This chapter focuses on the strategic motives and determinants of mergers and acquisitions. It begins with a discussion of one of the most often cited motives for mergers and acquisitions—synergy. Proponents of a deal will often point to anticipated synergy as the justification for a specific purchase price. The different types of synergy, operating and financial synergy, are explored in this chapter. It will be seen that operating synergy, including both economies of scale and economies of scope, has the most economically sound basis. Financial synergy is a more questionable motive for a merger or an acquisition.
Companies often merge in an attempt to diversify into another line of business. The history of mergers is replete with diversification transactions. The track record of these diversifications, with notable exceptions, is not very impressive. However, certain types of diversifying transactions, those that do not involve a movement to a very different business category, have a better track record. Companies experience greater success with horizontal combinations, which result in an increase in market share, and even with some vertical transactions, which may provide other economic benefits. Unfortunately, a less noble motive such as hubris, or pride of the management of the bidder, also may be a motive for an acquisition. This determinant, along with others, such as improved management and tax benefits, may serve as the motivation for a deal. These motives, with their respective shareholder wealth effects, are analyzed.
One of the most fundamental motives for mergers and acquisitions is growth. Companies seeking to expand are faced with a choice between internal growth and growth through mergers and acquisitions. Internal growth may be a slow and uncertain process. Growth through mergers and acquisitions may be a much more rapid process, although it brings with it its own uncertainties. Companies may grow within their own industry or they may expand outside their business category. Expansion outside one's industry means diversification. Because diversification has been a controversial topic in finance, it is discussed separately later in this chapter. In this section we focus on growth within a company's own industry.
If a company seeks to expand within its own industry, there are two alternatives: internal growth versus external growth. Sometimes internal growth is not an acceptable alternative. For example, if a company has a window of opportunity that will remain open for only a limited period of time, slow internal growth may not suffice. As the company grows slowly through internal expansion, competitors may respond quickly and take market