Economics of Transition

This would be the reasoning behind the estimation that there is an increase in EVA over the two consecutive time periods. From the above paragraph, it was said that EVA had to be above total operating profit otherwise the company would be better off broken down into smaller companies with some of its assets liquidated. In this case however, total operating profit is 420 million pounds which is less than the figure for EVA. This means that Tate & Lyle is better off staying as one company.

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a. ) The article under review is taken from the Reuters News Service UK dated 27 April 2001, ‘Merger talks upstage Bank of Scotland results’, concerning talks about Halifax and Bank of Scotland merging in a 27 billion pound deal. This move did not come as much of a surprise due to the merging of major banks last year. Royal Bank of Scotland took over NatWest, Barclays snapped up The Woolwich, and Abbey National bought life insurance company Scottish Provident.

The idea behind the merging of Bank of Scotland and Halifax like all the other banks mentioned is to achieve growth in order to be able to compete with the top four banks which are Royal Bank of Scotland, Barclays, HSBC and Lloyds TSB. The traditional method of expansion through internal growth would give fears to firms like Bank of Scotland and Halifax because they could be left behind in terms of competition as the effect of merging in a case like this would almost double the size of the company.

Like most other industries, the banking industry is becoming increasingly concentrated in the hands of a few banks giving an oligopolistic view of this market. The easiest way to achieve substantial growth would be to merge or to acquire another company which has several advantages. The merging of these two companies would make the new company the 11th largest on the FTSE 100 index and the fifth largest bank in the UK. The two companies confirmed that the discussions were based on a nil premium merger to create the UK’s fifth largest bank.

This essentially means that shareholders in both companies would receive one share for each share that they own in the merged company as a result of the deal. The shares in both companies increased almost equally with expected dividend increases. However, due to the one for one share exchange, Halifax would own approximately 60% of the merged company. The merger would be a merger of equals. Bank of Scotland are under a lot more pressure to merge than Halifax mainly because they have made two unsuccessful attempts to merge with other financial institutions.

The Royal Bank of Scotland defeated Bank of Scotland in a bid battle for NatWest last year and talks with Abbey National over a nil premium merger collapsed with the pulling out of Abbey in February. The fact that the current merger deal is out in the open is due to a leak in information similar to the situation with Abbey National which may have hindered the progress of the deal. The move by Bank of Scotland to try to take over Abbey was followed by a hostile takeover bid by Lloyds TSB worth 19 billion pounds.

The two companies, although different in their main expertise, which is mortgage lending for Halifax and corporate lending for Bank of Scotland, could complement each other very well. Halifax, with it’s large branch network around England, would give Bank of Scotland the opportunity to increase its customer base as well as access to cheap retail funding. This would be a very strong step in trying to compete with the four top banks.

Bank of Scotland is very active in the corporate market and a leading provider of credit cards for many different organizations such as universities, charities and football clubs. The two companies have very strong backgrounds. Halifax was founded in 1852 and is currently the number one mortgage lender in the UK. It’s stock market value as at 20 April was 16. 4 billion pounds and it employs 37,000 people. It’s pre tax profits have been strong, totaling 1. 89 billion pounds and on the increase with an 8% rise last year. Bank of Scotland was founded in 1695.

It’s stock market value as at 20 April was 9. 82 million pounds and it currently employs 20,000 people. Like Halifax, Bank of Scotland’s pre tax profits, totaling 535 million pounds have steadily increased with a 14% rise for the period March to August 2000 and is forecasted to report pre tax profits of approximately 1. 065 billion pounds in the year to the end of February. Bank of Scotland was considered too small to compete in the long run with the four major banks but if this merger were to take place, there would be no reason for the new company not to.

The proposal has been hailed by many financial analysts such as Mark Thomas, banking analyst at Fox-Pitt Kelton, who believes that the merger would be an excellent strategic fit and predicted that the banks would be able to cut 300 million pounds in costs should the merge go through. There would be job losses but these would not be on a very large scale it is thought that branch closures would be less than in the proposed Lloyds – BoS takeover.

The little overlap of geographical locations of both banks’ branches, as a result of majority of Halifax’s branches being in England and Bank of Scotland’s branches further to the north, would mean that it would be unlikely that there would be widespread closures. The merger is believed to have a good chance of regulatory approval by the Competition Competition due to the fact there is very little geographical overlap. The merger would be very advantageous to shareholders in both banks but even more so for shareholders in Halifax.

This is because many customers of Halifax are shareholders due to the fact that it transformed itself from a building society into a bank. The proposed merging of these two companies would also place a lot of interest by other firms and there is a strong possibility that one of the companies would be the subject of a hostile bid to try to bust the merger. The problems that Halifax and Bank of Scotland would have to handle with this merger would be the location of the headquarters again due to the lack of geographical overlap and who would take the leading role in the boardroom.

It is a good point to note that the two companies have the right to expect their company heads to take control over the new company, as it is a merger of equals. b. ) The article is informing the general public of the discussions between Bank of Scotland and Halifax about a nil premium merger between these two companies with plans to agree on a one for one share exchange which would give Halifax roughly 60% of the new bank. A nil premium would mean that both companies would not have to pay any extra money for the deal to go through.

This sort of merger is called a horizontal merger where two or more firms combine at the same stage of production, involving similar products or services. This is the most common of all mergers in the UK. Statistics show that horizontal mergers declined from 82% in 1965 to 62% in 1985 but increased in the 1990s making up more than 85% of all mergers in the UK. Further examples of such mergers are the merger between Royal SunAlliance and Royal Insurance and Hong Kong and Shanghai Banking Corporation’s acquisition of Midland Bank.

Bank of Scotland is reputed to be one of the UK’s best run banks with a very good management team. However, it will be unable to use this advantage that it has due to its’ size in comparison with the leading banks at present. Although a lot of companies in many industries think they are more likely to prosper if they are huge rather than merely large, the new bank would definitely need its’ size. Bank of Scotland or Halifax would not be able to achieve the sort of growth that it would require by single handed internal growth which would take years.

If they tried to expand rapidly, it would mean that most of the profits would be used for reinvestment which would lead to a reduction in the amount of profit that would be distributed among shareholders. The consequence of this could be a low share price reducing the market value of the firm in relation to the book value of its assets. The ratio of the market value of a company to the book value of its assets is known as the valuation ratio of the company. Mathematically Valuation ratio, V. r = market value = Share price * no. of shares Value of assets Book value of assets

The valuation ratio is important in determining whether a company is prone to takeover in most cases. This is because a company with a low market value in comparison with its book value means the acquirer can offer a higher price to compel such a company to accept its offer. Bank of Scotland and Halifax both have high valuation ratios due to their strong share prices so the two companies would be going at an extremely high price if they were subjected to a takeover bid. The merger is also said to be one of equals which means that no party would have to pay any extra money to the other.

A lot of economists look at this sort of merger skeptically and believe that these sorts of mergers are especially tricky. This is because they disrupt two very strong corporate cultures. In this case, the two banks are of a strong heritage and a huge problem that would need to be overcome would be that of leadership. Another important factor is the similarity of outlook. The two banks are strong in two different aspects of the banking sector. One of the most successful mergers in pharmaceuticals between Sandoz and Ciba Geigy to form Novartis was due to their closeness of approach.

Many economists such as Mark Thomas of Fox-Pitt Kelton believe that the merger is an excellent strategic fit because the expertise of both banks complement each other well. From both companies’ perspectives, there are many reasons why this sort of merger would be beneficial. Intense competitive pressure in times of low inflation means prices are not rising and firms must cut costs to raise profits. A good way of doing this would be to merge to with a competitor and rationalize both businesses.

The Market Power Theory suggests that the two banks’ motives behind the merger could be due to a number of factors. It could be as a result of a fall in demand in certain services which would lead to excess capacity and the danger of price cutting competition. This could apply to this merger because of Bank of Scotland’s credit card service, which although is not on the decline, would be able to introduce more competitive interest rates on their credit services and Halifax on their mortgage lending due to increased asset value.

International competition also poses a formidable threat to the domestic market. A good example of international influence would be the acquisition of Midland Bank by Hong Kong Shanghai Banking Corporation in 1992. The merger between Bank of Scotland and Halifax would be a positive step in forming a bank that would be able to compete internationally as increasing growth of the new company would enable it to acquire smaller companies or indeed merge with another company of the new company’s size. It would also make the new bank less susceptible to hostile takeover bids.

The tightening of legislation makes many forms of linkages between banks illegal but with the merger of these two firms, they will be able to share information on various aspects of banking which would improve the services that the new bank would provide. Increased market power is important to any firm that wants to compete with the top firms in its’ field both domestically and globally. Empirical analysis shows that an increase in the size of a firm would most probably yield less variability in their profits than smaller firms indicating that large firms would be able to cope with adverse economic circumstances such as recession.

The merger would enable the new bank to cut its’ average cuts by increased operations. The two banks specialize in different fields which indicates that a synergy effect, that is to say that the merger would increase the efficiency of the combined firm by more than the sum of its parts, would occur. In this particular example, the strength in mortgage lending of Halifax and the corporate lending skills that Bank of Scotland possesses would complement each other and result in a synergy effect. The merger would be very beneficial to the management in both companies.

Managers are more interested in the rate of growth of the firm than in its profit perfomance. Managerial theories suggest that the growth of a firm raises managerial utility by bringing higher salaries, power, status and job security to managers. Transaction related bonuses following mergers of two companies are often very substantial. Chris Gent of Vodafone received a 10 million pound reward for the Mannesmann takeover. This sort of reward is much to the shareholders’ disgust and it seems inevitable that such an occurrence is bound to happen in this case as well.

The managerial theories also suggest that fast growing firms such as the two banks in concern with growth maximizing intentions raise job security by being less prone to takeovers. There is a lot of debate as to whether mergers are really in the interest of consumers and the resulting growth in firm size will have implications for the public interest. When considering the impact of such a merger on the economy, we must look at the potential impacts of the merger on economic efficiency. The idea of economic efficiency is broken down into productive and allocative efficiency.

Productive efficiency involves the most efficient combination of resources to produce a given level of output with the least cost methods of production. The proposed merger is estimated to cut costs by 300 million pounds which would certainly improve productive efficiency. Allocative efficiency is taken to mean setting a price which corresponds to the marginal cost of production. The problem with most proposed mergers is the fact that the merger would give the new company an increased firm size with lower costs of producing output improving productive efficiency but may pull allocative efficiency in an opposite direction.

This is because the greater the market power possessed by a company of increased size, the better the opportunity for that company to charge prices above its marginal costs of production. In this case, it could mean the new bank could charge increased prices on services rendered to customers in the long run. The second aspect of the public interest would be economic welfare which involves ideas on consumer and producer surplus. Consumer surplus is the benefit to customers of being willing to pay more for a product than they actually have to in terms of market price.

It is usually shown by the area underneath the demand curve and above the ruling market price. Producer surplus is the benefit to producers of receiving a price higher than the actual price of supplying the product. The diagram above illustrates the possibility of a merger moving productive and allocative efficiencies in opposite directions. If the merger results in the new firm using its market power to raise price from P to P cutting output Q to Q and the firm cuts its costs so that MC shifts down MC due to its larger size.

In such a case, there would have to be a balance of loss of allocative efficiency against a gain in productive efficiency in order to access the overall impact on the public interest. The proposed merger has already increased the price of shares in both banks. This is usually the case when such a huge merger is being planned. Shares in each institution soared in early trading with Bank of Scotland up 54 1/2 p, more than 7% at 796 1/2p and Halifax up 48p, a 6. 5% totaling 786p. Customers in both banks would have a positive progress during the period that the merger is being discussed.

The share prices have already gone up and if one of the banks were subject to a hostile bid by a competitor trying to bust up the deal, it would just raise the price of shares even higher. In conclusion, we must try to establish whether the proposed merger would prove beneficial to customers and the public in general. The merger, if it were to go through, would have many strong points. The expertise of the two banks complement each other very well and the merger would bring improved services to customers of the two banks.

They would have the opportunity of tapping into each banks’ expertise which would mean that Bank of Scotland customers would be able to receive better advice on mortgages and Halifax customers would be able to get better credit services and a more efficiently run service. Fox-Pitt Kelton, an investment bank specializing in financial services predicts that if the merger were to go ahead, shares in the new bank could rise by as much as 15%. The merger would prove very beneficial to both banks as it would create the UKs’ fifth largest bank.

Bank of Scotland would be able to compete with the other top four banks with the backing of Halifax as it is believed that Bank of Scotland is one of the best run banks in the UK. Bank of Scotland have long been trying to penetrate the English market and this could well be achieved due to the vast number of branches that Halifax have in England. Similarly Halifax would be able to expand its mortgage lending service further north through the Bank of Scotland’ s branches in Scotland. However, the underlying fact is that the merger would give the new bank an increased market power and a higher monopoly power in a sense.

This could mean that as the new bank achieves further growth, it could begin to charge its customers higher prices for services rendered in the long run. Also, smaller banks would be facing tougher competition now and some would have to be liquidated or face the possibility of a hostile takeover as the trend to merge continues. Abbey National is currently in talks with Lloyds TSB to create the second largest bank after HSBC. All in all, the merger between Bank of Scotland and Halifax seems to have more advantages than disadvantages in my opinion, would be very good for its customers and the public in general.