Discuss the pros and cons of diversification as a rationale for mergers.

Discuss the pros and cons of diversification as a rationale for mergers.

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June 8, 2021
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Discuss the pros and cons of diversification as a rationale for mergers.

Answer and ExplanationSolution by a verified expert

Explanation

Pros:

Diversification helps in stabilizing the earnings and cash flows of the company. A company with a diversified business portfolio is less prone to the variations in profits due to the business cycle.
Diversifying the business into various sectors helps in the expansion of the parent company as a conglomerate.
The combined R&D and talent pool may lead to the development of breakthrough technology and processes that result in cost reduction and high profits in addition to the betterment of society as a whole.

 
Cons:

Shareholders who want the exposure to different sectors can directly buy the shares of companies working in that sector. Mergers take a lot of time and money, which results in the reduction of shareholders' value.
Acquiring company's management devotes a lot of its time to completing the merger and making it successful. This time can be better utilized by focusing on the critical areas of the company.

It is often seen in a diversified merger that the combined value of the parent company is significantly less than the sum of its constituent companies if added separately. This is because the parent company's management lacks expertise in running the various businesses.

Verified Answer

Pros:

The company's earnings stabilize.
The business of the company expands into multiple sectors.
The conglomerate benefits from the R&D and talent pool of its various constituent companies, resulting in synergistic gains.

 
Cons:

Shareholders can directly buy shares of various companies to diversify their portfolio.
The time devoted by the management to completing the merger can be used to generate profits.
Diversified mergers are often not successful due to a lack of managerial and operational expertise in the field.

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