We examine the determinants and effects of M&A activity in the pharmaceutical/biotechnology industry using SDC data on 383 firms from 1988 to 2001. For large firms, mergers are a response to expected excess capacity due to patent expirations and gaps in a firm's product pipeline. For small firms, mergers are primarily an exit strategy in response to financial trouble (low Tobin's q, few marketed products, low cash–sales ratios). In estimating effects of mergers, we use a propensity score to control for selection based on observed characteristics. Controlling for merger propensity, large firms that merged experienced a similar change in enterprise value, sales, employees, and R&D, and had slower growth in operating profit, compared with similar firms that did not merge. Thus mergers may be a response to trouble, but they are not a solution. Copyright © 2007 John Wiley & Sons, Ltd.