Risk, Strategy, and Optimal Timing of M&A Activity

In this paper, the problem of mergers and acquisitions under pro¯t uncer- tainty is considered. A two ¯rm model is developed where M&A activity is modelled as an act of risk diversi¯cation. We study the case where only the larger ¯rm engages in M&A activity and the case where both ¯rms do. It is shown that takeovers can be optimal during both economic expansions and contractions. The option value of M&A activity is determined. We argue that there is a minimum level of positive synergies for M&A activity to be optimal, which is increasing in the level of diversi¯cation. Furthermore, it is shown that under M&A competition, this option value vanishes completely and that hostile takeovers are never optimal. An analysis of optimal portfolio selection by a risk averse investor shows ambiguous wealth results of M&A activity.