[We use text-based analysis of 10-K product descriptions to examine whether firms exploit product market synergies through asset complementarities in mergers and acquisitions. Transactions are more likely between firms that use similar product market language. Transaction stock returns, ex post cash flows, and growth in product descriptions all increase for transactions with similar product market language, especially in competitive product markets. These gains are larger when targets are less similar to acquirer rivals and when targets have unique products. Our findings are consistent with firms merging and buying assets to exploit synergies to create new products that increase product differentiation.]

We use text-based analysis of 10-K product descriptions to examine whether firms exploit product market synergies through asset complementarities in mergers and acquisitions. Transactions are more likely between firms that use similar product market language. Transaction stock returns, ex post cash flows, and growth in product descriptions all increase for transactions with similar product market language, especially in competitive product markets. These gains are larger when targets are less similar to acquirer rivals and when targets have unique products. Our findings are consistent with firms merging and buying assets to exploit synergies to create new products that increase product differentiation. The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.

ABSTRACT We examine how product market competition affects firm cash flows and stock returns in industry booms and busts. Our results show how real and financial factors interact in industry business cycles. In competitive industries, we find that high industry‐level stock market valuation, investment, and financing are followed by sharply lower operating cash flows and abnormal stock returns. Analyst estimates are positively biased and returns comove more. In concentrated industries these relations are weak and generally insignificant. Our results are consistent with participants in competitive industries not fully internalizing the negative externality of industry competition on cash flows and stock returns.