Hostile Takeovers or Friendly Mergers?: A Real Options Analysis

Abstract

This study analyzes 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 incurs takeover costs, while in a friendly merger, both firms do not bear takeover costs but share the extra value through Nash bargaining. We show how demand uncertainty and takeover costs influence which firm is more likely to act as a bidder and which form of amalgamation will emerge. We also find that a smaller firm can be a bidder to a larger firm in a hostile manner, which is occasionally observed in actual markets.

Keywords: Merger and acquisition, Real option, Nash bargaining

JEL Classification: C61, G32, G34