Objectives of Mergers

Readers Question: Using the AOL/TW merger case study together with your experience, critically analyse the following:

The theory that mergers do not enhance shareholder value but are done in pursuit of other management objectives that are contrary to those of shareholders

This is an interesting question. You could argue mergers can benefit shareholders because the new firm will be more profitable. This is because of:

  1. Economies of scale – bigger firms gains from lower average costs. Note: this will particularly apply to horizontal mergers and in industries with high fixed costs e.g. if 2 car firms merged. However, in this case the economies of scale are limited to financial and risk bearing because it is a conglomerate merger.
  2. Market Power. The main benefit of a merger is to gain more market share. This increases a firms monopoly power and enables higher prices (this is why mergers are often regulated by government.) However, it is debatable whether this particular merger actually increases market power because the firms operate in different industries

However, it is important to bear in mind a new firm may suffer from:

  • Dis-economies of scale – a firm can get too big, unwieldy and difficult to manage (this could happen in this case)

Other Objectives of Mergers

  1. More prestige. This merger creates a media giant. Perhaps managers like the prestige of creating and working for a big company. Maybe this leads to a higher salary?
  2. Risk Avoidance. Perhaps a fledgling internet company fears being swallowed up. Certainly in 2000, many dot com firms were going to the wall. A merger might make the firm feel safer.
  3. Other Spheres of Influence. In the media world, a motive for a merger may be to create more political power and influence. For example, in Italy, Berlusconi’s media empire helped him gain political power.