Zsuzsanna Fluck, Anthony Lynch
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.
Subject: Mergers and Divestitures (Theoretical)
Fluck: (212) 998-0341 zfluck@stern.nyu.edu
Lynch: (212) 998-0350 alynch@stern.nyu.edu
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