Mergers and Acquisitions: Should the government encourage or discourage mergers and acquisitions? Illustrate your essay with specific examples.

Mergers and acquisitions form the subject of much debate in the commercial, academic and regulatory worlds, with various proponents and detractors arguing their points of view. The agency cost of mergers and acquisitions are to be measured by the companies involved, however the government has a considerable degree of influence over whether the costs to those companies encourage or discourage.
The net effect of government interference is that mergers and acquisitions are discouraged, because the competition between the private and public sphere is such that the legislative tendency of government binds the private sector with bureaucratic laws and increases agency cost. On the other hand, the private sector wishes to merge or acquire according to market principles. Therefore, mergers and acquisitions with the least agency cost are those where the government is not involved. This is to the benefit of companies wishing to merge or acquire. Clearly the reduction of agency cost alone is sufficient to require governments to encourage mergers and acquisitions.
Mergers and acquisitions that are carried out across jurisdictional boundaries provide a clear example of how government interference can raise agency cost. The acquisition of O2 by Telefonica of Spain in 2005, for example, was investigated by competition authorities of the British, Spanish and European governments. The acquisition was allowed to go ahead, although the company operates under a number of different brands across Europe. Regulatory approval raised agency cost to both O2 and Telefonica. The company is now listed on the stock markets of at least three countries and operates around the world. From its inception in 1924, its geographic strength in South America, and its privatization from the Spanish government in 1997, the company has consistently been subject to investigations by governments.
The purpose of legislation by governments is to variously represent the needs of its citizens and to promote the efficiency of the economy, although this may be implicitly assumed rather than explicitly stated. The purpose of the corporate executives who are the agents of the mergers and acquisitions can be assumed to be to maximize their profit, although this can also be called into question. It is also to be assumed – rather than known for a fact – that agents’ costs are not a deciding factor when governments intervene in mergers and acquisitions.
Bertrand and Mullainathan (2003) find that corporate executives are mostly concerned with reducing agents’ costs, indeed that they, as agents, prefer to enjoy the quiet life when it comes to making deals. Indeed these agents’ purpose in merging and acquiring is to reduce costs. The agency costs are their costs. Therefore, any merger or acquisition that does not reduce their cost, allowing them to pursue their quiet lives, will not be a merger or acquisition.
Government’s involvement in mergers and acquisitions will, in such cases, be largely spectatorial, because if a merger or acquisition does not take place, the government will neither be able to encourage nor discourage it. In such cases where the government wishes to encourage a merger or acquisition that is against the desire of corporate executives to enjoy the quiet life, it will fail (Shleifer & Summers 1988; Stein 1988; Blair 1995). Government’s laws may effectively increase takeover efficiency by prohibiting them in line with the agents’ preferences. After all, the agents do not want to increase their costs by engaging in a takeover that won’t benefit them or their company. If agents should takeover another company through merger or acquisition, the costs are therefore not certain to fall.
It is in these takeovers, where agents’ costs rise, that governmental intervention seems to make most sense. In Amanda In Acquisition Corp. v. Universal Food Corp., for example, the governmental authority ruled that its discouragement of agents promoted corporate governance. As noted by Bertrand and Mullainathan (2003, p. 1072), governmental discouragement probably leads to higher wages for agents. Clearly this is welcomed by agents, but perhaps not for the right reasons: “we found that these higher wages did not, on net, translate into greater operating efficiency suggesting that stakeholder protection did not “pay for itself.” (Bertrand & Mullainathan 2003, ibid.). If agents are discouraged from takeovers, whether they be mergers or acquisitions, governments should take the responsibility for declining efficiency. Unfortunately, it is also when governments encourage corporate takeovers that agents ‘costs rise.
Agents’ costs are not always equally spread between the parties of a takeover, as in an acquisition these are more likely to be borne by the acquirer (Firth 1980). In an acquisition that is encouraged by a government, such as a privatization of an existing state utility the government is likely to be the beneficiary of agency costs compared with the costs borne by those who acquire the utility. Returning to the example of the Spanish telecoms company Telefonica, its market listing in 2005 led to massive fiscal benefit to the Spanish government.
The most efficient form of takeover would seem to be the merger (Manne 1965, p199). From an agency cost point-of-view, a merger has none of the disadvantages to the acquirer that an acquisition has. If Telefonica had been merged with an existing telecommunications company, perhaps the costs to the shareholders of Telefonica would be fewer. However, if we accept that a merger is better than an acquisition, it is not entirely clear that the government should encourage mergers, nor that the government should discourage acquisitions. The sale by the Spanish government of Telefonica may have benefited it, but that’s not to say that the acquisition of 02 had fewer agency costs. Encouraging the acquisition of utility companies by governments is far from advantageous if those agents at Telefonica want a quiet life, for example.
Agents at Telefonica, such as those corporate executives, would have lost dearly if we accept the analysis of Franks and Harris (Franks & Harris 1989), who attribute to mergers a gain of 30% of shareholder value, because Telefonica was at first privatized by the Spanish government, then acquired O2 in 2005. Neither of these takeovers was a merger. There can be no possibility, therefore, that this corporate activity should have been encouraged. On the contrary, both acquisitions should have been discouraged. An analysis of why they took place may yield further insight as to why they did.
Governments and agents may be encouraged to merge or acquire where there is an overvaluation, or an undervaluation of agency costs. Telefonica was sold by the Spanish government because it undervalued the agency costs of privatising the utility to the corporate executives (who wanted a quiet life), and to the acquirers of shares in Telefonica (who paid too much). Telefonica acquired 02 because it was encouraged by an overvaluation of 02, because soon after the announcement of takeover the share price of 02 gained. A counterargument to this would be that 02’s share price would not have risen had Telefonica and 02 announced a merger. Rises in share prices and increases in agency costs are a feature of all mergers and acquisitions, largely because management of the acquiring company overestimates itself (van Fredrikslust, van der Wal & Westdijk 2005). Where it is the government that is privatising, the management further raises the costs of takeover.
There are, in conclusion, two possible outcomes of mergers and acquisitions: first, agents’ costs are lowered (Bertrand & Mullainathan 2003), or agents’ costs are raised, for example in the case of a company making an acquisition (Firth, 1980). In neither case should the government encourage the merger and acquisition. The government should, as is exemplified by Telefonica above, neither merge nor acquire agents, nor be acquired by agents. Government should discourage mergers and acquisitions.