When one company merges with another, common business wisdom suggests that the newly combined firm has a lower risk of going into default, because the transaction gives the merged corporation greater diversity than the two individual participants. But according to a study by Craig Furfine, a clinical professor of finance at the Kellogg School of Management, and Richard Rosen, of the Federal Reserve Bank of Chicago, that common wisdom is wrong. “On average,” Furfine says, “acquiring firms become riskier post-merger.”
“The natural intuition that many people would have is that when you combine two firms, the differences between the two firms would tend to make the combined firm safer through diversification,” Furfine explains. “This is not what happens in practice.”
The study goes beyond that counterintuitive conclusion. It also highlights possible reasons for it. “Our evidence suggests that managerial motivations may play an important role,” the two researchers write. “[T]he increased default risk may arise from aggressive managerial actions affecting risk enough to outweigh the strong risk-reducing asset diversification expected from a typical merger.”
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