ON REAL EFFECTS OF FINANCIAL SYNERGIES

The thesis investigates the impact of endogenous financial synergies on the product market behavior of merging firms. Examining a diversifying merger of risk-neutral firms in unrelated product markets, it finds that purely financial synergies have surprising real effects on output of merging firms that can harm and benefit consumers. Seemingly innocuous financial aspects of mergers and acquisitions that cause financial synergies are therefore important for the assessment of unilateral effects by competition authorities. The structure of the analysis and its essential results are summarized as follows. Chapter 2 presents a careful survey of causes and real effects of operational and financial synergies. Operational synergies arise because of scope economies, internal capital markets, anti-competitive strategies and operational cost of risk, while financial synergies are caused by limited liability, distress cost and corporate taxation. Real effects of operational synergies are well-understood, but the nature of real effects associated with financial synergies is still unknown. Chapter 3 thus introduces a model for the analysis of real effects associated with several different flavors of financial synergies. Endogenous financial synergies arise in the context of a diversifying merger of an arbitrary number of risk-neutral quantity-setting monopolists who exhibit normally distributed cash flows and operate in completely unrelated product markets. Comparison of firm values and output before and after the merger allows examining the implications of financial synergies and associated real effects for firm owners and other stakeholders like, customers, suppliers and tax authorities. The model's distinctive feature is its simplicity: a single period, risk-neutrality, symmetric information, no agency-problems and observable cash-flows. Three causes for financial synergies are examined in this model. Chapter 4 examines limited liability, which means firm owners are not liable for more than what they invest in a corporation. The limitation of liability allows owners to externalize losses of their business. Since the merger reduces the amount of losses that can be externalized, the value of financial synergies is negative. The first novel insight of this thesis is that such financial synergies have a negative real quantity effect, as output is strictly lower after the merger. Since both consumers and firm owners are worse off if firms merge, their preferences over the merger are aligned, and there is no rationale for policy intervention. Chapter 5 investigates costs that arise if the value of a firm's assets falls below a threshold that triggers distress, as, for example, bankruptcy costs. Since total expected costs of distress are strictly smaller after a merger there is a positive financial synergy. Yet, whereas financial synergies depend on the cumulative probability of distress that is strictly lower after the merger, real effects depend on marginal distress cost which may be higher. In other words, if firms merge to reap the benefits of a positive financial synergy output can decrease another novel result. Preferences of consumers and firm owners over the merger are not necessarily aligned, if output is lower after the merger there is a rationale for merger regulation. Chapter 6 discusses asymmetric corporate taxation, which means a firm's profits and losses are treated differently by tax authorities. Asymmetric proportional tax tariffs observed in reality imply a positive financial synergy, as the total expected tax payment after the merger is lower than before. Such synergies have positive real quantity effects, so that preferences of firm owners and consumers are aligned, but there is an interesting conflict between tax and competition authorities. The analysis discovers a wealth of positive and negative real effects associated with financial synergies, and these findings relate to at least three different literatures. First, they contribute to the literature on endogenous financial synergies by showing that such synergies affect the real behavior of firms. Second, results contribute to research on the interaction between a firm's financial constitution and its product market behavior by extending the analysis to diversified multi-product firms. Third, results add to the literature on firm behavior under uncertainty by showing that the paradigmatic conjecture that uncertainty has no impact on risk-neutral firms is not very robust to slightly more realistic assumptions about the financial constitution of firms.