Measuring financial synergies in cross-border M&A transactions using diffusion processes

In a cross-border M&A framework, the question and measurement of financial synergy can be important in the analysis of the transaction and consideration needs to be given to whether the specific cross-border financial risks outweigh operational synergies. This paper develops a diffusion model to explore a set of optimal capital structures of the acquiring firm, target firm and merged firm. Differential taxes, bankruptcy costs, interest rate risk and foreign exchange risk are considerations of the model. The model results in a measure of pure financial synergy. Further, capital structure can impact on the structure of the offer and the model allows for the determination of an optimal stock exchange ratio. Worked examples reveal that the cross-border M&A of two symmetric firms can result in negative financial synergy, whereas the merger of two asymmetric firms can lead to positive financial synergy.