Hostile takeovers or friendly mergers? Real options analysis

Abstract

This study analyzes a real options model of mergers and acquisitions between two firms facing different but correlated uncertainties in profits. It is assumed that firms can choose between two alternatives: a hostile takeover or a friendly merger. The bidder firm obtains extra value in a hostile takeover but incurs takeover costs. Although both firms do not bear takeover costs in a friendly merger, they share extra value through Nash bargaining. We formally define an equilibrium in our timing game under competition and then characterize the equilibrium types to discuss the influences of demand uncertainty, and takeover cost on which firm will act as a bidder and which form of amalgamation will emerge. We show that various types of equilibria can emerge because of the introduction of takeover costs. We also show that a smaller firm can be a bidder to a larger firm in a hostile manner, which is occasionally observed in actual markets. Finally, we also show that a preemptive equilibrium is likely to emerge if the takeover cost (premium) increases, which is consistent with the empirical results.