Benefits and Costs of Asset Reallocation in Mergers and Acquisitions
49 Pages Posted: 26 Jan 2012 Last revised: 3 Sep 2013
Date Written: August 18, 2013
The Q-theory of mergers and acquisitions proposes that takeovers of low-Q targets by high-Q acquirers should be value creating as acquirers redeploy the targets’ assets. Recent evidence on the direct relationship between Q and value creation is mixed. We present a simple model which suggests three modifications to the standard empirical approach. First, we allow for both benefits and costs of integration that are likely to accompany asset reallocation in M&As. Second, we use a modified proxy for the Q ratio in our empirical tests after decomposing the market-to-book ratio – the conventional proxy for Q – into its long-run and short-run components. Third, our model suggests that the correct regression specification requires the weighting of proxies for the benefits and costs of asset reallocation by the relative size of the resources being reallocated. After the modifications, we find evidence consistent with Q-theory using announcement returns and operating performance as alternative measures of value creation. The relation between value creation and Q-difference is inverse U-shaped, indicating a tradeoff between benefits and costs of asset reallocation. We also find that the long- and short-run components of Q relate significantly differently to value creation in M&As.
Keywords: M&As, Valuation, Asset reallocation, Q-theory
JEL Classification: G34, G14
Suggested Citation: Suggested Citation