1991a). Barney (1986b) has given several examples of inimitable resources and capabilities, including a ﬁrm’s culture, its unique history, its product reputation, etc. If any of these resources and capabilities are rare and, when combined with a target, generate a more valuable cash ﬂow than any other bidders can obtain when combined with a target, then the shareholders of these ﬁrms will obtain superior returns from acquisitions. This would occur even if all ﬁrms in this market for corporate control were aware of this more valuable synergistic cash ﬂow and its sources. This superior return will not be obtained by the shareholders of target ﬁrms because competitive bidding dynamics cannot unfold when the sources of a more valuable synergistic cash ﬂow are inimitable.
As before, the number of ﬁrms with this special synergistic cash ﬂow with targets must be less than the number of targets for the shareholders of these ﬁrms to obtain superior returns. If there are more of these special bidders than there are targets, then these ﬁrms are likely to engage in competitive bidding for targets, once again shifting superior returns from bidding to target ﬁrm shareholders.
If the number of bidding ﬁrms with these special attributes is less than the number of target ﬁrms, then these bidding ﬁrms enjoy some of the advantages of a monopolist, and the level of superior return they obtain will be approximately the same as for bidding ﬁrms with private and uniquely valuable synergies. However, if the number of special bidders and number of targets are the same, the market for corporate control takes on many of the attributes of a bilateral monopoly. In this setting, the level of return obtained by shareholders of bidding ﬁrms depends on their negotiating skill (Hirshleifer 1980), and is thus indeterminant. When all bidders and targets know the value of a target for a particular bidder, this negotiated price is likely to fall somewhere between the value of targets for ﬁrms with the highest value combined cash ﬂows and the value of targets for other bidding ﬁrms.
Of course, it may be possible for a unique and inimitable synergistic cash ﬂow to also be private. Indeed, it is often the case that those attributes of a ﬁrm that are inimitable are also diﬃcult to describe (Barney 1991b), and thus can be held as proprietary information. In this case the analysis of superior returns associated with unique and valuable synergistic cash ﬂows presented earlier applies.
3. UNEXPECTED SYNERGISTIC CASH FLOWS
The analysis thus far has adopted, for convenience, the strong assumption that the NPV of synergistic cash ﬂows between bidders and targets are known with certainty by individual bidders. This is, in principle, possi- ble, but certainly not likely. Most acquisitions and mergers are massively complex (Jensen and Ruback 1983), involving numerous unknown and complicated relationships between ﬁrms (Ruback 1982). In these settings, unexpected events may occur after an acquisition has been completed, making the synergistic cash ﬂow from an acquisition or merger more valuable than what was anticipated by bidders and targets. The price that bidding ﬁrms will pay to acquire a target will only equal the expected value of that target when it is combined with the bidder. The diﬀerence between the unexpected synergistic cash ﬂow actually obtained by a bidder and the price the bidder paid for the acquisition is a superior return for the shareholders of this bidding ﬁrm.
Of course, by deﬁnition, bidding ﬁrms cannot expect to obtain unex- pected synergistic cash ﬂows. Unexpected synergistic cash ﬂows, in this sense, are surprises, a manifestation of a ﬁrm’s good luck, not its skill in acquiring targets (Barney 1986a).
Source: Barney Jay B., Clark Delwyn N. (2007), Resource-Based Theory: Creating and Sustaining Competitive Advantage, Oxford University Press; Illustrated edition.