Quantifying Operational Synergies in a Merger/Acquisition

Merger and acquisition activity has increased sharply in the last decade. While the shareholders of the target firms appear to reap economic benefits from mergers, those of the bidder firms often do not fare well. In such an environment, it seems useful to have models that can help senior managers of bidder firms make informed decisions about the amount of premium, over target’s share prices prevailing prior to merger announcement, that can be justified on the basis of operational synergies. The goal of this article is to capture important parameters from the production side that have a bearing on the valuation of target’s shares. We show that the production characteristics of both the bidder and the target matter in a significant way. For example, if the bidder and target operate in independent markets, bidder has flexible production facilities, but target’s production facilities are inflexible, then an increase in the bidder’s demand can make the target less attractive, and lower the value of operational synergy.