Financial Synergies Research Articles

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

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.

Strategic Factors Underlying Acquisition Performance in a Post-communist Economy: Experience from Slovenia

This article examines the performance of acquisitions in Slovenia in the period of transition between communist rule and the advent of the market economy. The proposition is that, once the motives of an acquisition are identified, the success or failure of a particular acquisition can be measured by examining the extent to which those motives have been achieved. The actual realisation of some motives for acquisitions, such as to transfer skills and share activities, is strongly tied to the ROE and value added per employee in the acquired company in the post-acquisition period. On the other hand, realisation of financial synergies has not resulted in higher ROE or value added per employee. Based on our research into 45 acquisitions in Slovenia, we pinpointed some key success factors that determined the performance of the acquired firm. From the point of view of a local firm that was sold, the key question was how the acquirer would ensure the company's long-term development.

The Value of Synergy

Many acquisitions and some large strategic investments are often justified with the argument that they will create synergy. In this paper, we consider the various sources of synergy and categorize them into operating and financial synergies. We then examine how best to value synergy in any investment and how sensitive this value is to different assumptions. We also look at how this synergy value should be divided between the parties (or companies) involved in the investment. We conclude with an empirical examination of how much synergy is actually created in corporate mergers, and how much is paid. Synergy, we conclude, is so seldom delivered in acquisitions because it is incorrectly valued, inadequately planned for and much more difficult to create in practice than it is to compute on paper.

Multinational Diversification and Corporate Performance: Evidence from European Firms

Abstract We investigate the empirical relationship between accounting based measures of performance and the degree of multinational diversification for a set of European chemical industry firms. We find that for these firms, the degree of multinational diversification is strongly related to superior financial performance. The results hold for each of the three sample years. The findings suggest that multinational firms outperform purely domestic and exporting firms. The results provide strong support for gains from multinational diversification. The results indicate that while greater European unification may have eroded potential benefits of exploiting international capital and product market imperfections, the benefits of firm specific economies of scope and scale as well as managerial and financial synergies are still realised through exports.

The Analysis of Relationship between Market Reactions and Long Term Performance on Acquisition

This paper is the study of the research that gives attention to the activities of acquisitions made by firms acquirer (acquirer). The main purpose of this study was to see how the reaction of the market (market reaction) will provide guidance on the picture of the performance of the acquirer firms in the long term. In this study we used 39 acquirers who has made acquisitions in the period between 1991 to 1998. This study applies event study method using the market model to calculate abnormal return. The hypothesis test used was the One Sample T-test, the Multiple Regressions, Wilcoxon Signed-Rank Test and Manova Test. Results of hypothesis testing showed that the acquirer receives a significant negative abnormal return along the date of acquisition. This indicates that the acquisition of events produce a lower return than predicted return is predicted by the shareholders of the acquirer. This study indicated several factors that affect the abnormal return as: financial synergy, size of the acquirer, managerial efficiency, growth of the acquirer, and business relatedness. Results of testing hypotheses against against these factors indicate that none of those variables that provide significant value. This means that the motives of the acquisition is not a motivation for acquirers to engage in activities acquisition. To assess the performance of companies acquirer in the long term, use a proxy such as: ROA, ROE, OPM. The test results showed that overall there was no significant difference between performance before and after the acquisition. This means that most acquirer firms are generally not able integrate acquirer gains against long-term performance.

Financial Synergies and the Optimal Scope of the Firm: Implications for Mergers, Spinoffs, and Off-Balance Sheet Finance

We consider multiple activities with imperfectly correlated stochastic cash flows and zero operational synergies. These activities may be incorporated separately with their own debt/equity structures, or combined (merged) into a corporation with a single debt/equity structure. In a Modigliani-Miller (1958) setting, there will be no financial synergies and no gains to merging the activities. In the presence of corporate taxes and default costs, mergers can realize substantial positive financial synergies due to reduced risk and the potential for greater leverage, but at the cost of losing separate debt/equity choices and separate limited liability. Closed-form measures of financial synergies of combining activities are developed, using the model of optimal capital structure introduced by Leland (1994). Characteristics of activities that gain (or lose) from combination are identified. The results have direct application to the optimal scope of the firm, including the desirability of mergers, spinoffs, and off-balance sheet finance.

A Logistic Analysis of the Financial Features of Takeover Targets in the Gaming Industry

This study estimated a logistic model for predicting takeover targets in the gaming industry. The stepwise procedure selected six variables representing size, managerial efficiency, leverage, and liquidity for the model. The model predicts that large, under-leveraged and highly liquid gaming firms with good operating efficiency but low bottom-line profitability are likely to be takeover targets. The model reveals that gaming companies are engaged in mergers and acquisitions in pursuit of not only operating synergy through economies of scale and increased market shares but also financial synergy via tapping unused debt capacity and lowering debt costs. Improved financing efficiency may help raise the overall efficiency after the acquisition.

Effect of Mergers on Corporate Performance in India

This paper studies the impact of mergers on corporate performance. It compares the pre- and post-merger operating performance of the corporations involved in merger to identify their financial characteristics. Also, the effect on merger-induced monopoly profits is identified by looking at the persistence profile of the profits. Taking a sample of 36 cases of merger between 1992 and 1995, it is seen that there are no significant differences in the financial characteristics of the two firms involved in merger. The mergers seem to lead to financial synergies and a one-time growth. The analysis of the regression to norm shows that there is no increase in the postmerger profits. The competitive process is not impeded with merger even when no strong anti-trust laws are present.

Why Do Firms Merge and Then Divest? A Theory of Financial Synergy

This article develops a theory of mergers and divestitures. The motivation stems from inability to finance marginally profitable projects as stand-alones due to agency problems. A conglomerate merger is a technology that allows these projects to survive a period of distress. If profitability improves, the financing synergy ends and the acquirer divests the assets. The authors' theory reconciles two seemingly contradictory empirical findings. Mergers increase the combined values of acquirers and targets by financing positive net present value (NPV) projects that cannot be financed as stand-alones. At the same time, because these projects are only marginally profitable, conglomerates are less valuable than stand-alones. Copyright 1999 by University of Chicago Press.

Takeover Likelihood Models for UK Quoted Companies

This paper estimates takeover likelihood models for UK quoted companies. For a sample of 643 UK nonfinancial quoted companies over the period 1989-96, we find that the probability of being a takeover target is increasing in leverage and incidence of takeover speculation and decreasing in pre-bid performance, size and age since listing. Friendly and hostile targets differ in terms of age, size and capital structure, but not pre-bid performance. Lapsed and successful takeover targets differ in terms of size and age. Overall, the evidence here is consistent with a disciplinary view of hostile takeovers, while for friendly takeovers it is consistent with financial distress, financial synergy, going-public-to-sell-out and managerialist motivations.

Capital Shocks and Merger Activity in the Property-Liability Insurance Industry

Ths article investigates the prevalence of financial synergies as a motive for merger and acquisition activity in the property-liability insurnce industry. Two hypotheses are developed and tested based upon theories of information asymmetries and firm financing decisions (Myers and Majluf 1984): (1) that financial synergies are a primary motive for insurance mergers in general and (2) that mergers motivated by financial synergies wiU be more prevalent in periods following negative industry capital shocks. The hypotheses are tested via analysis of accounting ratios of acquisitions targets in the period 1980 through 1990 in relation to those of non-acquired firms of similar characteristics, and via analysis of acquisition characteristics. The hypothesis that financial synergies are a motive for mergers following negative industry capital shocks receives strong support.

Wealth creation versus wealth redistributions in pure stock-for-stock mergers

We examine wealth changes for all 1283 publicly traded debt and equity securities of firms involved in 260 pure stock-for-stock mergers from 1963 to 1996. We find no evidence that conglomerate stock-for-stock mergers create financial synergies or benefit bondholders at stockholders' expense. Instead, we document significant net synergistic gains in nonconglomerate mergers and generally insignificant net gains in conglomerate mergers. Conglomerate bidding-firm stockholders lose; all other securityholders at least break even. Convertible securityholders experience the largest gains, due mostly to their attached option values. Certain bond covenants are value-enhancing while leverage increases are value-reducing.

WEALTH CREATION AND BID RESISTANCE IN U.K. TAKEOVER BIDS

In this paper we investigate the determinants of, and relationship between, wealth creation and bid resistance for a sample of 178 successful takeover bids in the U.K. Within the context of an event study approach we test a range of hypotheses against a background that recognizes the existence of agency conflict and the role of corporate governance mechanisms designed to mitigate its effect. The results obtained are interpreted within the context of the U.K. corporate environment. We find that wealth creation and bid resistance are mutually dependent on each other. We find evidence suggesting the presence of managerial and financial synergy but the absence of operational synergy. Our results also suggest that there is some conflict between managers and shareholders but that significant monitoring is exercised by the particular governance mechanisms we investigate.

Mergers and macro‐economic factors

AbstractThis study investigates the relationship between macro‐economic factors and the time pattern of the degree of merger activity in the U.S. economy. The results of the study imply that whether mergers are motivated by operating or financial synergy, they are closely related to macro‐economic factors. The findings also indicate that this relationship is stronger for pure conglomerate than for non‐conglomerate mergers, and that while the impact of the interest rate on “cash” mergers is positive, for “securities” mergers the impact is negative.

The future of electric utility mergers in the USA

Mergers played a significant role in the structural development of the electric utility industry in the USA between 1880 and 1932. Abuses that occurred during that period have caused regulators to take a cautious and skeptical view of proposed mergers ever since. Based on a study of several mergers that have taken place between 1985 and 1992, this paper suggests significant potential for mergers to improve performance in the electric utility industry. Operating and financial synergies can occur without the historical abuses if regulators now allow and encourage consolidations.

STOCKHOLDER RETURNS AMONG HOMOGENEOUS GROUPS OF MERGERS

AbstractA sample of cash and stock merger transactions consummated between 1975 and 1987 is used to form homogeneous groups based on financial characteristics of both bidding and target firms. The results are used to determine how group heterogeneity with respect to financial characteristics influences intergroup differences in both bidding firm and target firm merger returns. Stockholders of bidding firms with attributes that fit the free cash flow hypothesis of merger motivation suffer wealth losses relative to firms that have characteristics consistent with achievement of scale or scope economies or financial synergies. Differences in target and merger portfolio returns are also found.

Types of synergy and economic value: The impact of acquisitions on merging and rival firms

AbstractAcquisitions, in general, have been demonstrated to create economic value. The intuitive reason underlying this value creation stems either from an ability to reduce costs of the combined entity, an ability to charge higher prices, or both. Current research in the area attributes these abilities to an opportunity to utilize a specialized resource. Our focus in this study is to compare three broad classes of resources that contribute to the creation of value. Following the conventional wisdom, these resources are classified as cost of capital related (resulting in financial synergy), cost of production related (resulting in operational synergy), and price related (resulting in collusive synergy). Given the limitations of our sample and research design, we find that collusive synergy is, on average, associated with the highest value. Further, the resources behind financial synergy tend to create more value than the resources behind operational synergy.

Bankruptcy Costs and the Firm's Optimal Debt Capacity: A Positive Theory of Capital Structure

independent of its capital structure is a conceptual subject which continues to receive considerable attention and discussion in recent financial theory literature.1 The basic underlying premise of the M-M proposition is simply that in perfect securities markets, the capital structure decisions by firms belonging to the same risk class do not alter the opportunity set available to investors. Hence any discrepancies in total market values of identical firms in the same risk class arising from differences in financing mix will be removed through arbitrage operations by investors. But as recent financial writers point out, individual investors do not enjoy the limited liability priviledge accorded to firms, and more significantly, there are explicit costs to bankruptcy which may offset the advantage to the firm arising from the tax deductibility of interest payments. Hence the purpose of this paper is to examine in a formal manner, within the context of a mean-variance framework, if recognition of these securities market imperfections are sufficient to establish the traditional finance position that capital structure decisions have a significant impact on total firm value, and thereby provide the theoretical basis for a financial synergy rationale for conglomerate

Abstract: Stock Price Movements of Firms Engaging in Large Acquisitions

During the past two decades, corporate managements have been increasingly Interested in growth through mergers and acquisitions. This external growth trend has been accompanied by the development of several merger strategies and philosophies. As a result, merger literature is frequently concerned with concepts such as price-earnings ratio strategy [13] and merger synergy. Synergy may be operational (e.g., the development of marketing or production economies) and/or financial in nature. Although financial synergy may produce “real” benefits (e.g., a lower cost of capital or increased cash flows), it is the general custom today to associate financial synergy with temporary [8], pecuniary [10], or instantaneous [9] earnings per share benefits.