Psychological pricing in mergers & acquisitions using game theory

Abstract

Mergers and acquisitions pricing is usually a difficult task as it is hard to estimate the price to be paid to purchase the target company. Corporate Finance valuations provide some support, however, Baker, Pan and Wurgler (2009) explain that psychological pricing factors exist and the final price can be quite different from the initial valuations. This paper develops a two-person Merger & Acquisition model that intends to provide a simulation model in order to understand if the final negotiated price of an Merger & Acquisition transaction equals the mid-point of the acquirer's offer and target's bid price. Also, it reviews behavioural factors that can be part of Merger & Acquisition valuation and uses the model to simulate results to identify, in this case, if it is better for the acquirer to be risk taking or risk averse and for the target to be optimistic or pessimistic. Results show that the equilibrium price (Nash Equilibrium Point) is closer to the acquirer's offer price. However, through the simulation of the behavioural factors it is seen that the most optimal outcome for the acquirer is to be a risk taker and for the target to be pessimistic. This seems like a suitable option because the acquirer will be willing to provide a higher offer and the target will be more open to accept a reasonable offer. Any of the other three options are less likely to provide such a suitable outcome. This paper has only undertaken preliminary research in this area, however it shows that there is a possibility to simulate behavioural factors in valuing two-person Merger & Acquisition transactions. This is specially the case as Merger & Acquisition valuations include a significant factor of psychological pricing that cannot be explained by traditional Corporate Finance models.