Market Optimism and Merger Waves

One of the most conspicuous features of mergers is that they come in waves, and that these waves are correlated with increases in share prices and price/earnings ratios. We argue that stock market booms and merger waves are both driven by increases in optimism in financial markets, and discuss two behavioral hypotheses about mergers – the managerial discretion and overvaluation hypotheses – that claim that merger waves are driven by market optimism. We also develop the hypothesis and present evidence that optimism in bond markets can cause mergers. We also briefly consider and reject two neoclassical hypotheses that claim to account for mergers waves. Empirical support for the managerial theory is provided by evidence that the amounts of assets acquired by companies increase as optimism in financial markets increases, and that the returns to acquiring companies ’ shareholders are inversely related to market optimism at the time of mergers. Our measures of market optimism are also shown to explain managerial choices of finance for mergers. Thus, we find that optimism in financial markets explains the amount of assets acquired through mergers at a point in time, the choice of means for financing the mergers, and the returns to the acquirers’ shareholders following the mergers