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If you’re the CEO of a big corporation and you want to place a bet on the future of your company, you might want to expand. That could mean investing in new hiring, new machinery or new locations. You might issue bonds, or stock, to raise money for all that expansion.
That kind of activity has been booming this year, in large part because borrowing money is starting to get cheaper.
But there’s a different type of corporate bet you could make on your firm’s future: You could merge with or acquire one of your competitors.
So far this year, that kind of activity hasn’t been happening very much. This year is on track to be the slowest for mergers and acquisitions in more than a decade, according to the research company Dealogic. And that slowdown in M&A activity is a kind of economic indicator.
Companies buy one another for a variety of reasons. It could be to expand geographically, to sell more types of products or to cut costs. But whatever the reason, a merger or an acquisition can be one of the riskiest and most complex transactions a company might ever do, said Drew Pascarella, who teaches finance at Cornell University and has spent about 25 years advising companies on mergers and acquisitions.
Pascarella said buying a company starts with spending millions upon millions of dollars. Then, the buyer will have to combine two corporate cultures, convince employees, shareholders and customers that the purchase is the right move, and hope that nothing bad happens in the broader economy.
“If you’re doing a deal where the whole point is to sell much more product into the market over the next couple of years, and then the economy goes into the tank and people aren’t buying product at all, well, now you’ve doubled down on your ability to sell product, and there’s no market for those products,” Pascarella said.
That’s why Pascarella said mergers and acquisitions are the ultimate bets that a company can make on its future — on the success of the combined company and the economy at large.
That means if there’s a big pickup in M&A activity, companies are feeling confident in the future.
“It’s an indicator that executives and boards of directors, and ultimately shareholders, are feeling comfortable enough with what tomorrow will look like that they’re willing to take that big, risky bet,” Pascarella said.
Over the last few years, companies have not been all that comfortable with what tomorrow will look like, said Christina Sautter, a law professor at Southern Methodist University’s Dedman School of Law.
Sautter said a big unknown has been inflation and how it could affect consumer spending. Another is where interest rates will end up, because they affect the initial cost of a merger and how much the combined company might need to invest after the deal closes.
“It’s just hard to plan for financing of their continuing operations, to keep the company running as usual,” Sautter said.
Political uncertainty has been a factor too, Sautter said. The Biden administration’s taken a hard line against deals that it argues could reduce competition. And up until this week, there was a lot of uncertainty about the election.
That said, a lot of the economic uncertainty behind the M&A slowdown has started to clear up. Inflation is coming down along with interest rates.
Afra Afsharipour, a professor at the University of California, Davis, School of Law, said some companies have been laying the groundwork for deals.
“That might mean that the sellers are really kind of putting their books in order or putting house in order, in order to make themselves attractive to buyers,” Afsharipour said.
Afsharipour said that’s most likely to happen in sectors that have been growing quickly, including the tech industry.
“One of the things buyers are thinking about is evaluating how [artificial intelligence] will impact their business models and looking into potential purchases of companies that are much more focused on AI,” Afsharipour said.
And if M&A starts to pick up, Afsharipour said there’s a lot of research showing that CEOs tend to get a little jealous when competitors start buying other companies.
“The executive sees that their competitor has just bought another big company, and now the CEO is the CEO of a much larger company,” Afsharipour said. “Then, that person might think, ‘Well, I want to be the CEO of a much larger company.’”
As a result, Afsharipour said a series of deals in a particular industry can cause M&A activity to snowball, as long as companies feel confident about the broader economy.
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