Acquiring Innovation Under Information Frictions

Abstract

Acquiring innovation through M&A is subject to information frictions, as acquirers find it challenging to assess the value of innovative targets. We find an inverted U-shaped relation between firm innovation and takeover exposure; equity usage increases with target innovation; and deal completion rate drops with innovation. We develop and estimate a model of acquiring innovation under information frictions, featuring endogenous merger, innovation, and offer composition decisions. Our estimates suggest that acquirers' due diligence reveals only 30% of private information possessed by targets. Eliminating information frictions increases capitalized merger gains by 59%, stimulates innovation, and boosts productivity, business dynamism, and social welfare.

Keywords: information frictions, adverse selection, innovation, mergers and acquisitions

JEL Classification: E20, G30, O40