Risky Business

7 common reasons given for a merger

Mergers and acquisitions are likely to be the biggest capital investment for a firm. For the acquired, stock prices typically rise significantly, but for the buyer, they typically fall. So what are the main reasons given for a merger or acquisition? In a recent Risk Series session hosted by The Risk Institute, Isil Erel discussed these and more during her talk.

1) Growth

Growth is a common reason given for a merger either because organic growth is too slow or because inorganic growth is desired.

Ask yourself: Should growth be your goal?

2) Market Power

This is a common, but unspoken reason. Plus, it’s constrained by anti-trust trust.

3) Operational Synergies

This is a great reason for a merger. Operational synergies result in cost savings through economies of scale and economies of scope.

4) Diversification

Does diversifying into industries without operation synergies create or destroy value?

Pros: a firm can allocate capital efficiently relative to the market

Cons: conglomerates seem to trade a discount — there’s little evidence that the act of corporate diversification adds value

5) Financial Synergies

Relieves the financial constraints of the targets

6) Managerial Entrenchment

Often the subject of movies, this is where empire building and job security comes into play. Spoiler: This is pretty much never a good reason for a merger

7) “Strategic” Reasons

While an acquisition may have a negative discounted cash flow, it may provide ‘strategic options’ for future cash flows, e.g. toehold investment in new countries, product lines.

The option value rather than the discounted cash flow may indeed justify an acquisition but, beware! “Strategic reasons” is a very common justification for many bad corporate decisions.

 

The Mergers & Acquisition session was held as a part of the Risk Series at The Risk Institute. The Risk Series brings together leading academic scholars and practitioners in a dialogue on the current trends and topics in risk. Speakers at this session included Isil Erel, Academic Director of the Risk Institute and Distinguished Professor of Finance at Fisher College of Business; Michael Repoli, Chief of Staff at Gallagher Bassett; Tom O’Hara, Enterprise Risk Management Director at Huntington; and Gavin Waugh, Vice President & Treasurer at Wendy’s Company.