Column : The acquisitive instinct

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SummaryThe prospects of a global recession are high. Integrated as it is with the world economy, it seems unlikely that India will escape unscathed. The decline in growth will bring some significant suffering to the economy.

The prospects of a global recession are high. Integrated as it is with the world economy, it seems unlikely that India will escape unscathed. The decline in growth will bring some significant suffering to the economy. The economic slowdown will distress many of them financially, and the effect of macro-economic uncertainty will be to remove the shreds of the safety net from beneath them. Macro-economic instability will seriously increase the risk of bankruptcy for a larger number of firms.

Of course, even at the best of times corporate sectors of modern economies are engaged in continuous and evolutionary programmes of restructuring. The prospects of any company at any time will depend on its management, technology, human capital, size and asset base. It will also depend on the nature of its industry, and on macro-economic conditions. Even at the best of times, some firms will inevitably go bankrupt as they operate in markets that are reasonably competitive. This is part of a natural selection process.

But stakeholders of firms at risk of going bankrupt always do have some prospect of finding a less painful exit route; the firm just may be acquired. This often helps in the efficient redeployment of their productive assets. Acquisitions constitute an important form of economic restructuring. The extent to which this type of salvage occurs will depend on the investment calculations of firms that are not distressed. For some of them at least, some portion of their optimal corporate investment will take the form of acquisitions, while some portion may take the form of organic growth.

But uncertainty damps enthusiasm. It becomes optimal for firms to either wait until the air clears and the investment project is more clearly likely to be successful, or to stage the investment process in such a way that the decision to proceed to the next stage of investment (or to abandon the project) can be made after new relevant information about the desirability of the project comes to be revealed. But as creditors stand by to pull the plug on distressed firms, the process for the acquisition of such firms does not readily permit any staged approaches.

A few years ago my colleagues Bhattacharjee, Holly, Higson and I studied the UK experience with macro instability, bankruptcies and acquisitions. The recession of the early 1990s coincided with heightened macro-economic volatility, and a large number of distressed UK firms simply went bankrupt. The stable macro-economic regime after 1997 when the Bank of England gained operational independence and responsibility for price stability, helped boost acquisitions and reduce the number of bankruptcies. In more stable periods, when business-relevant macro variables are more predictable, even when economic conditions are not rosy, the pool of distressed firms face a larger number of potential acquirers whose investment stances are encouraged by stability. Thus, firms that are on the verge of bankruptcy will have higher probability of being rescued.

The effect of instability is indeed beginning to show in the international M&A market. While recent years had seen Indian firms robustly investing in and acquiring companies in Europe, the US, as well other parts of the world, in sectors ranging from telecom, finance, construction, oil & gas, and metals, evidence is that the heightened uncertainty in global markets has slowed this process down now.

From the point of view of domestic economy, what is more worrying than the slowdown in global acquisitions is the potential slowdown of acquisitions within the country. Fewer distressed firms will be saved from bankruptcy through acquisitions precisely at that time when we may expect the pool of distressed firms to grow in size due to worsening business conditions. There is bound to be a much larger number of bankruptcies than the decline in growth would warrant in itself, unless RBI and the finance ministry can credibly commit and reduce uncertainty about key macro variables. I must admit it is not clear to me how exactly that bit of magic can be worked.

The author is reader in economics at the Judge Business School, University of Cambridge

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