Hostile Takeovers or Friendly Mergers?: A Real Options Analysis

Abstract

This paper analyses a real options model of mergers and takeovers between two firms facing different but correlated uncertainty in profits. It is assumed that firms can choose two alternatives; hostile takeover or friendly merger. In a hostile takeover, a bidder firm takes all the extra value but should incur takeover costs, while in a friendly merger both firms do not bear takeover costs and share the extra value through Nash bargaining. We show how demand uncertainty and takeover costs influence which firm to be a bidder and which form of amalgamation to happen. We also find that a smaller firm can be a bidder to a larger firm in a hostile way, which is sometimes observed in actual markets.

Keywords: Merger and acquisition, Real option, Nash bargaining

JEL Classification: C61, G32, G34