The managers of Firm A recommend that Firm A purchase Firm B because the purchas

Question

The managers of Firm A recommend that Firm A purchase Firm B because the purchase will diversify the business of Firm A. Diversification of risks is a desirable strategy for individual shareholders, but if shareholders can diversify their risk by holding stock in Firm B, is there any reason for Firm A to purchase Firm B? Suppose labor turnover is costly, could that provide an efficiency saving to support the proposed purchased? (Hint: If output is less variable, labor employment can be steadier.)

Explanation / Answer

now as the diversification brings in more labor cost, we can estimate the risk by the extra revenue that is brought by the diversification. If shareholders can diversify the risk by holding shares in firm B, the reason for firm A to purchase firm B can be that the diversification brings in extra revenue than the extra cost and so the profit will increase and also that firm B is owned, then the majority of shares of firm B will be with firm A and so it increases its efficiency.

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