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 inability to finance marginally profitable projects as stand-alo nes due to agency problems. A conglomerate merger is a technology that allo ws these projects to survive a period of distress. If profitability improve s, the financing synergy ends and the acquirer divests the assets. Our theo ry reconciles two seemingly contradictory empirical findings. Mergers incre ase the combined values of acquirers and targets by financing positive net present value (NPV) projects that cannot be financed as stand-alones. At th e same time, because these projects are only marginally profitable, conglom erates are less valuable than stand-alones.