The Role of Real Options in the Takeover Premia in Mergers and Acquisitions

Abstract

This paper applies a real option framework to suggest that the takeover premia in mergers and acquisitions can be influenced by (a) the pre-bid ownership of target and (b) the real option characteristics of both acquirer and target firms. Our findings show that pre-bid ownership reduces the takeover premia, which is consistent with the argument that pre-bid ownership reduces in- formation asymmetry. However, we find that the takeover premia is higher when both the acquirer and target firms exhibit real option capacity as measured by positive risk-return sensitivity. As a result, an acquirer with real option capacity is willing to pay higher takeover premia for an option embedded in the target firm.

Keywords: Real options, Takeover premia, Acquirer abnormal returns, Target abnormal returns

JEL Classification: G12, G14, G30, G34