Mergers tend to come in waves and cluster by industry suggesting that they are

Mergers tend to come in waves and cluster by industry

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Mergers tend to come in waves and cluster by industry, suggesting that they are largely driven by real changes in economies of scale and scope Steven Kaplan: “a general pattern emerges from these studies. It is striking that most of the mergers and acquisitions were associated with technological or regulatory shocks.” There has been a trend away from diversification mergers (wave in ‘60s) and hostile mergers (wave in ‘80s) (Source: Andrade, Mitchell and Stafford, 2001, “New Evidence and Perspective on Mergers.” Journal of Economic Perspectives)
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What does the empirical evidence show? “Ultimately, what the evidence shows is that it is hard for firms to consistently make investment decisions [i.e., acquisitions] that earn large economic rents, which perhaps should not be too surprising in a competitive economy with a fairly efficient capital market.” -Andrade, Mitchell and Stafford (2001) 40
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A concluding thought on mergers Akerlof’s theory of asymmetric information Key observation: in many markets, the seller has “private information” about the good being sold, i.e. information that the buyer does not know Examples: future profitability of an acquisition candidate, quality of a used car, riskiness of an insurance candidate, Sometimes it is possible to credibly eliminate the information asymmetry Ex: get a 3 rd party mechanic to certify the condition of the car, undergo a physical before getting life insurance But if not, this asymmetric information can cause markets to break down … Really, should cause markets to break down, because buyers should be especially wary of buying from a seller willing to sell 41
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A concluding thought on mergers Akerlof’s math is so simple and groundbreaking that I want to go through a quick example TargetCo has a standalone value of $100M+ X Value of TargetCo to AcquirerCo is $100M + 1.5 X Efficiency dictates that the acquisition should happen for any X Information: TargetCo knows X. AcquirerCo only knows that X is between $0M and $100M. Thinks all values equally likely (“uniform distribution”). That is, information is asymmetric Can trade occur? 42
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A concluding thought on mergers Consider a price of $100M + P When is the seller willing to sell at that price? Answer: when X < P Akerlof’s key insight: given which sellers are willing to sell at $100M + P , what should be Acquirer’s estimate of the value he will get when he buys at $100M + P ? He will get to buy when X is between 0 and P He won’t get to buy when X is between P and 100 On average, when he buys, X is P/2 So, the value to the Acquirer when the price is $100M + P is $100M + 1.5( P/2) = $100M + 0.75P. Which is LESS than the purchase price! So, trade should break down … Broader lesson: when buying, ask yourself who’s selling, and what they might know that you don’t … 43
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