Real Options in Acquisitions: Effects of Option Type and Competition on Premiums

Abstract

This paper considers the differences in premiums paid between different types of real options that exist in acquisitions. We compare single and compound options by considering single acquirers versus serial acquirers and find that the first group pays lower premiums for their acquisitions. This finding is in line with real option theory stating compound options are more valuable than single options as they incorporate the value of future growth options. Next, we focus on the difference between shared and proprietary nature of options in both single and compound options. In line with real option theory predictions, we find that shared options (measured by the number of bidders) require higher premiums, while proprietary options (measured by the presence of a minority stake) result in lower premiums paid for both single and compound acquisition options. The results are robust when considering serial acquirers who focus on related targets, an acquisition strategy called “buy-and-build”. We further find that acquirer market share increases the proprietary nature of acquisition options and leads to lower premiums paid.