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Merger: Economic Justifications and Incentives Essay

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Updated: May 21st, 2021

Introduction

A merger is the unification of two companies into a single financial entity. The participants may be equals, or one may be acquiring the other as a subordinate. In both cases, each of the companies that choose to merge loses a degree of autonomy. As such, significant economic benefits should result from the process for it to be justifiable. The present paper explores the potential financial incentives for mergers.

Synergy

One of the primary reasons why two companies would consider merging is the potential synergy between them. While significant results can be attained through partnerships, at times, the cooperation is so close and exclusive that it is convenient for the two companies to become one. Brigham and Ehrhardt (2017) list five primary sources of synergistic effects: operating economies, financial economies, tax effects, differential efficiency, and increased market power. It should be noted, however, that the synergistic benefits of a merger are not reliable, and they may instead lead to significant losses for the new joint entity.

Diversification

A merger can be an effective measure for the growth of a company that has a stable financial foundation but cannot significantly develop its presence in a target market further due to reasons such as the slow growth of the market in question or lack of innovations. Such a company could look to expand its business into another field or attempt to establish a branch in another country. According to Arora (2015), mergers are useful tools for both of these purposes since they eliminate the need for lengthy and expensive development and established procedures. The strategy is complicated and risky, but it results in significant benefits if it succeeds.

Personal Incentives

Mergers, particularly acquisitions, may be motivated by the personal wishes of the company’s management. According to Brigham and Ehrhardt (2017), business leaders like power, which is acquired by increasing the size of one’s company, and growth of an enterprise also tends to result in bigger salaries for its executives. Acquisitions present a quick and somewhat easy way of considerably enhancing the company’s scale. However, Brigham and Ehrhardt (2017) note that managers of smaller companies may resist acquisitions by larger businesses due to the fear of losing their jobs or autonomy. They may prioritize their benefits over the creation of value for the company.

Value Acquisition

The traditional economic theory claims that mergers will results in short-term losses rather than profits, destroying value for shareholders. However, modern tendencies may challenge that view and display that appropriate investment strategies can result in immediate as well as long-term benefits for the participants of the procedure. Alexandridis, Antypas, and Travlos (2016) note that recent acquisitions, particularly those by large companies, have shown abnormal positive returns for the companies as well as their shareholders. It is possible that the 2008 financial crisis led to improvements in corporate management methodology that developed the methods and outcomes of merging.

Conclusion

Mergers are often described as risky procedures that tend to destroy value and require significant incentives in contemporary economic literature. The primary reasons for a merger between two companies include synergy and diversification, but success in these goals is not guaranteed. The personal motivations of the company’s managers may also play a role. However, recent mergers by large corporations display significant positive economic outcomes, which may indicate that the strategies and approaches to the procedure have been refined to reduce risks and increase profitability. The dangers and benefits of mergers and acquisitions may require a re-evaluation shortly.

References

Alexandridis, G., Antypas, N., & Travlos, N. (2016). . Web.

Arora, M. (2015). Mergers and acquisitions in entrepreneurship for gaining strategic and competitive advancements. Pacific Business Review International, 8(6), 99-104.

Brigham, E. F., & Ehrhardt, M. C. (2017). Financial management: Theory and practice (15th ed.). Boston, MA: Cengage Learning.

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IvyPanda. 2021. "Merger: Economic Justifications and Incentives." May 21, 2021. https://ivypanda.com/essays/merger-economic-justifications-and-incentives/.

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IvyPanda. (2021) 'Merger: Economic Justifications and Incentives'. 21 May.

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