Review of Quantitative Finance and Accounting, 17: 397–420, 2001
2001 Kluwer Academic Publishers. Manufactured in The Netherlands.
Cost Inefﬁciency, Size of Firms
Research Economist, Milken Institute, 1250 4th Street, Santa Monica,
CA 90401. 310-998-8449
Associate Professor, Stern School of Business, New York University, New York,
NY 10003. 212-998-0453
Professor, Department of Economics, New York University, New York,
NY 10003. 212-998-8967
Abstract. This study, using the Cox proportional hazards model, ﬁnds that the risk of takeover rises with cost
inefﬁciency. It also ﬁnds that a ﬁrm faces a signiﬁcantly higher risk of takeover if its cost performance lags behind its
industry benchmark. Moreover, these ﬁndings appear to be remarkably stable over the nearly two decades spanned
by the sample. The effect of the variables used to measure the risk-size relationship, however, indicates temporal
changes. Lastly, the study presents evidence from ﬁxed-effects models of ex post cost efﬁciency improvements
that support the hypothesis that takeover targets are selected based on the potential for improvement.
Key words: corporate ﬁnance and governance, mergers, acquisitions, econometric methods, models with panel
data, truncated and censored models.
JEL Classiﬁcation: G3, G34, C2, C23, C24
Corporate takeovers have been a permanent feature of the American business landscape
since the mid-1800s (Pound, 1992). Mergers and acquisitions continue to play an important
role in allocating resources in the U.S. economy. The same number of mergers and acqui-
sitions were completed in the ﬁrst ﬁve years of the 1990s—about 23,000—as in the entire
previous decade (Mergers and Acquisitions, September–October, 1995). Furthermore, in
the peak years of each decade, the value of takeovers equaled about one-fourth of GNP
(Fortune, March 2, 1998.)
The prominent role of takeovers in reallocating control over capital in the U.S. economy
has generated vigorous debate over whether takeovers actually improve efﬁciency. Two
issues dominate the debate: the pre-takeover performance of targets and the post-takeover
changes in performance. As discussed in more detail in the next section, earlier studies of
the ex ante performance of target ﬁrms did not reach a deﬁnitive conclusion about the effect
of efﬁciency on the risk of takeover. Moreover, there is no consensus on the ex post effect
of takeovers on ﬁrm performance.