Diversifications Effect on Firm Value Mergers and Acquisitions

The different rationales that drive M&amp.A actions are:
1. Growth: In a bid to expand operations, the company is faced with the choice between internal (organic) growth and growth by acquiring another business. Internal growth can be a slow and uncertain process while the acquisition is a much more rapid path to growth, though it also brings its own uncertainties. Growth may be lateral (increase in market size or share) or vertical (backward or forward integration) within the same industry or diversification into a new line of business.
2. Synergy: The word refers to the result of two factors combining to produce a result that is greater than the sum of the two, operating independently, would produce. In the corporate backdrop, it translates to the combination of two entities to produce larger profitability than the total of the two separately.
Mergers, on the basis of a diversification strategy, have also taken place and have not been successful in most instances (Gaughan, 1996). Only where the merger did not involve a movement to a very different type of business some success has been achieved (Berger &amp. Ofek, 1995).
Theory suggests that synergy is an essential ingredient for value creation to occur as a result of mergers. Synergy realization depends on the similarities and the complementarities of the two merging businesses, the extent of interaction and coordination during the organizational into the migration process, and the lack of employee resistance to the combined entity (Larsson &amp. Finkelstein, 1999). On the other hand, it is argued (Harrison et al, 1991) that similarity among resources within the acquiring and the target firm is not essential and that uniquely viable synergy might be created even where differences exist between the resources of the two companies.
The types of synergies that may be perceived in a merger are operational and financial synergies. Operational synergy may include economies of scale and economies of scope and is perhaps the soundest basis for a merger. Financial synergy is much harder to define and thus a more obscure foundation for a merger or an acquisition. Synergy may be perceived as covering additional areas, including the effect of replacing inefficient or ineffective management with a more capable one from the acquiring company (Asquith, 1983).