The Free Cash Flow Theory of Takeovers: A Financial Perspective on Mergers and Acquisitions and the Economy

Economic analysis and evidence indicate the market for corporate control is benefiting shareholders, society, and the corporate form of organization. The value of transactions in this market ran at a record rate of about $180 billion per year in 1985 and 1986--47 percent above the 1984 record of $122 billion. The number of transactions with purchase prices exceeding one billion dollars was 27 of 3300 deals in 1986 and 36 of 3000 deals in 1985 (Grimm 1986). There were only seven billion-dollarplus deals in total, prior to 1980. In addition to these takeovers, mergers, and leveraged buyouts, there were numerous corporate restructurings involving divestitures, spinoffs, and large stock repurchases for cash and debt. The gains to shareholders from these transactions have been huge. The gains to selling-firm shareholders from mergers and acquisition activity in the period 1977-86 total $346 billion (in 1986 dollars).1 The gains to buying-firm shareholders are harder to estimate, and to my knowledge no one has done so yet, but I estimate that they would add at least another $50 billion to the total. These gains, to put them in perspective, equal 51 percent of the total cash dividends (valued in 1986 dollars) paid to investors by the entire corporate sector in the past decade.2