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Why not all mergers are good for shareholders

By Otieno Odhiambo | October 15th 2019

Companies exist to create wealth for their shareholders.

It is the shareholders’ hard-earned money that is tied in the assets of the firms.

Wealth maximisation is interpreted to mean a better share price. For firm managers, this means that any decision they make is evaluated in terms of its impact on the share price.

However, given how complex businesses are, it is not expected that owners always have the capacity to run their businesses.

This means that individual owners sometimes rely on professional managers to run their enterprises.

This arrangement has limitations in the sense that the manager may be more informed about the business activities than the owner, in which case an incentive to take advantage of fewer informed investors arises.

Therefore, managers may act in their own interest at the expense of the owners.

Economic sense

For example, managers may opt for a merger even when it is of no value to the firm’s shareholders.

In Kenya, several financial institutions have merged lately.

An example is the merger between KCB and the National Bank of Kenya.

The two banks were formed to bring banking services closer to the Kenyans at an affordable price after independence.

The question then is whether the merger makes economic sense to the shareholders of the two banks as well as the depositors or if it serves the interests of individual managers.

Research shows that a well-managed merger translates to improved share prices driven by reduced costs and a well-diversified company.

However, poorly planned and executed mergers can go horribly wrong. In the US, the largest merger was between American Online (AOL) and Time Warner Inc (TWX). The objective was to create a company to dominate in entertainment, news, the Internet and cable space. This merger, however, failed and the two companies unbundled. Another example was that of Exxam and Mobil merger.

At independence, there were no banks willing to lend money to Africans. This explains why the Government would later adopt a liberalised policy and in the process licensed a number of small banks.

Some of them such as the Equity Bank have grown in leaps and bounds to become some of the biggest banks in the country.

The sustained growth of the banking sector requires stability, and this necessitated a change in regulations. The new regulations require that some banks merge.

It is only fair that merging banks make their objectives known before the merger takes place.

This is meant to enable market players to evaluate the merger at a later date.

The objectives set are evaluated in financial terms. Unfortunately, this might not be the case for the KCB and NBK merger.

Insolvency concerns

The KCB must come out clean on the merger in terms of value creation and resulting efficiency.

A successful merger can’t be a zero-sum game given the huge transaction costs attached to the merging process.

The bank must tell the market how it will handle the NBK directors who will now join its board.

It is also imperative that KCB tells us the share price improvements expected from the merger with NBK. KCB must also be aware that it might not win full cooperation from the employees of NBK.

One study suggests that “acquisition often has a negative impact on employee behaviour, resulting in counterproductive practices such as absenteeism, low morale and job dissatisfaction.”

However, this is unlikely in an economy with high unemployment rates such as Kenya.

We don’t expect much from mergers that are regulation-driven. In any case, the merger is meant to benefit both entities.

The merger must also benefit depositors and borrowers in terms of attractive interest rates.

If there is any benefit to be realised for KCB, it will be in the form of economies of scale associated with NBK’s branch network.

There will be a large customer base that can enhance the former’s market leadership through product differentiation and cost reduction strategy.

NBK shareholders by accepting shares in KCB, on the other hand, have reduced their insolvency concerns. NBK has not been paying dividends to shareholders due to below-average financial performance.  Sometimes it pays to buy a poorly performing firm and then turning it around.

The market will be watching the KCB-NBK merger keenly, especially the post-merger financial performance, risk, growth in share price and dividends to shareholders.

However, if the new vehicle becomes too big to be managed, then merger benefits will evaporate, and KCB might decline in value.

-The writer teaches at the University of Nairobi  

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