Professor Rhodes-Kropf’s research in M&A examines why firms appear to merge in waves, demonstrating the rationality of merger waves and their link to misvaluation. He has shown that merger waves and waves of cash and stock purchases can be rationally driven by periods of over- and undervaluation of the stock market. To test his theory, Professor Rhodes-Kropf developed a novel decomposition that breaks the market-to-book ratio into three components: the firm-specific pricing deviation from short-run industry pricing; sector-wide, short-run deviations from firms’ long-run pricing; and long-run pricing to book. He has used this decomposition to find strong support for his theories of misvaluation and mergers.
Professor Rhodes-Kropf has also shown the role of matching in merger activity. The most-repeated fact in M&A is “high buys low” – that is, high market-to-book firms tend to purchase firms with lower market-to-book ratios. This maxim fits well with the classical view that higher-quality firms are purchasing poorly run firms in order to redeploy their assets to a better use. However, Professor Rhodes-Kropf has shown that, while the difference in acquirer-target market-to-book ratio is slightly positive on average, the difference is actually quite small. Thus, a better verbal description of M&A activity is not “high buys low,” but “like buys like.” He hypothesizes that this matching is actually the natural outcome of a search process where acquirers and targets try to find one another and negotiate mergers.
Professor Rhodes-Kropf’s latest work in M&A focuses on firms that “merge into the fast lane.” His preliminary work shows that firms move from industries that were valued more highly in the past into industries where firms will be valued more highly in the future. This finding suggests that M&A activity is about a management team looking for a new activity and leads to questions about the definition of a firm.