The Role of Business Ethics in

Merger and Acquisition

•Sunil Kumar Singhal – S-78•Rajat Gupta – S-48•Mukesh Panwar – S-38•Kamesh Sanghi – S-29•Parmanandh Ojha –S-44•Amit Kumar Bimal – S-04•Raj Kumar Nagar – S-47•Vivek Kumar Sachan – S-71•Ajay Gupta – S-01•G V Ramakrishnan – S-23•Rajesh Kumar Sahu – N-42

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Mergers and Acquisitions

(M&A) Ethics and its need in M&A M&A Success / Failure Primary risks associated

with M&A Success / Failure Structural risks People risks

Root of Ethical Problems in M&A

Questionable Practices in M&A

Ethical issues in M&A General Employer Employees Due-diligence Accounting Cross Border

AGENDA Legal Procedures for M&A

in India Regulation of M&A in India

The provision of the Companies Act, 2013

The Securities and Controls (Regulations) Act, 1956.

The Foreign Exchange Management Act (FEMA), 1999

The Competition Act, 2002

The Income Tax Act, 1961

Legal Measures against Takeovers

Ethical issues Horizontal Merger Vertical Integration Conglomerate Merger

Mergers and acquisitions are an efficient way for corporations pursuing a growth strategy to obtain external human resources, financial resources and to broaden their operational field.

The key principle behind mergers and acquisitions is to create shareholder or stakeholders value that is over and above that of the sum of the two companies involved in the transaction.

Mergers and Acquisitions (M&A)

Ethics concerns the process of making morally good decisions.

Andrew Wicks writes, “Ethics has to do with pursuing and achieving laudable ends.”

Business scandals have reawakened the need for businesses to create and adopt an ever-improving ethical framework in all areas of their business activities which includes Mergers and acquisitions (M&A).

Ethics and its need in M&A

Unethical conduct may play a critical part in M&A failure, as “M&A success lies not in the completion of the financial transaction but in the post-acquisition human resources integration and the realization of the synergy effects of the parties involved. Organizational commitment and job performance of the acquired company employees have been identified as major indicators of M&A success.”

Mergers and acquisitions involve a wide array of ethical questions, some of which relate to the degree of "fit" between the value systems of the merging firms. A mismatch can sometimes lead to serious problems, such as when one firm invests heavily in employees and the other focuses mainly on shareholders or customers?

M&A Success / Failure

McKinsey studies show that “management of the human side of the merger is the real key to maximizing the value of the deal.”

Mercer Human Resource Consultants found that out of three key merger factors – people, processes and systems – only people issues made a difference to the success of mergers in the decade to 2001.

M&A Success / Failure – some findings

A study conducted by the International Association of Business Communicators (IABC) and Mercer asked CEOs after a merger what changes they would make if they had it to do over again. Their top response: the way they

communicated with employees.

Based on Clarks 2003 Study, employees in organization undergoing M&A report observing misconduct and feeling ethical-related pressure at nearly double the rate of other workers.

Research suggest that 50% of the M&A are considered a failures. Failure to meet shareholder expectations within 18 months of the

merger announcement. Breakup of negotiations without signing an agreement Financial losses Human issues such as a wave of voluntary resignations, low

morale, reduced productivity and resentment of the acquired employees.

Thomas in 2004 described this as the most damaging situation incurring the highest cost.

Studies have reported that business ethics are positively related to organization commitments.

M&A Success / Failure – some findings

Primary risks associated with M&A Success / failure

Structural risks

People risks

Root of Ethical Problems in M&A

• Shareholder Values – but who are your shareholders?

• Same holds for Stakeholders.• Age old conflict between profitability and

Ethics• Ownership Change• Traditional practice of undertaking M&A in

secrecy“There is not a Crime, there is not a

Dodge, there is not a Trick, there is not a Swindle, there is not a Vice which does not live by secrecy”.

Dilemma of Having a Transparent debate about secret programs.

“Its very very difficult I think for us to have a transparent debate about secret programs approved by a secret court, issuing secret orders based on secret interpretation of the laws.”

Tom Udall

Ethical dilemmas pervade the field of mergers and acquisitions

Not Divulging information to the employees about the M&A. In response to a hostile takeover attempt, a CEO

considered paying “greenmail” to make the raider go away. The CEO had a strong self-interest in the outcome of the takeover attempt, as the retention of his position hinged on it. Is the payment of greenmail unethical?

The CEO of a firm sought to prepare the firm for sale. Part of this entailed the use of accounting policies to improve the financial track record of the firm. The practice of “prettying up” a target company for sale may be widespread—is this unethical?

Contd……

Questionable Practices in M&A

The directors of a public corporation approved without much analysis or discussion a leveraged buyout proposal from the CEO at a relatively low price. A number of the directors were friends or affiliates of the CEO. Was the behavior of the directors unethical? Most directors develop a personal or social acquaintance with the CEOs they employ. Is this affiliation unethical?

A large investment bank refused to provide acquisition financing for a deal unless it was to be listed as the lead underwriter, ahead of its rival, another firm also in the underwriting syndicate. Is the use of bargaining power unethical?

Contd….

Questionable Practices in M&A

A firm pursued an aggressive strategy of growth by acquisition that relied on creating the appearance of high growth, when in fact the companies acquired were mature and growing slowly. The appearance fuelled expectations of prolonged growth, granting the firm a high share price, and therefore a strong acquisition currency with which to do more deals. Was this strategy of momentum acquiring unethical? Many companies aim to persuade investors of good growth prospects even when that growth is uncertain. Is such persuasion unethical?

The ethical dilemmas in M&A are rarely clear or, if they are, they may entail a violation of the law.

Questionable Practices in M&A

Ethical issues in M&A - General

Lies & Coercion Deception in negotiation Employees concerns Acquisitions - Friendly and Unfriendly Stakeholders interest Avoidance of Tax payments Share holders & Insider Trading Competition Foreign Exchange

Major ethical issues in M&A transactions potentially refer to the issues of employees, whether being on the sell-side or buy-side during an acquisition. Some of the issues concerning employees are: Informational disclosure Welfare, rights and concerns of employees Morale, motivation and commitment during and

post- M&A Managerial motives - retain more earnings for

discretionary spending. Threats of jobs or employment security -

downsizing Employment conditions

Ethical issues in M&A-Employer

When to disclose plans for the merger to the employees?

What restrictions to place on insider use of information?

What ethical considerations are associated with downsizing decisions?

If you were part of a corporate downsizing, would you feel that your firm had acted unethically?

If you believe that downsizing has an unethical component to it, what should firms do to avoid using this technique?

Ethical issues in M&A-Employees

What ethical issues are involved with conducting a robust due-diligence process? Limited time for due diligence Lack of information Information in unfriendly format Not answering all the queries in

defined time frame. Withheld the information in the name

of commercial sensitive nature

Ethical issues in M&A – Due-diligence

Ethical risks in M&A - Accounting What counts as fair and proper

accounting and taxation? Manipulation of financial reporting Usage of subsidiaries or other entities to

borrow money without reporting the debt on their balance sheets

Using special entities to manipulate profits Manipulation of accounting for mergers

and acquisitions Pooling-of-interests

In M&A’s that cross borders, these issues can be particularly difficult because of cultural and legal differences. Legal definition of 'redundant employees'

varies widely as do requirements for severance arrangements.

Governments tend to protect their national interests when dealing with foreign-owned firms. For example, in the United States an airline cannot have more than 25% foreign ownership.

Governments may have currency laws that prevent a foreign-owned firm from taking money out of the country.

Labor laws may be different from those in a firm’s domestic market.

Ethical issues in M&A – Cross Border

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Legal Procedures for M&A in India

Permission for merger from regulator

Information to the stock exchange Approval of board of directors Application in the High Court Shareholders’ and creditors’

meetings Sanction by the High Court Filing of the Court order Transfer of assets and liabilities Payment by cash or securities

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Regulation of M&A in India

In India, mergers and acquisitions are regulated through: The provision of the Companies Act, 2013: The Securities and Controls (Regulations)

Act, 1956. The Foreign Exchange Management Act

(FEMA), 1999, The Competition Act, 2002, and The Income Tax Act, 1961, Ethics sets a higher standard than laws

and regulations.

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The provision of the Companies Act, 2013:

The Companies Act specifically provides for the manner in which mergers, demergers, amalgamations and/or arrangements may take place pursuant to an Indian court sanctioned scheme.

Disclosures in and attachment with notice calling meeting substantially increases.

In case of Takeover involving unlisted companies, an aggrieved party may apply to the Tribunal.

Protection of any class of creditors.

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The Securities and Controls (Regulations) Act, 1956. The Securities and Exchange Board of India

(SEBI) has issued guidelines to regulate mergers, acquisitions and takeovers under SCR Act 1956. SEBI (Substantial Acquisition of Shares and

Takeovers) Regulations, 1997 (“Takeover Code”). SEBI (Issue of Capital and Disclosure Requirements)

Regulations, 2009 (“ICDR Regulations”). Securities and Exchange Board of India (Delisting of

Securities) Guidelines, 2003, (“Delisting Guidelines”).

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The Foreign Exchange Management Act (FEMA), 1999:

The two most relevant regulations under FEMA from an M&A perspective are:

(i) Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 (“FDI Regulations”)

Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004 (“Foreign Security Regulations”)

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The Competition Act, 2002,

The Competition Act as amended by the Competition (Amendment) Act, 2007, inter alia provides for control over M&A activity and abuse of dominant position in the market.

Prior approval of the CCI is required for mergers and acquisitions above specified thresholds.

The CCI has extra territorial jurisdiction as regards mergers or combinations taking place outside India.

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The Income Tax Act, 1961, Any M&A transaction requires detailed

evaluation of the tax consequences. Under the present taxation system in

India, taxes vary for each method of acquisition.

An asset transfer by way of slump sale may result in higher income for the seller and higher value added tax liability for the buyer.

M&A under the court scheme may result in additional benefits under the Income Tax Act and stamp duty laws when compared to an M&A by private arrangement.

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Legal Measures against Takeovers

Refusal to Register the Transfer of Shares: a legal requirement relating to the

transfer of shares have not been complied with; or

the transfer is in contravention of the law; or

the transfer is prohibited by a court order; or

the transfer is not in the interests of the company and the public.

Protection of Minority Shareholders’ Interests

Ethical issues in Horizontal Merger

Competitors merge Example: merger of Chevron & Texaco

Ethical concern: might directly reduce competition significantly. To decide: Define relevant product market Define relevant geographic market Examine effect of merger on market

shares Analyze barriers to entry

Regulate merger terms & conditions

One of the outcomes associated with market power is that the firm is able to sell its good or service above competitive levels. Is it ethical for firms to pursue market power?

Does your answer differ based on the industry in which the firm competes?

For example, are the ethics of pursuing market power different for firms producing and selling medical equipment compared with those producing and selling sports clothing?

Ethical issues in Horizontal Merger

Ethical issues in Vertical Integration

Merger up or down the chain of production and distribution Example: Merger of Time-Warner (content) & AOL

(distribution) Ethical concern: might harm competition

significantly Why? Possibility of cut-off supply to the competitor. Issue: Are there alternative sources of supply that

are economically viable? Regulate merger terms & conditions

Ethical issues in Conglomerate Merger

Totally unrelated companies merge Example: US Steel and Marathon Oil

Rationale: diversification—“don’t put all your eggs in one basket”

Ethical concern: deep pockets / internal cross-subsidization / may facilitate predatory pricing

Regulate merger terms & conditions

Some evidence suggests that there is a direct relationship between a firm’s size and the level of compensation its top executives receive.

If this is so, what inducement does this relationship provide to top-level managers?

What can be done to influence this relationship so that it serves shareholders’ best interests?

Ethical issues in Conglomerate Merger

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