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Chapter 07 - Merger and Acquisition Strategies

True / False

1. Restructuring strategies are commonly used to correct or deal with the results of ineffective mergers and acquisitions.
a. True
b. False
ANSWER: True

2. Evidence suggests that acquisitions usually lead to favorable financial outcomes, especially for the acquiring firm.
a. True
b. False
ANSWER: False

3. Typical returns on acquisitions for acquiring firms are close to zero.

a. True
b. False
ANSWER: True

4. A merger is defined as a strategy in which one firm purchases controlling interest in another firm.
a. True
b. False
ANSWER: False

5. A merger is a strategy through which two firms agree to integrate their operations on a relatively coequal basis.
a. True
b. False
ANSWER: True

6. In the final analysis, firms use merger and acquisition strategies to improve their ability to create value for all
stakeholders, including stockholders.
a. True
b. False
ANSWER: True

7. An acquisition occurs when one firm buys a controlling, or 100 percent, interest in another firm and the acquired firm
becomes a subsidiary business within its portfolio.
a. True
b. False
ANSWER: True

8. Most acquisitions that are designed to achieve greater market power entail buying a competitor, a supplier, a distributor,
or a business in a highly related industry.
a. True
b. False
ANSWER: True

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9. Moon-in-June, a designer and manufacturer of wedding dresses, has decided to purchase a retail chain specializing in
bridal wear. This purchase will be useful in gaining more market power for Moon-in-June.
a. True
b. False
ANSWER: True

10. Research suggests that horizontal acquisitions of firms with dissimilar characteristics result in higher performance
levels.
a. True
b. False
ANSWER: False

11. Research suggests that horizontal acquisitions result in higher performance when the firms have similar
characteristics, such as strategy, managerial styles, and resource allocation patterns.
a. True
b. False
ANSWER: True

12. A horizontal acquisition involves two firms in the same industry.

a. True
b. False
ANSWER: True

13. A related acquisition involves two firms in the same industry.

a. True
b. False
ANSWER: False

14. An advantage of using horizontal, vertical, or related acquisitions is that they are not subject to regulatory review.
a. True
b. False
ANSWER: False

15. Firms are more likely to enter a market through acquisition when high product loyalty is present in the industry.
a. True
b. False
ANSWER: True

16. The lower the barriers to entry, the more likely firms will use acquisition as a means to enter a market.
a. True
b. False
ANSWER: False

17. In the current global landscape, firms from North America and Europe use the acquisition strategy more frequently
than firms from other nations.

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a. True
b. False
ANSWER: False

18. Junk bonds are used less frequently today and are now commonly called high-yield bonds.
a. True
b. False
ANSWER: True

19. One reason for an acquisition is to increase market power.

a. True
b. False
ANSWER: True

20. Among the challenges associated with integration processes is the need to link different financial and control systems.
a. True
b. False
ANSWER: True

21. Firms can increase their speed to market for new products by pursuing an internal product development strategy rather
than an acquisition strategy.
a. True
b. False
ANSWER: False

22. United Technologies Corp. (UTC) uses acquisitions of firms such as Otis Elevator Company (elevators, escalators,
and moving walkways) and Carrier Corporation (heating and air conditioning systems) as the foundation for
implementing its related diversification strategy.
a. True
b. False
ANSWER: False

23. Research has shown that the more different the acquired firm is in terms of competencies and resources than the
acquiring firm, the more likely the acquisition is to be successful.
a. True
b. False
ANSWER: False

24. Horizontal acquisitions and related acquisitions tend to contribute less to a firm's competitiveness than do unrelated
acquisitions.
a. True
b. False
ANSWER: False

25. The quickest and easiest way for a firm to diversify its portfolio of businesses is to make acquisitions.

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a. True
b. False
ANSWER: True

26. It is relatively common for a firm to develop new products internally to diversify its product lines.
a. True
b. False
ANSWER: False

27. The post-acquisition integration phase is less important for acquisition success than characteristics of the deal itself.
a. True
b. False
ANSWER: False

28. One of the attributes of a successful acquisition is that the acquiring firm conducts effective due diligence to select
target firms and evaluate the target firm’s health.
a. True
b. False
ANSWER: True

29. The reasons why a firm would overpay for a company that it acquires include inadequate due diligence.
a. True
b. False
ANSWER: True

30. Large or extraordinary debt is defined as overpaying for an acquired firm.

a. True
b. False
ANSWER: False

31. Junk bonds are now used more frequently to finance acquisitions primarily because of the belief that debt disciplines
managers.
a. True
b. False
ANSWER: False

32. Junk bonds are a financing option through which risky acquisitions are financed with debt that provides a large
potential return to bondholders.
a. True
b. False
ANSWER: True

33. Synergy is created by the efficiencies derived from economies of scale and economies of scope and by sharing
resources across the businesses in the newly created firm’s portfolio.
a. True
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b. False
ANSWER: True

34. Private synergies are unique to the acquired and acquiring firms and could not be developed by combining either
firm's assets with another company.
a. True
b. False
ANSWER: True

35. Transaction costs resulting from an acquisition refer to the direct and indirect costs resulting from the use of
acquisition strategies to create synergies.
a. True
b. False
ANSWER: True

36. Unrelated diversified firms become overdiversified with a smaller number of business units than do firms using a
related diversification strategy.
a. True
b. False
ANSWER: False

37. When a firm becomes highly diversified through acquisitions, managers often focus on financial controls rather than
strategic controls.
a. True
b. False
ANSWER: True

38. Top managers typically become overly focused on acquisitions because only they can perform most of the tasks
involved, such as performing due diligence on the target firm.
a. True
b. False
ANSWER: False

39. Company experiences show that participation in and overseeing the activities required for making acquisitions can
divert managerial attention from other matters that are necessary for long-term competitive success.
a. True
b. False
ANSWER: True

40. Acquisitions can become a substitute for innovation in some firms and trigger future rounds of acquisitions.
a. True
b. False
ANSWER: True

41. One of the potential problems associated with acquisitions is that the additional costs required to manage the larger
firm will exceed the benefits of the economies of scale and additional market power.
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a. True
b. False
ANSWER: True

42. One of the most effective ways to test the feasibility of a future merger or acquisition is for the firms to first engage in
a strategic alliance.
a. True
b. False
ANSWER: True

43. Hostile acquisitions provide greater financial returns to the acquiring company as it is easier for managers to integrate
the firms.
a. True
b. False
ANSWER: False

44. Research has shown that maintaining a low or moderate level of firm debt is critical to the success of an acquisition,
even when substantial leverage was used to finance the acquisition itself.
a. True
b. False
ANSWER: True

45. Wilberforce Press is a small book publishing firm in Iowa that has been owned by the same family since 1895. It is
being purchased by Ozarka Publishing, another family-run business in Nebraska, which has been a specialty publisher for
77 years. Each company is known for its unique culture passed down from its founders. Executives and employees in both
firms have "grown up" with their companies. Because both of these companies have a long, stable history in highly related
industries, this acquisition has a high probability of success.
a. True
b. False
ANSWER: False

46. When the actual results of an acquisition strategy fall short of the projected results, firms consider using restructuring
strategies.
a. True
b. False
ANSWER: True

47. Restructuring is a strategy through which a firm changes its set of businesses or its financial structure.
a. True
b. False
ANSWER: True

48. Downscoping represents a reduction in the number of a firm's employees and sometimes in the number of its operating
units, but it may or may not represent a change in the composition of businesses in the corporation's portfolio.
a. True
b. False
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ANSWER: False

49. Downscoping makes management of the firm more effective because it allows the top management team to better
understand and manage the remaining businesses.
a. True
b. False
ANSWER: True

50. Traditionally, leveraged buyouts were used as a restructuring strategy to correct for managerial mistakes or because
the firm's managers were making decisions that primarily served their own interests rather than those of shareholders.
a. True
b. False
ANSWER: True

51. Downsizing may be necessary because acquisitions often create a situation in which the newly formed firm has
duplicate organizational functions such as sales, manufacturing, distribution, and human resources management.
a. True
b. False
ANSWER: True

52. The outcome of downsizing, downscoping, and leveraged buyouts is higher firm performance.
a. True
b. False
ANSWER: False

53. The intent of the owners in a whole-firm leveraged buyout may be to increase the efficiency of the bought-out firm
and resell it in five to eight years. This tends to make the managers of the bought-out firm high risk takers, since they will
probably not survive the resale and thus have little to lose.
a. True
b. False
ANSWER: False

Multiple Choice

54. Researchers have found that shareholders of acquired firms often:

a. earn above-average returns.
b. earn below-average returns.
c. earn close to zero as a result of the acquisition.
d. are not affected by the acquisition.
ANSWER: a

55. All of the following statements are correct EXCEPT:

a. immediately after the announcement of a planned acquisition, the stock price of the majority of acquiring
firms declines.
b. shareholders of acquired firms often earn above-average returns from an acquisition.

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c. the majority of acquisitions increase long-term value for the acquiring firm.
d. shareholders of acquiring firms typically earn returns from the transaction that are close to zero.
ANSWER: c

56. Claude holds a large number of shares of Bayou Beauty, a regional brewing company that is considered a likely
takeover target by a major international brewer. It would probably be in Claude's financial interest if Bayou Beauty's
owners:
a. resisted selling at any price.
b. sold the company to the larger brewer.
c. designed a poison pill to discourage a takeover.
d. looked for smaller brewers to acquire instead of selling to the larger brewer.
ANSWER: b

57. In a merger:
a. one firm buys controlling interest in another firm.
b. two firms agree to integrate their operations on a relatively coequal basis.
c. two firms combine to create a third separate entity.
d. one firm breaks into two firms.
ANSWER: b

58. A(n) __________ occurs when one firm buys a controlling, or 100 percent interest, in another firm.
a. merger
b. acquisition
c. spin-off
d. restructuring
ANSWER: b

59. When the target firm does not solicit the acquiring firm's bid, it is referred to as a(n):
a. stealth raid.
b. adversarial acquisition.
c. takeover or unfriendly acquisition.
d. leveraged buyout.
ANSWER: c

60. Currently, the rationale for making an acquisition includes all of the following EXCEPT to:
a. increase market power.
b. decrease taxes paid by shareholders.
c. overcome entry barriers.
d. increase diversification.
ANSWER: b

61. Market power is derived primarily from the:

a. core competencies of the firm.
b. size of a firm and its resources and capabilities.
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c. quality of a firm's top management team.
d. depth of a firm's strategy.
ANSWER: b

62. The announcement that P&G was acquiring premium dog and cat food manufacturer Iams was a __________
acquisition and is intended to __________.
a. vertical; increase diversification
b. horizontal; increase market power
c. vertical; overcome entry barriers
d. related; increase speed to market
ANSWER: d

63. A primary reason for a firm to pursue an acquisition is to:

a. avoid increased government regulation.
b. achieve greater market power.
c. exit a hyper-competitive market.
d. achieve greater financial returns in the short run.
ANSWER: b

64. When a firm acquires its supplier, it is engaging in a(n):

a. merger.
b. unrelated acquisition.
c. hostile takeover.
d. vertical acquisition.
ANSWER: d

65. The acquisition of Sun Microsystems (a computer hardware producer) by Oracle Corporation (a software firm) is an
example of a(n):
a. vertical acquisition.
b. unrelated acquisition.
c. horizontal acquisition.
d. merger of equals.
ANSWER: a

66. Horizontal, vertical, and related acquisitions to build market power:

a. are likely to undergo regulatory review by various governmental entities.
b. are rarely permitted to occur across international borders.
c. typically involve a firm purchasing one of its suppliers or distributors.
d. concentrate on capturing value at more than one stage in the value chain.
ANSWER: a

67. Baby Doe's, a designer and manufacturer of children's clothing, has decided to purchase a retail chain specializing in
children's clothing. This purchase is a(n):
a. merger.

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b. unrelated acquisition.
c. horizontal acquisition.
d. vertical acquisition.
ANSWER: d

68. Manny Inc. recently completed the purchase of its primary supplier. Manny intends to begin expanding the market to
which the supplier’s products are sold. This purchase is a(n):
a. merger.
b. unrelated acquisition.
c. horizontal acquisition.
d. vertical acquisition.
ANSWER: d

69. Cross-border acquisitions are primarily made to:

a. reshape the firm's competitive scope.
b. reduce the cost of new product development.
c. take advantage of higher education levels of labor in developed countries.
d. overcome barriers to entry in another country.
ANSWER: d

70. The presence of barriers to entry in a particular market will generally make acquisitions __________ as an entry
strategy.
a. less likely
b. more likely
c. prohibitive
d. illegal
ANSWER: b

71. SpeakEasy, a U.S. software company that specializes in voice-recognition software, wishes to rapidly enter the
growing technical translation software market. This market is dominated by firms making highly differentiated products.
To enter this market, SpeakEasy would be best served if it considers a(n):
a. vertical acquisition of a firm that uses technical translation products.
b. acquisition of a highly related firm in the technical translation market.
c. cross-border merger, preferably with an Indian or Chinese company.
d. strategy of internally developing the technical translation products needed to compete in this market.
ANSWER: b

72. Cross-border acquisitions are critical to U.S. firms competing internationally:

a. if they are to develop differentiated products for markets served.
b. when market share growth is the focus.
c. where consolidated operations are beneficial.
d. if they wish to overcome entry barriers to international markets.
ANSWER: d

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73. Managers perceive internal product development as a high-risk activity and tend to choose acquisitions because
approximately __________ percent of innovations are imitated within four years after patents are obtained.
a. 5
b. 10
c. 60
d. 20
ANSWER: c

74. Internal product development is often viewed as:

a. carrying a high risk of failure.
b. the only reliable method of generating new products for the firm.
c. a quicker method of product launch than acquisition of another firm.
d. critical to the success of biotech and pharmaceutical firms.
ANSWER: a

75. A manager in your company is proposing the acquisition of Taylor Company, which has developed a new, innovative
product instead of a strategy of developing new products in-house. All of the following arguments are correct EXCEPT:
a. the acquisition of Taylor should be primarily for defensive rather than strategic reasons.
b. research suggests that acquisition strategies are a common means of avoiding risky internal ventures.
c. the outcomes of acquisitions can be estimated more easily and accurately than the outcomes for an internal
product development process.
d. acquisitions could become a substitute for innovation within your firm.
ANSWER: a

76. Entering new markets through acquisitions of companies with new products is not risk-free, especially if acquisition
becomes a substitute for:
a. market discipline.
b. innovation.
c. risk analysis.
d. international diversification.
ANSWER: b

77. Compared to internal product development, acquisitions allow:

a. immediate access to innovations in mature product markets.
b. more accurate prediction of return on investment.
c. slower market entry.
d. more effective use of company core competencies.
ANSWER: b

78. Research has shown that the more __________, the greater is the probability that an acquisition will be successful.
a. related the acquired and acquiring firms are
b. diverse the resulting portfolio of competencies
c. disparate the corporate cultures
d. involved investment banking firms are in the due diligence process

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ANSWER: a

79. When a firm is overly dependent on one or more products or markets, and the intensity of rivalry in that market is
intense, the firm may wish to __________ by making an acquisition.
a. increase new product speed to market
b. broaden its competitive scope
c. increase its economies of scale
d. overcome entry barriers
ANSWER: b

80. The fastest and easiest way for a firm to diversity its portfolio of businesses is through acquisition because:
a. of barriers to entry in many industries.
b. it is difficult and time intensive for companies to develop products that differ from their current product line.
c. innovation in both the acquired and the acquiring firm is enhanced by the exchange of competencies resulting
from acquisition.
d. unrelated acquisitions are usually uncomplicated since the acquired firm is allowed to continue to function
independently as it did before acquisition.
ANSWER: b

81. Sales of watches among teenagers and twenty-somethings are declining rapidly as this age group uses cellphones,
iPods, and other devices to tell time. A company that specializes in selling inexpensive watches to this age group may
wish to consider __________ in order to develop new products other than watches.
a. unrelated diversification
b. backward integration
c. forward integration
d. horizontal acquisition
ANSWER: a

82. All of the following are rationales for acquisitions EXCEPT:

a. achieving greater market power.
b. overcoming significant barriers to entry.
c. increasing speed of market entry.
d. positioning the firm for a tactical competitive move.
ANSWER: d

83. Research shows that about __________ percent of mergers and acquisitions are successful.
a. 20
b. 40
c. 60
d. 80
ANSWER: a

84. Problems associated with acquisitions include all of the following EXCEPT:
a. managers overly focused on acquisitions.
b. integration difficulties.
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c. large or extraordinary debt.
d. excessive time spent on the due diligence process.
ANSWER: d

85. The factors that lead to poor long-term performance by acquisitions include all of the following EXCEPT firms:
a. with insufficient diversification.
b. having too much debt.
c. being unable to achieve synergy.
d. growing too large.
ANSWER: a

86. The __________ phase is probably the single most important determinant of shareholder value creation in mergers
and acquisitions.
a. pre-acquisition negotiations
b. pre-acquisition due diligence
c. post-acquisition integration.
d. post-acquisition restructuring
ANSWER: c

87. Without effective due diligence, the:

a. acquiring firm is likely to overpay for an acquisition.
b. firm may miss its opportunity to buy a well-matched company.
c. acquisition may deteriorate into a hostile takeover, reducing the value-creating potential of the action.
d. firm may be unable to act quickly and decisively in purchasing the target firm.
ANSWER: a

88. Due diligence includes all of the following activities EXCEPT assessing:
a. differences in firm cultures.
b. tax consequences of the acquisition.
c. the level of private synergy between the two firms.
d. financing for the intended transaction.
ANSWER: c

89. Pappelbon Enterprises recently acquired a chain of convenience stores offering both fuel and food. Pappelbon is now
surprised and dismayed to find that the gas pumps have been poorly maintained and will need to be replaced at
considerable expense. All of the following statements accurately reflect this EXCEPT:
a. Pappelbon did not fully evaluate the target.
b. Pappelbon overpaid.
c. Pappelbon's due diligence was not fully effective.
d. Pappelbon's management was overly focused on acquisitions.
ANSWER: d

90. The use of high levels of debt in acquisitions has contributed to:
a. the increase in above-average returns earned by acquiring firms.

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b. an increased risk of bankruptcy for acquiring firms.
c. the confidence of the stock market in firms issuing junk bonds.
d. an increase in investments that have long-term payoffs.
ANSWER: b

91. __________ are unsecured obligations that are not tied to specific assets for collateral.
a. Bearer bonds
b. No-load stocks
c. Penny stocks
d. Junk bonds
ANSWER: d

92. Caterpillar's payment of a 32 percent premium for the acquisition of Bucyrus in 2011 and subsequent need to issue
more stock illustrates the acquisition problem of:
a. integration difficulties.
b. inability to achieve synergy.
c. large or extraordinary debt.
d. managers overly focused on acquisitions.
ANSWER: c

93. Which of the following statements is false?

a. Synergy resulting from an acquisition generates gains in shareholder wealth beyond what they could achieve
through diversification of their own portfolios.
b. Private synergy results when the combination of two firms yields competencies and capabilities that could not
be achieved by combining with any other firm.
c. Private synergy is easy for competitors to understand and imitate.
d. Private synergy is more likely when the two firms in an acquisition have complementary assets.
ANSWER: c

94. Private synergy:

a. occurs in most related acquisitions and allows firms to see increased returns.
b. is frequently achieved in conglomerates.
c. is not easy for competitors to understand and imitate.
d. is assessed by managers during the due diligence process.
ANSWER: c

95. The expenses incurred by firms trying to create synergy through acquisition are called __________ costs.
a. differentiation
b. diversification
c. transaction
d. interaction
ANSWER: c

96. Which of the following is NOT a result of overdiversification?

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a. Executives do not have a rich understanding of all of the firm's business units.
b. Managers emphasize strategic controls rather than financial controls.
c. Firms use acquisition as a substitute for innovation.
d. Managers become short-term in their orientation.
ANSWER: b

97. Acquisitions can become a time sink for top level managers for all the following reasons EXCEPT:
a. the integration process after acquisition requires managerial attention.
b. they must prepare for acquisition negotiations.
c. managers are involved in the search for viable acquisition candidates.
d. only top managers can perform the required due diligence.
ANSWER: d

98. One problem with becoming too large is that large firms:
a. tend to have less market power.
b. have less potential for economies of scale.
c. become attractive takeover targets.
d. usually increase bureaucratic controls.
ANSWER: d

99. Thomas is an upper-middle-level manager for a firm that has been actively involved in acquisitions over the last 10
years. The firm has grown much larger as a result. Thomas has been dismayed to find that recently the managerial culture
of the firm has been turning more and more to __________ controls.
a. bureaucratic
b. strategic
c. tactical
d. organic
ANSWER: a

100. A friendly acquisition:

a. raises the price that has to be paid for a firm.
b. enhances the complementarity of the two firms' assets.
c. facilitates the integration of the acquired and acquiring firms.
d. allows joint ventures to be developed.
ANSWER: c

101. __________ typically result(s) in the acquiring firm being able to prevent valuable human resources in the acquired
firm from leaving.
a. Financial slack
b. Private synergy
c. Friendly acquisitions
d. High compensation
ANSWER: c

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102. Which of the following is NOT an attribute of a successful acquisition?
a. The acquiring firm has a large amount of financial slack.
b. The acquired and acquiring firms have complementary assets and/or resources.
c. Innovation and R&D investments continue as part of the firm's strategy.
d. Investments in advertising and image building are made quickly.
ANSWER: d

103. Typically, in a failed acquisition, the organization will:

a. restructure.
b. go into bankruptcy.
c. focus on building private synergy.
d. increase integration.
ANSWER: a

104. Ambrose is a scientist working for a pharmaceutical company. His company was acquired by a rival pharmaceutical
company, and now it is involved in downsizing and downscoping. Ambrose is concerned about his job security, since he
is actively involved in amateur sports in his community and does not wish to disrupt his current lifestyle. Ambrose's job
will MOST likely be secure if:
a. Ambrose's research is in a non-core activity.
b. the acquisition has been financed by junk bonds.
c. Ambrose is in a position to take a poison pill.
d. Ambrose is a key employee in the firm's primary business.
ANSWER: d

105. Magma, Inc., acquired Vulcan, Inc., three years ago. Effective integration of the two companies' culture was never
achieved, and the two firms' assets were not complementary. It is very likely that Magma will:
a. go public through an IPO.
b. review the due diligence information collected before the acquisition.
c. restructure.
d. review its tactical-level strategies.
ANSWER: c

106. Which of the following is NOT one of the three main restructuring strategies?
a. Realigning
b. Downsizing
c. Downscoping
d. Leveraged buyouts
ANSWER: a

107. __________ is often used when the acquiring firm paid too high a premium to acquire the target firm.
a. Management buyout
b. Leveraged buyout
c. Downscoping
d. Downsizing

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ANSWER: d

108. __________ may be necessary because acquisitions create a situation in which the newly formed firm has duplicate
organizational functions such as sales, manufacturing, distribution, and human resource management.
a. Management buyout
b. Leveraged buyout
c. Downsizing
d. Downscoping
ANSWER: c

109. __________ refers to divestiture, spin-off, or some other means of eliminating businesses that are unrelated to a
firm's core businesses.
a. Downsizing
b. Hostile takeovers
c. Shakeouts
d. Downscoping
ANSWER: d

110. Failing to __________ appropriately will result in too many employees doing the same work and prevent the new
firm from realizing the cost synergies it anticipated.
a. downsize
b. spin off
c. downscope
d. buy out
ANSWER: a

111. An investor is analyzing two firms in the same industry. She is looking for long-term performance from her
investment. Both firms are basically identical except one firm is involved in substantial downsizing, and the other firm is
undertaking aggressive downscoping. The investor should invest in the:
a. downscoping firm because the higher debt load will discipline managers to act in shareholders' best interests.
b. downscoping firm because of reduced debt costs and the emphasis on strategic controls derived from focusing
on the firm's core businesses.
c. downsizing firm because it will be making decisions based on tactical strategies.
d. downsizing firm because it is eliminating employees who are essentially "dead weight" and are dragging down
the firm's profitability.
ANSWER: b

112. Compared with downsizing, __________ has (have) a more positive effect on firm performance.
a. reconfiguring
b. downscoping
c. leveraged buyouts
d. acquisitions
ANSWER: b

113. A leveraged buyout refers to a(n):

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a. firm restructuring itself by selling off unrelated units of the company's portfolio.
b. firm pursuing its core competencies by seeking to build a top management team that comes from a similar
background.
c. restructuring action whereby a party buys all of the assets of a business, financed largely with debt, and takes
the firm private.
d. action where the management of the firm and/or an external party buys all of the assets of a business financed
largely with equity.
ANSWER: c

114. The term "leveraged" in leveraged buyouts refers to the:

a. firm's increased concentration on the firm's core competencies.
b. amount of new debt incurred in buying the firm.
c. fact that the employees are purchasing the firm for which they work.
d. process of removing the firm's stock from public trading.
ANSWER: b

115. Whole-firm LBOs tend to result in all the following negative outcomes EXCEPT:
a. large debt and increased financial risk.
b. failure to invest in R&D.
c. risk-averse management.
d. inefficient operations.
ANSWER: d

116. After a leveraged buyout, __________ typically occur(s).

a. selling of assets
b. further rounds of acquisitions
c. due diligence
d. private synergy
ANSWER: a

Essay

117. How difficult is it for merger and acquisition strategies to create value, and which firms benefit the most from M&A
activity?
ANSWER: Evidence suggests that using merger and acquisition strategies to create value is challenging. This is
particularly true for acquiring firms in that some research results indicate that shareholders of acquired firms
often earn above-average returns from acquisitions, while shareholders of the acquiring firms typically earn
returns that are close to zero. In addition, in approximately two-thirds of all acquisitions, the acquiring firm's
stock price falls immediately after the intended transaction is announced. This negative response reflects
investors’ skepticism about the likelihood that the acquirer will be able to achieve the synergies required to
justify the premium to purchase the target firm.

118. Identify and explain the seven reasons firms engage in an acquisition strategy.
ANSWER: There are several unique reasons firms choose to use an acquisition strategy.
1. Increased market power. Market power exists when a firm is able to sell its goods or services above
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Chapter 07 - Merger and Acquisition Strategies

competitive levels or when the costs of its primary or support activities are lower than those of its competitors.
Market power usually is derived from the size of the firm, the quality of the resources it uses to compete, and
its share of the market(s) in which it competes. Firms use horizontal, vertical, and related types of acquisitions
to increase their market power.
2. Overcoming entry barriers. Firms can gain immediate access to a market by purchasing a firm with an
established product that has consumer loyalty. Acquiring firms can also overcome economies of scale entry
barriers through buying a firm that has already successfully achieved economies of scale. In addition,
acquisitions can often overcome barriers to entry into international markets.
3. Cost of new product development and increasing speed to market. Developing new products and ventures
internally can be very costly and time consuming without any guarantee of success. Acquiring firms with
products new to the acquiring firm avoids the risk and cost of internal innovation. In addition, acquisitions
provide more predictable returns on investments than internal new product development. Acquisitions are a
much quicker path than internal development to enter a new market, and they are a means of gaining new
capabilities for the acquiring firm.
4. Lower risk compared to developing new products. Acquisitions are a means to avoid internal ventures (and
R&D investments), which many managers perceive to be highly risky. However, substituting acquisitions for
innovation may leave the acquiring firm without the skills to innovate internally.
5. Increased diversification. Firms can diversify their portfolio of business through acquiring other firms. It is
easier and quicker to buy firms with different product lines than to develop new product lines independently.
6. Reshaping the firm's competitive scope. Firms can move more easily into new markets as a way to decrease
their dependence on a market or product line that has high levels of competition.
7. Learning and developing new capabilities. By gaining access to new knowledge, acquisitions can help
companies gain capabilities and technologies they do not possess. Acquisitions can reduce inertia and help a
firm remain agile.

119. Describe the seven problems in achieving a successful acquisition.

ANSWER: Acquisition strategies present many potential problems.
1. Integration difficulties. It may be difficult to effectively integrate the acquiring and acquired firms due to
differences in corporate culture, financial and control systems, management styles, and status of executives in
the combined firms. Turnover of key personnel from the acquired firm is particularly negative.
2. Inadequate evaluation of target. Due diligence assesses where, when, and how management can drive real
performance gains through an acquisition. Acquirers that fail to perform effective due diligence are likely to
pay too much for the target firm.
3. Large or extraordinary debt. Acquiring firms frequently incur high debt to finance the acquisition. High
debt may prevent the investment in activities such as research and development, training of employees, and
marketing that are required for long-term success. High debt also increases the risk of bankruptcy and can lead
to downgrading of the firm's credit rating.
4. Inability to achieve synergy. Private synergy occurs when the acquiring and target firms' assets are
complementary in unique ways, making this synergy difficult for rivals to understand and imitate. Private
synergy is difficult to create. Transaction costs are incurred when firms seek private synergy through
acquisitions. Direct transaction costs include legal fees and investment banker charges. Indirect transaction
costs include managerial time to evaluate target firms, time to complete negotiations, and the loss of key
managers and employees following an acquisition. Firms often underestimate the indirect transaction costs of
an acquisition.
5. Too much diversification. A high level of diversification can have a negative effect on the firm's long-term
performance. For example, the scope created by additional amounts of diversification often causes managers
to rely on financial controls rather than strategic controls to evaluate business units' performance. The focus on
financial controls creates a short-term outlook among managers and they forego long-term investments.
Additionally, acquisitions can become a substitute for innovation, which can be negative in the long run.
6. Managers overly focused on acquisitions. Firms that become heavily involved in acquisition activity often
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Chapter 07 - Merger and Acquisition Strategies

create an internal environment in which managers devote increasing amounts of their time and energy to
analyzing and completing additional acquisitions. This detracts from other important activities, such as
identifying and taking advantage of other opportunities and interacting with importance external stakeholders.
Moreover, during an acquisition, the managers of the target firm are hesitant to make decisions with long-term
consequences until the negotiations are completed.
7. Too large. Acquisitions may lead to a combined firm that is too large, requiring extensive use of
bureaucratic controls. This leads to rigidity and lack of innovation and can negatively affect performance.
Very large size may exceed the efficiencies gained from economies of scale and the benefits of the additional
market power that comes with size.

120. Describe how an acquisition program can result in managerial time and energy absorption.
ANSWER: Typically, a considerable amount of managerial time and energy is required for acquisition strategies to be
used successfully. Activities with which managers become involved include: searching for viable acquisition
candidates, completing effective due-diligence processes, preparing for negotiations, and managing the
integration process after completing the acquisition. Company experiences show that participating in and
overseeing the activities required for making acquisitions can divert managerial attention from other matters
that are necessary for long-term competitive success, such as identifying and taking advantage of other
opportunities and interacting with important external stakeholders.

121. What are the attributes of a successful acquisition program?

ANSWER: Acquisitions can contribute to a firm's competitiveness if they have the following attributes:
1. The acquired firm has assets or resources that are complementary to the acquiring firm's core business.
2. The acquisition is friendly.
3. The acquiring firm conducts effective due diligence to select target firms and evaluate the target firm's
health (financial, cultural, and human resources).
4. The acquiring firm has financial slack (cash or a favorable debt position).
5. The merged firm maintains low to moderate debt position.
6. The acquiring firm has a sustained and consistent emphasis on R&D and innovation.
7. The acquiring firm manages change well and is flexible and adaptable.

122. What is restructuring, and what are its common forms?

ANSWER: Restructuring refers to changes in a firm's portfolio of businesses and/or financial structure. There are three
general forms of restructuring: (1) Downsizing involves reducing the number of employees, which may
include decreasing the number of operating units. (2) Downscoping entails divesting, spinning off, or
eliminating businesses that are not related to the core business. It allows the firm to focus on its core business.
(3) A leveraged buyout occurs when a party (managers, employees, or an external party) buys all the assets of
a (publicly traded) business, takes it private, and finances the buyout with debt. Once the transaction is
complete, the company's stock is no longer publicly traded.

123. What are the differences between downscoping and downsizing, and why is each used?
ANSWER: Downsizing is a reduction in the number of a firm’s employees. It may or may not change the composition of
businesses in the company's portfolio. In contrast, the goal of downscoping is to reduce the firm's level of
diversification. Downsizing is often used when the acquiring form paid too high a premium to acquire the
target firm or where the acquisition created a situation in which the newly formed firm had duplicate
organizational functions such as sales or manufacturing. Downscoping is accomplished by divesting unrelated
businesses. Downscoping is used to make the firm less diversified and allow its top-level managers to focus on
a few core businesses. A firm that downscopes often also downsizes at the same time.

124. What is an LBO, and what have been the results of such activities?
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ANSWER: Leveraged buyouts (LBOs) are a restructuring strategy. Through a leveraged buyout, a (publicly traded) firm
is purchased so that it can be taken private. In this manner, the company's stock is no longer publicly traded.
LBOs usually are financed largely through debt, and the new owners usually sell off a number of assets. There
are three types of LBOs: management buyouts (MBOs), employee buyouts (EBOs), and whole-firm buyouts.
Because they provide managerial incentives, MBOs have been the most successful of the three leveraged
buyout types. MBOs tend to result in downscoping, an increased strategic focus, and improved performance.

125. What are the results of the three forms of restructuring?

ANSWER: Downsizing usually does not lead to higher firm performance. The stock markets tend to evaluate downsizing
negatively, as investors assume downsizing is a result of problems within the firm. In addition, the laid-off
employees represent a significant loss of knowledge to the firm, making it less competitive. The main positive
outcome of downsizing is accidental, since many laid-off employees become entrepreneurs, starting up new
businesses. In contrast, downscoping generally improves firm performance through reducing debt costs and
concentrating on the firm's core businesses. LBOs have mixed outcomes. The resulting large debt increases the
financial risk and may end in bankruptcy. The managers of the bought-out firm often have a short-term and
risk-averse focus because the acquiring firm intends to sell it within five to eight years. This prevents
investment in R&D and other actions that would improve the firm's core competence. But, if the firms have an
entrepreneurial mindset, buyouts can lead to greater innovation if the debt load is not too large.

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