The Hidden Cost of M&A

Abstract

The shareholder wealth maximization norm exerts tremendous influence on both business practice and corporate legal scholarship. Widespread acceptance of the norm has produced substantial focus among corporate executives, analysts, and scholars on one key metric: share price. The norm and the related focus on equity prices rest on two key assumptions: (1) that the pursuit of shareholder wealth maximization, as measured by share price, effectively maximizes the wealth of actual shareholders and (2) that the pursuit of shareholder wealth maximization, as measured by share price, is socially beneficial. If the shareholder wealth maximization norm does not truly maximize shareholder wealth, it fails by its own terms. If pursuing shareholder wealth maximization does not produce a net social benefit but instead generates a net social harm, the pursuit of shareholder wealth maximization no longer constitutes a “win-win” for businesses and consumers but instead elevates business interests in a zero-sum competition between the two groups. This Article addresses one context where the pursuit of share price gains both fails to maximize the wealth of all shareholders and fails to benefit society: corporate mergers and acquisitions activity. Since Henry Manne’s seminal paper, The Market for Corporate Control, it has been generally accepted that merger gains accrue either through efficiency or market power. Efficiency gains involve creating synergies and eliminating redundancies, thus enabling merged entities to do more with less. To the extent that merger gains accrue via this route, mergers benefit everyone involved: shareholders benefit from a boost in share prices, society benefits from a more efficient marketplace, and consumers benefit from lower prices for goods and services. In contrast, market power gains enable the merged entity to increase the price of the goods it sells or the services it provides, thereby reducing consumer welfare. Because of the increased cost to consumers, this second option pits the interests of some groups against others. Wealthy shareholders likely benefit more from share price increases than they are harmed by the increased cost of goods and services, since these shareholders tend to own substantial amounts of stock and to make substantial sums from that stock. However, the reverse may be true for less wealthy shareholders and society at large. Corporate legal scholarship has largely failed to address this hidden cost. Historically, economic literature has left unsettled whether merger gains accrue primarily through the former or latter routes, leaving scholars free to assume that merger gains do not necessarily come at the expense of consumers or society. Recent research, however, reveals that most gains in U.S. mergers come from market power increases. This finding exposes two key shortcomings of traditionalist interpretations of the shareholder wealth maximization norm: (1) share price gains serve as an inadequate proxy for increased financial welfare for all shareholders, and (2) share price gains serve as an inadequate proxy for increased social welfare. If we truly desire to maximize the wealth of all shareholders and to benefit society as a whole, then we cannot rely on share price gains as a proxy for the interests of all constituencies.