Who Should Merge with Whom? Financial Benefits and Costs from Mergers and Acquisitions

Who Should Merge with Whom? Financial Benefits and Costs from Mergers and AcquisitionsMergers and acquisitions are prominent forms of transactions that combine two firms in a way that one unit with a new asset and a new liability side arises. Since both the equity and the debt positions of the merging entities are affected by such a deal, it is not clear whether positive synergies are equivalent to an improvement of the acquirer equity holders' position, who initiate the takeover decision. We introduce a frictionless, continuous-time model to compute the financial costs for the acquirers' equity value, when carrying out a zerosynergy takeover. This allows us to identify the characteristics of potential target companies that are especially well-suited to reduce these financial costs (and thus make a deal worthwhile for given synergies). We find that firms should consider targets having about the same business risks and relatively low debt ratios. While targets are supposed to be small in mergers, they can also be comparably large in debt financed acquisitions. Empirical observations support the relevance of the wealth effects of the debt position suggested by the model and additionally reveal that the acquirers' debt position is affected in different directions depending on whether a merger or an acquisition takes place. (JEL G32, G34