(James Saft is a Reuters columnist. The opinions expressed are his own.)
By James Saft
Dec 28 (Reuters) - For all the talk about efficiencies as the driving logic behind corporate mergers, the real juice comes from increased power to hike prices.
A study using new techniques finds that industrial mergers show little evidence of increased efficiency or productivity.
What does happen is a lot simpler: bigger markups leading, theoretically, to higher profits.
If you listen to the typical conference call after a merger is announced you will hear a lot about “efficiencies,” shorthand for the sorts of economies of scale which form much of the supposed rationale behind most such deals. What you won’t hear is the very possibly true and more honest: “Now we’ll be hiking prices.”
On that basis, the most attractive merger for shareholders isn’t the one with the most scope to gain economies of scale, but the one which wins the buyers the most market power.
In other words, the merger that sails closest to the line of being rejected by regulators as anti-competitive.
For society and the economy, of course, it may well be that mergers are not so attractive.
The study, by Bruce A. Blonigen at the University of Oregon and Justin R. Pierce of the Federal Reserve, looked at census data on manufacturing plants in the U.S. between 1997 and 2007, allowing them to compare efficiency and markups among plants which were and were not part of mergers, examining as well those plants which were part of a merger which had been announced but not yet consummated.
“We find that evidence for increased average markups from M&A activity is significant and robust across a variety of specifications and strategies for constructing control groups that mitigate endogeneity concerns,” Blonigen and Pierce write in the October paper.
( here )
“In contrast, we find little evidence for plant- or firm-level productivity effects from M&A activity on average, nor for other efficiency gains often cited as possible from M&A activity, including reallocation of activity across plants or scale efficiencies in non-productive units of the firm.”
Besides having serious implications for investors and policy-makers, the results rather undercut the value of much of the output of consultants and buy-side analysts over the past 40 years, who have collectively expended forests of paper in praising and recommending the efficiencies which now, apparently, are nowhere to be found.
And while the study doesn’t prove, or set out to prove, why we get markups after mergers it does not take an Adam Smith to work out that it has something to do with taking full advantage of eliminating competition.
Central to the issue are the concepts of markups and market power.
Markups are the amount a company can charge above what it costs them to make goods or services. In a perfectly competitive market markups are winnowed away to nothing while the more market power a firm has the more it is able to impose markups.
Plants in the study which were part of a merger were able, mysteriously, to impose markups of 15 to 50 percent higher than the average of those which were not.
The study also looked, and found little evidence, to support the idea that mergers led to production being moved to more efficient plants or even of increases in efficiency by eliminating administrative costs.
It is enough to make you want to change the name of the degree from MBA (Masters of Business Administration) to MCE (Masters of Competition Elimination).
What makes the study particularly interesting, and even more richly ironic, is when you look at what it shows about markups, which after all imply higher top line profits, and the rather mixed history of actual mergers creating actual wealth for the actual shareholders.
A 1999 study by KPMG found that 83 percent of mergers fail to create shareholder value. A 2003 looking at more than 12,000 acquisitions by public firms over more than 20 years found that among large firms shareholders lost $218 billion in the aftermath. ( www.nber.org/papers/w9523 )
While part of this is doubtless that acquiring companies must pay up to clinch the deal, implying that sellers do quite well, the very high rate of post-merger failure implies something is wrong.
After all, if you can hike your prices by 15 to 50 percent more than your peers the market ought to set a very high premium on the value of your shares, even in the immediate aftermath.
That doesn’t happen and very likely it is because those excess profits are being diverted before they hit the bottom line. Fees and executive compensation are likely culprits.
Both shareholders and regulators, it seems, have good reason to be dubious about the benefits of many mergers.
At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at email@example.com and find more columns at blogs.reuters.com/james-saft Jim Saft