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Financial synergy occurs when the cost of capital of a company drops by merge or by taking over another company. The cost of capital can be reduced after a merger or acquisition. This is the case if the cash flows of businesses are not perfectly correlated and the volatility of cash flows of the company has narrowed. A lower volatility makes the company less risky for investors and hence a lower premium is questioned. This effect is also known as “debt coinsurance” (Higgins and Shall, 1975). These authors argue that there is no additional value created by financial power, but that just different distribution among the creditors and shareholders. In other words creditors get more and the shareholders less. There have been some empirical studies that confirm this hypothesis, but others contradict this. In addition to debt coinsurance, there are other benefits that large companies experienced in financial markets. For example, large companies are seen less risky than small firms, making it easier to them to access financial markets and having a lower cost of raising capital.
Finally, the fixed costs associated with the collection of capital are equal to large and small companies, but the cost per unit of capital is lower for the large companies.