Now back to some motives that push people to M and A transactions. Well, number five is Hubris and winner's curse. Again, sounds familiar, doesn't it? We talked about winner's curse, of course in capital markets in quite detail. But what do we talk about here? Well, Hubris basically means that the people who are about to buy the company they are over-optimistic. Sometimes they are kind of arrogant, they believe that they know the right way that they know better, and as a result that oftentimes leads to overbidding. And that winner's curse is the case that if you do get control over that, then you're likely to fail in the long run because you will have paid too much. Because these things they are oftentimes observed in multiple bidding. When there's more than one bidder then people believe that they are fighting for something precious, and that by no means attest to the fact that the company that they are in pursuit of is bad. But if there is a race between these two or more, then it's very much likely that they will overpay. And as a result, if you bought a great company but if you paid too much. We will talk about that in much greater detail next week. But you can see that this makes the potential of real wealth creation very low. And to some extent you can see that this is sort of, I will put the clause close to number four, when we talked about undervaluation. Now, the next very big area here is the agency problems, sounds familiar too. Because we talked about the most simplified way is that there are the principals, the owners of the company, and there are the management, their agents. And these agents they abuse, they act in their own interests oftentimes at the expense of their principals. And that's too bad. Now, the good news is that the existence of the M and A market is great here. So, the M and A market is a weapon against the agency problem. So, the idea goes like this. If some managers, they do not act in the best interests of their shareholders, then the company may be taken over. These agents can be thrown away and then some other managers will probably behave in better interests of the shareholders. Let's say, if the target company is slow or is not managed great, then if someone buys that and maybe even circumvents the management, goes directly to the shareholders and oust the management, then it's to the best interests of these target shareholders. Now, what else do we see here? There is the so-called idea of managerialism. Well, managerialism is that sometimes it has been observed that the bigger the company, the greater and sometimes disproportionally the pay packages to the management. In one study, it was specifically observed that it sometimes does not even depend upon the size of the company but upon the number of layers of the management. The more of them, the more cumbersome is the management process of the company, more likely it is that the top management receives huge payment packages. Clearly, this is against the interests of shareholders and M and A market may solve this problem. And in general there is the so-called free cash flow theory that basically says that if the company creates cash, so this is a good company. And then the management is prone to taking this cash and investing it in some projects that are not the best. So, if you just paid this cash out in the form of a dividend to the shareholders, they will be able to use that better. And finally, here for the first time but not for the last time on this course, we see the idea of corporate governance. And again, here in this course specifically, corporate governance is seen in the sort of more narrow sense, that basically means the set of procedures that protect smaller stakeholders here. We'll talk about corporate governance in much greater detail closer to the end of this course, we have a couple of special episodes devoted to that. Because basically it's great when all small stakeholders are protected. But again, hello, from our capital markets course, remember we said that deposit insurance is great for those who cannot protect themselves, but it's costly. By the same token we will see here that although it will be great to have a system that protects the small, we guys, but it costs some money. And the question arises, who pays for that? So, as always in Finance, there is nothing in the form of a free lunch. So, then we'll move forward. And now, we here come to the very special motive that is called redistribution. So, the general idea here is that value in the process of an M and A transaction, it travels from one group of stakeholders to the other. So, one group of stakeholders sort of wins at the expense of the others. And who may be these groups of stakeholders? Well, let me use some examples, taxes versus redistribution from the government. Well, we mean here that if tax savings is the main motive, what else? How about, let's say, market position or market power, what is this? We become bigger. So, from whom do we steal value? From our customers. Because if we are now more powerful we may dictate the terms. So, this is from customers. Now labor. We may try to save by laying people off or just by negotiating them in a tough way to, let's say, to bring their salaries down. So, here, this is from employees. And then the next thing, how about bondholders? You can say, what you mean? Well, here the idea is as follows. Well, remember, we talked about it in Corporate Finance. That you can think of an equity in a company as an option on its assets. So, it can be seen that sometimes as a result of a transaction there is some redistribution of value from bondholders to stockholders. There is another very special case. Let's say, I am taking the company private. So, I borrow a lot of money and then in this case, I buy the stock directly from shareholders. And now before the company had small leverage and its debt was almost riskless, now there's a lot of debt. So, the quality of their debt, its rating is deteriorated. Now, these people lost their value because before they had first grade debt, so they didn't care much about that. Now, there is a high probability of the fact that not all those debt will be redeemed. So, here we see that all that sometimes is kind of very important. Not only that, we can think when we talked about market power, you can always think about redistribution from competitors. But we talked about that up there and for that reason I do not pay that much attention to that. So, all these, now I am wrapping up, there may be some one or more motives. And now, here we take a small pause because supposedly you have the idea, you say, I am engaging in this transaction for this reason. And you have an idea how to create value in that. Now, comes the small but very important point, how exactly will you be able to complete this transaction? And in the two episodes to follow the closing episodes of this week, I will show to you that there is a special obstacle that you have to overcome. If you come to the target company and make an offer for them, then these people say, "Well, wait a minute. This guy must know something. Why wouldn't we just wait and see if he succeeds and makes the company more valuable. We will freeride on what he does." So, this is a classic case of a free rider problem that is very detrimental to the potential active bidder, active agent in this process. And that sometimes may very fundamentally prevent this value from being created. So, with what follows, we will talk about the free rider problem during the process of tender offers.
