Types of Synergy and Economic Value: The Impact of Acquisitions on Merging and
Rival Firms
Sayan Chatterjee
Strategic Management Journal, Vol. 7, No. 2. (Mar. - Apr., 1986), pp. 119-139.
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Types of Synergy and Economic Value:
The Impact of Acquisitions on Merging
and Rival Firms
S A Y A N CHATTERJEE
Krannert Graduate School o f Management, Purdue University,
W e s t Lafayette, Indiana, U.S.A.
Summsrj.
Acquisitions, in per~eral,/lave been det?lonstrafedio create econotnic
val~re. 7 k e itltuitirle reason rrnc/er[ving this value creation sterns
c i t h n Jkoin an ability to recl~rcecosrs of the cor?zhh?edertfitv, at1
irOi1it.v ro charge higher prices, or both. Crrrrcvit research in the area
~ f t r i h ~ cthese
l ~ ' ~al~ilitiesto un o p p o r t ~ c t ~ to
i l ~utilize
~
a specialized
t'esorrrce. Our focrrs in thir study is to corr~purethree b o n d c1ns.se.s of
r,esources that contribute ro file ci.eation o f value. Follo~sitigthe
conver~riot~ui
wisdotn, these resources are cla.s.sified as cost of capital
relater1 (tw~tftingit2 ,finarlcia/ synergy), cost of prod~iction t-elated
(res~cltingin opercttiotic/l svrrergy), cit~dprice reluted (resrrlting in
synergvj. C;ivclrr the litr~itutiorlsof our sa~tlplecirld research
c2o1lirsir~i.
desigtl, i.seJitld thut collir.sive .s.vrrerg;il is, on alwuge, a.ssociated rvith
the highest i~alrre,tiir//?er,f he resource.^ Oehiricl finuncial s.srrergy
refitl to create /?lore ~'aluethrrrr the resorrrcei. behitrd opercrtional
syi1erg?'.
INTRODUCTION
'A takeover wave is rolling across corporate America' (Akw York Tinies, 3 July 1984).
Whether or not they do in fact occur in waves, mergers have always been an endemic feature
of corporate America and consequently they have drawn the attention of academicians since
the mid-1950s. Researchers have attempted to answer many different questions concerning
acquisitions. However, the question that should be of primary interest to managers
concerning mergers is what are the 'strategies . . . of acquisition that offer the potential for
creating real economic value' (Salter and Weinhold, 1979).
While acquisitions in general have been demonstrated to create economic value (Jensen
and Ruback, 1983), very few studies have sought to identify the value related to specific
acquisition strategies (the exceptions being Singh 1984; Lubatkin, 1983, 1984). An intuitive
reason for this value creation is that it comes about either because the combined entity can
enjoy reduced coz;ts, charge higher prices for its products, or both. Current research in this
area suggests that the increased value results from an opportunity to utilize a specialized
resource \vhich arises solely as a result of the merger (Jensen and Ruback, 1983; Bradley,
Desai and Kim, 1983).
The purpose of this study is t o examine different types of acquisition strategies, and to
begin objectively exploring the determinants of the performance diff'erences. In order to
observe these diflerences, the changes in equity values of merging firms and their direct
0143-2095/86/020119-21$10.50
4'1986 bq John M'ilz! &Sons, Ltcl.
Received 25 M q v 1983
Revr red 27 Septettiher 1983
120
S. Chatterjee
competitors are ascertained at the time of the merger announcement for portfolios of firms
which are formed based on the imputed specialized resources utilized as a result of the
merger. Following the conventional wisdom, these resources are classified as cost of capital
related (resulting in financial synergy), cost of production related (resulting in operational
synergy) and price related (resulting in collusive synergy).' Given the limitatio~lsof our
sample and research design, we find that collusive synergies tend t o be associated with more
value than either of the two other types of synergies. Further, financial synergies, on
average, tend t o be associated with more value than d o operational synergies.'
A review of related re5earch
Most of the recent ~ o r on
k acquisitions has been done in the area of finance using capital
market data aggregated oker a large number of merging firms. These studies demonstrate
that on average a wealth gain accrues to the stockholders of the merging firms as measured
bq the cumulative abnormal returns (CAR) of the firms' stock prices during the merger
announcement period (see the section on methodology for details). The wealth gain is
attributed to the utilization of resources resulting in different types of synergies as discussed
earlier (see Eckbo, 1983; Bradley c.t a / . , 1983). However, while there d o exist comprehensive
theoretical reasons purporting to explain the underlying resources which give rise to these
synergies, a serious effort to link the type of synergy to the amount of economic kalue
created is absent from the literature.
Two studies in the field of business policy (Singh, 1984; Lubatkin, 1984) have taken steps
to fill this gap by analyzing the economic value associated with different types of mergers.
The focus on types of mergers n a s possibly, in part, motilated by the findings of other
business policy studies that indicate that related diversification strategies outperform
unrelated diversification strategies (Rumelt, 1974, 1982; Montgomery, 1979; Rettis, 1981).
I n order t o test these findings using the CAR methodology, the comparison of economic
value by types of acquisition is necessary. However, since there is usually rnore than one
type of synergy associated with the different types of mergers (see Table l), this approach
requires modification before the relative effects of the synergies can be directly compared.
At this point one might question why a typology of synergies is of interest. T o answer this
question, a conceptual frameuork of the creation of economic value is developed in the nevt
section.
A model of the creation of economic value
For an acquisition strategy to create economic value, a distinctive conzpetencc (i.e. scarce
resource) must be matched t o an opportunity in the environment (Andrews, 1971). This
leads t o a resource-based view of the firm as developed in Wernerfelt (1984). Given this
perspective, the amount of economic value that will result from a merger will depend on:
I By price related we illcan [he ability to increiire prices becausc of collusion among rile intl~istriparticipnnl. The reioi~rce\
can be u5ed to lo~t'er.the final price of the product, bur this is ail iiidirect rezult due to operational
related to cost of proil~~ccion
synergy which in the first place had enabled the merged entity to produce at a cheaper cost thau was possibie before tile merger
(also see Steiner, 1975:47-74).
? The term 'synergy' is ured in the literature hecause the value creation implie5 a bi-eakdo&ii in tiic value additi.iiiy principle for
of tile
tiic mel-ged entity (Stcincr. 1975:47-74; Salter and a-einholti, 1979:9). It zhoulti be noteti rl~atit is rile ~~riliratioti
resource that creates tlie value. Thus \$lien we say that financial synergy is aqsociated with higher l a e l of .iaii~ecrcarioil tlian
operation synergy, we mean that the resources related to cost of capital create more value that1 do resources rciateil to cost oi'
production. Tlie typology of s)nergies is, therefore, being usetl as an abbreviated way of linking the value crearetl lo thc
underlying class oS resource.. (See rhc sectioli oti 'A classificatioti of \carte reour-cei by s>tierpics', for Erirtlier di~c~i5cioii
of
this point .)
Types of Synergy and Econotnic Value
121
(a) the amount of the resource held by the firm, relative to the total amount present in
tlie economy, and
(b) the availability of opportunities to utilize this resource.
While the supply of a resource t o meet existing demands will always create value for the
economy as a whole, an individual firm will earn only a competitive rate of return (i.e. zero
economic profit) unless the firm has monopoly access to the resource. In other words, to
create economic value for the firm, the resource it owns has to be scarce. Further, as
Wernerfelt (1984) points out, resources can have multiple uses. This leads us to posit that
the more ways in which a scarce resource can be utilized, ceteris paribus, the greater the
expected economic value that it can potentially give rise to. Formally stated,
Expected economic value = F (Scarcity of resource, Availability of opportunities)
An additional element needs to be incorporated into the above model. The concept of
strategy emphasizes the rnatching of strengths (resources) to opportunities (uses). One
aspect of this matching is the difficulty of implementation. This difficulty, if present, will
adversely affect the chances of creating economic value. We shall therefore, use the
following modified model as the conceptual basis of this study.
Expected economic value = F
Scarcity of
Problems in
Availability of
resource
' implementing ' opportullities
A classification of scarce resources by synergies
Ultimately, the purpose of a study like this is t o enable the potential acquiring managers and
owners t o make an informed decision about which of the firm's resources would create the
most value upon a merger. T o tackle this proble~nat the individual firm level requires a
clinical study, the results of which may or may not be generalizable. However, the
differences in the level of value created by two or more different classes of resources can be
studied using a large sample design. We think that this is an improvement over examining
the level of value creation by type of merger because, in any given merger, more than one
class of resources may be utilized. A firm may have only a subset of all the different classes
of resources at its disposal. For such a firm the value-creating potential of different classes
of resources is more important than that of different types of mergers.
The typology of synergies that exists in the literature provides a convcnient means of
classifying the scarce resources. While other authors have used varying levels of detail in
their typologies (Lubatkin, 1983), the three broadest categories are used here. Thus,
collusive synergy represents the class of scarce resources leading t o market power.
Operational synergy represents the class of scarce resources that leads to production and/or
administrative efficiencies. Financial synergy represents the class of scarce resources that
leads to reductions in the cost of ~ a p i t a l . ~
This type of iynergy is not generally acccpted b> financial economists b e c a ~ ~ it
s eimplies privileged accerr to capital by some
firms, a n impossibility if the capital market is fully arbitraged. H o ~ v e ~ ereality
r,
(tlie existeiice o i the prime I-ate), ac~tdemicians
in general (Steiner, 1975:64) and theoretical econoniisti (Grossman and Stiglitz, 1976; Stiglitz, 1981; Teece, 1983) lead us t o
believe otherwise. From the theoretical ecotiomic perspectibe, privileged a c c e q to capital cannol sxiri if a n d only if
information is costless (i.e. if and only if strong-form efficiency, as defined in the fi~ianceliterature exists) (Stiglitz, 1981;
Teece, 1983). T h a t this is patently not the case is acimitted by tile financial econori~iits.LVc therefore argue for the existence of
financial synergies bia what Williamson (1975) callr the internalization of the capital m a r l e t by (congloinerate) iiiergers.
T o reiterate, our goal is to compare the values associated with these different types of
synergies and, hopefully, to explain any differences present by referring t o the three factors
in the conceptual model. If we have a defensible concept of the economic potential of each
of the different types of synergies, we are in a much better position to explain the economic
potential of different types of mergers, because the value created by a merger is associated
with one or more of these types of synergies. (This point is discussed in greater detail in the
section dealing with the research design.)
Effects of mergers on rival firms
Let us assume that we have managed to control for the impact of collusion in our sample of
mergers. Then the wealth gain attributable t o the merger should be related t o either an
operational and/or a financial synergy. A cost-efficient production and/or investment
policy will enable the merged firm t o sell the product at a lower price than can its rivals.
Also a cost-efficient production process will reduce the demand for factor inputs, thus
increasing factor prices. So the net effect of the cost-efficiency is that the rivals face a lower
final price of the product and also a higher cost of raw materials. Therefore, unless the rival
firms can adopt the same cost-efficient production process made possible by the merger,
they will not be able to be cost-competitive. Hence, the net impact on the rivals will be a
reduction in their market value. We shall call this the product/factor price effect.
It needs to be noted that the product/factor price effect is contingent on the rival firms'
inability to adopt the same cost-efficient production process and they, therefore, suffer a
loss in market value. However, the merger announcement may contain 'information' about
a process innovation or a technological innovation which makes these cost-efficiencies
possible. In order t o implement these innovations the rival firms, therefore, become
possible merger targets to take advantage of the technological complementarities (related
diversification) or simply t o provide capital mhich is not readily available in the capital
market (unrelated diversification). Jarrell and Bradley (1980) have demonstrated that the
stock price of the rivals will be bid up in anticipation of the gains from such mergers. We
attribute this increase in value to the 'information effect' of the mergers. The total wealth
impact on the rivals is the sum of the (negative) product/factor price effect and the (possibly
offsetting positive) information effect given as follows.
Dw
=
Information effect (gain)
+ Price effect (loss)
where Dw is the net change in market value of the rival firrn before and after the merger
announcement.
If we make the assumption that with a large sample the information effect of any merger
will be roughly equal across different classes of rivals, then the relative magnitude of the
wealth gain/loss of the rivals will be indicative of the negative (product/factor price) effects
on rivals in each class of mergers. In other words, our arguments lead to the prediction that
the relative wealth gain/loss of the rival firms should be inversely related to that of the
merging firms in each class. For example, suppose that u e are examining the impact of
related and unrelated mergers. If the targets of related mergers exhibit a proportionally
greater wealth gai11 than those of unrelated mergers, then it is reasonable t o think that the
combined related firms are a more cost-efficient corporate entity than are the merged
unrelated firms (Eckbo, 1983). In such cases we would expect the rivals of the related target
firrns t o experience a more negative change in market value due to the product/factor price
effect than the rivals of the unrelated targets. Even if this negative change in wealth were
Types of Synergy and Econo~nicValue
123
partially or fully offset by the information effect resulting in a net gain t o the rivals of both
classes of mergers, we would expect the gains to the rivals of the unrelated targets t o be
higher than the gains to the rivals of the related targets. This analysis leads to testable
implications which will serve as a check to the results of the merging firm.
RESEARCH DESIGN, DATA AND METHODOLOGY
Research design
In general, it is almost impossible to estimate the economic value of a particular strategic
move. However, the studies by Lubatkin (1984) and Singh (1984) utilize the CAR
methodology which provides an indication of the economic value created in an individual
acquisition. The same approach is used here to determine the economic value of the three
different types of synergy.
Merging firms
Ideally, t o study the three types of synergy, we would like to be able to draw the following
links:
Horizontal mergers
=
Collusive synergies
Related or vertical mergers
=
Operational synergies
Unrelated or conglomerate mergers
=
Financial synergies
These equivalencies imply that there is no difference between the type of mergers and the
type of synergy. Unfortunately, mergers in general are unlikely to fit into such a
classification. For example a horizontal merger, by definition, is a related acquisition and
may involve utilization of economies of scale and/or scope both in production and
distribution. This may lead to reduced costs (i.e. operational synergies), apart from any
collusive gains. By the same logic, financial synergies may also be present in horizontal
mergers (see Table 1). Hence, the types of synergies cannot be classified based on types of
mergers. In order t o empirically separate operational and collusive synergies, a research
design is required that is beyond the scope of this study. Here, we are concerned solely with
T a b l e 1.
Different types o f mergers a n d t h e associated synergies
T y p e o f merger
Related
Type of
synergy
Collusive
Operational
Financial
Unrelated
Horizontal"
Non-horizontal
Possible
Possible
Possible
Unlikely
Possible
Possible
Unlikely
Unlikely
Possible
* H o r i ~ o n t a lmergers are eliminated from this study as discusied in the section on
'Research design' and in footnote 4.
124
S. Chutterjee
separating financial and operational synergies so that the effects of these can be compared
in a' meaningful fashion.
In selecting the sample of merging firms, we go through the following steps:
(a)
elimination of collusive synergies,
(b)
elimination of speculative effects,
(c)
emphasizing financial synergies, and
(d)
standardization of synergistic gains.
Each of these is discussed in detail below.
Elimination of collusive synergies. For a merger t o be motivated by demand-side
collusion, it will of necessity have to be horizontal, i.e. the merging firms must be in the
same industr}. Note that the universe of nll related mergers contains both horizontal and
non-horizontal mergers (such as mergers undertaken for product or market extension by
firms that are not in the same industry).' If, therefore, we restrict our sample of related
mergers by excluding all horizontal mergers we can control for demand-side collusion that
might motivate such mergers. This sample of related, non-horizontal mergers can, of
course, contain firms which experience both operational and financial synergies. This
sample can be compared with a sample of unrelated mergers which are likely t o have only
one form of synergy present, i.e. financial synergy.
Eliinination of speculative gains. The second fact that we need to consider is the
measure of economic value. Singh (1984) and Eubatkin (1984) provide a detailed discussion
as t o why the CAR methodology is appropriate in examining the future economic value of
the combined firm. The interested reader is referred t o these studies. In order to maintain
consistency in comparing the CARS of individual acquisitions, only merger proposals will
be examined. Tender offers are not included in order t o eliminate the effect of any
speculative gains that may occur due t o the presence of risk arbitrageurs.'
This discussion has at least partial support from the empirical results in the finance
literature. The abnormal returns exhibited by target firms in the case of tender offers is on
the average 10 percentage points higher than the abnormal returns exhibited by targets who
enter into a mutual agreement to merge (Jensen and Ruback, 1953:7). Thus if one of our
sample groups contained an abnormally large proportion of firms receiving tender offers,
the abnormal returns t o that group would tend t o be inflated due to speculative motives,
masking the true gains that we are trying t o identify. Thus, irrespective of the fact that
Eckbo (1983) has examined horizontal mergers in detail. For this reason, horizontal mergers are riot considered in thib study.
Unfortunately, Lubatkin (1981) groups horizontal riicrgers with mergers made for rnarltet extension purposes. If these had not
been combined, his results would have provided a check o n Eckho'a and our results.
' W e d o share one concern in common with the lay person that sot7retitne.r \lock price movemenis may be causetl soiely by ,rock
market jockey3 (risk arbitrageurs, to use the technical term). Fortunately, there are some indication\ as t o wlicn the market is
reacting in a speculative manner. Acquisitions are usually carried out thi.ougIi one of three means: riiergcr agrcemerits, tender
offers, a n d proxy fights. Proxy fights are eliminated from this htudy due to d a t a probienii. Tender offers differ from mergers
in that (a) the announcement of a tender oRer is no guarantee of a n eventual merger, arid (h) the pricc of the target firm's
shares is artificially raised bq the fact of the tender bid. T h c price, in this instance. is not a iliarket coiisen<us :ibout the change
in the future performance of the merged entity, but simp]) I-epresents what tile bidding hrm is t~iliingt o pay for- the target.
This is a situation rife for speculation a n d the targct lirni's srockliolders uill try lo second-piless the bidding firm'? otfer.
Almost invariably, risk arbitragcurs will huy the target firm's shares ill hopes that a higher tentier bid \vill be forthcoming.
T h u s the price change during a tender offer ins) incliide a subttantial ipeculati\e elenleiit apart from ail) changes in
expectations about the merged firm's future performance.
Types of Synergy and Econoinic Value
125
tender offers may lead to speculation, we need consider only mergers, eliminating tender
offers from the sample.
E~nphasizingfinancial synergies.
We make the following assumption that is well
accepted in academia (except, perhaps, by financial economists, as discussed in footnote 3)
and by practitioners. This is that on average a large firm has cheaper access t o capital than
does a small firm (Steiner, 1975:64). T o highlight the financial synergy aspect of unrelated
mergers one should, therefore, choose only those unrelated mergers where thc bidding firm
is significantly larger than the target firm.b The reasons for this are as follo\vs.
Any synergy that is generated by the merger is limited by the size of the target firm. For
example, any operational synergy is limited by the economies of scale/scope that the (postmerger) target firm is capable of generating. The amount of synergy present should thus be
correlated with the target firm's size and hence can be proxied by it. Similarly, any capital
infusion provided by the acquiring firm is useful only t o the point that it can be absorbed by
the target.
By choosing relatively large acquiring firms compared to the targets in the unrelated
sample, we are simply trying to ensure that there is an 'overkill' in capital availability, i.e.
the potential financial synergy arising out of the merger can be fully exploited.' Hence, after
selecting the sample as described above, if we choose targets which are the same size on the
average in related and unrelated samples, then the comparison of the relative profitabilities
should be at least indicative of the relative economic value of financial synergy as compared
t o operatiorla1 synergy. The related mergers should again ideally be stratified according to
the relative sizes of acquiring firms to their respective targets in order t o try to capture the
differential impact of financial synergies in such merger^.^
Standardization of gains. It would be almost impossible t o select target firms that are
the same size in both samples. Since we are interested in comparing the absolute wealth
gains for the same size in the two samples, we have to standardize the wealth gain t o the
same asset base for each of the two samples. (If the absolute sire of any one target varies
significantly from the rest of the sample, it was felt that it was better t o eliminate it from the
sample than to control for any differential impact of absolute size,)
W ival firms
In the absence of any information effects, the gains experienced by the target firmi should
equal the losses experienced by their rival firms. However, three problems arise in
attempting to measure these wealth transfers: (a) all possible rivals cannot be accounted for
because only a fraction of them have stocks which are traded publicly, (b) the impact of the
product/iactor price effect on an individual rival will depend on how much stake the rival
firm har in the affected industry, and (c) the discernible efTect on an individual rival will
decrease as the number of rivals increases.
This should be done in two steps. O u r original h>pothe\ii \\as that the acquiring firms in c o n g l o m e ~ a t emergers \voitld have a
larger relarive size coinpared t o that of the related acquiring firms. Fur-ther, within the conglomerate clats we expect there
would be a correlatiori between relative si/e ant1 wealth gains. While these expectations are supported by casi~alobservation,
the sample size does not permit any conclusions t o be dralrn n i t h acceptable ,tatistical rigor. Strictly ,peaking, tliis fact ihould
be incorporated in the research design onl) if a positive correlation is p r e s e n ~ .\fre are, thcref'ore, ~ e l y i n go n intuition in
choosing larger relative size of the biddirig firm a compared L O the tai-get Iil-m to highlight the presence of financial synergies.
' S i ~ e per'se,
,
does not guarantee capital availability although it rnight iniply a cheaper cost of capital. T o ensure capital
availabilit~the acquiring firms need to be screened using some rneallire of liquidity. Also 5ize may be a pl-o~!, fur degree of
diversification. I'hi5 might meal? that a large firm has diversified to the point where ail of its future acquisitions are of the
conglomerate type (Ansoff, 1965). This could explain ibhy the unrelated acquit-ing firms terided to be larger than the related
acquiring firms.
\Ve h e r e unable t o d o this in this study due to tire paucit) of saniple points.
(
126
S . Chntterjee
T o deal with these problems, note that the target firms are usually iniolved in a single line
of business which accounts for the majority of their sales. This is usually the business that
the acquiring firm is interested in obtaining. In contrast, the acquiring firms are, on
average, much more diversified. Further, the observed abnormal returns of the target firms
are usually much larger than those of the respective acquiring firms (see section on 'Results
for target firms', for an explanation).
These facts prompt us to analyze the wealth gain/loss t o the rivals of the target firms for
two reasons. First, if the merger indeed improves the cost-efficiency of the merged firms, we
have a well-defined industry (based on the target's line of business) in mhich t o look for the
effects on the rivals. On the other hand, while theoretically the acquiring firm should also
become a stronger cost-efficient entity after the merger, we d o not know for certain which
of its many diversified businesses is most strengthened, and therefore it is difficult t o
determine the appropriate rival firms of the acquiring firms. Second, the wealth gain/Ioss to
the rivals needs to be compared with the wealth gains of the merged entities t o reach any
meaningful conclusions. Since the acquiring firms' abnormal returns are invariably much
smaller than those of the targets, it is easier to focus on the more apparent abnormal returns
of the targets as a yardstick against which the rivals' gains/losses can be compared.
Prediction of differential gains
At this point one might hypothesize that horizontal mergers produce the most value,
followed by related, non-horizontal mergers, with unrelated mergers creating the least
amount of value. The logic behind such a hypothesis would be as follo\vs. Horizontal
mergers can be expected to have all three forms of synergy and hence to exhibit higher gains
than the related, non-horizontal mergers which d o not have the collusive synergy
component. The related, non-horizontal mergers can, in turn, be expected t o result in higher
gains than unrelated mergers which should not have any operational synergies.
The fallacy in this logic is that there is no reason t o believe that all three types of synergy
contribute equally to a particular merger, i.e. a horizontal merger generates three units of
synergy, one each of collusive, operational and financial and an unrelated merger only one
unit, that of financial synergy. This point requires elaboration. Assume that firms A and B
enter into a related merger exploiting an economy of scope. This leads to operational
efficiencies that are reflected in cost reductions. The increased profits may be represented by
$X,,.Suppose firms C and D enter into an unrelated merger where firm C infuses capital
into a project that firm D can pursue at a cost of capital significantly cheaper than what it
could obtain in the capital market. This project then leads t o an increased profit of $Y,,.
Admittedly, firms A and B may also have opportunities for resource pooling leading to a
reduction in the merged firm's cost of capital and an incremental profit of $ Y,, associated
with this financial synergy. The conventional ~ i s d o mwould suggest that:
However, this statement need not always hold true, for two reasons, First, this relation is
realistically probabilistic in nature. In other words, the expected values of the amounts on
' iil\'eare making the somewhat arbitrary assuniption that synergies are additive. This need not be so. However, the argurnent
that follows i, nor dependcnr on the fu~ictionalform of the expressioi~o n the left-hand side of the cquation as long as tile righthand side of the inequalit) has only one form of synergy.
Types of Synergy crnd Econotnic Value
127
both sides of the inequality must be considered. This by itself ma-y reverse the sign."
Second, the actual values of $X,,, $Y,, and $Y,, must be considered. If $ Y C Dhappens to
be a large number with a high probability of occurrence, then the expected value of the
synergistic gains from the merger of firms C and D may be higher than that from firms A
and B. The actual values of $X,,, SY,,, and $Y,, would depend on the scale of capital
utilization and the magnitude of cost reductions that can be achieved in the unrelated and
related mergers respectively, as discussed earlier.
The values above are absolute profits, but if the target firms in each group are roughly the
same size on average, then the quantities become commensurate with profitability and are
then directly comparable. If the returns are compared directly, and if rational behavior on
the part of the managers of the acquiring conglomerate is assumed, we would expect them
t o invest their excess capital in a project (in this case the acquisition) which would generate a
return greater than the next-best use. In a study utilizing published data there is no way of
ascertaining what alternative uses are open to the acquiring firm. We shall, therefore, leave
that as an empirical question.
Data
The merger data were gathered primarily from the Federal Trade Commission's (FTC)
Statistical Report on Mergers and Acquisitions. This report contains all completed mergers
occurring between 1948 and 1976 where the merging firms had an individual asset base of
$10 million or more. The time period examined in this study, 1969 t o 1972, was chosen on a
random basis." Initially, a sample of 157 mergers was selected with at least one of the firms
involved in the merger being present o n the Center for Research on Security Prices (CRSP)
tapes. The sample of rival firms consists of firms whose business is the same as that of the
major business of the target firm during the period of this study."
Selection of the six sample portfolios
'Product extension conglomerate mergers' as classified by the FTC were used as the starting
point for forming the portfolios of related, non-horizontal mergers. 'Other conglomerates'
as classified by the FTC were used as the basis for forming the unrelated mergers portfolios.
Reference will be made to Eckbo's (1983) study of horizontal mergers in order to compare
our results with those of horizontal mergers where collusive synergy is most likely t o be
present.
Each individual firm in our data base was scrutinized t o ensure that it met the restrictions
imposed on the sample." The firms were then examined to see if there were any events
which might bias the estimated regression coefficients which are based on a window of 200
days prior t o the announcement date of the proposed merger. The sample of mergers was,
'" Lubatkin (1983) predicts synergistic benefits based itrictlq o n the probabilities that a certain type of synergy may be present.
Wliilc the probabilities that he asiigni reflect iubjectivc points of view, we d o not take argument with thcni. Ho\\ever, we
disagree on the iimple iummation of the probabilities and the use of the resultant scores to pretlict total synergistic benefits in
eacll class.
" Michacl 1,ubatkin has pointed out to me that thesc years albo happen t o be very active in terrns of the number of antitrust
rulings. T h e elimination of these potentially colluiiic synergies actuall) helps oul- reiearch design.
'' Tllc majority of the rivals had only one line of bniincss a identified b\ the S I C codes used in the D u n arltl Bradstreet Million
Dollor Direcfo,:~.If the target firms had more than one business, then the two primary businesses Lvcre used to identify the
rivals. It was impossible t o completel) restrict the rivals to just one o r two buiineises, but even for a tlivcrsified rival, 30 per
cent o r more of its business was in the same indu5try a i that of the respective target.
" In iome cases the FTC report clas,ifie, sorne merger5 as protluct eutension mergers even though thc acquiring company mas
classified under the SIC code of 671 1 , which indicates that the firm is a holtiing company. 'hese cares were then eliminatetl
frorri the related, non-horizontal portfolio since a holding company is urilikely ro contribute an) operational iynergy t o the
target firm.
128
S. Chatterjee
therefore, as clean as possible, which is of paramount importance given the relatively small
sample that resulted from the screening procedure^.'^ It was impossible, within the scope of
this study, to obtain a similarly clean sample of rival firms. Hopefully, the large number of
the rival firms eliminates any individual idiosyncrasies during the estimation period. The
composition of the six portfolios examined are sho\vn in Table 2.
Table 2.
Composition of portfolios
Merging firms
Merger types
Related, non-horizontal
Unrelated
Acquiring firms
Target firm5
Horizontal ricala
of target f i r 111s
16
9
Methodology
The methodology used to identify the wealth gain to the stockholders
Fama et a/., (1969). First, the expected rate of return for each firm
investigation is calculated using the market model. The market model
the expected value of a firm's return based on the following regression
is that introduced by
for the period under
allows one to predict
model:
where R, is the individual firm's return and a,, is the return on a market index for the same
period. If, for any (short) interval of time, the observed return is significantly different than
that predicted by the market model, me can infer that some neu information about the
firm's future performance has reached the market during the period under study.
The daily returns of all of the firms in the sample were obtained for a period ranging from
200 days prior to the merger announcement in the Wall Street Journal (day - 199), to 50
days after the merger announcement day (day + 50). The merger announcement day was
considered to be day zero. The market model was estimated for each firm from day - 199 to
day - 50 (i.e. for 150 days) and the estimated model was used to predict the returns for each
firm from day -49 to day +50. The differences between the predicted return and the
observed return (i.e. the regression residuals) were averaged for each of the six portfolios of
firms (i.e. acquiring-unrelated, target-related, etc.). The average abnormal returns (i .e. the
average residuals were then cumulated for each day beginning with day -49 through day
+50 for the six portfolios. These cumulative average abnormal returns (CAAR) are
presented in Table 3.
RESULTS
Three of the six sample portfolios experienced statistically significant(a 5 0.01) wealth gains
during the 5-day period surrounding the merger announcement reported in the Wall Street
Journal. These were the two portfolios of target firms and the rivals of the related, nonhorizontal target firms. The two portfolios of acquiring firms and the rivals of the unrelated
target firms also experienced wealth gains, significant at the 11, 20 and 15 per cent levels of
confidence respectively. These results are presented in Table 4.
'See Lubatkin (1983) for possible ptoblems ~ r i t h'non-dean' data.
T11pe.sof Synergy cci~ciEconotllic
Table 3.
I/irille
129
Curnulat~\e a\ elage abnorrllal return5 of the six portfolios of firrni
T! pes of merger\
Related. non-hor 17ontal
Un~eiateii
-
Day>
Targets
Acq~~irlng
Rlr als
Targets
Acquiring
Rihals
Table 4. Cumulative abnormal returns* of tlre six portfolios of firms over the 5 da5.s surrounding the merger
annotlncement
Related, non-hor i7ontal mergers
Tal get
Bidder
Rhal
fi~
ins
films
firms
Abnormal
returns
0.1232
(8.693) 1
0.0167
(1.594)
0.01 16
(2.941)
Unrelateti merger\
-
-.
Tal get
lirrn~
Bidder
firms
Ri\ a1
firms
0.1748
(10.941)
0.0208
(1.291)
0.0089
(1.346)
* T h e cumulative abnormal returns represents the surn of the average abnornial returns Eroni clay 2 t o day
+2
iFigures in parentheses a r e t-slatistics.
WeaIth gain of the target firms
As explained in the research design, the wealth gains of the target firms are standardized by
the same asset base." These results, along with the wealth gains for the other categories, are
'j It inakcs more sense t o calculate the wealrll gain .ivitll respect t o niarkzr \.due. Howexer cirlce the niarket value of tile
horizontal targets in Eckbo's study \var no1 abailable, \ye are using the asset base (ah reported by Eckho, 1983:4--5) t o
standardize the wealth gains. The conclusions that are drawn a r e the saine for both nizajiirss o f iiealiti gain.
130
S. Chatterjee
presented in Table 5 , which also contains the wealth gains experienced by two samples of
horizontal mergers (one of them challenged by the antitrust authorities) as reported by
Eckbo (1983).16
Table 5.
n'ealth gains* by merger type during the 5 day, surrounding the merger announcement ($ in millions)
Target Firms
Acquiring firms
HOIirontall
Related,
Kelatecl,
nonUnnonhorizontal Unrelated, Challenged challenged horizontal
Number of firms
Unrelated
17
13
29
57
16
9
A\ erage asset b a i e l
568.54
966.67
$168.30
$65.00
$613.60
$1154.00
A\ erage market \ alue of equltl
$83.26
$64.27
$494.07
$1485.48
$8.21
$7.92
$11 65
$11.23
$19.27
$24.80
$24.00
$30.89
Average ~vealth gain
A s w base
Market \ alue
Standard~zeclaherage \+ealth galn
Asset base
Market \ alue
$16 68
$9.35
* The wealth gain is calculated o n tfie ~ o t a as\et
l
base a s well a s the niai-ket value of the firm
10 days before [he e \ e n t . '1 Coinputed from F c k b o (1983: 6-7, 14-15). f Taken frorn the E'TC report arid the Cornpustat tile except for tile horizontal mergers which h a \ e been conip~itedfrom Eckbo (1983:6-7).
It is interesting to note that the targets in unrelated mergers fared much better than did
the targets involved in related, non-horizontal mergers. On average, the target in an
unrelated merger gained 17.48 per cent during the 5 days surrounding the merger
announcement as opposed to a gain of 12.32 per cent for the targets in related, nonhorizontal mergers. After standardizing the results for size, the average related target gained
$8.21 million and the average unrelated target gained $11.65 million based on a n average
asset size of $66.67 million.
As a point of comparison, Eckbo's (1983) results are shown in Table 5. They indicate that
the average challenged horizontal target gained $42.12 million during the merger
announcement period. Since the average size of the targets of the challenged mergers in his
rtudy is $168.28 million," the standardized wealth gain for an average horizontal merger
challenged by antitrust authorities comes to $16.68 million, greater than the standardized
gain for either of the two types of target firms in this study. Evidently, if we had included
horizontal mergers in the sample of related, non-horizontal mergers, the related mergers as
a portfolio would have performed at least as well as the unrelated merger portfolio and
there would be n o anomaly with the 'related is better' hypothesis.
' T h e challenged mergers are most likely t o be collusive. T h e unchallenged mergers are included in order t o compare them with
the related, non-horizontril mergers.
" The challenged mergers conie f r o m two sa~npleh.One sample represents mergers challenged by the U.S. .Justice Department
a n d the other by the FTC. The asset siie of S168.28 million is a Lreighted average of these two sample\.
Types of Synergy and Economic Value
Figure 1.
13 1
CAAR of relatcd, non-horizontal targets
Figure 2.
CAAR of unrelated targets
Discussion of results for target firms
The nature of the scarce resource that is contributing t o the superior performance of the
targets of the unrelated mergers requires explanation. Tentatively as suggested in the section
on 'Prediction of differential gains', this resource may be the availability of capital. As
mentioned in the research design, acquiring firms with relatively large sizes were chosen for
the unrelated merger portfolios in order t o highlight the availability of capital. It turned out
132
S. Chatterjee
that the average related, non-horizontal acquiring firm is 8.6 times as large as the
corresponding average target firm, and an average unrelated acquiring firm is 14.29 times as
large as its target. The asset ratio of the acquiring to target firms in unrelated mergers is
nearly 1.5 times as large as is the ratio in the average related, non-horizontal mergers,
corresponding very closely to the relative wealth gain (1.42) of the targets in the two
samples. This seems to indicate that uhen a large firm merges with a smaller firm, the
wealth gain of the target is proportional to the relative size of the bidder t o the target. This
result is not new. Kitching (1967) found a strong relationship between successful mergers
and relative size. Biggadike (1979) also found that scale of entry into new ventures is related
to performance. These studies led Lubatkin (1983) to observe the following.
The results of both studies are contrary to the belief that it is better t o enter small,
learn as one goes, and expand the experience. It would be worthwhile, therefore,
t o develop a study that examines in more depth the issue of relative size.
Our research design and the results provide a first step towards understanding this
phenomenon. Further, given the fact that in this sample the unrelated mergers have a larger
relative size, the results are indicative of one thing: relative size may be a good proxy for
financial synergy. This is intuitively appealing but has not been examined empirically.
However, the fact that financial synergy seems t o be associated with more value than
operational synergy is counterintuitive. In the discussion below some possible reasons for
this result are explored.
Note that if a target has no potentially profitable investment opportunities, no amount of
capital infusion will generate synergy. However, assuming that the target does have such
opportunities, the only reason it would engage in a merger with an unrelated firm would be
if it cannot afford t o raise the capital itself. This might occur if small firms must pay a risk
and/or liquidity premium t o obtain funds. Williamson (1975) argues that large firms which
have proven themselves to be profitable over long time periods are required t o pay a lower
risk premium than are smaller or less well-established firms. If his argument, which is
consistent with our findings, applies in the capital market, then the easier (cheaper)
availability of capital would simply be a function of lower risk and consequently a lower
cost of capital, even within the constraints of the capital rnarket partial equilibrium model.
One interpretation of our results is that (cheap) capital is a scarcer resource than are
resources that contribute to operational synergies. This would not be very surprising if all
forms of operational synergy could be acquired at a price. In fact, when firm A buys a
related firm B, it is paying the price for being able to exploit (for instance) the economies of
scope that the combined entity will realize. Extending this example, one could argue that the
reason firm B did not acquire firm A t o exploit the same synergy is because B did not have
the capital resources needed t o undertake the acquisition. So e\en though the synergy
generated in this acquisition is operational in nature, it could be utilized only because firm A
had the capital t o buy firm B. In other words, the fundamental scarce resource is capital.
Thus, if a firm is unable to afford the price for capital itself, then it is literally impossible t o
raise the required funds regardless of the presence of other types of synergies. Capital,
following this logic, is a scarcer resource than are resources contributing to operational
synergies and the holders of capital can extract a higher price for this synergy.
This line of reasoning assumes that there exists a market for goods and services that leads
t o operational synergies. As Teece (1983) points out, houever, there is no compelling reason
for mergers to exploit these synergies. A firm can simply lease the goods and services
Types of Synergy and Econo177ic Value
133
through market contractual mechanisms instead of combining with another entity. A
merger, therefore, makes sense only if there is a market failure for this type of goods and
services. In this case our assumption that all forms of operational synergies can be acquired
at a price becomes invalid.
A second interpretation of the results is that if the market for resources contributing to
operational synergies fails, these might become as scarce as capital. Under such
circumstances as Kitching (1967) notes, operational synergies may prove difficult to
implement. This, as we have argued earlier in the discussion of a model of the creation of
economic value, reduces the impact of resources related to cost of production on value
explanations underscore the fact that, to be definitive about our results,
c r e a t i ~ n . These
'~
we have to be able to tie them to an economic theory of the diversified firm as Teece (1983)
proposes.
Finally, the superior performance of the targets of the (challenged) horizontal mergers
can also be explained by the same logic. If horizontal mergers are indeed driven by collusive
motives,Ig then the scarce resource is the market power generated by the merger. The only
difference is that market power is created artificially at the expense of the consumer. It
seems plausible that monopoly profits can be realized more rapidly than can the profits
from non-collusive synergies, since the producer has control over both the price and
production level.2"
The results for the unchallenged sample of horizontal mergers as reported by Eckbo
(1983) lend support to this argument. If unchallenged mergers represent a significantly
reduced degree of collusion, then we would expect these results to be comparable to our
related, non-horizontal sample. Their standardized wealth gain of $9.35 million justifies
this belief.
Wealth gain of the acquiring firms
The CAARs of the acquiring firms are not strongly significant, a finding which is in
accordance with almost all of the results of previous studies of mergers. However, the
absolute wealth gain of $10.25 million for the average related, non-horizontal acquiring
firm and $24.00 million for the average unrelated acquiring firm appears reasonable when
compared to the average wealth gains of the respective target firms. The lack of strong
statistical significance is possibly a reflection of the significantly larger size of the average
acquiring firm as compared to the average target firm.
Discussion of results for acquiring firms
The proportion of the wealth gain accruing to the two portfolios of acquiring firms as
shown in Table 6 highlights the nature of the scarce resource that is being utilized. The total
wealth gain is likely to be divided equally between the acquiring and target firms unless one
' ' I a m grateful t o a n anonymous referee of this journal for this sccond interpretation.
' W b ~ i o u s l y ,neither thc product extension (the related. nor)-horizontal sample) nor the unreiatcd merger classification
controls for supply-side collus~ono r monopsonic behavior by the merging partners. A l ~ o tile
, unrelated niergers cannot be
chosen s o as t o prevent all possibilities of 'multimarket contact' type collusion. However, we argue that these effects can also
be present in horizontal mcrgcrs over a n d above demand-sidc collusion. So, while \ve cannot clairn that we have controlled for
all forms of collusion, \ve can certainly claim that the degree of collusion, if any, would be much lower in our sample than in
o n e containing horizontal rncrgers.
' O As a value creating resource, market power is possibly more powerful than cheap capital which accrues t o a firm only after it
has proven itself over a period of time, if we accept Williamson's (1975) argument. The magnitude of collusive synergy is
constrained only by the collusivc arrangement, the policing costs and (at least in the U.S.) what the cartel can get away with. In
other words, a firm cannot reduce its cost of capital overnigl~t(precisely the reason why rncrgers motibated by financial
synergies take place) but a firm can literally enhance its market power overnight by a colluri\c merger.
134
S. Chatterjee
Table 6. Proportion of the total wealth gain accruing to the acquiring and target firms standardized by asset
base and market value
Related, non-horizontal mergers
Unrelated mergers
Target
firms
Bidder
firms
Target
firms
Bidder
firms
Proportion of the total gain standardized by
total asset base accruing t o
0.45
0.55
0.33
0.67
Proportion of the total gain standardized by
market value accruing to
0.55
party in the merger has greater bargaining leverage (e.g. a scarce resource which does not
depend on the other party's participation). Related complementarities can only generate
synergy out of the joint participation of both parties, and thus one would expect that both
firms should have equal bargaining power. Economic theory suggests that such a situation
should lead t o the classic bilateral monopoly solution of equal distribution of the resulting
profits in the ~ y s t e m . This
~ ' is what we observe for the portfolio of related, non-horizontal
mergers. If, however, one firm has a relatively cheap source of capital, it has a superior
bargaining position since it can simply look for alternate projects (targets) for investment if
needed. Thus acquiring firms which are motivated t o exploit financial synergies can be
expected t o gain a larger share of the total wealth generated. The results appear to bear this
Further, the opportunities open t o an acquiring firm motivated by operation synergies are
necessarily restricted t o a few target firms. But capital does not require any
complementarities between the two partners. The acquiring firm, in a financial synergy
motivated merger, ex ante has a broader selection of target firms t o choose from, and thus
has one additional degree of freedom as compared t o the acquiring firms in the operational
synergy case. Not only may the acquiring firm choose the best project (target) from a larger
group, but further it determines the absolute profitability based on the proportion of the
total profit that it is willing t o appropriate through bargaining (i.e. how cheaply can the
target be bought). Based on the model presented in the section discussing the model of the
creation of economic value, the increased opportunities may be a factor in the superior
performance of the acquiring and target firms in unrelated mergers, c e t e r i ~ p a r i b u s . ~ ~
Effect on the horizontal rivals of the target firms
The rivals of the related, non-horizontal targets gained 1.16 per cent as compared t o the
0.89 per cent gained by rivals of the unrelated targets. These results are comparable t o those
" This is just o n e of several possible solutions. For example, explicit o r implicit competition would allocate all of the wealth
gain t o the target firm (see Bradley et a / . 1983 a n d Singh, 1984). However, all the firms in this sample have only o n e bidder, s o
any competition that might be present is implicit. T h e results, therefore, should be interpreted subject t o this limitation.
" Again the other side of the coin is that the target may look for other acquiring firms w h o also have excess capital. T o make
any definitive conclusions would, therefore, require a much more careful sample selection procedure than the one used here.
T h e target, however, may not have the expertise o f the bidder in this market surveying ability (see footnote 23).
' ) T h e author is currently looking at this issue. One way t o operationalize the number of options would be competence in
choosing targets which may be related t o what Lubatkin (1983) calls experience. This competence map be reflected in the
number of previous acquisitions (experience) o r the presence of a formal acquisitions program. In this study we are simply
conjecturing that the acquiring conglomerate firrns may have more options available for investment than the related, nonhorizontal firms.
Types of Synergy and Econovnic Value
13 5 reported by Eckbo (1983).24However note that the rivals of the related, non-horizontal
targets gain more than d o the rivals of the unrelated targets while the relative gains for the
targets in the respective classes are just the opposite-unrelated targets gain 0.5 times more
than d o the related, non-horizontal targets (17.48 per cent versus 12.32 per cent).
-49 - 3 9 -29 -19
-9
1
11
21
31
41
51 -U4 - 3 4 -24 -14
-4
6
16
26
36
46 DRYS Figure 3.
CAAR of r i ~ a l sof related, non-horizontal targets
-49 - 3 9 -29 - 1 9
-9
-44 -34 -24 - 1 4
-4
1
21
11
6
16
41
31
26
36
51 46 DRYS Figure 4.
CAAR of the rivals of unrelated targets
' T h e snlall magnitudes of the percentage gains a r e not rurprising since only a fraction of all the possible rivals a r e considered.
Theoretically, the net wealth loss t o the rivals should be equal t o the wealth gain t o the target.
136
S. Chatterjee
Discussion of the results for rival firms
If we assume that the rivals in the two portfolios are roughly the same size, then given the
argu~nentsof the section on 'Effects of mergers on rival firms', the relative wealth gain
becomes an indicator of the product/factor price effect of the mergers in the two classes.
Further, assuming that the information effect is on average equally present across the two
portfolios of rivals, the lower wealth gain by the rivals of the unrelated targets can be
attributed to unrelated mergers resulting in relatively cost-efficient corporate entities than
related, non-horizontal mergers. This result corroborates the synergistic interpretation of
the higher relative wealth gain of the unrelated targets as compared to the related, nonhorizontal targets.
Again as a point of interest, note that the ratio of the wealth gains of the rivals in the two
samples is 1.31 as compared to 1.42 (in the opposite direction) for the targets in the two
respective groups. This supports the proposition that, in the absence of collusion, the wealth
gain of the targets has to be at the expense of their horizontal rivals.25Thus it seems the
rivals of the unrelated targets lose a larger portion of the gain resulting from the
information effect than the rivals of the related, non-horizontal targets. This is inferred
from the higher net wealth gain by the rivals of the related, non-horizontal targets relative to
the rivals of the unrelated targets.
CONCLUSIONS
After reviewing nearly 20 years of research on corporate acquisitions, Jensen and Ruback
(1983) observe that we are:
reaching the point of diminishing returns from efforts that focus solely on effects
of stock prices (during acquisitions). . . . Further progress will be aided by efforts
that examine other organizational, technological, legal aspects of the environment
. . . the relationship between these other factors and stock prices will be of
continuing importance to future research.
It is encouraging to note that a number of business policy researchers have taken the
pioneering role in examining the strategic variables in acquisitions. However, we feel that it
is extremely important for all researchers in this emerging area to relate their results to past
efforts. We will, therefore, try to reconcile our results with those of Singh (1984) and
Lubatkin (1984).
Singh found that the wealth gains t o related targets were higher than those to unrelated
targets. Lubatkin's results (CAR) do not show any difference between conglomerate and
two classes of related mergers (except vertical mergers). Our results indicate that unrelated
targets significantly outperform the related, non-horizontal targets.
There are subtle but important ditrerences in the research designs of these three studies
which need t o be considered before an attempt is made to reconcile the results. Lubatkin's
classification is closest to the one used in this study. However, he uses monthly data to
estimate his regression parameters. There are two basic problems with using monthly data:
(a) the long estimation period is almost certain to pick up non-stationarity in the parameters
'' 111the case of a colluding merger, t h e wealth transfer is from the consumers to the firms in the industry. In this ca5e ciN of the
firms in the industry rhould gain wealth.
Types of Synergy and Econotnic Value
137
and (b) the CARS are likely to be influenced by events which are not related t o the merger.
In a large sample these problems could occur and the results might not be seriously affected.
However when the research is directed towards examining differences in the types of
mergers, a sharper focus is required.
The fact that Lubatkin's results in three of the four groups he examines are not
significantly different may be caused by the masking effect induced by the use of monthly
data. In this study and in other policy and finance studies which use this methodology the
focus is on a single event, the announcement day, for all classes of mergers. Admittedly, by
focusing on this event we are not capturing the effect of some of the merger-related
information which is bound to be incorporated in the stock prices both before and after the
announcement day. But as has been shown in almost all of the finance studies, the bulk of
the price change is captured on the announcement day for targets. Thus we feel that by
concentrating on a single day we are eliminating spurious events which might be highly firmspecific.
Singh's methodology is essentially the same as ours but his sample differs. It should be a
relatively simple matter t o reclassify his sample according t o the other two studies in order
to reconcile the results. Further, neither Singh nor Lubatkin controlled for the speculative
element. In fact, the magnitude of Singh's results using the FTC classification is over 30 per
cent. The average CAR for tender offers is 30 per cent, while that for merger proposals is 20
per cent. There is, therefore, a strong possibility that Singh's results may be influenced by
the inclusion of tender offers. But the one common fact between our results and Singh's is
that the difference between the groups is significant.
Finally, this study is designed differently from both of the other two studies. Here the
sample is chosen t o highlight the differences in the values associated with two types of
synergy. Within these types this study uses a research design which eliminates certain
unwanted factors and emphasizes others. Therefore, apart from methodological details, the
design itself contributes to the difference in the results. The tentative conclusion is that
relative size does appear t o be an indicator of financial synergy and, within the limitations
of this study, the results indicate that if financial synergy can be fully exploited (large
relative size of the acquiring firm), then the merger-related gains appear to be greater than
those which depend primarily on operational synergies. Further, it appears that horizontal
mergers outperform the other two types of mergers. Indeed, if horizontal mergers were
incorporated in our portfolio of related, non-horizontal mergers, then the results might
have been reversed.
The effects of the mergers on the rival firms, in general, support the direction of wealth
gains observed in the different classes of merging firms. However, it should be kept in mind
that the portfolios of rival firms were chosen in a fairly crude manner and the results are at
least partially the product of ex-post screening of the sample after a trial run. This may have
induced non-randomness in the sample. However, the magnitude of the results is
comparable t o those in other studies.
FUTURE RESEARCH
Because this is a n exploratory study, its limitations should be acknowledged before
embarking further. Some of the limitations, such as sample size and length of the time
period, can be easily rectified. However, there remain other methodological and corlceptual
limitations which pose more serious challenges for the future researcher. These are outlined
below.
138
S. Chatterjee
The current level of knowledge relates merger type to performance. This study attempts
to extend our knowledge of acquisitions by relating types of resources to performance.
However, unlike a clinical study, the resources could be identified only at a broad level and
further could only be investigated by using proxies (size) and by inference (elimination of
collusion). To say the least, this is not a methodological ideal and future research will have
to find ways to more directly measure the presence of various resources. One possible way is
to supplement a carefully selected sample with clinical investigation of key data points, an
approach used by Cowling et a1 (1980).
There is a second limitation which bears mention. One of the supposed merits of a large
sample study is its generalizability. However, the results are credible only to the extent that
the hypotheses tested are rooted in a rigorous conceptual framework. The conceptual model
that we use to try to explain our results does not represent anything more than a formal
compilation of ideas from economics and business policy. We feel that a more rigorous
framework should be developed which links the potential for the creation of economic value
not only to the decision to diversify but also to the type of acquisition (related or unrelated)
and the mode (de novo or acquisition) of diversification.
ACKNOWLEDGEMENTS
I am grateful for comments made by Cynthia Montgomery, Michael Lubatkin, Rob
Kazanzian and three anonymous referees of this journal. Birger Wernerfelt, Cheenu
Balakrishnan and Carla Hayn have been very helpful in discussing the conceptual issues.
The opinions expressed in this paper and any errors remain the sole responsibility of the
author.
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Types of Synergy and Economic Value: The Impact of Acquisitions on Merging and Rival
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Sayan Chatterjee
Strategic Management Journal, Vol. 7, No. 2. (Mar. - Apr., 1986), pp. 119-139.
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[Footnotes]
3
Information and Competitive Price Systems
Sanford J. Grossman; Joseph E. Stiglitz
The American Economic Review, Vol. 66, No. 2, Papers and Proceedings of the Eighty-eighth
Annual Meeting of the American Economic Association. (May, 1976), pp. 246-253.
Stable URL:
http://links.jstor.org/sici?sici=0002-8282%28197605%2966%3A2%3C246%3AIACPS%3E2.0.CO%3B2-H
3
Pareto Optimality and Competition
Joseph E. Stiglitz
The Journal of Finance, Vol. 36, No. 2, Papers and Proceedings of the Thirty Ninth Annual Meeting
American Finance Association, Denver, September 5-7, 1980. (May, 1981), pp. 235-251.
Stable URL:
http://links.jstor.org/sici?sici=0022-1082%28198105%2936%3A2%3C235%3APOAC%3E2.0.CO%3B2-L
3
Pareto Optimality and Competition
Joseph E. Stiglitz
The Journal of Finance, Vol. 36, No. 2, Papers and Proceedings of the Thirty Ninth Annual Meeting
American Finance Association, Denver, September 5-7, 1980. (May, 1981), pp. 235-251.
Stable URL:
http://links.jstor.org/sici?sici=0022-1082%28198105%2936%3A2%3C235%3APOAC%3E2.0.CO%3B2-L
References
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Performance Differences in Related and Unrelated Diversified Firms
Richard A. Bettis
Strategic Management Journal, Vol. 2, No. 4. (Oct. - Dec., 1981), pp. 379-393.
Stable URL:
http://links.jstor.org/sici?sici=0143-2095%28198110%2F12%292%3A4%3C379%3APDIRAU%3E2.0.CO%3B2-1
The Adjustment of Stock Prices to New Information
Eugene F. Fama; Lawrence Fisher; Michael C. Jensen; Richard Roll
International Economic Review, Vol. 10, No. 1. (Feb., 1969), pp. 1-21.
Stable URL:
http://links.jstor.org/sici?sici=0020-6598%28196902%2910%3A1%3C1%3ATAOSPT%3E2.0.CO%3B2-P
Information and Competitive Price Systems
Sanford J. Grossman; Joseph E. Stiglitz
The American Economic Review, Vol. 66, No. 2, Papers and Proceedings of the Eighty-eighth
Annual Meeting of the American Economic Association. (May, 1976), pp. 246-253.
Stable URL:
http://links.jstor.org/sici?sici=0002-8282%28197605%2966%3A2%3C246%3AIACPS%3E2.0.CO%3B2-H
The Economic Effects of Federal and State Regulations of Cash Tender Offers
Gregg A. Jarrell; Michael Bradley
Journal of Law and Economics, Vol. 23, No. 2. (Oct., 1980), pp. 371-407.
Stable URL:
http://links.jstor.org/sici?sici=0022-2186%28198010%2923%3A2%3C371%3ATEEOFA%3E2.0.CO%3B2-5
Mergers and the Performance of the Acquiring Firm
Michael Lubatkin
The Academy of Management Review, Vol. 8, No. 2. (Apr., 1983), pp. 218-225.
Stable URL:
http://links.jstor.org/sici?sici=0363-7425%28198304%298%3A2%3C218%3AMATPOT%3E2.0.CO%3B2-8
The Measurement of Firm Diversification: Some New Empirical Evidence
Cynthia A. Montgomery
The Academy of Management Journal, Vol. 25, No. 2. (Jun., 1982), pp. 299-307.
Stable URL:
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Divestiture, Market Valuation, and Strategy
Cynthia A. Montgomery; Ann R. Thomas; Rajan Kamath
The Academy of Management Journal, Vol. 27, No. 4. (Dec., 1984), pp. 830-840.
Stable URL:
http://links.jstor.org/sici?sici=0001-4273%28198412%2927%3A4%3C830%3ADMVAS%3E2.0.CO%3B2-D
A Theory of Conglomerate Mergers
Dennis C. Mueller
The Quarterly Journal of Economics, Vol. 83, No. 4. (Nov., 1969), pp. 643-659.
Stable URL:
http://links.jstor.org/sici?sici=0033-5533%28196911%2983%3A4%3C643%3AATOCM%3E2.0.CO%3B2-2
Diversification Strategy and Profitability
Richard P. Rumelt
Strategic Management Journal, Vol. 3, No. 4. (Oct. - Dec., 1982), pp. 359-369.
Stable URL:
http://links.jstor.org/sici?sici=0143-2095%28198210%2F12%293%3A4%3C359%3ADSAP%3E2.0.CO%3B2-A
A Theory of Oligopoly
George J. Stigler
The Journal of Political Economy, Vol. 72, No. 1. (Feb., 1964), pp. 44-61.
Stable URL:
http://links.jstor.org/sici?sici=0022-3808%28196402%2972%3A1%3C44%3AATOO%3E2.0.CO%3B2-3
Pareto Optimality and Competition
Joseph E. Stiglitz
The Journal of Finance, Vol. 36, No. 2, Papers and Proceedings of the Thirty Ninth Annual Meeting
American Finance Association, Denver, September 5-7, 1980. (May, 1981), pp. 235-251.
Stable URL:
http://links.jstor.org/sici?sici=0022-1082%28198105%2936%3A2%3C235%3APOAC%3E2.0.CO%3B2-L
PIMS and BCG: New Horizons or False Dawn?
Robin Wensley
Strategic Management Journal, Vol. 3, No. 2. (Apr. - Jun., 1982), pp. 147-158.
Stable URL:
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A Resource-Based View of the Firm
Birger Wernerfelt
Strategic Management Journal, Vol. 5, No. 2. (Apr. - Jun., 1984), pp. 171-180.
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