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IAI Actuarial Core Principles · Business Finance · Corporate growth, restructuring and divestment

Which statement about diversification as a motive for a conglomerate merger is most accurate from the viewpoint of a well-diversified shareholder in the acquirer?

Corporate diversification adds little value for a well-diversified shareholder, because investors can spread risk across many shares themselves at lower cost than a firm can by acquiring unrelated businesses. It does not remove systematic risk or guarantee synergies.

  1. AIt creates value because the shareholder can no longer diversify alone
  2. BIt adds little value because shareholders can diversify their own portfolios more cheaplyCorrect
  3. CIt always reduces the cost of capital of the combined firm
  4. DIt guarantees positive synergy from cross-selling
  5. It removes all systematic risk from the combined firm

Explanation

Investors can hold shares in many companies at low cost, so corporate diversification alone gives them little benefit. Systematic risk cannot be diversified away, and no synergy or lower cost of capital is guaranteed.

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