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The Q -Theory of Mergers

The Q -Theory of Mergers By BOYAN JOVANOVIC The Q-theory investment says that a firm’s investment rate should rise with its Q (the ratio market value to the replacement cost captial). We argue here that this theory also explains why some firms buy other firms. We find that: (i) a firm’s merger and acquisition (M&A) investment responds to its Q more (by a factor 2.6) than its direct investment does, probably because M&A investment is a high fixed cost and a low marginal adjustment cost activity; (ii) the typical firm wastes some cash on M&A’s, but not on internal investment (i.e., the “freecash flow” story works, but it explains only a small fraction mergers); and (iii) the merger waves 1900 and the 1920’s, 1980’s, and 1990’s were a response to profitable reallocation opportunities, but the 1960’s wave was probably caused by something else. There are two distinct used-capital markets. Used equipment and structures sometimes trade unbundled in that firm 1 buys a machine or building from firm 2, but firm 2 continues to exist. At other times, firm 1 buys firm 2 and thereby gets to own all firm 2’s capital. In both markets, the traded capital gets a new owner. In a http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png American Economic Review American Economic Association

The Q -Theory of Mergers

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Publisher
American Economic Association
Copyright
Copyright © 2002 by the American Economic Association
Subject
Technological Change
ISSN
0002-8282
DOI
10.1257/000282802320189249
Publisher site
See Article on Publisher Site

Abstract

By BOYAN JOVANOVIC The Q-theory investment says that a firm’s investment rate should rise with its Q (the ratio market value to the replacement cost captial). We argue here that this theory also explains why some firms buy other firms. We find that: (i) a firm’s merger and acquisition (M&A) investment responds to its Q more (by a factor 2.6) than its direct investment does, probably because M&A investment is a high fixed cost and a low marginal adjustment cost activity; (ii) the typical firm wastes some cash on M&A’s, but not on internal investment (i.e., the “freecash flow” story works, but it explains only a small fraction mergers); and (iii) the merger waves 1900 and the 1920’s, 1980’s, and 1990’s were a response to profitable reallocation opportunities, but the 1960’s wave was probably caused by something else. There are two distinct used-capital markets. Used equipment and structures sometimes trade unbundled in that firm 1 buys a machine or building from firm 2, but firm 2 continues to exist. At other times, firm 1 buys firm 2 and thereby gets to own all firm 2’s capital. In both markets, the traded capital gets a new owner. In a

Journal

American Economic Review – American Economic Association

Published: May 1, 2002

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