The Dynamics of Mergers and Acquisitions

Erwan Morellec
Ecole Polytechnique Fédérale de Lausanne; Ecole Polytechnique Fédérale de Lausanne – Swiss Finance Institute

Alexei Zhdanov
Pennsylvania State University

May 2004

Simon School of Business Working Paper No. FR 01-11


This paper presents a dynamic model of takeovers based on the stock market valuations of merging firms. The model incorporates competition and imperfect information and determines the terms and timing of takeovers by solving option exercise games between bidding and target shareholders. The implications of the model for returns to stockholders are consistent with the available evidence.

Notably, the model predicts that

  1. returns to target shareholders should be larger than returns to bidding shareholders, and
  2. returns to bidding shareholders can be negative if there is competition for the acquisition of the target.

In addition, the model generates new predictions relating these returns to the drift, volatility and correlation coefficient of the bidder and the target stock returns and to the dispersion of beliefs regarding the benefits of the takeover.

The Dynamics of Mergers and Acquisitions

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