How Do Mergers Create Value? A Comparison of Taxes, Market Power, and Efficiency Improvements as Explanations for Synergies

Posted: 20 Aug 2007

See all articles by Erik Devos

Erik Devos

University of Texas at El Paso - College of Business Administration - Department of Economics and Finance

Palani-Rajan Kadapakkam

University of Texas at San Antonio - Department of Finance

Srinivasan Krishnamurthy

North Carolina State University - Poole College of Management

Abstract

There is little evidence in the literature on the relative importance of the underlying sources of merger gains. Prior literature suggests that synergies could arise due to taxes, market power, or efficiency improvements. Based on Value Line forecasts, we estimate the average synergy gains in a broad sample of 264 large mergers to be 10.03% of the combined equity value of the merging firms. The detailed data in Value Line projections allows for the decomposition of these gains into underlying operating and financial synergies. We estimate that tax savings contribute only 1.64% in additional value, while operating synergies account for the remaining 8.38%. Operating synergies are higher in focused mergers, while tax savings constitute a large fraction of the gains in diversifying mergers. The operating synergies are generated primarily by cutbacks in investment expenditures rather than increased operating profits. Overall, the evidence suggests that mergers generate gains by improving resource allocation rather than by reducing tax payments or increasing the market power of the combined firm.

Keywords: mergers and acquisitions, sources of synergies, diversification

JEL Classification: G1, G34, L2

Suggested Citation

Devos, Erik and Kadapakkam, Palani-Rajan and Krishnamurthy, Srinivasan, How Do Mergers Create Value? A Comparison of Taxes, Market Power, and Efficiency Improvements as Explanations for Synergies. Review of Financial Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1007745

Erik Devos

University of Texas at El Paso - College of Business Administration - Department of Economics and Finance ( email )

500 W. University Ave.
El Paso, TX 79968
United States
915 747 7770 (Phone)

HOME PAGE: http://utminers/utep.edu/hdevos

Palani-Rajan Kadapakkam

University of Texas at San Antonio - Department of Finance ( email )

San Antonio, TX 78249
United States

Srinivasan Krishnamurthy (Contact Author)

North Carolina State University - Poole College of Management ( email )

Hillsborough Street
Raleigh, NC 27695-8614
United States

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