Return to Invested Capital and the Performance of Mergers and Acquisitions

We evaluate the efficiency of capital deployment for acquiring firms before M&As, and link this ex ante measure to firms’ post-acquisition performance. We construct the efficiency measure as the residual from regressions of firms’ return on assets, net of cost of capital, on invested capital and other firm characteristics for each industry and year. A higher residual thus indicates that a firm generates higher net returns on investment than its industry peers in a given year. Acquirers with higher residuals have higher announcement returns and better long-run operating and stock performance than acquirers with lower residuals. The hedge portfolios based on the measure also generate significant abnormal returns.