Legal Service India - Cross Border Mergers And Takeovers: A Recent Trend
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Cross Border Mergers And Takeovers: A Recent Trend

Written by: piyush singh and Daphne Menezes - 2nd year students of university school of law and legal studies, ggsipu
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Businesses were competitive locally expanded to the national arena. Competitiveness in the national arena is now forcing business to go global. The days of regional differentiation are over. Old strategies that professed Small is Beautiful or offered lessons on how companies could survive in a niche are no longer viable. Yes it is true that there are still micro-cosmos that that thrive at the small business level and there is a new generation of savvy entrepreneurs who will develop and continue to fuel healthy business in the shadows of corporate juggernauts well into the future. One of the most important situations that they eventually face is the key to their survival: acquire or be acquired. In other words the only optimal size is big- grow bigger than last year, grow larger and faster than the competitors. Stagnation or slow growth is a sure recipe for disaster.

Globalization is a strong force that enables industrial consolidation. During the Asian economic crisis in 1997 and 1998, global organizations such as International Monetary Fund, The World Bank and the WTO assisted and encouraged countries including Thailand, South Korea and Indonesia to restructure their financial institutions and open up their economies by reducing trade barriers. A direct result of these policies was that global financial services companies began to acquire and buy equity stakes in financial service players in each of these economies. From 1998 to 2000, Thailand experienced a wave of acquisition activity. Globalization has had a number of drivers including advances in information and communication technology, advances in travel, the reduction of barriers to trade and the growth of overseas markets that could no longer be ignored. What characterizes the current business environment is that we now see all industries are potentially global, and see all industries taking part in the game.

The fact to be noticed is that why are there are so many mergers and takeovers happening at such a rapid pace?
The history of the world, my sweet, is who gets eaten and who gets to eat. SWEENEY TODD

There are a variety of drivers and motivating factors at play in the M&A world. Apart from personal glory (or greed), M&A deals are often driven by many justifiable market-consolidation, expansion or corporate diversification motives. And, of course, ever present as an inspirational force in M&A is the old reliable financial, generally tax related motivation.

Expansion is one of the primary reasons to cross the borders as the national limits fail to provide growth opportunities. One has to look outside its boundaries and play out in the global arena to seek new opportunities and scale new heights. With the habit of creating an empire it becomes difficult for these entrepreneurs to stay within its limits. The simple fact is that most key players in many markets have already extracted a significant proportion of the available value from the domestic resources. They have improved profitability through better cost management and through efficiency gains realized after domestic consolidation.

Another reason is to gain monopoly, the company which has been acquired by the acquirer is always a company which is trembling financially but had something to offer the acquiring company. It may be the market share or intellectual capital or other reasons but one thing that the acquirer looks is for is the untapped resources to be exploited which can lead the company a step higher in the ladder of success.

Globalization is a key to help in the rapidity of the M&A as it is globalization that integrates world economies together and many nations have opened themselves, the countries have made laws and regulations that attract new companies to come into the country and make it easy for the companies to easily perform their operation of M&A.

There are also new forces in play that make cross-border expansion more feasible and capable of creating value. For example, international deregulation is removing old barriers. Institutional investors are taking a more global perspective. Customer profiles across markets are becoming more homogeneous.

At this point a question that arises, what are the legal implications to a cross border merger and takeover?
The decisions of the courts on economic and social questions depend on their economic and social philosophy - THEODORE ROOSEVELT
The answer to this question needs has been dealt in many dimensions of law.

International law prescribes that in a cross-border merger, the target firm becomes a national of the country of the acquirer. Among other effects, the change in nationality implies a change in investor protection, because the law that is applicable to the newly merged firm changes as well. More generally, the newly created firm will share features of the corporate governance systems of the two merging firms. Therefore:
Cross-border mergers provide a natural experiment to analyse the effects of changes–both improvements and deteriorations, in corporate governance on firm value.

· FDI plays an important role with the cross border mergers and takeovers as they are followed by sequential investment by foreign acquirer sometimes large especially in special circumstances such as that of privatization.

· Cross border M&A can be followed by newer and better technology (including organizational and managerial practices) especially when acquired firms are reconstructed to increase the efficiency of their operations.

· Cross border M&A leads to employment opportunity over time only when the sequential investments take place and if the linkages of the acquired firm are retained or strengthened.

The value of cross-border mergers and acquisitions (M&A) grew over 700% during the 1990’s to a value of $720 billion in 1999 (United Nations, 2000). Differences in tax and financial reporting policies across countries lead to a number of different opportunities, motivations and risks, yet there have been few empirical studies that have investigated how differing accounting and tax policies across countries affect cross-border M&A decisions.

Cross-border takeover bids are complex transactions that may involve the handling of a significant number of legal entities, listed or not, and which are often governed by local rules (company law, market regulations, self regulations, etc.). Not only a foreign bidder might be disadvantaged or impeded by a potential lack of information, but also some legal incompatibilities might appear in the merger process resulting in a deadlock, even though the bid would be ‘friendly’. This legal uncertainty may constitute a significant execution risk and act as a barrier to cross-border consolidation.

In some cases, legal structures are not only complex but also prevent, de jure or de facto, some institutions to be taken over or even merge (in the context of a friendly bid) with institutions of a different type. Such restrictions are not specific to cross-border mergers, but could provide part of the explanation of the low level of cross-border M&As, since consolidation is possible within a group of similar institutions (at a domestic level) whereas it is not possible with other types of institutions (which makes any cross-border merger almost impossible).

In some countries, the privatization of financial institutions has sometimes been accompanied by specific legal measures aimed at capping the total participation of non-resident shareholders in those companies or imposing prior agreement from the Administration (i.e. golden shares). Some of such measures were clearly discriminatory against foreign institutions, when it came to consolidation.

The European Court of Justice has indicated that such measures were not justified by general-interest reasons linked to strategic requirements and the need to ensure continuity in public services when applied to commercial entities operating in the traditional financial sector. Tax problems also occur and it is one of the ways to get out of tax hassles as when a strong company acquires a financially poor company the amount of profit earned is less in the first year therefore the tax burden on the company will be less.

Mergers and acquisitions are complex processes. Despite some harmonised rules, taxation issues are mainly dealt within national rules, and are not always fully clear or exhaustive to ascertain the tax impact of a cross-border merger or acquisition. This uncertainty on tax arrangements sometimes require seeking for special agreements or arrangements from the tax authorities on an ad hoc basis, whereas in the case of a domestic deal the process is much more deterministic.

In a pending case (Marks & Spencer), the European Court of Justice has been asked whether it is contradictory to the EC treaty to prevent a company to reduce its taxable profits by setting off losses incurred in other member states, while it is allowed to do so with losses incurred in subsidiaries established in the state of the parent company.

Specific domestic tax breaks may favour specific, non-harmonised products or services, with the result that every institution has to provide this service or product if it wants to remain competitive. In such a situation, a merger between two entities located in that domestic market may yield synergies of scale, whereas it will be more difficult to exploit comparable synergies for a foreign institution taking over a domestic one, while not being entitled to the tax break in their home state.

In some cases, there may be discriminatory tax treatments for foreign products or services, i.e. products or services provided from a Member State different from the one where it is sold. Therefore, a cross-border group will be at a disadvantage when trying to centralise the industrial functions (e.g. asset management functions) as in the case of overall domestic group. Since the latter may keep all its value chain within the country and still benefit from synergies.

The impact of taxation on dividends may influence the shareholders’ acceptance of a cross-border merger. Even though a seat transfer or a quotation in another stock market might be justified for economic reasons, groups of shareholders could be opposed to such an operation if it implies higher non-refundable withholding tax, and thus lower returns on their investments.

What are the challenges in cross-border mergers and acquisitions?
Marriage of two lame ducks will not give birth to a race horse.

The exponential rise in stock prices, due to mergers and acquisitions will have a ripple effect on the whole economy, technology innovation, market roll ups and mergers in addition to splits, spin offs and even corporate breakdown, may happen at speeds never encountered before. Along with this will come uncharted innovations in information technology and knowledge management and an explosion of new services, new products, new industries and new markets? The convergence of all this interconnectedness, interoperability and the value chain rationalization will turbo charge corporate development to a speed that will make unwary executives dizzy.

These all are the management challenges and whatever it takes, management must step up to the challenge. This mends learning to manage the knowledge and information while staying in the driver’s seat.

Executives will also confront perhaps the biggest bugaboo of all, complacency. The old watchword about fighting the lethargy that comes with contentment will be revived in the future .throughout history, long term market dominance has characteristically bred complacency among industry leaders. Few can stay lean, mean hungry once the corporate coffers are brimming with success and profit.

But the biggest challenge to a cross border merger and takeover are the cultural issues. According to KPMG study, 83% of all the mergers and acquisitions failed to produce any benefit for the shareholders and over half actually destroyed value. Interviews of over 100 senior executives involved in these 700 deals over a two year period revealed that the overwhelming cause of failure is the people and the cultural differences. Difficulties encountered in mergers and acquisitions are amplified in cross cultural situations, when companies involved are from two or more different countries. Up to the point in the transaction, where the papers are signed, the merger and acquisition business is predominantly financial valuing of the assets, determining the price and due diligence. Before the ink is dry, however this financially driven deal becomes a human transaction filled with emotions and trauma and survival behaviour, the non linear, often the irrational world of human beings in the midst of changes. In the case of international mergers and acquisition, the complexity of these processes is often compounded by the differences in national cultures. People living and working in different countries react to the same situation or events in a very different manner. Therefore a company involved in an international merger or acquisition needs to consider these differences right from the design stage if it is to succeed.

Individual preoccupation on How is it all going to impact me? weakens the commitment to the job at hand. This in turn translates people looking in for work in other companies. Often a firm in midst of transition loses its own talent, strengthening the competition. In countries where people identify largely with groups; people tend to look for support within their group. In France and Italy people caught in midst of mergers and acquisition often turn to unions. If unions cannot provide answers because they have been excluded from the negotiation process, they are likely to go on strikes. These strikes may do much more damage to organisation than any other factor.

Employees’ reluctance within the target company of a cross-border deal might also pose a threat to the successful outcome of the transaction. Indeed, employees may not accept to be managed from another country. A public opposition to the project may influence analysts’ assessment.

Cross-border mergers may imply a change in the place of quotation, or even in the currency of quotation. Shareholders’ acceptance of quotation changes may be limited, even all risks or tax impacts are eliminated. Indeed, the place of quotation may have an important symbolic value.

Given that cross-border mergers are complex and need to overcome a number of execution risks (as evidenced in this document), there might be an impact on shareholders’ and analysts’ apprehension of failure risk when it comes to cross-border mergers.

Consumers may mistrust foreign entities, meaning that all parameters being equal, a local incumbent may have an advantage over a competitor identified as foreign. This explains why foreign institutions often prefer to keep a local brand.

Of course, some of these challenges are not new-but the penalties for mis-steps will be greater and swifter than in the past. There are no longer any safe havens. It is expected that by 2010 there won’t be 50-60 undisputed global industry leaders as they exist today; there will be hundreds, each in its respective industry. Companies in such dominant positions will deal with high volumes of merger transactions- perhaps 10 or more per year. The companies will have to keep in mind that cross border mergers are not only business proposals but a corporate marriage of both the entities which require deeper and insightful solutions. The merger and acquisition activity in the past few years have become quite predictable and this trend is going to grow parallel with the desire and competitiveness of the society. Now let time be the emperor and decide the fate of this growing trend.

The author can be reached at: kaka@legalserviceindia.com / Print This Article

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