ON THE THEORY OF CONGLOMERATE MERGERS

Abstract

MERGERS CAN BE EXCITING, however their effects on stockholders remain unclear. Mandelker [18] found that the average firm that acquired another firm in the 1940's and 1950's did not benefit its stockholders. Given bleak findings such as this, it is not surprising to find theoretical controversy over what constitutes a good merger. From a theoretical standpoint, a number of benefits are obvious, though they may be difficult to estimate in practice. For example, the profitability of a merger is enhanced by positive synergistic effects, i.e. real gains due to the effective integration of productive facilities, distribution networks, etc. Tax loss carryforwards can also be a source of merger benefits. Another benefit is possible if, in an inefficient market, one large firm has better access to external sources of funds than do two smaller firms. However, if these and other real factors are swept aside, and if the securities markets are efficient, are there any purely financial benefits to merging? The answers to this question constitute the theory of conglomerate mergers and are the subject of this paper. The first major result of this theory concerns diversification per se. Is it worthwhile to merge two firms with dissimilar earnings streams to get a smoother path of earnings over time? If both firms are traded in a single, efficient capital market and if bankruptcy is not possible, Alberts [2], Myers [23], Levy and Sarnat [15], Adler and Dumas [1], and others have argued persuasively that investors can obtain the same diversification themselves by purchasing appropriate amounts of the unmerged firms. Thus a conglomerate merger will not alter the total value of the combining firms.' If no premium is paid to the shareholders of the acquired firm then the stock prices of both firms will remain unchanged. If there is a premium, the stockholders of the acquired firm gain what those of the acquiring firm lose. Assuming that corporate bankruptcy is possible, Levy and Sarnat [15], and Lewellen [16] have argued that if a merger reduces the probability that one of the firms would default on its debt, then the value of the debt will increase and the