RFS Advance Access published online on March 27, 2008
Review of Financial Studies, doi:10.1093/rfs/hhn019
How Do Mergers Create Value? A Comparison of Taxes, Market Power, and Efficiency Improvements as Explanations for Synergies
College of Business Administration, University of Texas at El Paso
College of Business, University of Texas at San Antonio
School of Management, SUNY-Binghamton University
Address correspondence to Srinivasan Krishnamurthy, School of Management, SUNY-Binghamton University, Binghamton, NY 13902; Telephone: (607) 777-6861; e-mail: srinik{at}binghamton.edu.
JEL Classification: G1, G34, L2
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Abstract |
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There is little evidence in the literature on the relative importance of the underlying sources of merger gains. Prior literature suggests that synergies could arise due to taxes, market power, or efficiency improvements. Based on Value Line forecasts, we estimate the average synergy gains in a broad sample of 264 large mergers to be 10.03% of the combined equity value of the merging firms. The detailed data in Value Line projections allow for the decomposition of these gains into underlying operating and financial synergies. We estimate that tax savings contribute only 1.64% in additional value, while operating synergies account for the remaining 8.38%. Operating synergies are higher in focused mergers, while tax savings constitute a large fraction of the gains in diversifying mergers. The operating synergies are generated primarily by cutbacks in investment expenditures rather than by increased operating profits. Overall, the evidence suggests that mergers generate gains by improving resource allocation rather than by reducing tax payments or increasing the market power of the combined firm.
We thank Malcolm Baker/Erik Stafford (discussant at the AFA meetings), Alex Butler, Honghui Chen, Upinder Dhillon, Melissa Frye, Jon Garfinkel (session chair and discussant at the FMA meetings), Murali Jagannathan, Rajesh Narayanan, John Puthenpurackal, Kasturi Rangan, Kristian Rydqvist, Ajai Singh, Sam Thomas, Kelsey Wei, and seminar participants at AFA annual meetings, FMA annual meetings, Binghamton University, Case Western Reserve University, University of Central Florida, Federal Reserve Bank of Cleveland, Hofstra University, Kent State University, Ohio University, and University of South Florida for helpful comments. We are especially grateful to an anonymous referee and Michael Weisbach (the editor) for their insightful comments. We thank Elizabeth Devos, Cheng Fu, Rong Hu, Dobrina Koycheva, Alex Meisami, Yilun Shi, and Joshua Spizman for help in data collection. Some of the work was done while Devos was at Ohio University, and assistance from the Gardner Fellowship of Ohio University is gratefully acknowledged. We retain responsibility for any errors.