Synergies, shareholder value and exchange ratios in “value‐creating” mergers: Why shareholders should doubt management's pre‐merger promises

The purpose of this research paper is to clarify why shareholders should be prudent when managers promise value gains from a synergetic merger. The paper proposes a simple two-state model of stochastic firm cash flows which allows for a discussion of wealth redistribution in conglomerate mergers, both under perfect information and moral hazard. It is found that shareholders regularly lose in non-synergetic mergers, and will not necessarily gain if synergies are positive. In the model, a corresponding critical level of synergies is calculated explicitly. It is shown that there are also new value effects induced by moral hazard, which constitute genuine financial synergies of their own. The positive synergies are due to the mitigation of asset substitution problems after the merger, and they are an interesting question for generalization in future research. As one of its practical implications, the findings suggest that managers should provide shareholders with concrete ideas of where promised synergies might come from, and why there should exist any bargaining range for equilibrium exchange ratios which leaves all shareholders better off. The paper shows that these questions can be answered on a rigorous basis which might improve the pre-merger decision process between managers, shareholders and the affected groups of stakeholders, respectively. [PUBLICATION ABSTRACT]