Market Valuation and Merger Waves

Abstract

Does valuation affect mergers? The data suggests that periods of stock merger activity are correlated with high market valuations. The naive explanation that overvalued bidders wish to use stock is incomplete because targets should not be eager to accept stock. However, we show that potential market value deviations from fundamental values on both sides of the transaction can rationally lead to a correlation between stock merger activity and market valuation. Merger waves and waves of cash and stock purchases can be rationally driven by periods of over and under valuation of the stock market. Thus, valuation fundamentally impacts mergers.