Theories Of Synergy Theory

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One of the theories used to explain why firms engage in M&A is the synergy theory. Synergy theory or hypothesis asserts that the sum value of both individual firms before an M&A is lower than that of the combined firm (Seth, 1990). This increase in value is due to the effect of the synergy potentials which could only be realized by combining operational and financial resources of both firms. These synergies present the extra value created by merger. Thus, creating value for shareholders that at least equates or exceeds the cost of the acquisition should be the primary objective of any M&A. Essentially, synergies should be the sole principle in justifying companies to engage in M&A. In theory, financial synergy of a merger is realized when …show more content…

No private assumption on the value of a company is given. Oftentimes, this is not the case. The Harris poll published in 1984 suggest otherwise. According to the Harris poll, only 32 percent of the surveyed executives thought that the stock market correctly value their companies’ price, while 60 percent disagreed and felt that their companies are undervalued (Harris poll, 20 February 1984). This private assumption of fair price could easily find its way onto the M&A negotiation table. Therefore, another theory- the valuation theory- is also used to analyze how M&A could create value for the shareholders. The valuation theory states that the managers of the acquiring firm may possess more knowledge of the target firm than what actually is being valued through the price of stock in the market (Trautwein, 1990). The knowledge, termed asymmetric information by Ravenscraft and Scherer (1987), could include an undervaluation of the target firm, or an unbeknownst advantage in the event the two firms are combined. While the later statement is more or less in alignment with the synergy theory, the mentioned synergy here has not been fully evaluated by the market. The former suggests that a discrepancy between market value and private assumption on the price of a target due to undisclosed asymmetric information. Both can put the price of acquisition at market value but well below its true value. Valuation theory suggested that once the target firm become acquired part of the acquiring firm and the asymmetric information is fully disclosed, the shareholders would experience an immediate wealth effect due to revaluation of the market based on the newly available

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