Synergies and Internal Agency Conflicts: The Double-Edged Sword of Mergers


  • Hodrick gratefully acknowledges research support from the Lynde and Harry Bradley Foundation and the National Science Foundation through a Presidential Young Investigator Award. The comments of an anonymous referee, an associate editor, and seminar participants at Columbia, Dartmouth, CEPR symposium at Gerzensee, HEC at Jouy-en-Josas, IGIER at Bocconi, Northwestern, Ohio State, Stanford, the Universities of Amsterdam, California (Berkeley), Chicago, Florida, Michigan, Naples, North Carolina, Southern California, Turin, and Washington (Seattle), and the Meetings of the Western Finance Association, especially Eli Berkowitch, Harry DeAngelo, Bob Hodrick, Colin Mayer, Mark Mitchell, and René Stulz are gratefully acknowledged.


This paper investigates the interaction between synergies and internal agency conflicts that emerges endogenously in multi-division firms. A divisional manager's entrenchment choice depends directly on the specificity of her division's assets, because the specificity governs whether entrenchment activities reduce the likelihood of her division being divested. The presence of synergies, by modifying the difference between the value of assets in their current use and in alternative uses, may alter the divisional manager's entrenchment incentive. In “the double-edged sword of mergers,” synergy and internal agency effects are of opposite sign and merger gains may not be increasing in expected synergies. We characterize when divisions should optimally stand alone and when they should be part of a merged firm. We predict an absence of diversifying mergers in industries plagued by misdeployed assets, offer a novel explanation for the cross-sectional variation in postmerger valuation, and explain why mergers may be valuable ex ante while leading to successful divestitures ex post.