The Payment Form Threshold in Mergers and Acquisitions - A Real Options Approach
In recent years, practitioners and academics have become increasingly concerned that traditional discounted cash flow valuation models, such as the net present value model, are not capable of adequately capturing the value of managerial flexibilities to delay, grow, scale down, or abandon projects. The effect of ignorance of such managerial flexibilities can be potentially substantial, with the possibility of producing biased decisions. Real options analysis provides the insights that business investment projects can be conceptually compared to financial options and is therefore able to seize the value of managerial flexibilities. The purpose of this thesis is to develop a theoretical model based on option pricing theory to evaluate the managerial flexibilities arising in a variety of mergers and acquisitions, which vary in payment forms. The thesis shows how transactions can be structured as a real exchange options, given the share price of each participating firm is subject to a specified degree of uncertainty. The takeover decisions of bidder or target, i.e., the takeover threshold to bid or to accept the bid, is obtained through the analysis. In addition, the thesis provides valuable theoretical insights into the following aspects: <ul> <li>The impact of the form of payment on the decision making process for each participant and corresponding merger terms</li> <li>The payment form that minimizes the threshold to trigger a transaction</li> <li>The allocating rule of mergers and acquisitions synergy when payment form threshold is employed </li> </ul> In the latter part of thesis, an empirical study is conducted on mergers and acquisitions completed by US public bidders between January 1985 and April 2004 excluding all financial institutions deals. Strong support is found from the data that some of the target firm characteristics such as expected growth rate and volatility are significant in explaining the payment form choices.
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