Mergers and market valuation: real options approach

Subject Areas : International Journal of Finance, Accounting and Economics Studies

Received: 2010-11-23 Accepted : 2011-01-17 Published : 2011-01-20

Keywords: Real options, mergers, least squares Monte Carlo meth,

Abstract :

This paper investigates the connection between market valuation anda type of the merger (stock, cash) using real options setup. I solveexplicitly for the timing and terms of cash mergers in two deferent settingsto demonstrate that cash mergers generally occur at low marketvaluations, whereas stock mergers that may be observed at both low andhigh valuations; the result holds with some dierences for two dynamicsetups. I also investigate the dynamics of the intra-industry mergerswithin the first setup. I solve for the optimal order of mergers inside anindustry for dierent initial capital allocations to demonstrate that stockmergers in more concentrated industries occur at higher market valuation(i.e. later) as compared to mergers in less concentrated industries.