The Fifteenth Dubrovnik
Economic Conference
Organized by the Croatian National Bank
The Q-Theory of Mergers:
International and Cross-Border
Evidence
by
Peter L. Rousseau
Discussant: K. Zigic CERGE-EI Prague,
Czech Republic
Summary of the Research
• The article belongs to the line of work made by the author and his
co-author B. Jovanovic.
• High importance in the context of macroeconomics
– It endogenizes incentives and trade-off between alternative means of
capital expansion
• direct investments vs. M&As.
– Very compelling story that belongs to the family of neoclassical models
of investment choice with adjustment costs of investments
• The theory of the choice of investment: directly or by means of
acquisition
• From partial equilibrium insight to the tractable GE model that
gives predictions on the choices of direct investments vs. M&As
• Response to the productivity shocks explain M&A waves as being
driven by episodes of major technological change (Jovanovic &
Rousseau, 2004: Mergers as Reallocation)
Predictions of the Model
• Three predictions of the model:
– 1) M&A are preferred if the level of total
investments is high
– 2) M&A investments depend on difference
between Q(acquirer) and q(targets)
– 3) Q of acquirers should be higher than Q targets.
• The contribution of this article is in providing
further empirical evidence for their story.
First Hypothesis
• M&As are preferred if the firms make very large
investments. The point i0 at which acquisition
investments overtake direct investments can be
linked to the fixed costs of M&As (Φ).
• For analytical tractability Φ assumed proportional
to the size of acquirer
• This is implausible:
– Large firms are more likely to have lower costs of
entering M&A deal relative to their assets
First Hypothesis(2)
• Conditional on firms being of the same size, Φ =>
higher if M&As are more difficult to pursue due
to either regulatory reasons, difficulties in
obtaining finance, or "distance" costs, => crossborder merger
• The higher the Φ, the higher should be the i0.
– M&As are less costly if domestic and less costly in US
than in EU (see Figures 2 and 3; latter being
presumably due to less frictional US market and easier
access to external finance).
– The story meets data very nicely here.
Second Hypothesis
• Regressions of investments, direct or M&A, on Q or Q-q,
respectively.
• Extension:
– inclusion of cash-flow a) to test the responsiveness of
M&As/direct investments to excess cash (managers drive to
expand the span of control) and
b) to explain cross-border mergers
• This methodology is subject to substantial debate in
corporate finance literature
– What is proper interpretation of estimated coefficients on cashflow? (we reaaly don’t know!)
– From the structural model to the linear regression specification=>
several strong assumptions have to be made
– These assumptions may drive the results (most notably
Kaplan&Zingales 1997, 2000).
– Endogeneity between Q and CF
Second Hypothesis (2)
• Sample is restricted to firms that engaged in M&A, leaving out firms
that invested only directly.
– So not surprising that for these firms we observe larger sensitivity of
cash-flows in case of M&A investments than direct investments.
– Opposite would be true for firms not engaging in M&A as for those the
sensitivity of M&A investment to CF would be 0 by definition.
• It would be more interesting here to actually estimate selection
equation
– e.g. investigate whether excess cash leads to decision to engage in MA
=> run probit where M&A binary dependent variable and CF is one of
the regressors
• Pretty large difference in sensitivity of y on Q-q between US and EU
(order of 4). Why?
Third Hypothesis
• Not completely new
– The author mentioned that similar result is obtained
by Andrade, Mitchell and Stafford, 2001. So this
result is not so surprising.
Other Objections and Comments
• It is based on firm specific factor, z (industry specific
and macro factors ignored) and yet it is kind of
macro model
• z is random variable representing technological
shock, so it seems to indicate that merger wave
coincides with business cycle insofar the latter is
governed by the real business cycle model
• Discuss more the underlying assumptions needed
to come to the figure 1:
Other Objections and Comments(2)
– It is not clear if this holds in general, that is, for any
shape of unit cost function c(x,y).
– Marginal costs of adjustment of the capital by direct
investments or by M&A (cx or cy) have to meet some
condition in order for the M&A investments to be
preferable (see eq. 9).
– For i>i*, => the minimum in the curly brackets has to
be such that y > 0
– If cy > cx for every i => more costly to invest additional
dollar through MA than through plain direct
investment
Cross-border Mergers from International
Trade and IO Perspective
• Cross-border mergers are an increasingly important
phenomenon in the world economy
– well over half of all foreign direct investment (FDI) trough crossborder mergers, considerably more than greenfield investment
• Importance of strategic interactions
• Cross-border mergers also constitute an increasing proportion
of all mergers
• Considerable anecdotal and other evidence suggesting that
cross-border merger waves coincide with episodes of trade
liberalization and market integration
• There is ample anecdotal evidence that cross-border mergers
tend to reflect comparative advantage
“Out of the Model” Criticism
• No strategic interaction
• No insight from international trade literature
• The model under consideration does not
explain why M&A intensify in periods of
adjustment to trade liberalization
• No discussion about competitive and social
welfare effects of these mergers
“Out of the Model” Criticism(2)
• “If (...) M&A is not clearly linked to cross- border
technological transfers, it may make more sense
for researchers to pursue frameworks that model
cross-border mergers as attempts to exploit
established organizational structures with an eye
to gaining “footholds” and ultimately substantial
market shares in targeted foreign sectors. When
the nature of cross-border mergers is largely
extractive as the latter case suggests, some
restrictions on the activity may be justifiable.”
Prediction from an IO/Trade model
• Appropriate methodology => oligopolistic
interaction in general equilibrium (see Neary, 2002,
and 2009)
• International differences in technology generate
incentives for bilateral mergers in which low-cost
firms located in one country acquire high-cost firms
located in the other
– Consistent with the prediction from Rousseau paper.
• As a result, cross-border mergers serve as
instruments of comparative advantage
Prediction from an IO/Trade model(2)
• Implications for income distribution:
putting downward pressure on wage => tilting
the distribution of income towards profits at the
expense of wages in both countries.
• Social welfare considerations:
– the fall in wages puts downward pressure on prices in
all sectors, which tends to increase the gains from
trade in both countries potentially offsetting price
increase in the sectors in which mergers occur. On
balance, the net effect on welfare is likely to be
positive.
Prediction from an IO/Trade model(3)
• the pattern of cross-border mergers which results from
market integration follows that of comparative
advantage, in the sense that low-cost firms acquire
high-cost foreign rivals (no cost synergies!).
• As a corollary, the model predicts that cross-border
mergers and exports are complements rather than
substitutes, in the sense that exporting sectors tend to
be sources of rather than hosts for foreign direct
investment
– see also Helpman, Melitz and Yeaple, 2004 and Nocke, V.
and S. Yeaple, 2007
How to obtain Rough Welfare Effects
in Rousseau (2009)Setup
• A simple test is the behavior of stock price of the
competitors at the announcement day of M&A
• If the price of competitors’ share decrease => the
M&A is considered pro-competitive and vice
versa (see Duso, Roeller, and Neven,2003)
• Thus, if M&A lead to the diffusion of technology
and there is stock price decrease of the
competitors after M&A announcement =>
welfare effects are likely to be positive.
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References
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Stock Market Data," CEPR Discussion Papers 3880, C.E.P.R. Discussion Papers.
Helpman, E., M.J. Melitz and S.R. Yeaple (2004): .Exports versus FDI with heterogeneous firms, American
Economic Review, 94:1, 300-316.
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Paper No. CES-WP-05-18, Washington D.C.: U.S. Census Bureau, Center for Economic Studies.
Kaplan, S and Zingales, L. (1997) "Do Investment-Cash flow Sensitivities Provide Useful Measures of Financing
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Business School
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Neary, P (2009):International Trade in General Oligopolistic Equilibrium,
http://www.economics.ox.ac.uk/Members/peter.neary/papers/pdf/gole.pdf
Neary, P (2007): "Cross-border mergers as instruments of comparative advantage," Review of Economic
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Nocke, V. and S. Yeaple (2007): .Cross-border mergers and acquisitions vs. greenfield foreign directinvestment:
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