In this paper a simple model of mergers in which synergies, private benefits and CEO power play a crucial role is proposed. A merger is modeled as a bargaining process between the acquiring and target board with the gains from a merger divided according to Rubinstein’s alternating-offer game with inside options. Boards consider both firm value and CEOs’ payoff. when deciding whether or not to merge. The more powerful CEOs are, the more board members consider the consequences of a merger on CEOs’ payoffs. The model determines the optimal firm scope and yields predictions that are consistent with several empirical regularities about mergers such as: (i) inefficient mergers take place when acquiring CEOs are powerful and units are not related; (ii) target shareholders are better-o. after a merger, acquiring shareholders are sometimes worse-off., and combined value is positive; and (iii) in the presence of credit constraints, acquiring firms are more likely to merge with low-productivity firms and with firms in which CEOs are less powerful.

Felipe Balmaceda