Acquiring Innovation under Information Frictions

Abstract

Acquiring innovation through M&A is subject to information frictions, as assessing the value of innovative targets is a challenging task. We find an inverted U-shaped relation between firm innovation and takeover exposure; equity usage increases with target innovation; and the deal completion rate drops with innovation. We develop and estimate a model of acquiring innovation under information frictions, featuring endogenous merger, innovation, and offer composition decisions. Our estimates suggest that acquirers’ due diligence reveals only 30 % of private information possessed by targets. Eliminating information frictions increases capitalized merger gains by 59 % ⁠ , stimulates innovation, and boosts productivity, business dynamism, and social welfare.