Why Do Firms Merge and then Divest? A Theory of Financial Synergy

This article develops a theory of mergers and divestitures. The motivation stems from an inability to finance marginally profitable projects as stand-alones due to agencyproblems. A conglomerate merger is a technology that allows these projects to survive a period of distress. If profitability improves, the financing synergy ends and the acquirer divests the assets. Our theory reconciles two seemingly contradictory empirical findings. Mergers increase the combined values ofacquirers and targets by financing positive net present value (NPV) projects that cannot be financed as stand-alones. At the same time, because these projects are only marginally profitable, conglomerates are less valuable than stand-alones