Measuring the Quality of Mergers and Acquisitions

We use accounting theory to develop a new measure of the quality of mergers and acquisitions, implied return-on-equity improvement (IRI), which quantifies the minimum improvement in the target’s accounting returns after acquisition needed to justify the offer price. We validate our measure by showing that it captures disclosed synergies and estimated EPS accretion. Consistent with larger performance improvements being less achievable, we find that high-IRI acquirers have worse post-acquisition ROE and more frequent and larger goodwill impairments. We also show that this worse long-run performance is likely driven by overconfident and poorly incentivized managers undertaking acquisitions of inferior quality.