Market Valuation and Mergerwaves

Does valuation affect mergers? Data suggest that periods of stock merger activity are correlated with high market valuations. The naı̈ve 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 overand undervaluation of the stock market. Thus, valuation fundamentally impacts mergers. ONE OF THE PUZZLES IN FINANCE is why there are periods when mergers are plentiful and other periods when merger activity is much lower. For example, in the period 1963–1964 there were 3,311 total acquisition announcements, while in 1968–1969 there were 10,569 acquisition announcements. Similarly in both the period from 1979 to 1980 and from 1990 to 1991 there were approximately 4,000 acquisition announcements while the late 1980s and late 1990s were much more active, with 9,278 announcements in 1999 alone (see Mergerstat Review 2001). These periods of high activity seem to be correlated with high market valuations, as shown by Maksimovic and Phillips (2001) and Jovanovic and Rousseau (2001). For example, 1998–2000 saw over $1.5 trillion in announced deals per year while 2001, after the market correction, saw half as much. Furthermore, casual observation suggests that firms tend to use stock in these high activity/high stock market periods as an “acquisition currency.” In 1990 the percentage of stock as a fraction of total deal value was only 24%, while by 1998 the use of stock peaked at 68% of total deal value!1 Further, Martin (1996) shows that firms that use stock in acquisitions have lower bookto-market ratios than those that use cash. Stock deals were especially common in the high-flying high-technology sector where most takeovers involved securities. From 1996 to 2000 the computer software, supplies, and services industry ∗ Matthew Rhodes-Kropf and S. Viswanathan are with Columbia University and Duke University, respectively. We thank Michael Bradley, Espen Eckbo, Larry Glosten, Pete Kyle, Augustin Landier, Costis Maglaras, Jan Mahrt-Smith, Mit Mehta, Michael Riordan, David T. Robinson, Tano Santos, and Daniel Wolfenzon for useful discussions. The anonymous referee’s comments have improved the paper considerably. We thank participants at the American Finance Association, Columbia University, Duke University, London Business School, National Bureau of Economic Research, Oxford University, Rutgers University, and Stanford University workshops for insightful comments. All errors are our own. 1 Source: JP Morgan M&A Research, Thomson Financial Securities Data Company Inc. based on announced transactions.