A Study On Firm Vertical Integration And M&A's Effect

As one of corporation behaviors in market economy, M&A is a highly efficient means to make approaches to expanding quickly for the integration strategy. As can be seen in the histories of big enterprises' growth worldwide, almost all the firms achieved their goals for fast growth by M&A. Issues on M&A's effects on performance have always been the core problems argued internationally because different models of M&A will lead to different effects on operational performance of enterprises. With respect to M&A's effects on performance, the author is trying to find all types of incentives of M&A and vertical integration in theory, synchronously, starting positive analysis on the effects of M&A of public companies in China in order to provide relating evidence both in positive angle and in normative angle for guiding China enterprises how to optimize their performance of M&A.In the first few chapters, traditional theories on M&A and the effects on performance are demonstrated briefly as the fundamentals for further research. Though incentives of M&A have been interpreted from different aspects respectively in incentive theory of M&A, the numerous practices of M&A in the real world are not involved. These theories have their own standpoints separately, but correlate each other more or less. Consequently, to begin with Transaction cost economics and Property right theory, this paper aims to study concretely on effects of asset specificity on performance of M&A and the connection between Synergy Effect and ownership structure through theory analyzing and proving them positively.Transaction cost economics with an asset specificity angle is considered as the key tool for analyzing vertical integration, and the theory defines corporations, market and mixture of the two as totally different economic organizations with an absolutely new method when studying on economic organization. Meanwhile, it is thought that of the three structures, market contract, vertical integration and the mixed model, each has its own unique costs according to the theory. And there are three significant concepts, asset specificity, limited rationality and opportunistic behaviors. Transaction cost could be minimized by arranging transaction and governance structure in groups accordingly one by one. Whether firms should arrange producing themselves or purchasing from market only depends on the price contrasts between governance costs and produce costs of the two modules. However, the angles for analysis are not comprehensive on characteristicsof vertical integration and its causes; maybe there are some other sources or types of transaction costs at work such as quantitative change caused by fast growing market and qualitative change developed by high technological and organizational innovation. So, when analyzing incentives of vertical integration, certain perspectives of industry life-circle, demand, economies of scale and asset specificity theory should be combined and researched as a whole. That is to analyze by a method of dynamic transaction costs. "Make or buy" strategy is not a once and for all decision, and firm may choose to vertically integrate and then decide that it is less costly to rely on market contracting. Better understanding on how idiosyncratic contractual relationships adapt to changing supply and demand conditions, how organization responds to changing circumstances and ageing, and why governance arrangement changes will provide deeper insights into both the market imperfection and organization imperfection consideration that affect the choice of governance arrangement.The method of Property right theory emphasizes the proprietary right of physical and intangible asset and the authority that such proprietary right has in deciding the usage of these assets, the policy of transaction afterwards and any interior transfer price, and so on. When specialized investment happens, the proprietary of specialized assets distributes the residual control power to the part that does the specialized investment. By vertical integration, it endows the owner with the right of asset usage. These satisfy the residual power of objective function further. Property right theory proposes that investment incentives is a main factor that affects the integration of company. The cost and benefit of integration is to decrease and increase the relationship specific investment incentives respectively.Because of the globalization of economy and the rapid change of economic and technical environment, the explanation of Transaction Cost Economics and Property right theory in vertical integration has been influenced comprehensively. The importance of it is declining gradually. What's more, its realized income can be achieved by strategic alliance. Despite this, vertical integration, especially forward integration, is adopted widely in motor and pharmaceutical industry. Therefore, this paper analysis is based on the deficiency of the explanation, which is from the current theory of vertical integration. And it demonstrates real motivation under the vertical integration including transmission of value, difference, customer's need, learning related relationship and so on. Among these, learning oriented relationship cannot be achieved by negotiation with the customers. And knowledge created by this also cannot berepresented by the form of formal written words. It is this "untradeability"of learningthat explains the vitality of downstream vertical integration.In terms of M&A's effects on performance of enterprises, the methods of event study and financial data analysis were adopted by researchers home and abroad. Different approaches yield to different results. However, they do have common ground, which is no matter estimated by price of stock or financial data, a considerable number of enterprises involved in M&A have not reached expected effects. In other words, these enterprises were unsuccessful in M&A. Nevertheless, it is noticed that M&A plays a positive role and contributes to enhancing firm market power and optimizing industry structure, and so on, and that is one of the key factors driving enterprises to carry out integration. With a model composed by positive research and normative research, after reviewing certain theories of M&A's effects on performance as fundamental preparation, this dissertation sets M&A activities in China securities business since 2002 as research background, and studies on the change of fore-and-aft performances of enterprises have executed M&A by aspects of asset specificity, integration and firm scale with financial data study method, targeting on two financial guidelines, NROA and CROA of sample companies from 2001 to 2003,. Through the significant test of performance change and correlation analysis, 99 sample companies, which took vertical integration in 2002, reached satisfactory effects. Besides, the higher asset specificity gets, the better performance of vertical integration and horizontal expansion will be; Thus, asset specificity still could be considered as one of main incentives of M&A; the bigger the enterprise is, the worse the performance of M&A of the enterprise will be. The explaining power of three variables is stronger to vertical integration than to horizontal integration. So the characteristic of firm assets should be considered fully in the activities of M&A at present. An activity that belongs to the core of firm's competencies should be integrated. The firm should not expand blindly.Synergy effect has been always considered as the all-important basic principle for western multinational corporations to obey when making diversification expansion strategies and scheming M&A activities. In essence, M&A is aiming for gaining Synergy effect. That is firms sharing sources and abilities and transfer of knowledge to create more profits, expected Synergy effect is the main motivity to make more value by M&A. Therefore, Synergy effect has the important influence on the ownership structure of the asset. This dissertation uses mathematics model emphasizing on analyzing Synergy effect of vertical integration and its influence on ownership structure of the asset. According tothe research of this dissertation, if the potential synergies that can be realized by full specificity is sufficiently large, integration may be optimal. It is true that incentives to exert investment effort may be smaller under integration than under non-integration. But under non-integration the investing party has an incentive not to choose full specificity, because this increases the revenue he could obtain on the spot market. On the other hand, if the potential synergies are small, less specificity is not as harmful as underinvestment, so that non-integration is the preferred ownership structure. This trade-off can help to identify activities that belong to the firm's core competencies. Given a basic product a firm sells, an activity belongs to the core of a firm's competencies and should be integrated if the gain from increased specificity and realized synergies is large enough to outweigh the losses from integration.Lastly, this dissertation analyzed pertinence between horizontal expansion and vertical integration with a point of view of economics. The management of vertical integration has contributed respectably to a number of firms in 80s of 20th century; but as the economic globalization prevails and the knowledge economics era approaches, more and more disadvantages have shown up in the vertical integration model, which has been the firm belief of firms. And an increasing number of companies are turning to horizontal expansion module while abandoning the vertical integration model. After all, obviously, corporation's horizontal integration still has some connection with its vertical integration. It is believed by the writer that when firms differ with regards to their initial cost structures, efficient firms-that is, firms that have carried out more cost-reducing investments than others-will integrate vertically, and inefficient firms stay separated. In brief, cost-reducing investments are more attractive for integrated firms and vertical integration is more attractive for efficient firms, and further explanation will be demonstrated by enclosed cases of structure change between automakers and suppliers of parts.In conclusion, this dissertation lists the main factors influencing on M&A's effects of corporation, and builds a framework theoretically on analyzing connections between Synergy Effect and ownership structure. It will play a guiding role on promoting competitiveness and performance of M&A of China public companies.