by Kanes
TNCs undertake FDI in a host country in either of two ways: greenfield investment in a new facility or acquiring or merging with an existing local firm, privately or state-owned. In a cross-border merger, the assets and operations of two firms in two different countries are combined to establish a new legal entity while in a cross-border acquisition, the control of assets and operations is transferred from a local to a foreign company, the former becoming an affiliate of the latter. The great majority — 97 per cent — of mergers and acquisitions (M & As) are acquisitions. Over the past decade most of the growth in international production has been via cross-border M & As rather than greenfield investment.

The value of M & As rose from less than $ 100 billion in 1987 to $ 720 billion in 1999; they doubled in value in the seven years 1990 to 1997 and doubled again in two years 1998 and 1999. Most of the M As — over 90 per cent of them — take place in developed countries and only about 9 per cent of them are in developing countries. It is significant that 83 per cent of the foreign direct investment flows of $865 billion in 1999, were by means of M & As. M & As have become the dominant mode of FDI in the developed countries, nearly all the FDI inflows being M & As. In the developing countries, however, M & As form about a third of the FDI inflows, rising from one-tenth ten years ago.

The recent M & A boom has been facilitated by the increased use of such financing mechanisms as the issuance of common stocks, the exchange of stocks and corporate debt. In addition to traditional bank loans, venture capital funds also have become an important source of finance, enabling many small firms to engage in M & A activity. M & As are classified as horizontal (between firms in the same industry), vertical (client-supplier or buyer-seller (M & As) or conglomerate (between firms in unrelated industries).

Short-term financial gain

About 70 per cent of cross-border M & As are horizontal. While many of the cross-border M & As in the late-1980s were motivated by short-term financial gain, the more recent ones appear to have strategic and economic rather than immediate financial motives. Cross-border M & As have two main advantage over greenfield investment as a mode of FDI entry: speed and access to proprietary rights such as R & D or technical know-how, patents, brand names, the possession of licences or permits and supplier or distribution networks. They represent the fastest means of building up a strong position in a new market, gaining market power and indeed market dominance, increasing the size of the firm or spreading risks. Cross-border M & As allow firms to realize synergies by pooling the proprietary resources and capabilities of the firms involved, with potential static and dynamic gains.

There are also other reasons why M & As have become popular in spite of their poor financial performance record. They have to do with advances in technology, liberalization and changes in capital markets. The rapid advances in technology have intensified competitive pressures on the TNCs (which are the world’s technological leaders). By merging with other TNCs with complementary capabilities, firms can share the costs of innovation, access new technological assets and enhance their competitiveness.

The spreading and deepening of the international production system through cross-border M & As have furthermore been facilitated by the ongoing removal or relaxation of restrictions on FDI in many countries. Trade liberalization and regional integration efforts have added a further impetus to cross-border M & As by setting the scene for more intense competition and by prompting regional corporate restructuring and consolidation. Capital market liberalization, in turn, and the proliferation of new methods of financing M & As have made cross-border M & As easier.

For many firms, the quest to survive and prosper in the emerging global market for firms, by defending and developing competitive market positions becomes the key strategic issue and hence, drives the M & A trend. Cross-border M & As are growing so rapidly precisely because as pointed out earlier, they provide firms with the fastest way of acquiring tangible and intangible assets in different countries, and because they allow firms to restructure existing operations nationally or globally to exploit synergies and obtain strategic advantages. In brief, cross-border M & As allow firms rapidly to acquire portfolio of locational assets which has become a key source of competitive strength in a globalizing economy.

Strong concentration

Automobiles, pharmaceuticals and chemicals and food, beverages and tobacco were the leading industries in the manufacturing sector in terms of worldwide cross-border M & As in 1999. Most of these M & As in those industries were horizontal aiming at economies of scale, technological synergies increasing market power, eliminating excess capacity or consolidating and streamlining innovation strategies and R & D budgets. These M & As have also led to strong concentration. Telecommunications, energy and financial services were the leading areas in the services sector where M & As were active, largely as a result of recent deregulation and liberalization in those industries. In financial services, competitive pressures and mounting information technology costs have given an added impetus to M & As.

Developing countries

Developing countries emerged as important locations for incoming cross-border M & A only in the late-1990s. In 1989, the value of M & A sales in developing countries to foreign investors was only $ 5 billion or 4 per cent of total M & A sales in the world. Thereafter, the share of the developing countries rose to 21 per cent in 1997—the peak—and declined to 15 per cent in 1998 and 9 per cent in 1999. Among the developing regions, Latin America dominates the cross-border M As sales—mainly by privatization — with Brazil, Argentina and Chile being the main sellers. In Asia, cross-border M & A sales became significant only in 1999. Foreign acquisitions in South Korea exceeded $ 9 billion in 1999 — making it the largest recipient of M A associated FDI in developing Asia.

The other countries where M & A sales were significant were Hong Kong, China, Thailand, Malaysia and the Philippines. Such sales assumed importance in Korea only in 1998-1999 and in Singapore and Taiwan in 1999. There have been foreign acquisitions on a smaller scale in Africa, particularly in Egypt! Morocco and South Africa. The principal acquirers of firms based in developing countries have traditionally been TNCs based in developed countries — EU and US.

In recent years, however, M & A purchases of Asian firms by firms based in developing countries such as Singapore increased as a result of the Asian crisis. Worldwide the value of cross-border M & As undertaken by firms from developing countries rose from $ 4 billion in 1989 to $ 41 billion in 1999 — a tenfold increase in 10 years. These firms were mainly from Bermuda and to a lesser extent from Argentina and Brazil in Latin America, and Singapore, Hong Kong, South Korea and Malaysia in Asia. Iran has also come into the picture in 1999.

Concerns

Cross-border M & As are the most visible faces of globalization and they appear to be a vehicle for the expansion of big business. TNCs are seen to benefit disproportionately from globalization while local small and medium enterprises in host developing countries are affected adversely. Developing countries have expressed their grave concerns about cross-border M & As acquiring their national firms. At the heart of their concerns is that foreign acquisitions do not add to productive capacity but simply transfer ownership and control from domestic to foreign hands. This transfer is often accompanied by layoffs of employees or the closing of some production or functional activities. It also entails servicing the new owner in foreign exchange. If the acquirers are global oligopolies, they may well come to dominate the local market.

Cross-border M & As can, moreover, be used deliberately to reduce competition in domestic markets. They can lead to strategic firms or even industries (including key ones like banking) falling under foreign control, threatening local entrepreneurial and technological capacity building. The areas of concern transcend economic and reach into the social, political and cultural realms. In industries like media and entertainment for example, M & As may seem to threaten national culture and identity.

The transfer of ownership to foreign hands may be seen as eroding national sovereignty. When the acquisition involves "fire sales — sales of companies in distress, often at abnormally low prices as during the East Asian crisis, such concerns are intensified. The Prime Minister of Malaysia, Mahathir Mohamed expressed the concerns of developing countries on cross-border M & As as follows:

"...mergers and acquisitions are making big corporations even bigger. Now many of these corporations are financially more powerful than medium-sized countries. While we welcome their collaboration with our local companies, we fear that if they are allowed into our countries unconditionally, they may swallow up all our business".

Greenfield Investments and M & As

Generally greenfield FDI is more useful to developing countries than cross-border M & As, as it not only brings a package of resources and assets, technology and skills, but simultaneously creates additional productive capacity and employment. Cross-border M & As, on the other hand may bring some package but do not create immediate additional capacity. Furthermore, they involve several risks at the time of entry such as from reduced employment through asset stripping to the slower upgrading of domestic technological capacity. When M & As involve competing firms there is the danger of market concentration and reduced competition.

Under exceptional circumstances, however, such as when a country’s firms face bankruptcy or when there is large-scale privatization with no local investors, M & As can play a useful role. Apart from providing finance they can restructure existing capacities through modern managerial practices. The East Asian crisis for example, resulted in many bankrupt firms and failed banks and as the government and the local private sector were unable to give them a helping hand, cross- border M & As became inevitable.

Need for competition policy

The risks and negative effects of M & As need to be reduced through appropriate government policies aimed at maximizing the benefits and minimizing the costs. Among the sectoral policies which can be used are sectoral reservations, ownership regulations, size criteria, incentives and screening to ensure that they meet certain criteria. The most important policy instrument, however is competition policy. The search for increased market shares and indeed market domination is one of the main characteristics of business behaviour. The threat of monopoly or tight oligopoly is potentially the single most important negative effect of cross-border M & As and therefore poses the single most important policy challenge.

The challenge is to ensure that policies are in place to deal with those M & As that raise competitive concerns and that they are implemented effectively. Indeed as FDI restrictions are liberalized worldwide, it becomes all the more important that regulatory barriers to FDI are not replaced by anti-competitive practices of TNCs. Thus, it is imperative for governments to adopt measures aimed at proper functioning of markets, including in particular, measures to control anti-competitive practices by firms by the adoption of competition laws and their effective implementation. Competition policy at national level alone is not enough to cope with cross-border M & As with global dimensions. National policies need to be complemented by international action to regulate the anti-competitive practices of TNCs. The UNCTAD set of Principles and Rules on Restrictive Business Practices — the only multilateral instrument in the area — could provide the basis for such action.