Stock Market

When investors or individuals put money into the stock market, their goal is to receive a return on the capital invested. Many investors try not only to make a profitable return, but also want to outperform or beat the stock market. For this situation, Eugene Fama suggests that at any given time, prices fully reflect all available information on a particular stock and no investor has an advantage in predicting a return on a stock price because no one has access to information not already available to everyone else.

Many financial researches recognize that the financial markets are informationally efficient as the market prices fully show publicly available information. But the market may not attain such efficiency when publicly available information is costly to produce and when investors can always purchase better information at a higher price. While, when investors stop to buying information and trade shares, the amount of information purchased by the public and the quality of information reflected in the market price can be endogenous. Therefore, market efficiency relies on the cost structure of producing information, investors’ behaviors and risky return.

Market efficiency does not require prices to be equal to fair value all the time. Generally, stock prices would be over or lower than the actual prices but eventually revert back to their mean values. This is because the deviations form a stock’s fair prices are in themselves random, investment strategies that result in beating the market cannot be consistent phenomena. Furthermore, the hypothesis argues that an investor who outperforms the market does so not out of skill but out of luck. However, we cannot deny that in the real world of investment, there exists investors that have beaten the market, for instance, Warren Buffet, whose investment strategy focuses on undervalued stocks, made millions and set an example for numerous followers.

There are three levels of efficiency, weak form efficiency, semi strong form efficiency and strong form efficiency, which are used to reflect in prices and to define whether the market is efficiency. For weak form efficiency, share prices fully reflect all information contained in past price movements. But it is useless for investors to gain profit based on share price history. Semi strong form efficiency, share price indicates all the relevant publicly available information, which implies that there is no advantage in analyzing publicly available information after it has been released, because the market has already absorbed it into the price, therefore, investors technical analysis cannot result in profits but internal information may bring in profits. Strong form efficiency, all relevant information, including that which is privately held, is reflected in the share price. In this market, even insiders are unable to make abnormal profits for investors.

Take the HP acquired Autonomy as an example. The US stock market can be considered in the level of semi strong form efficiency market. As the management overprice the Autonomy's share price, HP made a $8.8 billion loss after 15 months of the acquisition.This is owing to the fact that Autonomy has inflated in their accounting data, which belongs to a insider information. If the HP's managers has discovered the forge before the acquisition, they would not overprice the share price and result in great losses.

It is important for the market to be efficient. Because a more efficient market encourages individuals invest in private enterprise. If shares are incorrectly priced many savers will refuse to invest because of a fear that when they come to sell the price may be perverse and may not represent the fundamental attractions of the firm. Secondly, as the object of one company is to create shareholders value, this provides a signal for company managers to make a sound decision. In addition, share prices signal the rate of return investors demand on securities of a particular risk level. If the market is inefficient the risk return relationship will be unreliable so that managers might misestimate the price, leading to excessive high cost capital. Thirdly, valuation of the stock market helps the company allocate resources, including operating efficiency and pricing efficiency.

                                                 

Merger and Acquisition (M&A)

Last week I talked about the how the multinational companies direct invest in the foreign business market, which relates to the method of investment. This week I am going to discuss about one of the method: merger and acquisition.

According to Arnold (2008) merger is used mean the combing of two business entities under common ownership while an acquisition includes one company essentially taking over another company. Although the motivations may differ, the essential feature of both mergers and acquisitions involves one firm emerging where once there existed two firms. Another term frequently employed within discussions on this topic is takeover. A so called friendly takeover is often a euphemism for a merger. A hostile takeover refers to unwanted advances by outsiders. Thus, the reaction of management to the overtures from another firm tends to be the main influence on whether the resulting activities are labeled friendly or hostile.

There are a number of possible advantages that may result in a merger or acquisition. One of the most often cited benefits is to achieve economies of scale. Economies of scale may be defined as a lowering of the average cost to produce one unit due to an increase in the total amount of production. The idea is that the larger firm resulting from the merger can produce more cheaply than the previously separate firms. Efficiency is the key to achieving economies of scale, through the sharing of resources and technology and the elimination of needless duplication and waste. Economies of scale sounds good as a rationale for merger, but it may show that combining separate entities into a single, more efficient operation is not easy to accomplish in practice.

Another competitive advantage is to enlarge market presence and market share. After the combination, larger entity may have the ability to buy bulk quantities at discounts, the ability to store and inventory needed production inputs, and the ability to achieve mass distribution through sheer negotiating power. Greater market share also may contribute to advantageous pricing, since larger firms are able to compete effectively through volume sales with thinner profit margins. This type of merger or acquisition often results in the combining of complementary resources, such as a firm that is very good at distribution and marketing merging with a very efficient producer. The shared talents of the combined corporation may mean competitive advantages versus other, smaller competition.

There still exits restrictions and risks in a merger or acquisition, the major risk in M&A processes results from the fact that they are complex and time consuming, as the combination may last for several years. Furthermore, mergers and acquisition are very often connected with high operating costs as a result of the organizational and personal changes, severance pay for dismissed workers, technical and technological changes, training workers, etc. Barriers and the limitations which can appear before, during or after the consolidation process. Hence, it can be divided into internal which have their source in the enterprise and external on which the company only has limited influence.

The internal restrictions, which include workers’ resistance to changes or gaining funds for transactions, can be eliminated by proper actions undertaken by the management , for instance, preliminary research about the corporate financial possibilities and informing employees about planned changes. The external factors is the economic factor, such as the economic situation, GDP, legal and administrative solutions, the level of interest rate as well as political tensions, whose elimination or moderation is more difficult to control.

Apart from the unpredict changes of outside, lacking of suitable preparation and analysis prior to the completion of the transaction can also lead to a failure merger. One example of this is the merger of Daimler Benz AG ( Germanys) and CHrysler Corporation (USA) in 1998 resulting in a new connected company. However, a number of acquisitions proved to be misconceived and economically groundless. I 2004 the market value of the whole company was over half lower than the accumulated value of both companies before merger and in 2007 they decided to divide the company again. Therefore, before deciding to merger, the buyer company needs to make a prudent analysis of another corporate financial statement, avoiding unnecessary losses.

Nevertheless, not all mergers lead to unfavorable results. A significant example can be quoted is Facebook announced that they had bought messaging app Whatsapp in a deal worth a total of $19bn (£11.4bn) in cash and shares on 20th February, 2014. It is the social networking giant's biggest acquisition to date. The deal to buy it includes $4bn in cash and approximately $12bn worth of Facebook shares, plus an additional $3bn in stock to Whatsapp's founders and employees at a later date. 

Conventional wisdom seems to be saying that Facebook paid too much to acquire Whatsapp, a mobile texting startup that is enjoying meteoric success in  developing countries. However, from the perspective of market share, the price chart indicates that the Facebook has experienced a raising tendency as a whole, even though there is a slight drop (5%) after buying the Whatsapp. As Whatsapp enables people for free massages, more people start to use this application, and Whatsapp actually has greater penetration in a lot of international markets than Facebook. Therefore, such purchase benefits Facebook bringing in more overseas individuals to join in, especially young adults. 

Foreign Direct Investment

Foreign direct investment (FDI), in its classical definition, is defined as a corporation from one country making a physical investment into building a factory in another country. However, given rapid growth and change in global business, the majority companies prefer making a portfolio investment, which can be less time consuming and easy to manage. It may take many forms, for instance, a direct acquisition of a foreign company, construction of a facility, or investment in a joint venture or strategic alliance with a local company with attendant input of technology, licensing of intellectual property. 

FDI could provide a firm with new markets and marketing channel, cheaper production facilities, access to new technology, skills and financing. For a host country which receives the investment, providing a source of advanced technologies, capital, processes and management skills enable promote local economic growth. Therefore, FDI plays an extraordinary and growing role in current global business. Faced with changes in technology, increasing liberalization of the national regulatory framework governing investment in enterprises and changes in capital markets, profound changes have occurred in FDI. In the new information age, decline in global communicative costs have made management of foreign investments far easier than in the past. 

As corporations want to earn a positive return on the investment, a great number of firms merger or acquire a foreign corporation. Also, mergers sometimes occur when business firms require diversification. This means one company do not put all its fundings in one industry, but make an acquisition of a foreign company, which benefits the corporation to reduce their investment risk. In other words, the acquiring firm no longer has all its eggs in one basket. However, in the diverse economic and political climate, they may need to have great capacity to tackle other risks, such as the foreign exchange rate risk (which has discussed in last week).

The party making the investment is usually known as the parent enterprise, and the party invested in can be referred to as the foreign affiliate. Together, these enterprises form what is known as a Transnational Corporation (TNC). In the last few years, TNC from developed counties play a significant part in FDI, however, the government of developing country encourage their corporations to invest in foreign country when recognized the importance of FDI. Take Chinese investment in the US as an example. Chinese foreign direct investment in the United States is an attractive and vital source of investment which is particularly welcomed, especially as the US begins to recover from the worst economic downturn since the financial crisis in 2008. Although sensitivities exist with respect to foreign investment in America’s most strategy sectors, overall, Chinese investment is fundamentally beneficial for the US economy as it creates opportunities of employment, maintains existing ones, provides new sources of capital and ultimately serves to strengthen the commercial ties between the two counties.

China’s remarkable economic growth stems in part from its ascendance as a trade and export powerhouse. However, to achieve future sustainable development, China must move beyond the export driven model and strengthen the investment and capital relationship with the multinational companies. AS a result of the global economic, in 2009, the figure of Chinese FDI had reached $6.4billion. Hair Group, as one of the multinational corporations, expand market into the US providing a good example of a successful globalization strategy. Before entering the US market, Hair Group first extended its brand in Asia in order to build its presence and develop international brand recognition. Having penetrated neighboring Asian markets, Hair Group setted up the value of $35million refrigerator products in 2000, and in 2005 the group acquired Maytag Corporation, which is a venerable US appliance marker for $1.28 billion. 

With the expansion of Hair Group in US, benefits brought in. First of all, transfer the technology, which is not just restricted to actual technologies, involving sharing skills, manufacturing methods and even entire facilities as well. It can also refer to the knowledge passed by scientific research institutions. Furthermore, foreign direct investment assumes the creation of new jobs. As investors build new corporations in the new country they create new job openings and opportunities. This leads to an increment in income and the development of competition. New jobs offer more buying power to the population of that country which in turn leads to economic boosts. Another of the advantages is the rise of the income for the receiving country. With higher wages and more jobs, the income of the entire country rises as well. Overall, all these in turn spurs economic growth in US.