Corporate Acquisitions, Diversification, and the Firm's Lifecycle
The acquisition rate follows a u-shape: ... higher when firms are young ... and when they are mature...than when they are middle-aged.
In Corporate Acquisitions, Diversification, and the Firm's Lifecycle (NBER Working Paper No. 17463), Asli Arikan and Rene Stulz analyze a dataset of over 6,000 firms that initiated an initial public offering (IPO) between 1975 and 2002 to study when public corporations make acquisitions over their lifecycle. The evidence here is inconsistent with lifecycle theories, which predict that firms acquire and diversify through acquisitions when they have exhausted their growth opportunities.
The authors study the "acquisition rate," defined as the number of acquisitions in an IPO cohort-year divided by the number of firms in that cohort-year. They find that firms are most active in the corporate acquisition market in the year following their IPO. Those results are mainly driven by the merger/IPO wave of the 1990s, during which young firms were dramatically more acquisitive than mature firms.
The acquisition rate follows a u-shape. It is higher when firms are young (their first three complete calendar years as public firms) and when they are mature (years ten to twenty) than when they are middle-aged (years four to ten). These results hold even after controlling for the fact that firms that go public vary in their age since incorporation. The u-shape pattern in the acquisition rate is driven by the cohorts that had their IPO after 1991. The cohorts that had IPOs in the 1970s and the 1980s have a peak acquisition rate when the firms are more mature (in year ten or later for all but two cohorts).
Young firms also differ from mature firms in the type of acquisitions they make. Young firms make fewer acquisitions of public firms than mature firms, but they are more likely to acquire private firms and subsidiaries. Surprisingly, firms make diversifying acquisitions early in life: 40 percent of the acquisitions in the first year following the IPO are diversifying acquisitions, that is, acquisitions of targets in a different industry from that of the acquirer. The authors find that firms make diversifying acquisitions at roughly the same rate early in their life as they do when they mature.
If acquisitions are made because internal growth opportunities have vanished, then the market should react adversely to acquisitions by young firms, and especially diversifying ones, since those firms just went public based partly on their investment opportunities. On the other hand, if young firms make acquisitions to exploit their growth opportunities because acquisitions are complementary to capital expenditures, then there is no reason for the market to react adversely to acquisitions. The results of this study show that the market generally reacts more positively to acquisitions by young firms than to those by more mature firms. There is no evidence that the market punishes diversifying acquisitions by young firms relative to other acquisitions. Both facts support the complementary nature of acquisitions and internal investment for young public firms.