Acquisitions in the U.S. Economy: An Aggregate and Historical Overview.” In A. Auerbach, ed. Mergers and Acquisitions, 25–47, Chicago: University of Chicago Press, 1988.
W. T. Grimm & Co. and Houlihan Lokey Howard & Zukin, Mergerstat Review, Chicago and Los Angeles (various issues 1988–1999).
Mergers & Acquisitions (various issues 1989–1999).
Thomson Securities Data Corp., Mergers & Acquisitions Database.
Wave 2: 1925–1929
Vertical combinations characterized this wave as firms sought to integrate backward into supply and forward into distribution of their core businesses. Stigler (1950) called it a period of “merger for oligopoly.” Large public utility holding companies emerged on the business landscape. The U.S. government increased its antitrust enforcement following the passage of the Clayton Act. The wave coincided with a boom in stock market prices and volume that began following the recession of 1923 and ended with stock market crash in 1929.
Wave 3: 1965–1970
In the context of heightened antitrust enforcement to limit horizontal combinations, firms turned to conglomerate or diversifying combinations in this wave. Activity was especially concentrated among a group of conglomerates and oil companies. The wave coincided with a strong economy and bull market in the 1960s. Antitrust enforcement against the rise of conglomerates marked the peak of this wave.
Wave 4a: 1981–1987
The popular hallmarks of this wave were larger deals involving more hostile takeovers, more leverage, and more going-private transactions than previous waves. However, the activity was very broad-based, touching virtually all sectors of the U.S. economy, and dominated by combinations among small and medium-sized firms. The Tax Reform Act of 1986 may have contributed to the boom in M&A activity as tax changes took effect. This wave featured the appearance of financial and international buyers as more significant players than ever before. The complexity of transactions increased in concert with growing capital market innovation and sophistication. This was a period of generally falling interest rates and rising stock prices.
Wave 4b: 1992–2000
Following the 1990–1991 recession, M&A activity increased briskly in all segments of the economy and all size categories. The announcement of a few large deals signaled to some observers a “paradigm shift”3 in M&A where old rules about strategy, size, and deal design were being replaced by new rules. Of general note was the significance of “strategic buyers” who sought to combine with targets who were related along business lines, and with whom synergy value might be created. The superior economics of strategic combinations dampened somewhat the influence of financial buyers (i.e., LBO specialists). Of special note was the high M&A activity in banking, health care, defense, and technology. This sector-focused activity was a response to overcapacity as the industry was deregulated (banking), as national defense spending declined, and as the payment patterns by insurers changed (health care). In technology, the high rate of activity was stimulated by rapid invention and technological change. Finally, the high rate of M&A activity coincided with historically low rates of interest, and rising stock prices. As Exhibits 4.1, 4.2, and 4.3 reveal, the M&A activity in the most recent wave far exceeded any levels seen previously, with transaction values rising to about 15 percent of the U.S. gross national product (GNP) in 1999. Following the bursting of the Internet bubble in March 2000, M&A activity declined sharply, in tandem with the stock market and the U.S. economy, and in conjunction with the rise of global economic and security concerns.
This review of the four waves reveals much more about their differences than similarities. What they seem to bear in common is low or falling interest rates, a rising stock market, and an expanding economy. But they differ sharply in industry focus (e.g., oil, banking, utilities, Internet, conglomerate, etc.), in type of transaction (e.g., horizontal, vertical, conglomerate, strategic, or financial), in the presence or absence of hostile bids, in industry breadth, in breadth of deal size, and in the role of large blockbuster deals. Merger activity appears to slow down when the cost of capital increases, as measured by real interest rates. Studies4 show that M&A activity is countercyclical to bond yields. More generally, merger activity increases with the level of overall economic activity, as measured by nominal GNP; see Golbe and White (1988).
On close examination, there appears to be an industry-based pattern to the waves of M&A activity. The Mergerstat database suggests that in 1998 and 1999 the most active 14 percent of industries accounted for 60 percent of all M&A deal value. In the period 1995 to 1998, financial services accounted for 22 percent of all M&A value. In 1981 to 1984, oil and gas accounted for 25 percent of all transaction value.
EXPLANATIONS OF M&A ACTIVITY
What drives these waves of M&A activity, creating “hot” and “cold” markets for firms? What causes some industries to grow hot and others remain cold? Research lends some speculative answers to these questions. The explanations should be approached with caution since they are not mutually exclusive and more research remains to be done. But these ideas can help the practitioner frame a view about M&A activity, and thus more ably interpret events and opportunities as they appear. While some of these explanations are stronger than others, they all offer a useful perspective on the activity we observe.
Hubris
The first explanation for M&A activity lies in managerial psychology. Richard Roll (1986) suggested that the urge to merge is driven by pride, or hubris, in the face of considerable evidence that earning supernormal returns from acquisitions is difficult. Roll notes that the negative returns following mergers are well known. Only an irrational belief that your deal will be different could prompt you to strive where others have failed. Popular accounts of particular deals or deal makers would seem to support this view (see, for instance, Bryan Burrough and John Helyar’s classic 1990 account of the RJR Nabisco LBO, Barbarians at the Gate). The hubris of the rich and famous is a timeless theme, certain to sell books. And it is timeless for a very good reason: we benefit from the reminder that hubris undercuts rational analysis and self-discipline.
But the hubris hypothesis for M&A activity says too much and too little. It says too much in the sense that hubris could be used to explain most business failures. For instance, something like 70 percent of all new businesses fail within three years. Drug companies spend millions of dollars annually most of which hits dead ends. The revolution of digital computing has left countless failed firms in its wake. The odds of success are low in business start-ups, drug discovery, and technological innovation, and it takes an entrepreneur with at least a modicum of hubris to press ahead. We applaud hubris in these cases because it advances the welfare of society through the discovery of new products and markets. Isn’t M&A a discovery process as well? If hubris were to be the dominant explanation for M&A activity, it would need to explain the appearance of merger waves and the clustering of merger activity by industry.
Hubris says too little in that one wishes it had more prescriptive content. It urges us to avoid managerial irrationality, and warns that if we fail to do so, markets will judge accordingly.
