DEBT CAPACITY, DIVERSIFICATION AND CONGLOMERATE MERGERS

DEBT CAPACITY, DIVERSIFICATION AND CONGLOMERATE MERGERS * Technion-Israel The Journal oj Finance in order to achieve economies of scale and implies that mergers are more than just summing individual companies." The diversification motive suggests that by branching into different types of activity the conglomerate firm can reduce its risk. Improvements in profits from conglomerate mergers might be expected from introducing more effective management techniques. Such an improvement is likely to occur if the acquired company uses a similar production technology as the acquiring company or, if part of its operation is complementary to that of the acquiring concern. In this paper, however, our main concern is with the financial rationale for conglomerate merger. Thus, both the diversification and the economies of scale effects will be discussed from a financial viewpoint. The plan of the paper is as follows. In Section II we review the two major theories which focus on the financial variables as means for explaining and rationalizing conglomerate mergers. In Section III we describe the objective function of a firm which is considering the possibility of acquiring another firm. This function is based on a utility function which incorporates explicitly both the synergistic and diversification motives. This utility function is not continuous http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Finance Wiley

DEBT CAPACITY, DIVERSIFICATION AND CONGLOMERATE MERGERS

The Journal of Finance, Volume 28 (5) – Dec 1, 1973

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Publisher
Wiley
Copyright
1973 The American Finance Association
ISSN
0022-1082
eISSN
1540-6261
D.O.I.
10.1111/j.1540-6261.1973.tb01456.x
Publisher site
See Article on Publisher Site

Abstract

* Technion-Israel The Journal oj Finance in order to achieve economies of scale and implies that mergers are more than just summing individual companies." The diversification motive suggests that by branching into different types of activity the conglomerate firm can reduce its risk. Improvements in profits from conglomerate mergers might be expected from introducing more effective management techniques. Such an improvement is likely to occur if the acquired company uses a similar production technology as the acquiring company or, if part of its operation is complementary to that of the acquiring concern. In this paper, however, our main concern is with the financial rationale for conglomerate merger. Thus, both the diversification and the economies of scale effects will be discussed from a financial viewpoint. The plan of the paper is as follows. In Section II we review the two major theories which focus on the financial variables as means for explaining and rationalizing conglomerate mergers. In Section III we describe the objective function of a firm which is considering the possibility of acquiring another firm. This function is based on a utility function which incorporates explicitly both the synergistic and diversification motives. This utility function is not continuous

Journal

The Journal of FinanceWiley

Published: Dec 1, 1973

References

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