This article presents a study to verify the common belief that mergers create value for shareholders. There is dilution in the earnings for both the target and the acquiring company immediately after the merger, but studies show that when there is a merger between two profitable companies, both companies experience an accretion in the Market Price Per Share (MPS).

Merger generally means a transaction among two or more existing companies to form a new economic unit. The apparent reason for companies to merge is to make profits larger than the joint profits of the merging companies. Theories hold that mergers and amalgamations have potential social benefits. They generally improve the performance of incumbent management or infuse a form of synergy. Related corporate finance theory states that the method of payment used in a merger may influence the returns to the stakeholders of both the acquiring and the acquired firms. However, in the process of maximizing returns to the shareholders, companies at times end up paying excess premium, which results in earnings dilution. Some of the empirical studies reveal that the acquirer may suffer from initial earnings dilution as well as possible initial market price dilution. This is relevant in cases where the P/E ratio of the target company is higher than the pre-deal P/E ratio of the acquirer. It becomes more apparent when the merger involves exchange of shares. George E Pinches (1968)1 has found that the earnings available to the equity owners of the acquiring firms are slightly higher for majority of the firms employing convertible preferred stock as compared to the returns from common stock merger, which usually results in immediate earnings dilution. John SR Shad (1969)2 has shown that in stock-for-stock exchange, the seller will gain 20% in market value and 30% in dividend value. But for the buyers there is a dilution of 19% in both current earnings and book value per share on the additional shares to be issued. The main reasons for dilution are buyers outnumbering sellers, synergistic aspects of some mergers and favorable growth prospects of sellers. John Lintner (1971)3 has stated that, in all equity mergers, the earnings per share of the acquiring company increases automatically, if the company’s P/E ratio is higher than that of the acquired firm, even though there is no increase in combined total earnings or accounting manipulations.

Much of the business finance is directed at maximizing shareholders’ wealth through synergy. Synergy can be achieved through merger as it allows entry into new product lines, which changes the level, stability and cyclical nature of the firms’ profitability.

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