The question reads: Is the following statement correct: “The merger will result in lower risk for our shareholders because of diversifacation effects.” The answer says this is not correct because “diversification by itself does not lower rirsk for shareholders.” I don’t agree because non-systematic risk can be diversified away. Only systematic risk cannot be diversified away. However, I do agree that it is cheaper for a shareholder to diversify his own portfolio, but that is not the question the book asks. Will someone please comment? Thanks.
Interesting, at first blush I almost agree with you and might have answered that it does reduce risk. Upon reflection the answer is more opaque. Let us assume the merger is two disparate businesses and that post merger, if both firms operate as one and synergies exist by a lower cost of capital and other synergies, then it is possible that the merger has also lowered risk. A vertical merger while reducing costs, will increase your exposure to industry up and down cycles, not reducing risk but exacerbating it. So a newspaper buying another newspaper is increasing risk, while a on-line job site being bought might be considered reducing it. Diversification does lower risks for portfolios though, if they are carefully constructed.