Efficient and Distortional Components to Industry Merger Waves

Abstract

This study asks whether industry merger waves can best be explained as efficient reactions to industry shocks or as clusterings of distortional activity. Waves create wealth overall, in contrast to non-wave periods in the same industries. Bidders in waves are less likely to display characteristics consistent with either free cash flow or hubris explanations of mergers. Bidder stock price reactions to bids as well as combined bidder and target returns in waves are higher than those outside waves. Bids later in waves exhibit evidence consistent with herding, including lower announcement and long-run returns. Overall, the explanation of merger waves most consistent with the evidence is that a shock to an industry's environment motivates an efficient large-scale reallocation of industry assets. The distortional component of the wave occurs at the end as the reallocation continues past its optimal stopping point due to herding behavior. Because the characteristics of merger activity vary substantially over wave cycles, it is important to distinguish between mergers inside and outside waves when investigating the motives of mergers and sources of wealth creation in mergers.