We present a model of mergers and acquisitions based on stock market misvaluations of the combining firms. The model explains who acquirers whom, whether the medium of payment is cash or stock, what the valuation consequences of mergers are, and why there are merger waves. Some of the key predictions of the model are: 1) acquisitions are disproportionately for stock when market valuations are high, and for cash when they are low; 2) targets in cash acquisitions earn low returns prior to the acquisitions, whereas bidders in stock acquisitions earn high returns; 3) long run returns to bidders in stock acquisitions are likely to be negative, those to bidders in cash acquisitions are likely to be positive; 4) despite negative long run returns, acquisitions for stock serve the interest of long run shareholders of the bidder; 5) diversification strategies serve the interest of bidding shareholders even when they earn negative announcement returns; 6) such diversifying acquisitions are likely to be for stock; 7) management resistance to cash tender offers is often in the interest of shareholders; 8) acquisition targets are likely to have managers and shareholders with relatively shorter horizons than the bidders. 1 We are grateful to Robin Greenwood and Rafael La Porta for helpful comments, to Mark

In 2004 all ECB publications will feature a motif taken from the €100 banknote. This paper can be downloaded from the ECB’s website

We review the literature regarding the impact of financial innovation on the monetary transmission mechanism and on the way the central bank can achieve its ultimate goal, that is to control the price level.We argue that, although the form of central bank instruments and current methods for implementing monetary policy may change, the goals that the policy makers try to achieve by employing these instruments remain valid, and achievable.