“The Q-Theory of Mergers” by Jovanovic & Rousseau

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Table of Contents

Introduction
Method and Main Results
Discussion
Reference List

Introduction

In their article, the authors argue that the Q-theory can be linked to the purchasing/merging motives of the firms. The authors also test that (i) companies with a high Q are more likely to engage in merger and acquisition (M&A) operations because M&A is a high fixed cost. Moreover, they find that more mergers and acquisitions result from successful companies when replacement cost of capital is cheap (ii) and if the firms spend proper money on mergers and internal investment, they are overpaid. (iii) The author’s theory describes 4 decades of mergers from the prospect of merger waves but does not explain the peculiarities of the 1960s M&As. The data authors used for conducting this research is taken from newspaper sources dated between 1885 and 1925. As for the 1925-1998 period, the merger data was obtained from the Chicago’s Center for Research in Securities Prices (CRSP) database.

Method and Main Results

The authors propose a model, which considers mergers and acquisitions as “used-capital-market” deals (Jovanovic & Rousseau 2002, p. 198). By deploying it, they make an attempt to explain the motives of mergers and acquisitions. This model operates on obtained financial assets and immediate acquisitions of utilised capital between the “exchange-listed” companies and their transaction ratios (Jovanovic & Rousseau 2002, p. 198). They use the data about used and acquired capital and direct capital purchases between 1970 and 2000.

The authors focus on several aspects of the model such as costs of growth, merger gains, the Q equation, interior maxima, fixed costs of mergers, the disappearance of firms, evidence on overtaking, M&A deflator, etc. They use regressions for estimating equations of investment and acquisitions. At the same time, to properly address research questions, they normalise cash by firm capital (Jovanovic & Rousseau 2002, p. 200).

As a result, the authors come up with several findings. First and foremost, the firms are more interested in M&A operations instead of allocating cash resources for the purposes of internal investment (Jovanovic & Rousseau 2002, p. 198). The authors explain this phenomenon by pointing to higher profitability and efficiency of injecting funds in M&As (Jovanovic & Rousseau 2002, p. 199). Moreover, they state that Q is associated with M&As instead of direct investments due to the fact that mergers are “a high fixed cost and a low marginal adjustment cost activity” (Jovanovic & Rousseau 2002, p. 198). That said, they answer the initial research question.

Discussion

The authors’ model makes it possible to show that a company’s unification and purchase expenditure is more consistent with its Q than the company’s straight expenditure. Jovanovic and Rousseau (2002) perform a thorough analysis of several unification waves, which allows them to conclude that the causes for these waves are diverse. Still, they give an economic explanation but ignore the humanistic reasons. For instance, the role of CEOs and senior management is critical when it comes to analysing the causes of mergers but this aspect is not addressed in the article. Nevertheless, the initial objective of the article was to test the assumptions of the Q-theory of mergers. Reviewing the findings of the authors, it is possible to state that this goal was achieved, as they explained the behaviour of typical firms and factors, which stimulate them to get involved in mergers (Jovanovic & Rousseau 2002, p. 198).

Reference List

Jovanovic, B & Rousseau, P 2002, ‘The Q-theory of mergers’, The American Economic Review, vol. 92, no. 2, pp. 198-204.

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“The Q-Theory of Mergers” by Jovanovic & Rousseau

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