History and Causes of Merger Waves

Throughout history, giant companies have joined together through mergers but what causes merger waves? In the United States alone, there were six periods of high merger activity. These higher merger activities are often referred to as merger waves as well.

These periods of merger waves are characterized by cyclic activity. That means high levels of mergers followed by periods of relatively fewer deals.

A quick history recap for you: the first four waves of mergers occurred between the years 1897 and 1904, the next wave happened in 1916 and 1929, followed by the merger deals in 1965 and 1969, then again in 1984 and 1989.

After that, the merger activity began to decline at the end of the 1980s, but it resumed again in the early 1990s was the fifth merger wave began. Between 2003 and 2007, a relatively short but intense merger wave happened too.

The first merger wave occurred after the depression of 1883, peaked between 1898 and 1902 and ended in 1904. Although these mergers affected all major mining and manufacturing industries, certain industries clearly demonstrated a higher incidence of merger activity.

The second merger wave happened between 1916 and 1929 in which several industries were consolidated. This time, however, the result was often oligopolistic industry structure rather than monopolies. The consolidation pattern that was established in the first merger period continued into the second period.

The third merger wave (1965–1969) featured a historically high level of merger activity. This was brought about in part by a booming economy. During those years, it was not uncommon for relatively smaller firms to target larger companies for acquisition.

What Causes Merger Waves?

So, you might be wondering what causes these merger waves and how they came about. According to multiple research, it shows that merger waves tend to be caused by a combination of different factors. There are economic, regulatory, and technological shocks. All of these we will discuss in detail below.

First, we have an economic shock factor. This usually comes in the form of an economic expansion which motivates different companies to expand in able to meet the rapidly growing aggregate demand in the economy. In short, a company mergers with another company is able to supply the demand.

Mergers and acquisitions are a faster form of expansion than internal, organic growth. Hence, a merger would be the most ideal way to go.

The second cause of a merger wave is the regulatory shock. These regulatory shocks can occur through the elimination of regulatory barriers that might have prevented corporate combinations. Take the changes in the United States banking laws for instance, these prevented banks from crossing state lines or entering other industries.

Ovtchinnikov found that the industry deregulation tends to occur whenever industries experience performance. He also found that industry merger partners tend to be poor performers prior to the merger. Not only that, but he found that these poor performers tend to have significant excess capacity.

Next, on the list of causes, we have the technological shocks. This one is tricky, as it can come in many forms. Technological shocks happen as technological changes can bring about dramatic shifts in existing industries. Additionally, these technological changes can even create new industries. For instance, the newspaper industry was once booming until technology happened. Most newspaper companies switched to websites instead of prints.

Harford shows that these various shocks by themselves are not generally enough to bring about a merger wave. He also looked at the industry waves instead of the overall level of merger and acquisition activity between the years 1981 to early 2000.

Harford did his research on 35 industry waves that occurred in the years mentioned above, and it shows that capital liquidity is also a necessary condition for a wave to take hold. This means that capital liquidity also contributes to creating a merger wave.

In his studies, Harford found that the misevaluation or market timing efforts by managers are not a cause of a wave, although they could be a cause of specific deals. The misevaluation findings, on the other hand, are contradicted by Rhodes-Kropf, Robinson, and Viswanathan. Their research found that misevaluation and valuation errors do, in fact, motivate merger activity.

In their research, they measured these by comparing the market to book ratios to true valuations. These brilliant authors do not say that valuation errors are the sole factor in explaining merger waves. However, they did say that they can play an important role that gains in prominence the greater the degree of misevaluation.

Moreover, Rau and Stouratis have analyzed a sample of 151,000 corporate transactions over the period of the year 1980 to 2004. This research included a broader variety of different corporate events than just merger and acquisitions.

In their research, they have found that corporate waves seem to begin with the new issue waves. It all starts with the seasoned equity offerings first, then the initial public offerings, which are then followed by stock-financed merger and acquisitions. This is later followed by repurchase waves.

This finding supports the neoclassical efficiency hypothesis which suggests that managers will pursue transactions when they perceive growth opportunities and will later engage in repurchases in the event that these opportunities fade.

There is also another view that may explain some of the mergers than can occur during a merger wave. This view focuses on defensive mergers. Defensive mergers consider situations where the management of a potential target wants to maintain their positions and the control that they may have over their company.

As a result, the management may choose to pursue their own bid for a rival rather than lose control to a hostile bidder (these are often one of their competitors). The combined entity will then be significantly larger and more of a challenge to acquire and to raise the requisite financing to complete the deal. However, defensive mergers are another topic for another day.

To summarize, there are many different factors that contribute to able for a merger wave to happen. It is not just one single event or factor, there are different factors in play. There are also different types of mergers: short form and long form which you can read on our previous articles.