Wave #1: 1893-1904
The first wave followed after a period of economic expansion, and an important characteristic was the simultaneous consolidation of manufacturers within one industry (Sudi Sudarsanam
(2003)). This within industry consolidation led to horizontal consolidation of major industries and created the first „giants‟ in the oil, mining and steel industries, among others.
Furthermore, the horizontal mergers led to the creation of monopolies. According to Stigler
(1950), mergers “permit a capitalization of prospective monopoly profits and a distribution of portions of the capitalized profit”. In 1890 the Sherman Antitrust Act1
, which limits cartels and monopolies, was passed but it was not yet clear in the beginning so the direct impact
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Having said this, we still do not know why the merger wave started in the first place.
In the first place, laws on incorporations2 were evolving and were implemented more rigorously at the end of the nineteenth century. Before proper legislation, entrepreneurs had an unlimited liability on their assets which means that growth of your company also means greater exposure and greater risk. Improvement of laws on incorporations led to limited liability for entrepreneurs. Furthermore, economic expansion and the development of the modern capital market, i.e. the improvement of the New York Stock exchange, also boosted the number of mergers because capital needed to acquire, or merge, became more accessible.
The end of the first wave came due to a more rigorous enactment of the new antitrust laws,
e.g. the Sherman Antitrust Act. Besides this, the stock market crashed around 1905 which resulted in a period of economic stagnation. Furthermore, the beginning or threat of the First
1
Sherman Antitrust Act: purpose was to restrict the combination of entities that could limit competition unlawful. 2
Incorporate: combined into one united body; casu quo:
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Similar to the second wave was that equity was the dominant source of financing.
The method of diversification led to the rise of conglomerates, which are large corporations that consists of numerous businesses not necessarily related. Example of a conglomerate is
General Electric, which has interest in a vast number of businesses including healthcare, transportation and energy. Diversification can be a method to reduce the cash flow volatility through reduction in the exposure to industry specific risk. The conglomerate will be less vulnerable to shocks in one industry because it generates income in different, maybe unrelated, industries so that loss of income in one industry can be offset by other industries.
Due to conglomerate creation, growth opportunities in unrelated businesses can be exploited.
Finally, a conglomerate will create its own internal capital market which is especially useful when outside capital is expensive.
The diversification process also led to changes in the market structure. Chandler (1991) with his concept of the Multidivisional Enterprise stated that: “structure follows strategy and the most complex type of structure is the result of concatenation of several basis