The importance of targets and value creation in vertical acquisitions

• Published date: 01 June 2021
• Author: Manapol Ekkayokkaya,Krishna Paudyal
• Date: 01 June 2021
• DOI: http://doi.org/10.1111/irfi.12280

LETTERS SECTION

The importance of targets and value creation

in vertical acquisitions

Manapol Ekkayokkaya

1

| Krishna Paudyal

2

1

Chulalongkorn Business School,

Chulalongkorn University, Bangkok, Thailand

2

Department of Accounting and Finance,

University of Strathclyde, Glasgow, UK

Correspondence

Manapol Ekkayokkaya, Department of

Banking and Finance, Chulalongkorn Business

School, Chulalongkorn University, Bangkok

10330, Thailand.

Email: manapol@cbs.chula.ac.th

Funding information

Faculty of Commerce and Accountancy,

Chulalongkorn University

Abstract

We study how value creation in vertical acquisitions varies

in the importance of the target's assets to its acquirer. The

synergistic gain increases in the degree of vertical related-

ness between the acquirer and target industries. This find-

ing suggests that the importance of the target firm's assets

to its acquirer's productivity is an important value-creating

channel in vertical acquisitions. We also find evidence

suggesting that acquirers extract greater value as the syner-

gistic gain increases, consistent with an efficient investment

incentive underlying the integration decision.

KEYWORDS

synergy, vertical acquisitions, vertical integration, vertical

relatedness

JEL CLASSIFICATION

G34; L22; G14

1|INTRODUCTION

Vertical acquisitions have long been known to both practitioners and academics since 1920s (Weston, Mitchell, &

Mulherin, 2004). Grossman and Hart (1986) demonstrate that it is optimal for a party in writing an incomplete con-

tract to take ownership of, that is, integrate, relationship-specific assets if the assets are more important to its pro-

ductivity than to the other party's. Accordingly, a key mechanism underlying value creation in vertical acquisitions is

the importance of the target's assets to the acquirer's productivity. Despite its theoretical foundation and the

renown of vertical acquisitions, the empirical validity of this fundamental implication thus far appears unknown. As

Bresnahan and Levin (2013) note, a specific prediction of the theory has been subjected to only little empirical

investigation.

We explore how value creation in vertical acquisitions varies in the importance of a target firm to its acquirer. In

the Grossman and Hart (1986) model, the rationale behind integration when assets are important to the firm is that

Received: 3 February 2019 Revised: 11 May 2019 Accepted: 20 July 2019

DOI: 10.1111/irfi.12280

© 2019 International Review of Finance Ltd. 2019

636 International Review of Finance. 2021;21:636–644.wileyonlinelibrary.com/journal/irfi