Abstract

Multiple activities may be separated financially, allowing each to optimize its financial structure, or combined in a firm with a single optimal financial structure. We consider activities with nonsynergistic operational cash flows, and examine the purely financial benefits of separation versus merger. The magnitude of financial synergies depends upon tax rates, default costs, relative size, and the riskiness and correlation of cash flows. Contrary to accepted wisdom, financial synergies from mergers can be negative if firms have quite different risks or default costs. The results provide a rationale for structured finance techniques such as asset securitization and project finance. DECISIONS THAT ALTER THE SCOPE of the firm are among the most important faced by management, and among the most studied by academics. Mergers and spinoffs are classic examples of such decisions. More recently, structured finance has seen explosive growth: Asset securitization exceeded $6.8 trillion in 2004, and Esty and Christov (2002) report that in 2001, more than half of capital investments with costs exceeding $500 million were financed on a separate project basis. 1 Yetfinancial theory has made little headway in explaining structured finance. Positive or negative operational synergies are often cited as a prime motivation for decisions that change the scope of the firm. A rich literature addresses the roles of economies of scope and scale, market power, incomplete contracting, property rights, and agency costs in determining the optimal boundaries of the firm. 2 But operational synergies are difficult to identify in the case of asset securitization and structured finance.

Citations