coercion leads to cleaner signals
Why would a surge in mergers and acquisitions (M&A) activity not necessarily signal an economic recovery?
- In every transaction, there is a buyer and a seller. Assuming that neither side is under any coercion, the expectations regarding the future value of the company in question should diverge. In other words, an increase in M&A activity may contain the same signals as a surge in initial public offerings (IPOs) does.
Companies are not apples. They are complicated entities. (Let's ignore the irrelevant fact that the biological complexity of an apple probably surpasses the organizational complexity of any company.) That is essentially why buying and selling companies is more sensitive to information asymmetries than trading apples. If sellers (e.g. previous owners or founders of the company) are more informed than the buyers, then there are grounds for being suspicious that the current rally in valuations is unjustified.
- A peak in the number of sales of distressed companies may signal a trough in the economy. Note that this type of M&A activity differs from the one mentioned above. Here the equity holders, who have the informational edge, usually get wiped out. The new owners of the company (e.g. Debt holders), who are less informed than the original equity holders, are forced into an untimely sale due to lack of coordination, liquidity needs etc. The presence of coercion renders the signals remitted by these transactions more trustworthy.
Those signals could be any of the following: Credit markets have thawed / Risk appetite has returned back to the equity markets / Separation of good from the bad is setting clean grounds for a new sustainable economic revival.
- In every transaction, there is a buyer and a seller. Assuming that neither side is under any coercion, the expectations regarding the future value of the company in question should diverge. In other words, an increase in M&A activity may contain the same signals as a surge in initial public offerings (IPOs) does.
Companies are not apples. They are complicated entities. (Let's ignore the irrelevant fact that the biological complexity of an apple probably surpasses the organizational complexity of any company.) That is essentially why buying and selling companies is more sensitive to information asymmetries than trading apples. If sellers (e.g. previous owners or founders of the company) are more informed than the buyers, then there are grounds for being suspicious that the current rally in valuations is unjustified.
- A peak in the number of sales of distressed companies may signal a trough in the economy. Note that this type of M&A activity differs from the one mentioned above. Here the equity holders, who have the informational edge, usually get wiped out. The new owners of the company (e.g. Debt holders), who are less informed than the original equity holders, are forced into an untimely sale due to lack of coordination, liquidity needs etc. The presence of coercion renders the signals remitted by these transactions more trustworthy.
Those signals could be any of the following: Credit markets have thawed / Risk appetite has returned back to the equity markets / Separation of good from the bad is setting clean grounds for a new sustainable economic revival.
