Market Timing and Merger Waves

Abstract

Merger activity tends to peak at times of high stock prices. I examine the allocation of equity issue proceeds conditional on the level of merger activity to shed light on the source of this empirical regularity. I find that firms do not allocate more of the equity proceeds raised in high merger times to increase debt repayment or to increase equity payouts. This lack of substitution of old for new (presumably cheaper) financing runs against the idea that equity overvaluation drives both merger activity and equity issuance. Instead, firms tend to permanently allocate more of the equity proceeds raised in high merger times to hoard cash. This is especially true in a sub-sample of financially constrained firms. This finding is consistent with the notion that times of high merger activity are also times of less adverse selection in the stock market. I also show that firms use significantly more of the equity proceeds raised in high merger times to increase investment. This increased allocation towards investment is associated with a gradual increase in debt issuance. These findings suggest that times of high merger activity are also times at which firms exercise growth options and prefer a conservative leverage ratio. This pattern is consistent with the existence of irreversibility and uncertain time-to-build in investment decisions. Overall, the evidence suggests that investment and financial frictions are important elements to explain the time series behavior of M&A activity.