Do Mergers and Acquisitions Create Value?

Although there are various methods of executing mergers and acquisitions, a few general outcomes of such transactions may be pointed out. First, a merger resulting from the combination of unrelated investments (conglomerate acquisitions) does not necessarily yield positive returns for the acquirer's shareholders. The reason for this is that the acquirer's shareholders can usually buy the shares of companies similar to the target by themselves, and the fact that the acquirer's managers compel them to participate in the investment reduces the attractiveness of the acquirer altogether. Obviously, this principle does not apply if indeed the acquirer has managerial abilities which may be implemented in different fields. However, such situations are quite rare, and among the past conglomerates, General Electric is probably the only successful one.

However, on average, companies which are conglomerates are traded at a discount compared to the sum of the values of the companies they manage, mainly due to the additional managerial and administrative costs which result from the difficulties in managing diverse and unrelated businesses.

Similarly, while mergers which are explained by the desire to reduce a dependency on seasonal sales or to reduce sensitivity to an economic situation in such or another field do indeed reduce the specific risk in the investment, they do not create value to the shareholders, who examine investments in accordance with the systematic risk they entail, as they can diversify away the firm's specific risk. On the other hand, such mergers obviously generate value if a positive synergy is created between the activities, for example, by streamlining the managerial and administrative infrastructure.

Acquisitions which create value to the acquirer's shareholders are those which utilize the acquirer's know-how, capabilities, and resources to improve the target's operating performance or, alternatively, use the target's resources to improve the acquirer's operating abilities and hence its own operating performance. The acquisition or merger may naturally generate value when it creates a company which benefits from the economies of scale in a more efficient cost structure, or when it creates a marketing power which enables it to benefit from a sustainable competitive position in the market. For instance, there is an advantage to size in the development of core technologies, which small companies find hard to shoulder.

Furthermore, acquisitions do create value through the fact that they may provide an efficient mechanism for investing the company's money. Specifically, the tax system in most countries imposes double taxation on the company's earnings: once in the form of corporate tax and again when the shareholder pays tax on the dividend paid to him or her. Even when the company buys its own shares ("share repurchase"), the payment of capital gains tax by some of the shareholders constitutes, in practice, a tax of sorts on the company's earnings. On the other hand, no tax is paid on money which remains in the company and is re-invested, until it is distributed. In practice, the acquisition, as long as it generates at least the alternative return on the money, is an efficient instrument for deferring the payment of tax on the company's earnings, which are instead invested in another firm.