Measuring the Quality of Mergers and Acquisitions

We develop an ex-ante measure of merger and acquisition quality using accounting theory. The measure, implied return-on-equity improvement (IRI), quantifies the minimum improvement in the target’s return-on-equity post acquisition to justify the offer price. Consistent with greater implied earnings improvements being less attainable ex-post, we find that high-IRI acquirers have worse post-acquisition accounting returns, lower returns to shareholders and debtholders, and more frequent and larger goodwill impairments. IRI’s negative association with acquirer performance is stronger among overconfident and poorly incentivized acquirer managers and weaker among financially disciplined acquirers, suggesting managerial incentives and behaviors are important economic mechanisms underlying acquisition quality.