Applied Mergers and Acquisitions. Robert F. Bruner

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theory of industry shocks is appealing, not only because it can rationalize merger waves (e.g., caused by large-scale shocks), but also the clustering of M&A activity within industries or regions (e.g., caused by more focused shocks). Finally, this theory can embrace a wide range of possible drivers, including globalization, trade liberalization, changes in tax, accounting, government regulation, and antitrust policy; see, for instance, Ravenscraft (1987). Several empirical studies support the notion that industry shocks drive M&A activity. Mitchell and Mulherin (1996) found that in the 1980s merger wave, industries with the greatest amount of takeover activity were those that experienced fundamental economic shocks like deregulation, technological innovation, demographic shifts, and input price shocks. They wrote:

       Our work also has implications for interpreting the effect that a takeover announcement for one firm in an industry has on the equity value of other industry members. Because we find that takeover activity has industry-driven factors, our results imply that one firm’s takeover announcement gives information about other industry members that may be tied to economic fundamentals rather than market power, as is often asserted by regulators. Some observers express concern that takeovers are too often followed by business failures. Because we find that takeovers are driven in part by industry shocks, it is not surprising that many firms exhibit volatile performance following takeovers, with actual failures following some negative shocks. Rather than being the actual source of performance changes, the takeovers are often merely messengers of the underlying economic changes taking place in the industry. (Pages 195–196)

      Schoenberg and Reeves (1999) identified the most important determinants of industry merger activity as being, in order: deregulation, industry growth rate (higher growth attracts more acquisitions), and industry concentration (lower concentration attracts more acquisitions). Jovanovic and Rousseau (2002) have argued that large technological change and M&A activity are associated. They studied the waves of the 1890–1930 and 1971–2001 and conclude that the former was significantly associated with the diffusion of electricity and the internal combustion engine and the latter with the diffusion of information technology. Mitchell and Mulherin (1996) offer a sample of industry shocks affecting M&A activity in the 1980s: banking and broadcasting by deregulation, textiles by liberalized trade policy, energy by petroleum price changes, food processing by a demographic shift/low population growth. Jensen (1988) noted that a slowdown in primary industry growth may spur firms to acquire as a means of reallocating resources into higher growth areas.

      The theory of industry shocks also is relevant to the choice of diversifying or focusing the firm. Maksimovic and Phillips (2001, 2002) studied acquisitions of manufacturing plants. Their model suggests:

      As a practical matter, industry shocks yield a rich range of explanations for M&A activity, waves, and industry clusters of transactions. Detailed comments on implementing this perspective are given in the next two sections and in Appendixes 1–4 of this chapter. The tools and concepts in Chapter 6 further support an analytic understanding of the effect of industry shocks on M&A activity.

      Summary Overview of the Drivers of M&A Activity

      1 Rational managers and markets. In the northwest corner of the table is the “base case” of economics, which assumes that markets and the decision makers within those markets are rational. In this quadrant, share prices fairly reflect intrinsic value. Managers take effective action to maximize share prices. Economics offers the richest set of explanations for M&A activity here: Both waves and industry clustering can be rationalized. But assumptions of widespread rationality have become the piñata for business critics and reregulation advocates. Even the friends of M&A would have to admit, following the experience of 1995–2000, that bubbles happen.

      2 Rational managers, irrational markets. The northeast corner accommodates the possibility of bubbles and assumes that individual managers can and will act rationally. This approach gains good traction on the explanation for why the form of payment in M&A varies with the market cycles. But it has less to say about industry clustering of M&A activity.

      3 Irrational managers, rational markets. In the southwest corner is the world of managers who do stupid things for which the market reacts and penalizes them and their firms. Hubristic M&A is possible in a world with poor governance systems. But hubris says virtually nothing about M&A waves or industry clustering.

      4 Irrational managers and markets. Economics has little to say about this world. When you assume away rationality, you sacrifice considerable traction from modeling and empirical research. Here, the best one can say is, “We don’t know what’s going on, but it’s probably bad.”

Buyer’s Managers Are: Markets Are:
Rational Irrational
Rational Managers and firms pursue competitive advantage within constraints of antitrust. With external shocks markets, firms, and managers respond rationally. It is difficult to determine whether negative returns to buyers are due to merger or the shock. Firms conduct M&A to exploit profitable opportunities and avoid losses. This may include exerting capital market discipline to correct agency problems and improve governance. With overvaluation markets express irrationality. With information asymmetry managers are able to respond rationally on behalf of shareholders. Firms conduct share-for-share M&A to exploit overvaluation of their shares. Explains why we see many share-for-share deals near market peaks, and cash deals in the troughs.
Irrational Managers make decisions based on hubris and markets punish the managers’ firms. Explains why firms do bad deals and why buyers’ share prices fall after the deal is done. Managers and markets exhibit swarm behavior and market mania. Market prices regularly overshoot or

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