AN ANALYTICAL STUDY OF MERGER AND ACQUISITION IN THE INSURANCE INDUSTRY IN NIGERIA

AN ANALYTICAL STUDY OF MERGER AND ACQUISITION IN THE INSURANCE INDUSTRY IN NIGERIA

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CHAPTER ONE

INTRODUCTION

                1.1 Background of the Study

The rise of merger activity worldwide has been eminent in that with increased competition, technological advances together with increased globalization, businesses are looking for ways to remain competitive as well as achieve non - organic growth (Radović, 2008). Organizations are striving for strategies that are not too costly, risky and technologically advanced in order to become reputable along with a vision to maximize market share and future growth (Christensen, 2013). Global markets have continuously experienced increased M&A’s over the last decade. Various reasons have driven firms to undertake in M&A’s. According to Mboroto (2013), growing business confidence, consumer demand and improving economic conditions in the region have whetted business executive’s appetite for firms in the technology, mining and financial services sectors.

The Nigerian insurance industry is a vital part of the entire financial system. Apart from commercial banks, insurance companies contribute significantly to financial intermediation of the economy. As such, their success means the success of the economy; their failure means failure to the economy (Ansah-Adu, Andoh, and Abor, 2012; and Agiobenebo and Ezirim, 2002). Mergers and acquisitions are continuously being adopted for progressive company competitiveness by expanding market share and also to diversify the company’s portfolio as a risk management strategy. Additionally, to enable

companies penetrate to new geographical markets to support growth by capitalizing on economies of scale and increase on customer base among other reasons (Kemal, 2011). The logic behind any corporate merger is the synergy effect; two is better than one. Martynova and Oosting (2007) state that the overarching reason for combining with another organization is that the union will provide the attainment of strategic goals in a cheaper and quicker way rather than on its own. Organizations that are able to merge stand in a better position to flexibility, leverage competencies, share resources and create opportunities that otherwise will be inconceivable.

Companies believe that by either merging or acquiring another company, the performance would be better than a single entity. This is attributed by the fact that shareholder value would effectively be maximized (Sharma, 2009). Acquisitions bring operational efficiencies which may arise from economies of scale, production economies of scope, consumption economies of scope, improved resource allocation like moving to an alternatively less costly production technology, improved use of information and expertise, a more effective combination of assets and improvements in the use of brand name capital (Piaskoki, 2004).

Recent corporate M&A’s activity witnessed in the Nigerian economy is a sign that companies are increasingly accepting this takeover option as a means towards developing their corporate strategies either in the country or in the industry (Onyuma and Inoti, 2014). Besides, the move towards regional integration has indeed sparked a flurry of cross regional expansion as a means of increasing regional presence M&A’s is a critical

vehicle in facilitating corporate growth, productivity and absolute organizational performance (Botchway, 2010).

1.1.1      Mergers and Acquisitions

Kovacich and Halibozek (2005) describe an acquisition also known as a takeover, or buyout or a purchase business combination as a situation where one company known a predator or acquirer takes over another company known as the target firm cease to exist. A firm that seeks to acquire another firm is known as the acquiring company, and the one that it seeks to acquire is known as the target company. Lole (2012) states that in most acquisitions, one firm (usually the lager of the two) simply decides to buy another company, negotiate a price with the management of the target firm, and then acquire the target company.

Nakamura (2005) asserts that an acquisition takes place when a company attains all or part of the target company’s assets and the target remains as a legal entity after the transaction whereas in a share acquisition a company buys a certain share of stocks in the target company in order to influence the management of the target company. In acquisitions, one firm proposes the purchase of another firm in the same industry, where if it accepts, it becomes subject to the acquirer’s management (McLaughlin, 2010).

There are many motives behind M&A’s in line with achieving organizational strategy. According to Myers and Marcus (2002), managers believe their firm will have a competitive edge by being bigger and through economies of scale an organization is able

to lower cost per unit of output. Mergers and acquisitions are intended to add shareholder value through economies of scale. The combined company can often reduce duplicate departments or operations hence lowering the costs of the company relative to theoretically the same revenue stream, thus increasing profit (Boff and Herman, 2001).

Another motivation for M&A’s is synergy. Synergies can be operational, financial or managerial. Karenfort (2011) argues that company will have synergy benefits when the value of the combined firm is greater than the stand alone valuation of the individual firm and acquisitions produce synergy, hence better use of complementary resources leading to geographical or other diversification. This smoothens the earning of a company, which over the long term smoothens its stock price, giving conservative investors more confidence in investing in the company (Marks and Marvis, 2011). Other motivations to merge include increase customer base, gain access to funds, tax advantages, and growth.

1.1.2 Financial Performance

Healy and Ruback (1992) define financial performance as the measure of how well a firm can use assets from its primary mode of business and generate revenues. In addition, financial performance is essentially a measure of an organizations financial health over a given period of time, used to compare similar firms across the same industry or to compare industries or sectors in aggregation. Lole (2011) states that the fundamental aim of M&A’s is the generation of synergies that can, in turn, foster corporate growth, increase market power, improve production efficiencies, boost profitability, and improve shareholders’ wealth.

There are many different ways to measure a company’s financial performance. For example, cash flow based measures, stock based measures and accounting based measures. Companies’ performance can be evaluated b y way of performing analytical reviews. Ratio is the simple mathematical statement of the relationship between two items listed in financial statements (Akguc, 1995). Through ratios, it is possible to measure the power of the company’s liquidity, solvency and its profitability.

Profitability reflects a companies' ability to manage their economic exposure to unexpected losses. This ratio represents the potential impact on capital and surplus of deficiencies in reserves due to financial claims (Adams and Buckle, 2000). Three measures of profitability are employed which include; Return on Asset, Gross Profit Margin and Earning before Tax. Liquidity refers to the degree to which debt obligations coming due in the next twelve months can be paid from cash or assets that will be turned into cash (Mwangi and Murigu, 2015). Measures of liquidity employed include; Current ratio and Quick ratio. Moreover, solvency indicates a company’s ability to meet long-term obligations when due and measures the long term financial strength of a firm (Laitinen, 2000). Solvency is best conducted via Total Debt ratio and Total Assets ratio.

However, studies depict a different picture on the results of M&A’s involving failures and poor financial returns. Researchers have indicated that approximately 70-80% of M&A’s does not create significant value above the annual cost of capital (Bruner, 2002). Even conservative estimates place M&A’s failure rates at approximately 50% or higher for nearly four decades (Coffey, Garrow and Holbeche, 2003). Despite this, the rise of

merger activity worldwide has been eminent and continues to increase at a phenomenal rate climbing from $1.9 trillion in 2004 (Susan Cartwright and Schoenberg, 2006).

 Effects of Mergers and Acquisitions on Financial Performance

Mergers and acquisitions are used in improving company’s competitiveness and gaining competitive advantage over other firms through gaining greater market share, broadening the portfolio to reduce business risk, entering new markets and geographies, and capitalizing on economies of scale (Saboo and Gopi, 2009). The success of any mergers is defined by the core competences generated to create value or enhance value. It is measured using the parameters such as market attractiveness, competitive positioning because of cost leadership and product differentiation. This results in the long-term profit sustainability and the creation of shareholders wealth (Hildebrandt, 2005).

Financial performance is a general measure of a firm’s overall financial health over a given period of time, and can be used to compare similar firms across the same industry or to compare industries or sectors in aggregation or firms performance across time; in this case before and after acquisition (Mboroto, 2012). Varieties of measures can be used to examine the impact of M&A’s on overall financial performance of an entity, where measures might be accounting measures-based, market measures-based, mixed measures, or qualitative measures-based.

The potential economic benefits of M&A’s are changes that increase value that would not have been made in the absence of a change in control (Pazarkis et al. 2006). These changes in control are potentially most valuable when they lead in the redeployment of assets, providing new operating plans and business strategies. Accordingly, Baldwin (1998) argues that merged firms may also increase their bargaining power over suppliers by pooling their prices and forcing suppliers to sell their supplies to the combined firm.

The definition of success may vary, but any activity that fails to enhance shareholders interest and value cannot be deemed as a success (Hildebrandt, 2005). A long-term decline in shareholder wealth after a M&A can term the combination process to be a failure (Straub, 2007). Managers of firms undertaking mergers and acquisitions often anticipate an improvement in production efficiency. However, profitability still remains the most influential variable in determining growth of firms through M&A in Nigeria. The main motive behind M&A’s is to improve revenues and profitability (Gachanja, 2013).

1.2 Research Problem

The concept of M&A’s on the effect of financial performance of companies has received significant attention from scholars in the various areas of business due to mixed results. It is of primary concern of virtually all business stakeholders in any sector since financial performance is an ingredient to organizational health and ultimately its survival. High performance reflects management effectiveness and efficiency in making the use of a company’s resources and this contributes to the economy at large (Ansah-Adu, Andoh, and Abor, 2012; Batra, 1999; and Barney, 1991).

The insurance industry is a vital part of the entire financial system. Apart from commercial banks, insurance companies contribute significantly to financial intermediation of the economy. As such, their success means the success of the economy; their failure means failure to the economy (Ansah-Adu, Andoh, and Abor, 2012; and Agiobenebo and Ezirim, 2002). Merger is a tool used by companies for the purpose of expanding their operations often aiming at an increase of their long term profitability (Bert, 2003).

Yeh and Hoshino (2002) examined the effects of acquisitions on the firm’s operating performance using a sample of 86 Japanese corporate acquisitions between 1970 and 1994. The successfulness of acquisitions was tested based on efficiency, profitability and growth. The results of their study indicated a significant downward trend on profitability and sales growth.

Additionally, their study results showed an insignificant downward trend in productivity. According to their conclusions, acquisitions have a negative impact on firm performance in Japan.

Lole (2012) conducted a study set out to investigate the effects of mergers and acquisition on the financial performance of the insurance industry in Nigeria. The study took a causal research design in order to determine the effects of mergers on financial performance. The performance measures used were based on long-run profitability, stability, leverage and liquidity. According to the study, M&A’s were positively correlated with financial performance after the merger. A unit increase in underwriting ratio and decrease in management expense ratio lead to an increase in application of financial performance on underwriting ratio at the expense ratio. Overall mergers and acquisition and financial performance coefficients were significant indicating firms performed better financially after the resulting merger and/ or acquisition. This research study will attempt to fill a gap in academia by investigating the effects of mergers and acquisitions on the financial performance of insurance firms in Nigeria.

1.3 Research Objective

The objective of this study is to establish the effects of mergers and acquisitions on the financial performance of insurance firms in Nigeria.

1.4 Value of the Study

Firstly, it has the ability to create awareness in the general public about the M&A’s and its possible effects on the growth and performance of the firms indulged and also the challenges they face. Scholars who are interested in advancing the theoretical studies discussed herein and engaging in further research in this field will be able to investigate any gaps and also make great contributions to the already existing study theories either in critique or complement.

To the regulator i.e. Insurance Regulatory Authority, the study will enable the organization to understand how better to mitigate the risks that engrosses the insurance industry in Nigeria.


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