CO-INSURANCE AND CONGLOMERATE MERGER.

Theoretical analysis of mergers has a great deal of significance independent of the fact that, when markets are perfect and in equilibrium, incentives for further merger activities are, by definition, exhausted temporarily. Two originally separated gases in a closed container will get mixed up and reach an equilibrirum state after one removes the partition. But that is hardly any reason for neglecting the investigation of how and why they get mixed up. It is in light of this observation that an attempt is made in the present article to reexamine a purely financial rationale for merger, which has already attracted a lot of attention in the finance literature. By drastically simplifying our considerations, we are able to arrive at three general conclusions on the basis of structured models. First, co-insurance, one of the many things that take place in a merger, has a cost and benefit structure to an equity class that can in principle be delineated. The pure cost of co-insurance to an equity class, if perceived, consists of that part of the expected residue used to subsidize the loan class of the other firm at the pre-coinsurance rate when default occurs in the latter. The pure benefit of co-insurance to an equity class is made possible by the concessions, if any, in contractual loan rates of both firms following the co-insurance. It is argued that the source of this benefit is a far cry from that resulting from preferential tax treatment of the allegedly enlarged "debt capacity" (however defined) of the participating firms. Second, residue redistribution effect in a merger must not be ignored. The simple but essential point is that it, again largely a matter of perception, may be regarded as working for or against the interest of a particular equity class. To that extent, therefore, any conclusion based on co-insurance effect alone is weakened. Third, to dispose of the misplaced emphasis on statistical correlation of revenues, it is reasoned that the really... [ABSTRACT FROM AUTHOR]