1

Faculty of Economics & Business Administration

Master Thesis

M&A waves in the United States –

a comparison between the 5th and the 6th wave

Sarah Malaise (2522914)

MSc in Business Administration:
Specialization Financial Management

Supervisor: Arjen Siegmann

Amsterdam, 1 July 2013

Abstract

During the past 120 years, six large merger waves occurred in the United States. Possible
explanations are manifold, three of them being the clustering of industry shocks, market timing or
the managerial discretion theory. I study the two recent cycles in the 1990s and 2000s and
directly compare the factors triggering the wave and the driving factors during the wave.
Responsible for the beginning of the fifth wave are industry shocks and overall liquidity. In the
year following the wave start, behavioral factors drove merger activity. Thus, liquidity was
necessary to initiate the wave, but afterwards, when optimism and herd behavior played a role, it
ceased to be of importance. For the 2000s’ cycle no clear conclusions with regard to the driving
factors can be drawn. However, it seems as if managers have learnt their lesson from the previous
wave and misvaluation factors were not mainly responsible for enhanced transaction activity
during the sixth wave.
 1

1. Introduction

In the United States (U.S.), merger and acquisitions (M&A’s) clustered in six large cycles during the
past 120 years. There is abundant literature discussing waves number one to five, but not too
much about the most recent wave that ended with the financial crisis in 2007. M&A’s as such and
M&A waves will continue in the future and it is proven that ”early birds” have a significant
advantage (Carow, Heron and Saxton, 2004). Therefore, it is important to understand the driving
factors behind a wave. These factors help to figure out the best point in time for acquisitions and
how to structure and finance future transactions.

This study first proves that the fifth and the sixth merger cycle in the 1990s and 2000s have
actually occurred. Afterwards, it answers three main questions: First, which factors have initiated
the fifth wave and which factors have led to the sixth merger wave? What is especially interesting
concerning the sixth wave, which is labeled “the rebirth of leverage” (DePamphilis, 2012), is
whether excessive liquidity caused the start of the wave. Second, are the triggering factors of the
wave also those that drive merger activity during the wave? And finally, are those factors causing
and driving a merger wave alike during both waves?

The available literature does not agree on merely one theory explaining M&A waves. Basically,
three models are frequently discussed. The first one, the neoclassical theory, predicts that M&A
activity clusters in time and industries due to shocks in the operating environment. Shocks can be
of economic, regulatory or technological nature. The response to a shock requires a reallocation
of assets within an industry through mergers and partial-firm acquisitions. This has to be done as
efficient and as fast as possible (Harford, 2005). It is assumed that markets are efficient and
managers act rationally (Park, Morel and Ravi, 2009). Harford (2005) argues that shocks only lead
to a wave if there is sufficient capital liquidity in the market. In the neoclassical theory, M&A
occur for efficiency reasons (Macias, Raghavendra Rau and Stouraitis, 2010).

The second theory is based on misvaluation, also called market timing theory. The market timing
explanation hinges on market inefficiencies that are exploited by rational managers who have
superior information (Shleifer and Vishny, 2003). M&A’s occur when managers use their
overvalued stock to acquire assets of less overvalued or undervalued firms (Shleifer and Vishny,
2003). This theory suggests that transactions are driven by the stock market valuation of the
merging firms and that valuation impacts M&A’s regardless of the underlying motivation of the
mergers. The method of payment should be primarily stock (Harford, 2005). If driven by market
timing, a merger wave would end once people become aware of the mispricing and valuations
return to normal levels, see Rhodes-Kropf and Viswanathan (2002).

The third theory that is dealt in detail with by Gugler, Mueller and Weichselbaumer (2012) is the
managerial discretion theory by Jensen (1986). Within this theory, managers want to stimulate
their firm’s growth. Either because their income is related to growth or because they get ”psychic
income” from running a larger firm. Jensen claims that managers undertake mergers or
acquisitions when internal funds are available. A high level of liquidity facilitates takeover
activities and allows for making quick decisions. Furthermore, shareholders are more likely to give
their consent when cash flows are abundant.
 2

It is not easy to formulate predictions regarding the fifth M&A wave. The catch-words
characterizing this period are “globalization” and “deregulation” (Andrade, Mitchell and Stafford,
2001). These are both strong indicators for the neoclassical theory. In addition, it was a time of
very high stock market valuation and equity was the main source of financing for M&A deals
(Martynova and Renneboog, 2008). After the burst of the Internet bubble and the end of the
wave, empirical studies proved that many M&A deals undertaken during this period actually
destroyed value (Moeller, Schlingemann and Stulz, 2004). Value destroying mergers are an
indicator for market timing as well as for the managerial discretion theory. In accordance with
Harford (2005), who stresses the importance of the liquidity component, the 1990s wave was also
a time of low interest rates and bank’s rather risky attitude towards lending (Martynova and
Renneboog, 2008). Summarizing, there are strong signs for both theories and abundant liquidity
further enhancing M&A activity. However, I expect a stronger influence of behavioral factors due
to the hype during the Dot-com bubble.

During the sixth M&A wave globalization still played an important role. Furthermore, it was
characterized by highly leveraged buyouts and private equity investments, labeled ”the rebirth of
leverage” (DePamphilis, 2012). Extremely low interest rates and excessive lending seem to have
encouraged firms to engage in M&A activity. Stricter lending at the beginning of the financial crisis
ended the same wave (Kleinert and Klodt, 2002). Since the liquidity component is rather
attributed to the neoclassical theory, I expect to find prove of it during the sixth merger cycle.

This study proceeds by using a sample of U.S. mergers, tender offer bits and leverage buyouts
announced between 1991 and 2010 in which the acquiring company is from the U.S. and publicly
listed. The U.S. market has been chosen due to the dispersed ownership and the market for
corporate control; two factors that favor M&A’s to occur more frequently in the U.S. than for
example in the U.K. or Continental Europe (Gugler et al., 2012). The time frame from 1991 to
2010 is especially interesting because it covers the two recent waves and allows a direct
comparison between them. This approach is new in academic research. New as well is the
differentiation between the triggering factors of a wave and the driving factors after the wave has
started with one single sample of transactions.

I will present evidence that merger waves actually occurred, but that my expectations regarding
the underlying reasons were not completely confirmed. The fifth wave was triggered by the
neoclassical factors sales growth coupled with abundant liquidity and deregulatory shocks while
for the sixth wave no clear triggers could be found.

After industry waves started during the fifth aggregate wave, behavioral factors like optimism
proxied by the price-earnings ratio, cash flow and stock as the main form of financing drove
merger activity. However, for the sixth wave no clear pattern can be identified. These findings are
in line with previous research on the fifth wave by Harford (2005) and Gugler et al. (2012). The
literature review makes clear that the sixth wave has not been researched yet.

The remainder of this paper is organized as follows. Section 2 contains a literature review of the
existing literature on the three main theories for merger waves. Chapter 3 presents the data used
in the analysis. In section 4, I explain in detail the methodology applied and the empirical tests
conducted. Section 4.3.1 illustrates the factors that have initiated industry merger waves by
 3

means of a Logit model. Part 4.3.2 points out the driving factors after the wave had started using
an ordinary least square (OLS) regression. After each section I present and discuss the results. In
chapter 5, I conclude, point out certain limitations and make suggestions for further research.

2. Literature Review

2.1 Overview of historical waves

Each of the past merger waves in the U.S. has its own characteristics and particularities. Before I
start reviewing different theories of merger waves, I will give a brief summary of past waves.

The first wave in the U.S. was recorded between 1897 and 1904. 1 It was characterized by
horizontal mergers mainly in the industrial production. As a result, giant companies emerged that
aimed at reducing competition (Martynova and Renneboog, 2008). The first wave ended with the
stock market crash in 1904 and merger activity got further depressed during World War I (Lipton,
2006).

While the first wave was marked by monopolization efforts, the second wave (1916-1929) led to
further concentration but vertical integration played an important role, too. Anti-trust policy was
introduced to ”crack monopolies” which forced companies to focus also on vertical integration.
The Great Depression and the stock market crash in 1929 ended the wave abruptly (DePamphilis,
2012).

The third wave (1965-1969) was called the ”Conglomerate Era” (DePamphilis, 2012). The U.S.
takeover activity concentrated on diversification and the creation of large conglomerates. This
was mainly due to stricter anti-trust laws that prohibited further horizontal consolidation
(Martynova and Renneboog, 2008). In the end, steadily rising prices paid for target companies
coupled with increasing leverage led to the conglomerate stocks crash in 1969/70 (Lipton, 2006).

Wave number four (1981-1989) was the era of leveraged buyouts and hostile takeovers by major
investment banks on behalf of raiders (Lipton, 2006). These transactions were favored by the
breakup of many large conglomerates (DePamphilis, 2012). The junk bond market, that at first
encouraged an increasing volume of M&A activity, also led the wave to an end when it crashed in
1989/90 (Martynova and Renneboog, 2008).

The fifth wave (1992-2000) was characterized by the largest mega-deals in history so far. It was a
time of economic expansion and stock market boom in the U.S., combined with several factors
favoring M&A activity: Inter alia deregulation, privatization, technology revolution and increasing
globalization. Since mega-mergers require substantial amounts of money, equity was the main
source of financing by overvalued bidders (Shleifer and Vishny, 2003). When the internet bubble
burst and the U.S. encountered an economic slowdown, merger activity declined sharply (see
Figure 1).

1
Academic researchers like Martynova and Renneboog (2005), Lipton (2006) or DePamphilis (2012) do not
agree on one exact time frame for each wave. The years presented are approximations suggested by
DePamphilis.
 4

The most recent is the sixth wave (2003-2007) with the least available academic literature. It took
place during a time that offered abundant leverage evoked by complex securities and low interest
rates (DePamphilis, 2012). Excessive lending and too much liquidity made overpaying possible. In
the end this led to the global financial crisis and the concomitant shrink in M&A activity.

2.2 Review of the neoclassical theory

The neoclassical theory is based on the presumption that economic disturbances (≈ shocks) of
economic, technological or regulatory nature lead to industry-wide merger waves (Gort, 1969).
Assuming that markets are efficient and managers act rationally, assets are reallocated through
mergers and partial-firm acquisitions as a response to a shock (Park et al., 2010). Mitchell and
Mulherin (1996) define a shock as ”any factor that alters industry structures". Briefly speaking,
M&A’s occur for efficiency reasons (Macias et al., 2010).

Simultaneous occurrence of several industry waves can lead to an aggregate merger wave if there
is sufficient liquidity in the market (Harford, 2005). Liquidity is an indispensable factor and a shock
to an industry alone is not sufficient to trigger a wave. Like Gugler et al. (2012), Harford includes
the interest rate spread in his regression model to test the liquidity component. Both point out
that an increasing spread decreases merger activity.

To test whether a shock can initiate an industry wave Harford (2005), as well as Mitchell and
Mulherin (1996), use the absolute value of the industry sales growth as a proxy for a shock. Both
conduct a robustness check with several variables that could serve as a proxy, e.g. net
income/sales, asset turnover, return on assets (ROA) or employee growth. All variables tested
were highly correlated and each of them could be selected interchangeably for further tests. Like
Harford, Mitchell and Mulherin find a significant influence of shocks on takeover activity.
Economic growth and the business cycles are strongly related to M&A activity (Nelson, 1959).

It is also reasonably argued that fewer and simpler regulations remove artificial barriers, e.g. on
firm sizes and stimulate the level of competitiveness (Mitchell and Mulherin, 1996). More
competition in turn leads to increased merger activity (DePamphilis, 2012). The second frequently
tested variable is therefore a dummy variable selecting transactions that took place within two
years after a deregulatory event (Becher, 2009).

In the 1980s and 1990s, shocks of deregulations were significantly positive related to takeover
activity (Mitchell and Mulherin, 1996 & Harford, 2005). Some even called the 1990s a “decade of
deregulation” with deregulatory events accounting for almost 50% of the transaction activity
(Andrade et al., 2001).

Post-deregulation mergers and acquisitions present a form of exit for distressed companies and
serve a contractionary role. These firms are often characterized by a poor pre-merger (industry)
performance (Ovtchinnikov, 2013). Ovtchinnikov identifies peaks in merger activity after dere-
gulation in his sample period 1960 to 2008. Spikes were evident especially in the airlines,
railroads, telecommunication and trucking industries, whereas cycles are less pronounced in the
natural gas and oil industries. He explains this phenomenon with excess capacities. Since the
latter two are usually of higher regulation, they have less excess capacity and thus have a less
pronounced need for exit.
 5

In summary it can be said that if the neoclassical theory holds, my regression results will show
significantly positive coefficients for sales growth and for the deregulatory event dummy. If I can
prove the importance of liquidity, the interest rate spread will be significantly negative.

2.3 Review of the misvaluation theory

The misvaluation theory is also known as the market timing theory and both expressions can be
used interchangeably. The core of this theory lays in the assumption of market inefficiency and
completely rational managers that use M&A’s as a form of arbitrage (Shleifer and Vishny, 2003).

Transactions are driven by the valuation of the stock market, meaning that managers of firms with
overvalued stock acquire target companies with relatively undervalued stock. The method of
payment during high stock market valuations should be mainly shares. Though it is mainly cash
when valuations are low. Shleifer and Vishny also find that stock acquisitions occur more
frequently when the level of dispersion of valuation between bidder and target company
increases. In earlier years, Nelson (1959), Andrade et al. (2001) and Verter (2002) already pointed
out the same three results:

1. Mergers cluster during periods of high stock market valuations, because the number of
overvalued companies increases. This consequently leads to a wave.
2. The form of payment is mainly stock.
3. Higher levels of transaction activity are correlated with larger gaps between the acquirer’s
and target’s valuation.

Especially the third finding is in line with Jovanovic and Rosseau (2002) and their ”Q-Theory of
mergers”. They argue that valuation differences lead managers to prefer acquiring other firms
over direct, more costly investments which creates a merger wave. Overvalued shares offer the
opportunity for acquirers to purchase a target firm by issuing fewer shares. This results in less
dilution of ownership for the current shareholders of the bidding companies in the newly merged
company (DePamphilis, 2012). The difference in Tobin’s Q can therefore be included in the
regression model if both companies involved are publicly listed.

Another explanation of the misvaluation theory revolves around the assumption that it is difficult
for targets to distinguish between bidding companies that have overvalued stock and expected
synergies being actually high. Targets use all available information to make an appropriate
assessment of the situation and they are mainly right. However, during times of high valuations,
they tend to overvalue the expected synergies. Due to the overestimation of synergies during bull
markets, merger waves can occur (Rhodes-Kropf and Viswanathan, 2004).

All explanations of the market timing theory just presented suggest that mergers and acquisitions
occur solely due to mispricing and regardless of the underlying motive for the transaction. The
fact that managers become aware of the market-wide mispricing at some point in time will lead
the wave to an end (Rhodes-Kropf and Viswanathan, 2004).

For testing the misvaluation theory it is common practice to include the industry median price-
earnings-ratio as well as the median market-to-book ratio and the difference in Tobin’s Q. If this
theory holds, I will find significantly positive coefficients (Harford, 2005 & Gugler et al., 2012).
 6

2.4 Review of the Managerial Discretion Theory

In the managerial discretion hypothesis (MDH) psychology plays an important role. Hubris, herd
behavior and empire building are phenomena that are often subsumed within this theory.

Managers pursue company growth as their main objective (Marris, 1964). They do so because
either their income is related to growth instead of profits or because they get “psychic income”
from managing a larger firm (Gugler, Mueller and Yurtoglu, 2006). Psychic income can be best
defined by prestige and power. It is argued that managers engage in M&A transactions only for
the sake of maximizing the firm size, irrespective of the consequences for the company’s
shareholders (Mueller, 1969).

Especially for the managerial hubris hypothesis, overconfidence and the overestimation of
synergies are key factors. Managers “build a world of speculative make-believe” and try to find
”excuses to believe” why share prices will rise (Galbraith, 1961). This “theory of industry-specific
synergies” will contaminate other firms, too. Additionally, during stock market booms, investors
are more willing to believe in good news and unprofitable mergers are perceived less costly
(Gugler et al., 2006).

Since managerial hubris can promote herding behavior, psychology can lead to M&A waves and to
a high number of value-destroying transactions. The first successful deals might serve as best-
practice for other firms, encouraging them to undertake similar transactions. However, mergers
and acquisitions are highly wealth-destroying at the end of a wave by triggering low abnormal
returns (Martynova and Renneboog, 2008 & Harford, 2005). Roll summarizes that bidding firms
run by irrational managers who are affected by hubris blatantly overpay their acquisitions (Roll,
1986).

Instead of overconfidence, it might be excessive liquidity that drives value-destroying acquisitions

(Jensen, 1986). A high level of liquidity facilitates mergers and acquisitions and allows quick
decision making without deep strategic analysis. Shareholders are more likely to give their
consent when cash flows are abundant, indicating that managers steered the company
successfully in the past. Thus, shareholders allow the transactions of poor acquisitions when
managers lack profitable alternatives (Martynova and Renneboog, 2008). Harford (2005) also
proves that abundant cash flows increase managerial discretion and lead to unprofitable
transactions.

Several variables can be included in the regression model to test the managerial discretion
hypothesis. Firstly, the acquiring firm’s size proxied by the natural logarithm of total assets (lnA).
If the MDH holds, a positive coefficient will be found. Secondly, the weighted average price-
earnings ratio as a proxy for the optimism in the stock market. According to the managerial
discretion theory, a higher P/E ratio will stimulate merger activity. Thirdly, I will include cash flows
as a proxy for the firm’s liquidity. If I can prove the MDH, I will obtain a significantly positive
coefficient. Lastly, the company’s leverage can be incorporated into the model. High leverage can
signal a growth-oriented management and the MDH predicts a positive coefficient on leverage
(Gugler et al., 2012).
 7

3. Data

All data for U.S. mergers and acquisitions announced between 1991 and 2010 with a transaction
value above $50 million has been derived from the Securities Data Company’s (SDC) Mergers and
Acquisitions database. Due to incomplete data for non-listed companies, only deals involving
publicly listed U.S. acquirers are included in the sample. The target company is not restricted to
the U.S. and can be both listed and unlisted. The sample includes friendly and hostile takeovers:
mergers, tender offer bids as well as leveraged buyouts (LBOs), as the latter have been very
popular during the sixth aggregate merger wave.

A competitive nature is essential for exploiting my research question. Therefore deals with the
acquirer belonging to a highly regulated industry as financial services or to monopolies (e.g. utili-
ties and public administration) are excluded from my sample (Mitchell and Mulherin, 1996).
Target companies from these regulated industries are kept in the sample, because these deals are
even more valuable for answering my research question. 1,723 deals belong to the banking and
insurance sector, 510 to utilities and one deal to public administration. In total, 2,234 are exclu-
ded from the analysis. The affiliation process of a firm to an industry is explained in section 4.1.

Remaining industries are required to have at least ten deals in at least one of the sample years.
Otherwise, the merger wave-identification will not be possible (Carow et al., 2004). The method
of identifying industry merger waves is explained in section 4.2. Additionally, as suggested by
Bernile, Lyandres and Zhdanov (2012), only corporate transactions involving at least 51% of the
target’s equity are kept in the sample.

Finally, data for all variables used in the empirical tests in section 4.3 has to be available. Applying
all criteria mentioned above, I obtain a final sample size of 6,536 deals for the period 1991-2010
in 30 different industries. For a detailed breakdown, see Table 1. The total number of mergers and
acquisitions as well as transaction values over the sample period is presented in Figure 1.

All other data is derived from the DataStream and Compustat North America Databases, from the
Board of Governors of the Federal Reserve System as well as from Lexis Nexis.

Table 1: Number of deals obtained from SDC for 1991-2010

This table shows the breakdown from the initial sample of 13,120 announced deals between 1991 and 2010 to the final
sample of 6,536 deals.

13,120 Deals announced between 1991 and 2010

10,873 Deals excluding acquirers from financial services, utilities and public administration
10,795 Deals where the acquirer ultimately acquires > 50% of the stake of the target’s equity.
10,289 Deals in industries that have at least ten deals in the one of the years. 2
6,536 Deals with available data for all variables
6,536 Final sample (1,626 deals with listed targets and 4,910 deals involving unlisted targets)

2
Number of mergers is calculated as the total number of deals involving acquirers from industry i in year t
(Bernile et al., 2012).
 8

500000 800
450000 700
400000
Deal Value in millions of USD

Number of deals per year

600
350000
300000 500

250000 400
200000 300
150000
200
100000
50000 100

0 0
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Figure 1: Number of deals and total transaction value
The line shows the total number of deals (right axis) for each year for the whole sample period. Included are only deals
in industries with at least ten deals in one year and with a value greater than $50 million. Additionally, the bidder had to
acquire more than 50% of the targets equity. The bars represent the total deal value in $ millions per year (left axis).

4. Methodology and Empirical Results

4.1 Affiliation to an industry group

In the first step, each bidder and each target is assigned to one of 49 industry groups based on
their standard industrial classification (SIC) code recorded by SDC (Harford, 2005). 3 It is required
that all industries have a minimum of ten acquisitions in at least one year over the sample period;
otherwise the corresponding industry has to be excluded (Carow et al., 2004). SIC codes that
cannot be matched to one industry group because of an obviously flawed SIC code in SDC, are
excluded from the sample. A merger counts towards an industry if the acquirer belongs to that
industry (Bernile et al., 2012). Due to these criteria, mergers in 18 industries are excluded. As a
result, a total of 30 industries remain in the sample. Table 2 shows the 30 industries in the sample
with corresponding number of deals and transaction value for the time period 1991 to 2010. For a
detailed overview of the number of deals and transaction value by year for each industry see
Appendix B.

The dataset includes 6,536 deals with a total transaction value of $4,077,455 million. The average
deal value per industry is $605 million and the median deal value amounts to $164 million across
all industries. Enormous differences in average and median transaction values can be seen in each
industry which indicates that some large deals drive the total deal value and the average. The

3
These industry groups are the same 48 groups as used in Fama and French (1997). Additionally, the
industry group “public administration” (SIC codes 9100-9999) has been added (see Appendix A) but
afterwards excluded from the sample, because of its regulated nature.
 9

average standard deviation per industry amounts to $1,151 million. Since the sample is restricted
to mergers and acquisitions with a transaction value greater than $50 million, most of the
industries show a minimum deal value of $50 million. The maximum deal value across all
industries is observed in the Pharmaceutical Products industry with $89,168 million.

Table 2: Number of deals and deal values per industry 1991-2010

This table gives an overview of the 30 sample industries, their number of deals in the period 1991-2010, mean and
median deal values, the standard deviations, minimum and maximum deal values as well the total deal value in
$ millions.

Industry N Mean Median SD Min Max Total

Food Products 116 546 225 1,191 50 10,529 63,273
Entertainment 58 1,083 194 2,834 50 18,837 62,839
Printing and Publishing 81 565 208 1,169 50 9,070 45,729
Consumer Goods 93 1,091 229 5,728 50 54,907 101,481
Apparel 68 289 167 430 50 3,160 19,686
Healthcare 135 415 157 766 52 6,611 55,991
Medical Equipment 227 491 147 1,953 50 27,861 111,535
Pharmaceutical Products 305 1,688 240 7,721 50 89,168 514,862
Chemicals 147 730 235 1,855 50 15,513 107,256
Rubber and Plastic 45 210 130 210 50 1,000 9,460
Construction Materials 107 360 136 898 50 7,857 38,472
Construction 61 299 107 520 50 3,106 18,219
Steel Works, etc. 91 539 204 880 52 6,077 49,051
Machinery 250 462 152 1,086 50 9,751 115,509
Electrical Equipment 95 521 133 1,195 50 9,582 36,110
Automobiles and Trucks 99 387 144 822 54 6,450 38,279
Coal 30 564 174 867 54 3,475 16,917
Petroleum and Natural 440 858 227 3,000 50 40,298 377,717
Telecommunication 370 1,559 185 6,628 50 72,671 576,739
Personal Services 46 224 121 295 50 1,821 10,295
Business Services 994 358 131 1,115 50 18,515 355,950
Computers 354 576 161 1,685 50 21,101 230,822
Electronic Equipment 573 486 158 2,005 50 41,144 278,550
Measuring and Control 180 367 168 843 50 10,292 66,057
Business Supplies 79 821 222 1,764 55 9,640 64,858
Transportation 105 514 191 881 52 5,538 53,955
Wholesale 227 414 151 1,132 50 14,320 94,021
Retail 186 721 183 2,232 50 26,294 134,191
Restaurants, Hotel, Motel 75 486 119 1,212 50 7,811 36,476
Trading 899 437 137 1,126 50 13,345 393,155
Total 6,536 605 164 1,151 50 10,022 4,077,455
* Small differences arise because total, average and median deal value have been rounded up.
 10

4.2 Identifying industry waves

For identifying the start, peak and conclusion of an industry merger wave, a similar method to the
one applied by Carow et al. (2004) will be used. First, the peak year with the highest number of
acquisitions in a given industry needs to be detected. Next, the start of a wave is calculated.
Carow et al. consider the start of a wave the first year in which the number of M&A is less than
one third of the number in the peak year. If the year previous to this year (Start -1) had even less
merger activity, this year will be considered the start of the wave. Finally, the end of a wave is
determined in a similar manner. Starting in the peak year, I roll forward until I find a year with less
than one third of transaction activity; it is considered the end of the wave. However, if the
downward trend continues for another year, this year (End +1) will be considered the end of the
wave. Figure 2 illustrates this process.

The procedure described has to be repeated for each industry. Since there was a great decline in
M&A activity in the U.S. between the fifth and the sixth aggregate merger wave, the procedure is
done once for the first decade and once for the second decade of the sample period. Thus, a
maximum of two waves in each industry can be identified.

Figure 2: Merger wave identification

process (based on Carow et al.,2004)

The wave-identification procedure shows 22 complete industry merger waves (with a start, peak
and conclusion) in the first time period and 16 in the second time period. Eleven out of 30
industries experienced a wave in both time frames. Three industries did not experience any wave.
Table 3 gives an overview of the 30 industries and their waves if existing.

The first decade of my sample, the 1990s, clearly shows one aggregate merger wave (hereafter:
the “fifth wave”). Most industries experienced the start of their industry waves in 1995 or 1996,
the peak around 1998 and the end between 2000 and 2002. For four industries I am able to
identify a start and a peak, but no clear conclusion. Three industries do not show any remarkable
pattern.

The second decade, the 2000s, shows a similar albeit slightly less homogenous pattern. The next
wave (hereafter: the ”sixth wave”) already started for several industries between 2001 and 2003.
Merger activity peaked in 2004 and 2005 and ended between 2007 and 2009 with the beginning
of the financial credit crisis. For some industry groups a peak and a conclusion are identified,
however no clear start. This finding supports previous research indicating that the intervals
between the aggregate merger waves become shorter during the past 120 years. Thus, a clear
start cannot be identified in every case (Lipton, 2006). Considering my sample, the sixth wave
even follows immediately the fifth wave.
 11

Table 3: Merger waves per industry and decade (1990s and 2000s)

This table shows the year of the start, the peak and the end of an industry merger wave per decade for each industry in
the sample. Visualization for each industry is presented in Appendix B.

1st decade (1990s) 2nd decade (2000s)

Industry Group Start Peak End Complete Start Peak End Complete
wave? wave?
Food Products - - - no - - - no
Entertainment 1996 1999 2002 yes 2003 2004 2008 yes
Printing and Publishing - 1994 1996 no 2003 2004 2009 yes
Consumer Goods 1996 1997 2000 yes 2001 2005 2007 yes
Apparel - - - no 2000 2004 2007 yes
Healthcare 1996 1997 2000 yes 2000 2004 2009 yes
Medical Equipment 1995 1998 - no 2001 2004 2007 yes
Pharmaceutical Products 1995 2000 - no - 2004 2006 no
Chemicals 1995 1999 2001 yes 2003 2004 2007 yes
Rubber and Plastic Products 1996 1999 2001 yes - - - no
Construction Materials 1996 1998 2001 yes 2002 2004 2006 yes
Construction 1996 1998 2001 yes - - - no
Steel Works, etc. 1996 1999 2001 Yes - 2005 2008 no
Machinery 1996 1997 2001 yes - 2005 2009 no
Electrical Equipment 1996 1998 2001 yes 2002 2004 - no
Automobiles and Trucks 1996 1997 2001 yes 2002 2003 2006 yes
Coal - - - no 2004 2005 2007 yes
Petroleum and Natural Gas 1996 1997 - no - 2004 - no
Telecommunication 1996 1999 2002 yes - 2005 2008 no
Personal Services 1995 1998 2000 yes 2002 2003 2007 yes
Business Services 1996 2000 2001 yes - 2004 - no
Computers 1996 2000 2002 yes - 2004 2007 no
Electronic Equipment 1997 2000 2003 yes - 2005 2006 no
Measuring and Control Eq. 1996 2000 - no 2002 2004 2008 yes
Business Supplies 1996 1997 2003 yes - - - no
Transportation 1996 1997 1998 yes - 2005 2007 no
Wholesale 1996 1998 2000 yes 2003 2005 2007 yes
Retail 1996 1998 2002 yes 2002 2004 2007 yes
Restaurants, Hotel, Motel 1996 1997 2001 yes 2003 2004 2008 yes
Trading 1996 1997 2000 yes 2001 2005 2007 yes
 12

4.3 Test of theories

4.3.1 Predicting the start of a merger wave - Logit model

The first research question explored is which factors have triggered the fifth and the sixth (in the
previous section clearly identified) aggregate merger wave. In order to answer this question, I
make use of a maximum likelihood estimation of a Logit model similar to the one used by Harford
(2005).

Logit regressions are used to predict the outcome of a categorical dependent variable. The
outcome is dichotomous, i.e. it can only take two values - zero or one (Peng, Lee and Ingersoll,
2002).

The sample for this model contains 600 observations (30 industries each over 20 years (1991-
2010)). The dependent variable equals one if the industry-year was the start or the successive
year of a merger wave in that industry. If the year was not the start of a wave, it is labeled zero.
Industries that did not experience a complete wave, but show a clear start and peak in one or in
both decades are assigned a one as well in the corresponding years (Carow et al., 2004).

In order to find out if the triggering factors of the fifth and the sixth merger wave were different
ones, I split my sample into two parts. Part one includes all industries from 1991-2000 and part
two includes all industries from 2001-2010. Thus both parts comprise 300 observations.

4.3.1.1 Variables

In this section the variables used for testing the different merger theories are presented. This
includes variables that could have initiated the start of a merger wave. Harford (2005), however,
only distinguishes between the misvaluation theory and the neoclassical theory combined with a
liquidity component.

All variables are measured in year t-1 and most of the data is obtained from Compustat North
America. It is a database containing approximately 24,000 publicly held active and inactive
companies in the United States.

I estimate the following model

(1) 𝑦 = 𝑀/𝐵𝑖𝑡−1 + 𝑃/𝐸𝑖𝑡−1 + 𝐺𝑟𝑜𝑤𝑡ℎ𝑖𝑡−1 + 𝐷𝑒𝑟. 𝐸𝑣𝑒.𝑖𝑡−1 + 𝑆𝑝𝑟𝑒𝑡−1 + 𝐺𝑟𝑜𝑤𝑡ℎ ∗ (𝑇𝑖𝑔ℎ𝑡𝐶𝑎𝑝. )𝑖𝑡−1 +
µit−1 ,

where M/Bit-1 is the industry median market-to-book ratio in year t-1, P/Eit-1 is the industry median
price-earnings ratio in year t-1, Growthit-1 is the sales growth in industry i in year t-1, Der.Eveit-1 is a
dummy variable selecting the two following years after a deregulatory event in industry i, Spret-1 is
the interest rate spread between the Federal Funds rate and the interest rate on commercial and
industrial loans and Growth*(TightCap.)it-1 is an interaction term selecting low liquidity years for
industry i in year t-1.

Table 4 gives an overview of deregulatory events. Table 5 reports the summary statistics for M/B,
P/E, Growth and Spread.
 13

Misvaluation theory

Industry median market-to-book ratio (M/B ratio)

Previous research (e.g. Shleifer and Vishny, 2003) has shown that merger activity is driven by
stock market valuations. During bull markets, bidders and targets overestimate the possible
synergies arising from a merger and are more willing to engage in transaction activities (Rhodes-
Kropf and Viswanathan, 2004).

Therefore, the industry median market-to-book ratio in the year previous to the merger will be
included in the Logit model.

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒

Market-to-book ratio =
𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒

The closing price and the book value per share for all companies in an industry according to their
SIC codes (see Appendix A) was obtained from the Compustat North America database for the
time period 1990-1991. For each industry, the yearly median was computed.

Industry median price-earnings ratio (P/E ratio)

The misvaluation or market timing theory argues that mergers and acquisitions take place when
the acquirer is perceived to be overvalued relative to the possible target. It implies that
transactions are stock market driven and that valuation aspects as well as expectations about the
future are the main reasons why companies merge.

A proxy for optimism in the stock market is the price-earnings ratio (P/E ratio) in a country or
industry (Gugler et al., 2012). High P/E ratios indicate that the stock market values the stock of a
company rather high in comparison to their reported earnings.

𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒

Price-earnings ratio =
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒

In order to get a representative picture of the optimism in the stock market and not facing the
problem of a selection bias, I choose all U.S. companies and not only the acquiring companies in
my sample. Therefore, I extract the market values and earnings per share for all available com-
panies per industry for the years 1990-2009 from Compustat North America. Since planning a
merger or acquisition requires some preparation time, median P/E ratios one year previous to the
industry-year are used.

If the misvaluation (market timing) theory holds, I will obtain a positive and significant coefficient
for the P/E ratio.

Neoclassical Theory
Sales growth

Proponents of the neoclassical theory believe that economic shocks can initiate a merger wave
within an industry. There are several variables that can be used to measure economic shocks in an
industry: Net/income over sales to measure profitability, asset turnover, R&D, capital expen-
ditures, employee growth, ROA and sales growth. Since all variables are highly correlated, only
 14

one of them should be included in the regression model (Harford, 2005). Mitchell and Mulherin
(1996) test both the sales growth and the employment growth variable and find that both can be
equally used as a proxy for an economic shock. Due to data availability, the absolute value of the
yearly sales growth per industry in t-1 is utilized in this study. It is important to take the absolute
value because an economic shock can have both a positive and a negative effect on sales (Mitchell
and Mulherin, 1996).

𝑆𝑎𝑙𝑒𝑠𝑡 −𝑆𝑎𝑙𝑒𝑠𝑡−1
Industry sales growtht =
𝑆𝑎𝑙𝑒𝑠𝑡−1

For the purpose of constructing the variable, data from the Compustat North America database is
obtained. For all companies belonging to the same industry group, I extract total revenues for the
years 1989-2009 according to SIC codes. Since sales growth is the real growth for each industry,
sales values have to be put in real terms using the consumer price index (CPI) 4 for deflating the
figures. In order to calculate the sales growth in year t, data for the same companies have to be
available in year t-1 and t. If data is available only in one of the two years, the company is
excluded for year t’s calculation. Afterwards, total revenues are summed up for t and t-1 and the
sales growth according to the formula above is computed. Owing to the fact that Compustat does
not provide sufficient data to compute sales growth for the coal industry, I take the growth rates
from the U.S. Energy Information Administration. 5 Finally, the data is winsorized at the 99%-
quartile due to large outliers.

If a shock to an industry triggered the beginning of a merger wave and thus the neoclassical
theory holds, a positive coefficient on sales growth will be expected.

Deregulatory event

According to the neoclassical theory, industry merger waves cannot only be provoked by shocks
but also by major deregulatory events in an industry (e.g. Mitchell and Mulherin, 1996 &
Ovtchinnikov, 2013). One explanation often used is that fewer regulations raise the overall level
of competitiveness. This then leads to higher productivity which in turn encourages M&A activity
(Mitchell and Mulherin, 1996).

Industries that are naturally highly regulated, for example the banking sector, have already been
excluded from the sample. Table 4 gives an overview of the six major deregulatory events that
took place in my sample industries. As we can see, deregulation only played a role in the first
decade (1991-2000) but not during the second decade (2001-2010). The information was derived
from several sources. I found the events listed in the table below in Harford (2005), Viscusi,
Vernon and Herrington (2005) and in Ovtchinnikov (2013). Additional deregulatory events for the
time periods not covered by the papers mentioned are searched via Lexis-Nexis and Google, but
no events for the sample industries could have been found.

Deregulatory event is a dummy variable equal to one for the two years following a major
deregulatory event, zero otherwise.

4
U.S. Dept. of Labor, Bureau of Labor Statistics: http://www.bls.gov/cpi/.
5
U.S. Energy Information Administration: http://www.eia.gov/forecasts/aeo/MT_coal.cfm.
 15

Harford (2005) as well as Mitchell and Mulherin (1996) find positive and strongly significant
coefficients for this variable. Therefore, I expect the same result if the neoclassical theory also
holds for my tested sample period. One limitation is of course that the dummy can only be
incorporated in the first decade of the sample period.
Table 4: Deregulatory Events 1991-2010

Effective year Deregulatory event Industry affected

1992 Cable Television Consumer Protection and Competition Act Entertainment
1992 FERC Order 636 Petroleum and Natural Gas
1993 Natural Gas Wellhead Decontrol Act Petroleum and Natural Gas
1993 Negotiated Rates Act Transportation
1995 Interstate commerce Commission Termination Act Transportation
1996 Telecommunications Act Telecommunication

Liquidity
Interest rate spread (Spread)

The interest rate spread between the Federal Funds rate and the interest rate on commercial and
industrial loans (C&I loans) can be used as a proxy for overall liquidity in the market or ease of
financing in the economy (Harford, 2005 & Gugler et al., 2012). The Federal Funds rate is the
interbank-interest rate at which depository institutions lend each other funds overnight. C&I loans
are loans to enterprises or joint ventures.6

The spread is extracted on a quarterly basis from the Federal Reserve’s Survey of Terms of
Business Lending. 6 From the four-quarter moving average I compute a yearly average for the
years 1990-2009.

With respect to previous research, I expect a negative coefficient on Spread. If the spread
between the Federal Funds rate and the rate for C&I loans increases, liquidity will be reduced and
M&A activity will be stemmed.

Interaction Term Sales Growth*(Tight Capital)

Harford (2005) shows that a sales shock alone is not sufficient for triggering a merger wave. He
argues that liquidity is an essential factor, too. According to him, I therefore construct the variable
Sales Growth*(Tight Capital) interacted with a dummy variable identifying low liquidity years. Low
liquidity years are all years in which market-to-book ratios are below their times-series median or
the interest rate spread was above its time-series median. The neoclassical theory predicts that
high sales growth is more likely to initiate an industry merger wave if there is sufficient capital in
the economy. It is interesting to see that low liquidity years cluster around 1991/92, 2000/02 and
2008/2009. These years mark the end of the fourth, fifth and sixth merger wave respectively.

6
Federal Reserve’s Survey of Terms of Business Lending:
http://www.federalreserve.gov/releases/e2/e2chart.htm
Table 5: Descriptive Statistics Logit Model

This table shows the summary statistics across all industries for the median industry market-to-book ratio, the median industry price-earnings ratio, industry sales growth and the interest rate
spread between the Federal Funds rate and the interest rate on commercial and industrial loans.

Mean Median SD Min Max Mean Median SD Min Max Mean Median SD Min Max Interest
M/B M/B M/B M/B M/B P/E P/E P/E P/E P/E Growth Growth Growth Growth Growth Spread (%)
1990 1.4 1.3 0.7 0.5 4.0 10 9 7 -3 32 0.02 0.01 0.01 0.00 0.05 1.9
1991 1.7 1.4 0.9 0.6 4.7 14 13 16 -8 88 0.05 0.04 0.03 0.00 0.13 2.1
1992 1.9 1.8 0.7 0.9 4.0 13 16 30 -114 70 0.03 0.02 0.02 0.00 0.08 2.1
1993 2.2 2.1 0.7 0.0 4.0 24 19 24 -5 132 0.06 0.04 0.08 0.00 0.39 2.1
1994 1.9 1.8 0.7 0.0 3.3 19 16 22 -4 132 0.08 0.08 0.05 0.01 0.18 1.8
1995 2.1 1.8 1.0 0.0 5.1 20 16 19 -10 82 0.28 0.27 0.14 0.00 0.70 1.8
1996 2.0 1.9 0.8 0.0 4.5 14 15 9 -15 28 0.08 0.06 0.07 0.00 0.34 1.7
1997 2.1 2.0 0.8 0.0 4.3 12 15 11 -26 26 0.06 0.05 0.06 0.00 0.22 1.7
1998 1.7 1.5 0.7 0.0 3.7 14 12 24 -4 138 0.08 0.08 0.07 0.00 0.26 1.8
1999 2.4 1.6 3.3 0.0 19 8 10 7 -8 23 0.20 0.08 0.59 0.01 3.30 2.0
2000 1.6 1.2 0.8 0.0 4.5 7 7 6 -9 19 0.09 0.06 0.11 0.00 0.49 2.1
2001 1.5 1.4 0.7 0.0 3.7 7 7 11 -8 51 0.05 0.04 0.05 0.00 0.15 2.0
2002 1.2 1.2 0.4 0.0 2.2 6 5 7 -2 18 0.05 0.03 0.05 0.00 0.17 2.2
2003 1.8 1.7 0.7 0.0 3.9 8 10 8 -6 21 0.06 0.05 0.04 0.00 0.21 2.4
2004 2.1 2.0 0.6 1.5 4.0 13 15 7 -6 31 0.14 0.12 0.10 0.03 0.59 2.4
2005 2.4 2.1 1.8 1.3 11 16 15 13 -5 69 0.06 0.05 0.04 0.01 0.16 2.4
2006 2.2 2.0 0.7 1.4 4 22 14 34 -4 147 0.08 0.07 0.06 0.00 0.29 2.1
2007 2.0 1.8 0.7 1.0 4.3 13 14 9 -4 39 0.09 0.08 0.07 0.01 0.35 2.0
2008 1.1 1.0 0.2 0.6 1.7 5 4 6 -1 22 0.07 0.04 0.07 0.01 0.26 2.3
2009 1.5 1.4 0.4 0.9 3.1 17 8 41 -3 173 0.11 0.09 0.09 0.00 0.38 3.0

16
 17

4.3.1.2 Descriptive Statistics

Table 5 reports the descriptive statistics for the Logit model. The median market-to-book ratio
ranges from 1.0 in 2008 to 2.1 in 1993 and 2005. When we relate the years to the different phases
of identified merger waves we can see that M/B ratios are extremely low towards the end of both
waves (2000-2002 and 2008/2009). The maximum values can be observed before the start of the
fifth wave and during the sixth wave. In 1999, the year of the burst of the dot-com bubble, we can
observe the highest standard deviation of 3.3.

The pattern for the median price-earnings ratio is similar. Over the sample period it ranges from 4
in 2008 to 19 in 1993. The highest values can be observed around the start of the fifth wave and
during the sixth wave, whereas the lowest values are found at the end of both waves in
2001/2002 and 2008.

For the median industry growth rates no clear picture can be drawn. Values vary from 0.01 in
1990 to 0.27 in 1995. It is noticeable that the highest median growth rate occurred in 1995, which
is the start of the fifth wave. Furthermore, the highest standard deviation is found in 1999 as for
the M/B ratio.

The interest rate spread between the Federal Funds rate and the interest rate on commercial and
industrial loans shows an exceptional pattern. The lowest values of 1.7% and 1.8% are observed
from 1994-1998, which is considered start and peak of the fifth wave. The maximum values of
2.4% can be seen around the peak of the sixth wave from 2003-2005.

4.3.1.3 Results

Interpreting the results of a Logit regression (Table 6) for continuous variables is not as easy and
straightforward as in an OLS-regression. This is due to the nonlinear nature of the maximization
process. However, knowing the sign of the coefficient allows us to interpret whether the variable
increases or decreases the odds of the year being the start of an industry merger wave. This is
known as response probability. Since the maximum likelihood estimation is based on the
distribution of the dependent variable (y) given all explanatory variables (x), it is automatically
controlled for heteroskedasticity (Wooldridge, 2005).

As an OLS regression, a Logit regression also offers several measures of goodness of fit, called
pseudo R-squares. The one reported by Stata and commonly used is the McFadden R2:

2 ln 𝐿𝑀
𝑅𝑀𝑐𝐹𝑎𝑑𝑑𝑒𝑛 =1− ln 𝐿0
; ln 𝐿= log-likelihood function

This pseudo R2 shows the degree of improvement of the complete model with explanatory
variables (numerator) in comparison to a model with only an intercept (denominator). A rule of
thumb is that the adjustment of the model is highly satisfactory if the McFadden R² is between 0.2
and 0.4 (McFadden, 1979). Thus, regression 2 for the period 1991-2000 has an excellent
adjustment, as shown in Table 6.

Additionally, I perform a Wald test to verify if the coefficients of the variables used are
simultaneously equal to zero. Based on the p-value I am able to reject the null hypothesis in all
 18

three models, indicating that these explanatory variables are different from zero and significantly
improve the fit of the model.

Table 6: Predicting the start of a merger wave – Logit regression

In Column 1, a Logit regression with the variables described in the previous section is run for the whole sample period
from 1991-2010. Column 2 shows the regression results for the first decade from 1991-2000 and column 3 displays
results for the second decade from 2001-2010. The deregulatory event dummy variable was not included in (3) because
no deregulatory events took place during this time. The dependent variable equals 1 if the industry year was the start or
the successive year of an industry merger wave; zero otherwise.
Note: T-statistics are given in parentheses; *** p<0.01, ** p<0.05, * p<0.1.
1991-2010 (1) 1991-2000 (2) 2001-2010 (3)
Intercept 4.67*** 15.90*** 3.76
(3.62) (4.01) (1.56)
Market-to-book ratiot-1 -0.02 0.11 -0.45
(-0.15) (0.79) (-1.41)
Price-earnings-ratiot-1 0.003 0.004 -0.007
(0.38) (0.39) (-0.46)
C&I Rate Spreadt-1 -3.49*** -10.47*** -2.05*
(-5.40) (-4.55) (-1.86)
Sales Growtht-1 4.27*** 10.38*** -7.37*
(3.67) (5.35) (-1.76)
Deregulatory Eventt-1 0.11 1.46*
(0.14) (1.78)
Sales Growtht-1 6.25* -10.38*** -4.99

Observations 600 300 300

Pseudo-R2 0.13 0.36 0.08
chi2 49.01 43.85 12.30
Prob > chi2 0.00*** 0.00*** 0.03**

In column 1, I estimate model (1) for the whole sample period from 1991-2010 with 600
observations- 30 industries for 20 years each. Both variables used for testing the misvaluation
theory, the median market-to-book ratio and the median price-earnings ratio, are insignificant.
This is in line with the findings in Harford’s (2005) research. The interest rate spread used as a
proxy for the overall liquidity in the market is highly significant and negative as predicted by
Harford. In a Logit regression a negative sign means that if the spread increases, the probability of
the year being the start of an industry merger wave will decrease. The exact interpretation of the
coefficient is more complex, because the scale factor depends on all explanatory variables. Due to
the nonlinear nature of the model, a one unit increase from 1% to 2% does not have the same
effect as a one unit increase from 2% to 3%. The effect of 1 unit change in the rate spread on the
response probability can be estimated as follows:

∆P(y=1|x) ≈ [g(𝛽0 + 𝑥𝛽)𝛽𝑗 ]∆𝑥𝑗 ; g= probability density function; x = all explanatory variables
 19

In order to get an idea of the economic interpretation of the coefficients, the C&I rate spread can
serve as an example. It’s coefficient of -3.49 can be transformed to odds by raising it to the
power e.

𝑒 −3.49 = 0.03 meaning that a one unit change in the C&I rate spread leads to the event being less
likely (≈0.03/0.97) to occur. Positive odds ratios are easier to interpret. The odds ratio for sales
growth equals 𝑒 4.27 = 71.5. A 1 unit increase in sales growth (≙ 100%) would make the event 71.5
times (≈0.9863/0.0137) more likely to occur than the non-event holding all other variables equal.

Changes in probabilities cannot be generalized as in a linear regression analysis. Therefore only

the signs of the coefficients as well as their significance will be interpreted for making statements
about the influence of the response probability. Harford (2005) applies the same method for
drawing conclusions from his regression results.

Looking at the variables chosen to test the neoclassical theory, the industry sales growth and the
deregulatory event dummy, we can see that only sales growth is highly significant. The interaction
term Sales Growth*(Tight Capital) is surprisingly positive, indicating that sales growth in connec-
tion with tight capital increases the odds of an industry merger wave. However, this result is only
significant at the 90% level and should be interpreted with caution. It is inconsistent with previous
research and cannot be explained at the moment.

In a next step, I split my sample and estimate the model for the first and the second decade
separately. In column 2, the results for the period 1991-2000 are shown. As in column 1, the
misvaluation variables median market-to-book ratio and median price-earnings ratio are not
significant. The interest rate spread again is highly significant and negative. In this period
however, both neoclassical variables are significant; sales growth even at the 99%, but the
deregulatory event dummy only at the 90%. Both variables have a positive sign. This means that
an increase in sales growth or a deregulatory event increases the probability of the following year
being the start of a merger wave in the corresponding industry. The interaction term Sales
Growth*(Tight Capital) is significant as well and this time negative, meaning that shocks in times
of liquidity constraints are not enough to propagate a wave but will decrease its probability.

Considering only this time period, my findings equal those of Harford for his sample period 1981-
2000. He did not find proof of the misvaluation theory but strong proof of the neoclassical theory
with a liquidity component.

Lastly, I estimate the model for the time 2001-2010, a period that was not covered in Harford’s
study. As it can be seen, the measures of goodness of fit are poorer than in the previous esti-
mations and solely two variables are significant, however only at the 90%. These are again the
interest rate spread and the sales growth, showing further support of the neoclassical theory with
a liquidity component, albeit with rather low significance. The deregulatory event dummy was not
included because no deregulatory events could be identified applying the method explained
earlier. Overall it seems as if in the second decade, the time of the sixth aggregate merger wave,
none of the presented theories was prevailing and significantly responsible for initiating industry
merger waves.
 20

My next step is to estimate an OLS model to analyze the driving factors after the industry wave
had started.

4.3.2 What drives merger activity during a wave? - Ordinary least square (OLS)
regression

For answering the second part of my research question, I estimate a model similar to the one
suggested by Gugler et al. (2012). This model oughts to identify the driving factors during the fifth
and the sixth aggregate merger wave and to clarify similarities and differences in both waves.
Knowing the driving factors will allow us to derive conclusions about the different prevailing
theories on M&A waves.

The model to be estimated is the following

(2) Mit= α + 𝛽1 P/Et + 𝛽2 Spret + 𝛽3 CFit-1 + 𝛽4 lnAit + 𝛽5 Levit + (𝛽6 𝑄𝑖𝑡 ) + 𝛽7 DFinit + µit ,

where M is the transaction value / total assets, P/E is the price-earnings ratio among the S&P 500
companies. Spread is the interest rate spread between the Federal Funds rate and the interest
rate on commercial and industrial loans. CF is the cash flow of the acquiring company. LnA is the
natural logarithm of total assets of the acquiring company. Lev is the acquiring company’s
leverage. Q is the difference in Tobin’s Q between acquirer and target and DFin is a dummy
variable equal to one if the consideration paid was mainly stock and zero otherwise.

4.3.2.1 Variables

In this section I present the variables used for estimating the OLS regression. Not all variables can
be clearly matched to only one theory as in the Logit model estimated earlier. Table 7 gives an
overview of the expected coefficients for each theory.

Transaction volume/acquirer’s total assets (M)

The dependent variable M is the transaction value over the acquirer’s total assets. If only the
transaction value was used, the size of the acquiring firm would greatly affect the results.
Constructing a ratio allows to demonstrate also the effect for small buyers that acquire a target
that is small in absolute size, but still a large acquisition for the acquiring firm (Gugler et al., 2012).

Gugler et al. name this variable “assets acquired over total assets”. However, they use the
consideration paid by the acquirer over its total assets and assume that the goodwill is equal to
zero.

Both parts of the variable were readily available in the SDC Mergers and Acquisitions database.

Weighted average price-earnings ratio (P/E ratio)

As explained earlier, the misvaluation theory argues that mergers and acquisitions take place
when the acquirer is perceived to be overvalued relatively to the possible target.
 21

A proxy for optimism in the stock market is the weighted average price-earnings ratio (P/E ratio)
in a country (Gugler et al., 2012). High P/E ratios indicate that the stock market values the stock of
a company rather high in comparison to their reported earnings.

𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒

Price-earnings ratio =
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒

In order to calculate this variable I extract the monthly P/E ratios and market values (MV) for the
S&P 500 companies from DataStream for the years 1990-2009. For getting a representative
picture of the optimism in the stock market and not facing the problem of a selection bias, I
choose the S&P companies and not the acquiring companies in my sample. Yearly averages for
each company are computed and weighted with their market value.

According to the overvaluation and the managerial discretion theory, merger activity of listed
companies is positively associated with the degree of optimism in the stock market.

Interest rate spread (Spread)

The interest rate spread is the same variable as used in the Logit regression model. Gugler et al.
(2012) expect a negative coefficient, as an increasing spread decreases the ease of financing and
will obstruct M&A activity.

Cash Flow as a fraction of total assets (CF)

The managerial discretion theory by Jensen (1986) claims that managers undertake mergers and
acquisitions when internal funds are available. An important measure of the availability of internal
funds is Cash Flow (CF) (Schwartz, 1984). If no external capital has to be raised, it will be easier for
the company to make quick decisions (McCarthy, 2011).

Cash Flow over total assets can therefore be used for distinguishing between the managerial and
the neoclassical theory. The MDH predicts a positive sign. Planning a merger requires some time,
thus the cash flows in the year previous to the merger are considered.

𝐶𝐹𝑡−1
= 𝑇𝐴𝑡−1

I obtain the data by extracting the different components for each acquiring company from the
Compustat North America Database. A company’s total net cash flow comprises the net cash flow
of operating activities, the net cash flow of investing activities and the net cash flow of financing
activities. The number of total assets has already been obtained from SDC.

Firm size (LnA)

Managers of large companies have more discretionary power to follow own goals because bigger
firms are more difficult to take over. Hence the acquiring company’s firm size can be used as a
control variable (Gugler et al., 2012). The managerial discretion theory predicts a positive
coefficient on firm size; other theories do not make any predictions.

Firm size = Natural logarithm of total assets (log TA)

 22

Leverage (Lev)

The company’s leverage can reflect several things and interpreting the coefficient is not straight-
forward. On the one hand, high leverage puts a constraint on the access to additional external
capital which will result in lower M&A activity. On the other hand, high leverage can signal a
growth-oriented management and the managerial discretion theory predicts a positive coefficient
on leverage (Gugler et al., 2012). Leverage is calculated as the sum of long-term debt and debt in
current liabilities over the company’s total assets.

(𝐿𝑇 𝑑𝑒𝑏𝑡+𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠)

Leverage =
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

Tobin’s Q (Q)
Previous research conducted by Jovanovic and Rousseau (2002) shows that the level of dispersion
of the acquirer’s and the targets’ Tobin’s Q influences merger activity. They argue that when the
gap of Q’s increases, companies favor to engage in M&A activity.

Actually, the Q ratio is calculated as the market value of a company divided by the replacement
value of the firm's assets. A company’s market value is the sum of the market value of its equity
and the market value of its liabilities. The book value of debt can be used as a proxy for its market
value. For estimating the replacement value, it is common practice to use book values as a proxy.
Therefore, in this paper the ratio of Tobin’s Q is calculated as follows:

(𝐸𝑞𝑢𝑖𝑡𝑦 𝑀𝑉+𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 𝐵𝑉)

Tobin’s Q =
(𝐸𝑞𝑢𝑖𝑡𝑦 𝐵𝑉+𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑒𝑠 𝐵𝑉)

For the calculation of the Q of each listed acquirer and each listed target company, the three
different components of the equation above are obtained from DataStream. The equity’s market
value is proxied by the company’s market capitalization; the equity’s book value by the common
equity and the debt’s book value is proxied by the company’s total liabilities.

Since the Tobin’s Q and the difference between acquirer and target can only be calculated for
publicly listed companies, this variable is solely used in the estimation with listed targets. Due to
the limited number of listed target companies and data unavailability, a total of 652 differences in
Q can be computed.

The overvaluation as well at the managerial discretion predict a positive coefficient on Q, meaning
that M&A will increase if the gap between the acquirer’s and the targets’ Q increases.

Form of Financing

The form of financing in a merger or acquisition is also an indicator of the reason behind the
transaction. The misvaluation theory predicts that the method of payment will be mainly stock. If
an acquiring company reacts to an economic shock by means of a merger, the method of payment
can be either stock or cash and I expect an insignificant coefficient on the variable (Harford,
2005). The managerial theory does not make an explicit assumption. However, I consider a stock
 23

merger to be more likely, because stock financing also signals that the acquirer is less certain
about the underlying value of the transaction (Carow et al., 2004).

The explanatory variable is a dummy indicating the method of payment. It is equal to one if the
proportion of stock used in the acquisition exceeds the proportion of cash; zero otherwise
(Carow, 2004). The consideration structure and description is available on SDC. However, for
some companies the consideration structure is not explicitly stated. Therefore I analyze the
description and assign the dummy due to the description.

Gugler et al. (2012) do not incorporate this dummy variable in their analysis. Yet I do because I
consider it an appropriate measure to further distinguish the prevailing merger theories.

Largest Shareholder (S)

In their research, Gugler et al. also include the fraction of the largest shareholder for discrimi-
nating between the managerial and the overvaluation theory. According to the managerial
theory, large shareholders avoid wealth-destroying mergers. By contrast, controlling shareholders
risk wealth-destroying transactions if they believe that their company is overvalued. However, I
am not able to include this variable into my regression model due to limited data availability.

Table 7: Predicted signs of coefficients for the different merger wave theories

The table gives an overview of the predicted coefficients if the respective theory holds. Zero indicates that the variable
does not help to validate the theory. For example, the P/E ratio should not have any influence on merger activity if the
neoclassical theory holds.

P/E ratio Spread Cash Flow Ln Assets Leverage Q DFin

Misvaluation
+ 0 0 0 0 + +
Theory

Managerial
+ - + + + + +
Discretion
Theory
Neoclassical 7
0 - 0 0 - 0 0
Theory

7
Strictly speaking, cash flow does not belong to the investment equation in the neoclassical model.
However, empirical studies found that cash flow is positively related to investment (Gugler, Mueller and
Yurtoglu 2004).
 24

4.3.2.2 Descriptive Statistics

Variables that are not given as (weighted) yearly averages or as a dummy have been winsorized at
the 99%-quartile to account for outliers. These are the dependent variable M as well as cash flow,
firm size, leverage and Tobin’s Q.

Summary statistics for the data set are presented in Table 8. All numbers are reported for four
different time frames – for the entire period from 1991-2010, for transactions announced in the
fifth and the sixth wave as well as for transactions announced in non-wave periods.

During the fifth merger wave companies made on average 60% larger acquisitions than during the
sixth wave and non-wave periods compared to their size. The weighted average price-earnings
ratio in the U.S. has been more than twice as large during the fifth wave compared to the sixth
wave and non-wave periods, while the interest rate spread was much lower during the fifth wave.
The average cash flow as a fraction of total assets in the year previous to the merger more than
doubled during the fifth wave whereas the acquiring firm’s size does not vary greatly over time.
During the sixth merger wave, labeled ”the rebirth of leverage” by DePamphilis (2012), average
leverage was 0.32, 30% higher than during the fifth wave. The gap between Tobin’s Q’s varied
greatly over the sample period. During the fifth wave it was on average 1.34 while the mean gap
was -0.61 during the sixth wave. With regard to the method of payment, 1,635 transactions payed
with a majority of stock are included in the sample. 774 taking place in the fifth and 156 in the
sixth wave.
 25

Table 8: Descriptive Statistics OLS Model

This table shows the variable’s mean and median, their standard deviation as well as minimum and maximum values
after the data has been winsorized at the 99%-quartile. Values are given over the whole sample period and separately
for the fifth and sixth wave as well as for non-wave periods.

Period Mean Median SD Min Max

Deal Value/ 1991-2010 0.37 0.13 0.75 0.00 5.28
Total Assets (Mit) 5th Wave 0.51 0.17 0.96 0.00 5.28
6th Wave 0.32 0.10 0.69 0.00 5.28
Non-wave 0.32 0.12 0.61 0.00 5.28

Price-earnings 1991-2010 46 34 29 21 108

ratio (P/Et) 5th Wave 73 54 32 23 108
6th Wave 34 33 10 21 107
Non-wave 35 27 19 21 108

Spread (Spret) 1991-2010 2.21 2.14 0.39 1.66 3.35

5th Wave 1.91 1.94 0.17 1.66 2.39
6th Wave 2.30 2.36 0.16 1.96 3.01
Non-wave 2.34 2.33 0.45 1.66 3.35

Cash Flow (CFit-1) 1991-2010 0.03 0.00 0.10 -0.24 0.53

5th Wave 0.05 0.00 0.13 -0.24 0.53
6th Wave 0.02 0.00 0.07 -0.24 0.53
Non-wave 0.02 0.00 0.09 -0.24 0.53

Ln Assets (LnAit) 1991-2010 3.26 3.22 0.76 0.23 6.05

5th Wave 3.13 3.07 0.78 0.34 5.63
6th Wave 3.33 3.33 0.68 1.01 6.05
Non-wave 3.31 3.25 0.77 0.23 6.03

Leverage (Levit) 1991-2010 0.25 0.23 0.21 0.00 0.85

5th Wave 0.25 0.22 0.22 0.00 0.85
6th Wave 0.32 0.29 0.22 0.00 0.85
Non-wave 0.23 0.21 0.19 0.00 0.85

Difference in 1991-2010 0.18 0.09 9.56 -13 83

Tobin’s Q (Qit) 5th Wave 1.34 0.18 8.88 -29 83
6th Wave -0.61 0.03 8.37 -89 6.22
Non-wave -0.07 0.07 1.80 -13 7.88

Dummy Fin 1991-2010 1635 observations (25%)

(DFinit) 5th Wave 774 observations (40%)
6th Wave 156 observations (13%)
Non-wave 705 observations (21%)
Notes: For the period 1991-2010, the values for M, CF, Ln(A), Lev and DFin are based on the entire sample of 6,536
observations. Q is based on 652 differences between the acquirer’s and the target’s Tobin’s Q. P/E is a weighted average
of the S&P 500 companies and Spre is the yearly average spread between the federal interest rate and the industrial loan
rate given by the Federal Reserve’s Survey of Terms of Business Lending. For the fifth and the sixth wave as well as for
non-wave periods only those observations belonging to the corresponding period are included.
 26

4.3.2.3 Results 1991-2010

In the first step I estimate model (2) for the whole sample period from 1991-2010, irrespective of
merger waves. Table 9 gives an overview of the results. Column 1 presents the regressions results
for all target companies. Column 2 shows the same estimation but with an additional dummy for
the form of financing. In Column 3, the results only for listed targets with an available Q are given
and in column 4 the dummy for the form of financing is added once more.

The first analysis is carried out for column 1 and 2 comprising the entire sample of 6,536
observations between 1991 and 2010. Price-earnings ratio and Cash Flow are both positive and
statistically significant. Market optimism and higher cash flows lead companies to acquire more
assets in relation to their firm size. A positive sign for the P/E ratio can be attributed to both the
misvaluation and the managerial discretion theory while the positive sign for Cash Flow is clear
evidence of only the managerial discretion theory. These findings are in line with the results of
Gugler et al. (2012) for the United States. However, I find a stronger influence of Cash Flow on the
assets acquired.

In column 1, Spread is positive but insignificant, while it turns significant when the dummy for the
form of financing is added (2). It means that an increase in the rate spread leads to the acquisition
of more assets; a finding that contradicts previous research and is difficult to explain.

Firm size (Ln Assets) and Leverage are both negative and highly significant at the 1% level. This
indicates that a greater firm size and more leverage have a negative influence on the dependent
variable. These results are not supporting the managerial discretion theory, but the negative
coefficient on leverage supports the misvaluation as well as the neoclassical theory. More
leverage hampers M&A activity. Yet, from the misvaluation and neoclassical theory’s perspective,
firm size should not influence significantly the amount of assets acquired. The negative influence
on M, meaning that smaller firms acquire more assets, is hence not in line with any of the
prevailing theories. Towards the end of section 4.3.2.4, I will further explore and explain this
finding.

Finally, the dummy for the method of payment is added in column 2 which increases the R2 from
24.1% to 29.6%. Dummy Fin picks up a positive and strongly significant coefficient. If a transaction
is paid with mainly stock (>50%) and the dummy takes the value one, assets acquired as a fraction
of total assets will increase by 0.432. The influence of the form of payment on M has not been
tested by Gugler et al. (2012) but gives interesting insights into the merger theory. If an
acquisition is paid with stock, acquiring firms will purchase greater amounts of assets in relation
to their own size.

In column 3 and 4 Tobin’s Q is added and therefore the sample is reduced to 652 observations, all
of them having a listed target with available data for Tobin’s Q. The P/E ratio, firm size (Ln Assets)
and the financing dummy show the same results as in the estimation for the whole sample.
Spread is again positive but insignificant and not supporting the importance of liquidity found by
Harford (2005) as well as Gugler et al. (2012). In both estimations (3 and 4), the coefficients on
Cash Flow and Leverage are not significant, which is against the managerial discretion theory.
 27

Table 9: What drives merger activity during a wave? OLS regression results for 1991-2010

Column 1 shows the regressions results for all target companies. Column 2 shows the same estimation but with the
dummy for the form of financing added. In Column 3 the results only for listed targets with an available Q are given, in
column 4 the dummy for the form of financing is added. The dependent variable is M= Transaction value / total assets.
Note: T-statistics are given in parentheses; *** p<0.01, ** p<0.05, * p<0.1.

(1) All targets (2) All targets (3) Listed targets (4) Listed targets
Constant 1.75*** 1.47*** 2.03*** 1.61***
(27.72) (23.77) (7.18) (5.65)
P/E ratiot 0.003*** 0.001*** 0.004*** 0.003**
(8.59) (4.93) (3.14) (2.44)
Spreadt 0.02 0.06*** 0.08 0.12
(0.75) (2.72) (0.77) (1.22)
Cash Flowit-1 0.36*** 0.19** 0.11 0.12
(4.39) (2.44) (0.31) (0.35)
Ln Assetsit -0.45*** -0.42*** -0.51*** -0.46***
(-40.23) (-38.63) (-12.05) (-10.98)
Leverageit -0.27*** -0.14*** -0.25 -0.25
(-6.90) (-3.73) (-1.35) (-1.37)
Dummy Finit 0.43*** 0.40***
(22.73) (6.07)
Tobin’s Qit 0.05*** 0.04***
(3.24) (3.17)

Observations 6,536 6,536 652 652

R-squared 0.24 0.30 0.24 0.28
Notes: Variables are price-earnings ratio (P/E ratio), spread between the federal interest rate and the industrial loan
rate (Spread), cash flow divided by total assets (Cash Flow), log of total assets (Ln Assets), Leverage, Dummy for the
form of financing (Dummy Fin) and the difference between the acquirer’s and the target’s Tobin’s Q (Tobin’s Q). Dummy
Fin equals 1 if the consideration was mainly stock; zero otherwise.

When the sample is limited to listed target companies and Q is added, Tobin’s Q has a positive
and significant sign. When the gap between the acquirer’s and the target’s Q increases by 1 unit,
the amount of assets acquired increases by 0.05 (column 3) or 0.04 (column 4). The positive
influence of Q on M is supported by the managerial discretion as well as the misvaluation theory.

Summarizing the regression results for the entire period from 1991-2010, we can draw two
conclusions. First, when the sample comprises all target companies, no clear proof of one of the
presented theories can be found. Second, when the sample is restricted to listed target
companies, most of the coefficients show evidence of the misvaluation theory, except firm size
being significantly negative and spread being insignificant. If the misvaluation theory held, firm
size would not influence a firm’s merger activity. These findings are not in line with Gugler et al.’s
(2012) results who found evidence of the misvaluation theory for listed U.S. firms acquiring listed
target firms. The underlying reason can be twofold. First, Gugler et al. tested a much bigger
sample with corporate transactions accounting for deal values of at least $ 1 million which could
 28

have caused the differences. And second, their sample comprised U.S. merger activity between
1991 and 2004 and thus not the entire period of the sixth merger wave.

4.3.2.4 Results 5th wave, 6th wave and non-wave periods

In this section I estimate model (3) with dummy variables for the fifth and the sixth wave which
allows us to differentiate between the two M&A waves. This will answer the last part of my
research question whether the driving factors in the two waves were the same or different ones.

(3) 𝑀𝑖𝑡 = 𝛼 + 𝛽1 𝑃/𝐸𝑡 + 𝛽2 𝑑𝑤5 𝑃/𝐸𝑡 + 𝛽3 𝑑𝑤6 𝑃/𝐸𝑡 + 𝛽4 𝑆𝑝𝑟𝑒𝑡 + 𝛽5 𝑑𝑤5 𝑆𝑝𝑟𝑒𝑡 + 𝛽6 𝑑𝑤6 𝑆𝑝𝑟𝑒𝑡 + 𝛽7 𝐶𝐹𝑡−1 +
𝛽8 𝑑𝑤5 𝐶𝐹𝑡−1 + 𝛽9 𝑑𝑤6 𝐶𝐹𝑡−1 + 𝛽10 𝑙𝑛(𝐴)𝑡 + 𝛽11 𝑑𝑤5 𝑙𝑛(𝐴)𝑡 + 𝛽12 𝑑𝑤6 𝑙𝑛(𝐴)𝑡 + 𝛽13 𝐿𝑒𝑣𝑡 +
𝛽14 𝑑𝑤5 𝐿𝑒𝑣𝑡 + 𝛽15 𝑑𝑤6 𝐿𝑒𝑣𝑡 + 𝛽16 𝑑𝐿 𝑄𝑖𝑡 + 𝛽17 𝑑𝑤5 𝑑𝐿 𝑄𝑖𝑡 + 𝛽18 𝑑𝑤6 𝑑𝐿 𝑄𝑖𝑡 + 𝛽19 𝐷𝐹𝑖𝑛𝑖𝑡 +
𝛽20 𝑑𝑤5 𝑑𝐹𝑖𝑛𝑖𝑡 + 𝛽21 𝑑𝑤6 𝑑𝐹𝑖𝑛𝑖𝑡 + 𝜇𝑖𝑡 ,

where dw5 and dw6 are dummies for the fifth and sixth merger wave, dL is a dummy for listed
target companies and the other variables are as before.

The focus of the description and interpretation of the following results lays especially on the fifth
and the sixth merger wave for the whole sample with 6,536 observations. All results for the non-
wave periods as well as for the estimation restricted to listed targets can be found in Table 10.
Since Gugler et al. (2012) in their research basically only covered the fifth merger wave in the U.S.,
I am not able to compare my results. Furthermore, assigning the sample transactions to two
wave-periods seems to be new in academic research and provides new insights into possible
differences between the two merger waves.

In column 1 of Table 10 I estimate model (3) with wave dummies but without the financing
dummy and obtain an R2 of 26.7%. Adding the financing dummy increases the explanatory power
of the model by 5.6% and makes Leverage insignificant (column 2). It can be seen in column 1 and
2 that almost all variables lose significance in wave 6; some even get statistically insignificant at
the 90% level. However, insignificance of a variable chosen to prove one specific theory can also
be evidence of another theory.

During the fifth wave the P/E ratio is positive and significant at the 95% level (column 1), but has
only a weak influence on the assets acquired. If the weighted average P/E ratio in the U.S.
increases by 1 unit, M will increase by 0.002 showing signs for the misvaluation and for the
managerial discretion theory. During the sixth wave P/E gets statistically insignificant in both
estimations (column 1 and 2).

The interest rate spread is positive as well as significant in both waves in regressions 1 and 2
contradicting previous research but being in line with my findings from model (2) for the entire
sample period. It is noticeable, however, that the effect is stronger during wave 5.

In wave 5, Cash Flow picks up a positive and significant coefficient in both estimations. This is
predicted by the managerial discretion theory. Nevertheless, the influence is rather small since an
increase in cash flow over total assets of 0.01 increases M only by approximately 0.005. In wave 6,
Cash Flow becomes insignificant in column 1, but continues to have a positive influence on M in
column 2 when the financing dummy is added.
 29

Ln Assets and Leverage are both significantly negative during both waves in estimation 1 what
clearly contradicts the managerial discretion theory. A negative coefficient on leverage supports
the neoclassical theory, while the negative coefficient on firm size does not support any of the
three presented theories.

It can even be seen in column 1 and 2 that the effect of firm size on the assets acquired in wave 5
is approximately three times as strong as in wave 6. While the managerial discretion hypothesis
predicts that managers of larger companies have less fear of being taken over and hence have
more discretion to pursue their own goals, another theory brings up “the desire not to be
acquired” (Gorton et al., 2009). According to this theory, firms acquire other firms in order to
increase their own size and thereby reducing their chance of being taken over. “Eat or be eaten”
can be applied especially to the fifth merger wave when M&A activity broke all records and
behavioral factors dominated events. Smaller companies therefore had to increase their firm size
to avoid being eaten which was facilitated by their lower leverage. Comparing the average
leverage of the 50% largest sample firms measured in total assets with the 50% smallest firms, I
find a difference of 3%. The difference even accounts for 6% when the highest quartile is
compared to the lowest one. This theory is also in line with the negative coefficient on leverage.

The dummy for the consideration is significantly positive and has a large influence on M as in
model (2). Companies paying the transaction with stock acquire more assets. During wave 6, this
effect is approximately three times as strong as in wave 5. When the financing dummy is added,
leverage becomes insignificant in both waves.

Having a glance at column 3 and 4 we can see a mixture of indications for the misvaluation theory
and for the neoclassical theory, but not for the managerial discretion theory.

P/E ratio is insignificant being a sign for the neoclassical theory. The interest rate spread is
significantly positive in both estimations and for both waves what is clearly against the
neoclassical theory as well as against the MDH. Cash Flow and Leverage are positive but not
significant in any of the waves meaning that the MDH cannot be validated. As in column 1 and 2,
Ln Assets is negative. However, the form of financing ceases to have a significant impact on M.

The gap of Tobin’s Q, the most interesting variable in column 3 and 4 is only positively significant
at the 90% level during the fifth wave and ceases to be significant in the sixth wave. Since a
positive Q is clear support of the misvaluation theory and the MDH, we cannot validate these
theories by including Q in the regression.

Summarizing the results, we can conclude that for the restricted sample in both waves none of
the merger theories is prevailing. For the entire sample of 6,536 observations we can find slight
indications of the behavioral theories in wave 5 while in wave 6 none of the theories is dominant.
 30

th th
Table 10: What drives merger activity during a wave? Results for the 5 wave, the 6 wave and non-wave periods

Column 1 shows the regression results for all targets companies. In column 2 the dummy for the form of financing
added. In column 3 the results only for listed targets with an available Q are given while in column 4 Dummy Fin is
added. The dependent variable is M= transaction value / total assets.
Note: T-statistics are given in parentheses; *** p<0.01, ** p<0.05, * p<0.1.
(1) All targets (2) All targets (3) Listed targets (4) Listed targets (Q)
Constant 1.68*** 1.45*** ( )
1.92*** 1.56***
(23.23) (20.51) (5.92) (4.81)
P/E ratiot 0.0009 0.0005 0.0025 0.0020
(1.51) (0.97) (1.15) (0.94)
P/E ratiot*w5 0.0016** 0.0013* 0.0044 0.0042
(2.16) (1.72) (1.42) (1.40)
P/E ratiot*w6 -0.043 -0.001 -0.005 -0.006
(-0.04) (-0.50) (-0.99) (-1.09)
Spreadt -0.05** -0.02 -0.12 -0.08
(-2.08) (-0.67) (-1.05) (-0.76)
Spreadt*w5 0.34*** 0.26*** 0.40** 0.37*
(6.80) (5.54) (2.17) (1.95)
Spreadt*w6 0.15*** 0.11** 0.66*** 0.52***
(3.16) (2.37) (3.41) (2.59)
Cash Flowit-1 -0.06 -0.11 -0.53 -0.51
(-0.46) (-0.87) (-1.01) (-1.00)
Cash Flowit-1*w5 0.52*** 0.32** 0.65 0.57
(3.05) (1.97) (0.87) (0.78)
Cash Flowit-1*w6 0.51 0.60** 1.05 2.01
(1.61) (2.00) (0.71) (1.39)
Ln Assetsit -0.37*** -0.35*** -0.35*** -0.31***
(-26.09) (-25.26) (-6.49) (-5.80)
Ln Assetsit*w5 -0.21*** -0.20*** -0.33*** -0.33***
(-8.91) (-8.84) (-3.67) (-3.77)
Ln Assetsit*w6 -0.08*** -0.07** -0.32*** -0.26**
(-2.82) (-2.32) (-2.83) (-2.29)
Leverageit -0.12** -0.09 0.08 0.04
(-2.17) (-1.61) (0.29) (0.17)
Leverageitv*w5 -0.24*** -0.01 -0.49 -0.37
(-2.68) (-0.12) (-1.11) (-0.86)
Leverageit*w6 -0.20* -0.08 -0.64 -0.63
(-1.90) (-0.82) (-1.34) (-1.32)
Dummy Finit 0.33*** 0.33***
(12.58) (3.73)
Dummy Finit*w5 0.13*** 0.07
(3.12) (0.49)
Dummy Finit*w6 0.36*** 0.30*
(5.98) (1.70)
Tobin’s Qit -0.06 0.00
(-0.00) (0.04)
Tobin’s Qit*w5 0.06* 0.05*
(1.78) (1.75)
Tobin’s Qit*w6 0.05 0.04
(0.97) (0.86)
Observations 6,536 6,536 652 652
R-squared 0.27 0.32 0.28 0.33
th th
Notes: w5 and w6 means that the transaction took place in the 5 or 6 merger wave. All other variables as in Table 9.
 31

5. Conclusion and Discussion

The novelty of this study is the clear distinction between two merger waves in only one model –
namely the differentiation between driving factors during the fifth and the sixth aggregate merger
wave in the United States. By means of a Logit model, I identified the factors that had caused the
wave. In a second step, I detected the driving factors during a wave with the help of an OLS-
regression.

First, I clearly identified one aggregate wave in the 1990s and one in the 2000s, exactly like
various previous researchers.

Testing possible factors that might have triggered the start of a merger wave, I obtained different
findings for the two waves. Concerning the fifth wave, my findings are almost consistent with
Harford (2005). It was not the behavioral factors market-to-book value and price-earnings ratio
that caused the wave. In fact, it was proved that the neoclassical factor sales growth in
connection with a liquidity component was the driving force. Deregulation however, was only
significant at the 90% level not being totally in line with Harford. This might be explained with the
limited number of deregulatory events in my sample after the exclusion of the financial services
and utilities industry.

The start of the sixth merger wave cannot be concluded from any single theory. No deregulatory
events took place in my sample industries. Moreover, merely the neoclassical variables sales
growth and interest rate spread were significant, yet only at the 90%; a value that is usually
rejected as an indication for significance. Therefore, we can conclude that it was not excessive
liquidity that significantly caused the wave. The misvaluation variables market-to-book ratio and
price-earnings ratio are not statistically significant either.

In a next step, I estimated a model for the entire sample period from 1991-2010 to find the
driving factors of merger activity during this time. For the complete sample of 6,536 observations
no clear signs for one of the merger theories could be identified. When I restricted the regression
to listed targets only, most of the coefficients showed evidence of the misvaluation theory.

The results with reference to the driving factors during a wave do not show clear evidence of one
theory either. During the fifth wave, there are light signs of the behavioral theories in contrast to
the neoclassical theory. When the financing dummy is added, P/E ratio, Spread, Cash Flow and the
Dummy Fin are positive. Firm size is negative and Leverage becomes insignificant, probably
because the dummy raises the probability that a (highly) leveraged company pays the acquisition
with stock. The negative effect of firm size on M&A activity can be explained by the “eat or be
eaten” phenomenon; smaller firms had to acquire other firms in order to survive. This effect was
extremely strong during the fifth merger wave.

For the sixth wave I found mixed indications of all three theories and therefore no clear
conclusions can be drawn. P/E ratio ceases to be significant while the influence of Cash Flow on
merger activity doubles; the positive effect of the consideration structure even triples. The effect
of firm size on merger activity diminishes significantly.
 32

Even though there are no clear signs for one of the prevailing merger theories, we can derive one
conclusion. Managers have learnt their lesson from the fifth merger wave and acquisitions were
not mainly driven by behavioral factors. The price-earnings ratio during the sixth wave is not
significant, stock payments have been reduced from 40% to 13% and the gap in Tobin’s Q is much
less pronounced.

Restricting the tests only to listed targets with available Tobin Q’s does not help in obtaining clear
results either. Even the Q itself does not show any significance at the 95% during both waves. This
could be caused by the weak availability of data for Q’s, especially in the early years of the sample
period. It thus might be interesting to run the same regression in a few years when the seventh
wave started up and more data is available.

Two further limitations are that the proportion of the largest shareholder could not be included in
the model due to data unavailability. Furthermore, my sample of transactions was smaller than
the one used by Gugler et al. (2012).

At least for the fifth wave it is now possible to answer the questions whether the triggering
factors of the wave are also those that drive merger activity during the wave. The Logit model
proved clearly that the neoclassical factors had a great influence on the wave start whereas the
OLS-regression showed signs of the behavioral factors driving merger activity during the wave.
Especially interesting is the discovery that liquidity is a prerequisite for provoking a wave, but
afterwards, when excessive optimism and herd behavior play a role, it ceases to be of importance.

Further Research

Further research could be done in two different directions. To test whether one of the theories
explained was clearly prevailing in particular industries, industry dummies could be included.

Another possibility of research aims to investigate the different phases of merger waves.
Martynova and Renneboog (2008) found that takeovers towards the end of a wave are usually
driven by behavioral factors and non-rational managerial decision-making. Thus, it could be
interesting to assign transactions to the different stages of a merger wave and then test the
theories.
 33

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 36

Appendix A – Industry groups and their corresponding SIC codes

These are the same 48 industry groups as used in Fama and French (1997). Additionally, the industry group 49 “public
administration” (SIC codes 9100-9999) has been added.

Industry Group Short Four-digit SIC codes

1 Agriculture Agric 0100-0799, 2048-2048
2 Food Products Food 2000-2046, 2050-2063, 2070-2079, 2090-2095,
3 Candy and Soda Soda 2064-2068, 2086-2087, 2096-2097
4 Alcoholic Beverages Beer 2080-2085
5 Tobacco Products Smoke 2100-2199
6 Recreational Products Toys 0900-0999, 3650-3652, 3732-3732, 3930-3949
7 Entertainment Fun 7800-7841, 7900-7999
8 Printing and Publishing Books 2700-2749, 2770- 2799
9 Consumer Goods Hshld 2047-2047, 2391-2392, 2510-2519, 2590-2599,
10 Apparel Clths 2300-2390, 3020-3021, 3100-3111, 3130-3159,
11 Healthcare Hlth 8000-8099
12 Medical Equipment MedEq 3693-3693, 3840-3851
13 Pharmaceutical Products Drugs 2830-2836
14 Chemicals Chems 2800-2829, 2850-2899
15 Rubber and Plastic Products Rubbr 3000-3000, 3050-3099
16 Textiles Txtls 2200-2295, 2297-2299, 2393-2395, 2397-2399
17 Construction Materials BldMt 0800-0899, 2400-2439, 2450-2459, 2490-2499,
18 Construction Constr 1500-1549, 1600-1699, 1700-1799
19 Steel Works, etc. Steel 3300-3369, 3390-3399
20 Fabricated Products FabPr 3400-3499, 3443-3444, 3460-3479
21 Machinery Mach 3510-3536, 3540-3569, 3580-3599
22 Electrical Equipment ElcEq 3600-3621, 3623-3629, 3640-3646, 3648-3649,
23 Miscellaneous Misc 3900-3900, 3990-3990, 3999-3999, 9900-9909
24 Automobiles and Trucks Autos 2296-2296, 2396-2396, 3010-3011, 3537-3537,
25 Aircraft Aero 3720-3729
26 Shipbuilding, Railroad Ships 3730-3731, 3740-3743
27 Defense Guns 3480-3489, 3760-3769, 3795-3795
28 Precious Metals Gold 1040-1049
29 Non-metallic Mining Mines 1000-1039, 1069-1099, 1400-1499
30 Coal Coal 1200-1299
31 Petroleum and Natural Gas Enrgy 1310-1389, 2900-2911, 2990-2999
32 Utilities Util 4900-4999
33 Telecommunication Telcm 4890-4899
34 Personal Services PerSv 7020-7021, 7030-7039, 7200-7212, 7215-7299,
35 Business Services BusSv 2750-2759, 3993-3993, 7300-7372, 7374-7394,
36 Computers Comps 3570-3579, 3680-3689, 3695-3695, 7373-7373
37 Electronic Equipment Chips 3622-3622, 3661-3679, 3810-3810, 3812-3812
38 Measuring and Control LabEq 3811-3811, 3820-3839
39 Business Supplies Paper 2520-2549, 2600-2639, 2670-2699, 2760-2761,
40 Shipping Containers Boxes 2440-2449, 2640-2659, 3120-3221, 3410-3412
41 Transportation Trans 4000-4099, 4100-4199, 4200-4299, 4400-4499,
 37

42 Wholesale Whisl 5000-5099, 5100-5199

43 Retail Rtail 5200-5299, 5300-5399, 5400-5499, 5500-5599,
44 Restaurants, Hotel, Motel Meals 5800-5813, 5890-5890, 7000-7019, 7040-7049,
45 Banking Banks 6000-6099, 6100-6199, 6300-6399, 6400-6411
46 Insurance Insur 6300-6399, 6400-6411
47 Real Estate RlEst 6500-6553
48 Trading Fin 6200-6299, 6700-6799
49 Public Administration PubA 9100-9999
Appendix B: Number of deals and total transaction value per industry

The line shows the total number of deals with a value greater than $50 million where the bidder acquired more than 50% of the targets equity (right axis). The bars represent the total deal value in
$ millions per year (left axis).

Food Products Entertainment Printing and Publishing

30000 16 30000 16 16000 16
14 14 14000 14
25000 25000
12 12 12000 12
20000 10 20000 10 10000 10
15000 8 15000 8 8000 8
6 6 6000 6
10000 10000
4 4 4000 4
5000 2 5000 2 2000 2
0 0 0 0 0 0

Consumer Goods Apparel Healthcare

70000 20 4000 16 30000 40
60000 3500 14 35
25000
50000 15 3000 12 30
2500 10 20000 25
40000
10 2000 8 15000 20
30000
1500 6 15
20000 10000
5 1000 4 10
10000 500 2 5000 5
0 0 0 0 0 0

38
Appendix B (continued)

The line shows the total number of deals with a value greater than $50 million where the bidder acquired more than 50% of the targets equity (right axis). The bars represent the total deal value in
$ millions per year (left axis).

Medical Equipment Pharmaceutical Products Chemicals

40000 40 140000 50 70000 30
35000 35 120000 60000
40 25
30000 30 100000 50000
25000 25 20
80000 30 40000
20000 20 15
60000 20 30000
15000 15
10
10000 10 40000 20000
10 5
5000 5 20000 10000
0 0 0 0 0 0

Rubber and Plastic Products Construction Materials Construction

3000 12 30000 25 6000 18
2500 10 16
25000 20 5000
14
2000 8 20000 4000 12
15 10
1500 6 15000 3000
8
1000 4 10
10000 2000 6
500 2 5 4
5000 1000
2
0 0 0 0
0 0
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009

39
Appendix B (continued)

The line shows the total number of deals with a value greater than $50 million where the bidder acquired more than 50% of the targets equity (right axis). The bars represent the total deal value in
$ millions per year (left axis).

Steel Works, Etc. Machinery Electrical Equipment

14000 16 25000 50 12000 14
12000 14 10000 12
20000 40
10000 12 10
10 8000
8000 15000 30 8
8 6000
6000 10000 20 6
6 4000
4000 4 4
5000 10 2000
2000 2 2
0 0 0 0 0 0

Automobiles and Trucks Petroleum and Natural Gas

Coal
25000 25 7000 12 120000 80
6000 10 100000 70
20000 20
5000 60
8 80000
15000 15 4000 50
6 60000 40
10000 10 3000
4 40000 30
2000
20
5000 5 1000 2 20000 10
0 0 0 0 0 0

40
Appendix B (continued)

The line shows the total number of deals with a value greater than $50 million where the bidder acquired more than 50% of the targets equity (right axis). The bars represent the total deal value in
$ millions per year (left axis).

Telecommunication Personal Services Business Services

350000 120 3500 14 350000 250
300000 100 3000 12 300000
200
250000 2500 10 250000
80
200000 2000 8 200000 150
60
150000 1500 6 150000 100
40
100000 1000 4 100000
50000 20 500 2 50
50000
0 0 0 0 0 0

Computers Electronic Equipment Measuring and Control Equipment

60000 80 140000 160 25000 40
50000 70 120000 140 35
20000
60 100000 120 30
40000 50 100 25
80000 15000
30000 40 80 20
60000 10000 15
20000 30 60
20 40000 40 10
5000
10000 10 20000 20 5
0 0 0 0 0 0

41
Appendix B (continued)

The line shows the total number of deals with a value greater than $50 million where the bidder acquired more than 50% of the targets equity (right axis). The bars represent the total deal value in
$ millions per year (left axis).

Business Supplies Transportations Wholesale

16000 20 10000 25 35000 50
14000 30000
8000 20 40
12000 15 25000
10000 6000 15 30
20000
8000 10
4000 10 15000 20
6000
4000 5 10000
2000 5 10
2000 5000
0 0 0 0 0 0

Retail Restautrants, Hotel, Motel Trading

60000 50 25000 40 100000 200
50000 35
40 20000 80000
30 150
40000 25
30 15000 60000
30000 20 100
20 10000 15 40000
20000
10 50
10000 10 5000 20000
5
0 0 0 0 0 0

42