Abstract

According to authors' their work with several large diversified manufacturers that have grown through merger has led them to investigate whether empirical research sheds light on the performance of such a growth strategy. As long as the prospective returns of the combining enterprises are not perfectly correlated, the surviving firm will yield an income stream for its owners having less dispersion per dollar of expected return than would be attainable by holding only one of its predecessors. On the other hand, to claim that the market will pay a premium for the new income stream ignores the opportunity, which individual investors had prior to the merger to combine the predecessor shares in their own portfolios. A merger is justified only if it is expected to make the merged firm's profits greater than the sum of the original firms' profits, a result, which is commonly termed "synergy." There should then be an increase in shareholder wealth, thus providing a strong incentive for shareholders to seek such mergers. A decision to acquire another firm should be evaluated in the same way as any other investment decision: if the acquisition adds more value to the firm than it costs, it should be undertaken.