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

• 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)

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

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

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

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