The following post comes to us from Marc Martos-Vila of the Department of Finance at UCLA, Matthew Rhodes-Kropf of the Entrepreneurial Management Unit at Harvard Business School, and Jarrad Harford, Professor of Finance at the University of Washington.
In our recent HBS working paper, Financial vs. Strategic Buyers, we highlight and then set out to explain the oscillating pattern of financial vs. strategic acquirers within overall merger activity. Mergers and Acquisitions occur in great waves of activity with recent troughs, for example, of only a few thousand deals in 2003 and peaks of over ten thousand deals in 1999 and 2006. Within this oscillation of activity there is another shifting pattern: the percentage of so-called financial sponsors (private equity firms) vs. strategic buyers (operating companies) seems to ebb and flow. Aggregate numbers show that the fraction of total deal value acquired by financial sponsors has varied dramatically over the last 25 years with peaks in the late 80s, 90s and the period of 2005-2007. This same pattern is true across many industries and geographies.
Any particular transaction has many factors that drive the ultimate acquirer’s willingness to pay. And many theories propose reasons why particular firms or industries may be ripe for acquisition activity. However, the broad pattern of financial sponsor activity that spans industries and geographies at a given point in time suggests a broad economic explanation for the coordination. Little research directly considers the competition between financial and strategic buyers. And almost no research offers any broad insights into the rising and falling tides of private equity activity through the different merger waves.
What drives either financial or strategic buyers to have a more dominant position in M&A activity at different points in time? This question is important not only because the economic magnitude of this activity is so large, but also because the balance of power between financial vs. strategic acquirers changes the ownership structure of assets and alters the incentives and governance mechanisms that surround the economic engine of our economy.