Financial Economics

WEB–APPENDIX H

MERGER AND ACQUISITION STRATEGIES

One investment strategy that has frequently been followed by corporate management is that of merging or acquiring firms, which often come in waves with heavy activities in certain periods and few at other times. In this appendix, we consider whether financial economic theory provides a rationale for such investment strategies.¹ As we show, the theory of a perfect capital market (even under uncertainty) cannot explain merger or acquisition activity. For these reasons, after showing why there is no value to a merger or acquisition effected in a perfect capital market, we discuss the kinds of market imperfections² that may provide a rationale for the activity. In this appendix, we attempt merely to highlight the main strands of the arguments regarding mergers and acquisitions.³

H.1 MERGERS AND ACQUISITIONS IN A PERFECT CAPITAL MARKET

The argument that in a perfect capital market merger or acquisition activities have no economic value follows from what is sometimes called a homemade diversification argument. That is, value is not created by any merger that has no synergistic effects such as those due to savings in combined operating costs, because investors have the same opportunities to combine firms' shares, in their own portfolios, as can be realized by actually combining the firms.

To see this, consider two firms: A (umbrella company) and B (ice cream company), each of which may be held separately in any proportions in investors' ...