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The Q-Theory of Mergers

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  • Boyan Jovanovic
  • Peter L. Rousseau

Abstract

The Q-theory of investment says that a firm's investment rate should rise with its Q. We argue here that this theory also explains why some firms buy other firms. We find that 1. A firm's merger and acquisition (M&A) investment responds to its Q more -- by a factor of 2.6 -- than its direct investment does, probably because M&A investment is a high fixed cost and a low marginal adjustment cost activity, 2. The typical firm wastes some cash on M&As, but not on internal investment, i.e., the 'Free-Cash Flow' story works, but explains a small fraction of mergers only, and 3. The merger waves of 1900 and the 1920's, `80s, and `90s were a response to profitable reallocation opportunities, but the `60s wave was probably caused by something else.

Suggested Citation

  • Boyan Jovanovic & Peter L. Rousseau, 2002. "The Q-Theory of Mergers," NBER Working Papers 8740, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:8740
    Note: AP CF EFG PR
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    References listed on IDEAS

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    1. Boyan Jovanovic & Peter L. Rousseau, 2001. "Why Wait? A Century of Life before IPO," American Economic Review, American Economic Association, vol. 91(2), pages 336-341, May.
    2. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-329, May.
    3. Boyan Jovanovic & Peter L. Rousseau, 2000. "Vintage organization capital," Proceedings, Federal Reserve Bank of San Francisco, issue Apr.
    4. Servaes, Henri, 1991. "Tobin's Q and the Gains from Takeovers," Journal of Finance, American Finance Association, vol. 46(1), pages 409-419, March.
    5. Gregor Andrade & Mark Mitchell & Erik Stafford, 2001. "New Evidence and Perspectives on Mergers," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 103-120, Spring.
    6. Hayashi, Fumio & Inoue, Tohru, 1991. "The Relation between Firm Growth and Q with Multiple Capital Goods: Theory and Evidence from Panel Data on Japanese Firms," Econometrica, Econometric Society, vol. 59(3), pages 731-753, May.
    7. Hayashi, Fumio, 1982. "Tobin's Marginal q and Average q: A Neoclassical Interpretation," Econometrica, Econometric Society, vol. 50(1), pages 213-224, January.
    8. Hopenhayn, Hugo A, 1992. "Entry, Exit, and Firm Dynamics in Long Run Equilibrium," Econometrica, Econometric Society, vol. 60(5), pages 1127-1150, September.
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    JEL classification:

    • O3 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights

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