Why Do Firms Merge and then Divest: A Theory of Financial Synergy

55 Pages Posted: 7 Nov 2008

See all articles by Zsuzsanna Fluck

Zsuzsanna Fluck

Michigan State University - Department of Finance

Anthony W. Lynch

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER)

Date Written: October 1998

Abstract

This paper develops a theory of mergers and divestitures wherein the motivation for mergers stems from the inability to finance marginally profitable, possibly short-horizon projects as stand-alone entities due to agency problems between managers and potential claimholders. A conglomerate merger can be viewed as a technology that allows a marginally profitable project, which could not obtain financing as a stand-alone, to obtain financing and survive a period of distress. If profitability improves, the financing synergy ends and the acquirer divests assets to avoid coordination costs. Since it is the project's ability to survive as a stand-alone that causes the divestiture, divestiture decisions are interpreted as good news by the market in our model. Further, our theory is able to reconcile two important but seemingly contradictory empirical findings: 1) mergers increase the combined value of the acquirer and target (Jensen and Ruback (1983), Bradley et al. (1988) and Kaplan Weisbach (1992)): and, 2) diversified firms are less valuable than more focused stand-alone entities (Berger and Ofek (1995), Lang and Stulz (1994), and Servaes (1996)). Diversification adds value in our model by facilitating the financing of positive net present value projects that cannot be financed as stand-alones. At the same time, because these same projects are only marginally profitable, diversified firms are less valuable than stand-alones.

Suggested Citation

Fluck, Zsuzsanna and Lynch, Anthony W., Why Do Firms Merge and then Divest: A Theory of Financial Synergy (October 1998). NYU Working Paper No. FIN-98-036. Available at SSRN: https://ssrn.com/abstract=1297096

Zsuzsanna Fluck (Contact Author)

Michigan State University - Department of Finance ( email )

Eli Broad Graduate School of Management
315 Eppley Center
East Lansing, MI 48824-1122
United States
517-353-3019 (Phone)
517-432-1080 (Fax)

Anthony W. Lynch

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
(212) 998-0350 (Phone)
(212) 995-4233 (Fax)

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
United States

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