A Financial Perspective on Mergers and Acquisitions and the Economy

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The Free Cash Flow Theory of Takeovers: A Financial Perspective on Mergers and Acquisitions and the Economy

Michael C. Jensen
Harvard Business School MJensen@hbs.edu

© Michael C. Jensen, 1987

“The Merger Boom”, Proceedings of a Conference sponsored by Federal Reserve Bank of Boston, Oct. 1987, pp.102-143

This document is available on the Social Science Research Network (SSRN) Electronic Library at: http://papers.ssrn.com/ABSTRACT=350422

The Free Cash Flow Theory of Takeovers: A Financial Perspective on Mergers and Acquisitions and the Economy
Michael C. Jensen*
Harvard Business School MJensen@hbs.edu From, “The Merger Boom”, Proceedings of a Conference sponsored by Federal Reserve Bank of Boston, Oct. 1987, pp.102-143
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It is not surprising, therefore, that this change creates controversy and that those who stand to lose are demanding that something be done to stop the process. At the same time, shareholders in restructured corporations are clear-cut winners; in recent years restructurings have generated average increases in total market value of approximately 50 percent. Those threatened by the changes argue that corporate restructuring is damaging the U.S. economy, that this activity damages the morale and productivity of organizations and pressures executives to manage for the short term. Further, they hold that the value that restructuring creates does not come from increased efficiency and productivity; rather, the gains come from lower tax payments, broken contracts with

Total dividend payments by the corporate sector, unadjusted for inflation, are given in Weston and Copeland (1986, p. 649). I extended these estimates to 1986.

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managers, employees and others, and mistakes in valuation by inefficient capital markets. Since the benefits are illusory and the costs are real, they argue, takeover activity should be restricted. The controversy has been accompanied by strong pressure on regulators and legislatures to enact restrictions to curb activity in the market for corporate control. Dozens of congressional bills in the past several
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