Firm Heterogeneity and Acquisition Incentives
45 Pages Posted: 29 Dec 2008
Date Written: May 18, 2008
Abstract
This paper presents a tractable model of acquisitions with heterogeneous firms. Acquisitions improve aggregate productivity by transferring productive assets from the least efficient firms to more efficient firms. However, these acquiring firms are in a mid-range of productivity, whether acquiring at home or abroad. This result is a function of a variable-elasticity demand framework, and highlights the sensitivity of investment decisions to model preliminaries. In linking the model to a Q-Theory of investment, a corollary of this result is that a firm's average-Q is a poor proxy for marginal-Q, especially for the highest productivity firms. The predictions of the model are tested using a 25-year sample of firms from the Compustat database. To account for productivity, a measure of average Q is constructed which controls for serial correlation in Q values. By accounting for serial correlation, average-Q is positively related to firm size (sales). Using this measure, and by harnessing nonparametric techniques, I find precise evidence that mid-productivity (mid-Q) firms are the most likely to acquire another firm.
Keywords: Mergers and Acquisitions, Tobin's Q, Firm Heterogeneity
JEL Classification: G34, F21, F23
Suggested Citation: Suggested Citation
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