The Effect of Search Frictions on Mergers

Abstract

We empirically study the existence and impact of search frictions in the market for corporate control in order to explain who makes acquisitions. We proxy search frictions with the board of director's degree of connectedness. Alternatively, we capture such frictions using geographic proximity and business similarity. Measures of market thickness also contribute to the overall effect of search frictions and are included. Based on recent theoretical approaches to the M&A market, management incentives are an important element when identifying who might become an acquirer. Using data from 1990 to 2006, we find that firms are more likely to be acquirers (targets) when search frictions are low (high), there are more firms available to buy (thicker market), and a golden parachute is not (is) provided to the firm's manager. These findings are largely consistent with predictions from the recent theoretical literature that models the decision of firms to actively search for potential targets. We alleviate concerns that these results are driven by firm heterogeneity or selection bias, by showing that they are robust to the use of OLS with firm-level fixed effects and instrumental variables using CEO salary and lagged board connectedness, respectively. Furthermore, a dynamic panel data estimator is also used. We find that the provision of golden parachutes increases the average acquirer abnormal return by 2.5% whereas it does not significantly impact target premiums and that business similarity and geographic proximity affects target premiums.

Keywords: Mergers, Acquirer, Target, Search, Golden Parachute, Premiums, Board of Directors

JEL Classification: C78, D82, D83, G34, J33, G14, M52