Question

What are some valid economic justifications for mergers? Please see chapter Ch.22 for references to this topic.

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Answer 1

What are some valid economic justifications for mergers?

Value creation — Two companies can undertake a merger to improve their shareholders' wealth. In general, consolidating two corporations leads to synergies that improve the profitability of a newly formed corporate company. In fact, synergy ensures that a combined firm's worth equals the sum of two separate firms' assets.

Diversification — Mergers are also performed for purposes of diversification. For example, a corporation can use a merger by entering new markets or providing new goods or services to diversify its business operations. In fact, it's usual for a company's executives to strike a acquisition agreement to diversify the uncertainties involved with the activities of the company. Notice that shareholders are not necessarily happy with circumstances where the acquisition agreement is solely driven by a risk diversification goal. The owners can effectively diversify their liabilities in certain situations through investment portfolios, while a merger of two firms is usually a lengthy and costly process.

Asset acquisition — A transaction can be driven by a need to purchase those properties that are not obtainable through certain approaches. It is very common in M&A deals that some businesses plan mergers to obtain access to specific assets or to assets that normally take a long time to grow internally. Exposure to emerging technology, for example, is a common target of multiple mergers.

Financial flexibility increase — Any business faces full financial ability to fund its activities via either debt or equity markets. In the absence of adequate financial resources, one firm could combine with another. A combined company would thus ensure greater financial power.

Tax reasons — When a corporation earns considerable taxable profit, it can combine with a corporation that has substantial tax losses to take forward. Following the merger the merged company's gross tax burden would be significantly smaller than the individual company's tax liabilities.

Incentives for executives — Mergers are often guided solely by the financial desires and goals of a company's top management. A corporation formed as a result of a merger, for example, ensures more control and reputation which management will perceive favorably. Such a motivation can also be compounded by the vanity of the executives, as well as their desire to create the industry's largest business.

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