A CRITICAL REVIEW OF NEOCLASSICAL AND BEHAVIOURAL THEORIES OF MERGER WAVES

Abstract

This paper aims to identify and critically evaluate the theoretical explanations of mergers happening in clusters. We identified two streams of theories: neoclassical and behavioural explanations of merger waves. Neoclassical theories include q theory and industry shock hypothesis. Behavioural theories studied incorporate share misvaluation theory, managerial hubris hypothesis, and managerial discretion theory. Q theory states that efficient firms take over inefficient firms during market expansions. Industry shock hypothesis views resource reallocation requirements due to economic, technological, or regulatory shocks as causes of merger waves. Neoclassical theories, hypothesizing gain from mergers, assumes that markets are efficient, and managers maximize shareholder wealth. Share mis-valuation theory suggests that mergers waves occur when managers of overvalued firms use overvalued stocks to takeover undervalued targets in inefficient markets. Managerial hubris hypothesis, assuming of strong market efficiency, attributes merger waves to overconfidence of irrational managers about estimated gain from acquisition. Managerial discretion theory, more relevant for conglomerate merger, attributes merger waves as results of managerial empire building. We conclude that both the streams of theories should co-exist unless a new theory incorporating the strengths of the two has emerged.

Keywords

• mergers and acquisitions
• restructuring
• economic theories of finance
• behavioural finance theories