The theory of mergers and divestitures is developed in this article. This theory does not depend on taxes or the enormous surpluses of the buyer. The inability of short-term projects or marginally profitable companies to finance themselves as independent entities due to problems caused by action between managers and potential debt holders is cited as the motivation for mergers. The good performance of previously marginally profitable projects allows for subsequent sale. There are two prerequisites for this theory to be applicable. One is that financial difficulties must be experienced by one of the merging companies and the other is that there must be serious agency problems between the directors and beneficiaries of the company in difficulty. Therefore, this theory is more applicable to mergers in which one of the merging companies faces difficulties in cash flow verification and is small in size. Say no to plagiarism. Get a tailor-made essay on “Why Violent Video Games Should Not Be Banned”? Get an original essay It is well known that positive net present value projects can be denied financing when cash flows can be manipulated by management. Marginally profitable firms are sometimes unable to support outside capital since the manager's incentive constraints require that he receive a share of the project's cash flows. Thus, a merger can serve as a tool for these companies to survive their difficult times because the merged entity can raise full financing more easily than a standalone entity. Shareholder value increases according to the authors' theory and empirical evidence, as mergers allow marginally profitable firms to obtain financing. However, this financial synergy may not last. Once the project has reached a stage where it can raise funds on its own, there are coordination costs associated with mergers. This encourages companies to disengage. This article measures the vertical relationship between two merging firms using industry raw material flow information in the input-output table. A merger is classified as a vertical merger when one firm can use the services or products of others as an input to its final output or its output constitutes the input of the other firm. A significant positive wealth effect is generated by vertical mergers. Over the three days surrounding the merger announcement, the average combined wealth effect is about 2.5%. The paper measures the vertical relationship using a cross-sector vertical relationship coefficient. The merger is qualified as a vertical merger if the coefficient is greater than 1% (lenient criteria) or 5% (strict criteria). Furthermore, firms that exhibit a vertical relationship with the lenient criteria (1%) and belong to different IO industries are identified as pure vertical mergers by the author. To measure the wealth effect of mergers, the authors use the CRSP value-weighted index as a market indicator..