Effect of Taxes on Business Mergers

• DOI: 10.1177/0003603X7802300304
• Published date: 01 September 1978
• Author: Conway L. Lackman
• Date: 01 September 1978
• Subject Matter: Article

EFFECT

O'F

TAXES

ON

BUSIN'ESS

MERGERS

by

CONWAY

L.

LACKMAN-

I.

THE

NATURE

OF

MERGERS

Definition

The term

"merger"

has several precise definitions depend-

ing on how it is used.

It

has alegal meaning, atax meaning,

and a specific economic meaning.

In

general however, the

term is used to describe all "combinations of formerly inde-

pendent companies

and

not in a restricted or legal sense." 1

This definition includes purchase of assets, consolidation,

merger (in a technical sense), lease,

and

the holding company

device." All of these

terms

refer

to forms of external acquisi-

tion by a firm.

It

is in this general sense

that

the

term

will

be used in this paper. Other general expressions such as

acquisition and combination will be used in the same sense.

Means of Industrial Growth

Ever

since the

industrial

revolution in the United States,

it has been considered desirable, if

not

necessary,

for

the

successful firm to grow

and

expand. To the U.S. business

mind, a

stagnant

firm will soon be a dead one.

With

the

dynamic market

that

has

prevailed in the U.S., this

trend

to

expand seems to be well founded. One of the most common

ways to keep up with the market

has

been to expand phys-

ically. Indeed the words "growth"

and

"physical expansion"

are

considered the same in many circles.

For

these reasons,

expansion has been one of the most outstanding features of

our economy.

-Department of Economics, Rutgers University.

1J. K. Butters, J.

Lintner

and W. L. Cary, Effects 01 Taxation:

Corporate Mergers,

Harvard

Univ. Press, Boston: 1951, p. 3.

2J.

Fred

Weston, The Role 01 Mergers in the Growth 01 Large

Firms, .Univ. of Calif. Press, Berkeley: 1953, p. 7.

551

552

THE

ANTITRUST

BULLETIN

TWO WAYS TO

EXPAND

The individual firm

has

two methods

at

its

disposal by

which it

may

expand."

It

may

engage in

internal

expansion.

With

this method, the firm expands its facilities by building

new ones

and

remodeling old ones. This process does not

directly affect the other firms in the

industry

although it

may

indirectly affect them by changing the competitive structure.

The second method is to engage in external growth.

Here

the firm expands its facilities via the

merger

route. This

method directly involves others in the economy. Merger re-

duces immediately the number of competing firms thereby

decreasing competition.

EXTERNAL

EXPANSION

IS FAVORED

It

is the second method mentioned above which is of pri-

mary

importance for our study. There

are

several reasons

why this method is favored over the first, although the end

results

are

the same.' The first one is

that

new facilities can

be acquired more quickly.

There

is no need to

wait

for

the

completion of buildings. Second, the facilities

may

be ob-

tained more easily. This is usually

true

because of special

circumstances of the seller

or

a low

market

evaluation of the

acquired firm's stock. A

third

reason is

that

the acquired

firm

may

already

have

proven

its

ability to be profitable.

This

greatly

reduces the

risk

of the purchasing firm

and

may

also reduce the need to establish a new organization.

Fourth,

a

merger

may

be easier to finance than

internal

growth. The

seller

may

be more willing to accept stock in the purchasing

firm

than

would public investors. Afifth reason is

that

a

merger

may

eliminate competition

that

otherwise would have

to be

dealt

with.

Further,

the

purchaser

may

acquire a

ready

made

market

that

otherwise would have to be built up. Sixth,

a small

merger

movement

may

be a good method to stabilize

an

industry

when a precarious

stage

has

been reached.

sWeston, op. cit., p, 2.

4

tua;

pp.

75-76.

TAXES

AND

MERGERS

553

Lastly, it must be admitted

that

mergers give a

greater

de-

gree of market control more rapidly,

and

with less effort

on

the

part

of the purchasing firm. I have mentioned these

seven points because they can be considered the motivations

for the purchasing firms to merge

just

as the body of this

paper

deals with amotivation

for

selling a firm into merger.

-It is merely the other side of the same picture.

Concentration in Industry

The seventh point above leads us to the question of con-

centration.

If

one of the reasons

for

merging is to gain a

degree of market control, then

aren't

mergers a main source

of business concentration and therefore of monopoly, oligopoly

and

their

associated abuses? The people of the U.S. have

long been opposed to business concentration. There is a long

list of

antitrust

legislation to

attest

to this. All of this brings

up the

very

basic question: is bigness in

industry

desirable?

There can be no doubt

that

in some cases bigness breeds

effi-

ciency. Will we sacrifice efficiency

for

what

some consider

social justice? There

are

many such unsettled questions.

For

our purpose, the big question is whether or

not

we should

outlaw the causes of concentration, specifically mergers. The

answer revolves

around

whether or

not

merger

is a prime

cause of concentration. An examination of this question is

in order.

DO MERGERS FOSTER

CONCENTRATION'

The effects of mergers can be classified into direct

and

indirect effects," The direct effect

refers

to the assets ob-

tained through merger. This effect is

easy

to see and measure.

Indirect effects

refer

to how a

merger

will influence the

future growth of a firm. This can be seen only in retrospect

and varies a

great

deal. Examples

are

increased efficiency,

and overcentralization of management,"

It

is the' indirect

GWeston, op. cit., p. 7.

6Ibid., p, 8.