What will happen if I do not attack Sephiroth on the final battle?

Solution 1:

Sephiroth attacks Cloud, but doesn't kill him. Cloud automatically counters, and Sephiroth dies.

What's actually happening is that Sephiroth's AI script has him target cloud with an attack that deals 31/32 Current HP damage to Cloud, and then directly commandeers Cloud to use a simple attack (AI scripts can actually directly control other battle actors - this is how Ruby weapon's tentacles work). This will always kill Sephiroth (as Sephiroth has 1 HP), but even if not, the AI script will run an attack called 'done in' on Sephiroth that makes the camera zoom in on the target and makes our villain double over.

Interestingly, 'done in' is set as an automatic counter on any type of attack, so using a GameShark to give Cloud the 'sense' command means you can kill Sephiroth just by scanning his stats (which read Level 50, HP 1/1).

Another piece of trivia: the model of Cloud Strife used for this battle is actually more detailed than the typical battle model - it has more polygons.