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In recent years, practitioners and academics have argued that traditional discounted cash flow (DCF) valuation models do not adequately capture the value of managerial…
In recent years, practitioners and academics have argued that traditional discounted cash flow (DCF) valuation models do not adequately capture the value of managerial flexibility to delay, grow, scale down or abandon projects. The insight is that a business investment opportunity can be conceptually compared to a financial option. The purpose of this paper is to develop a theoretical model based on option pricing theory to value managerial flexibility arising in stock for stock exchanges. The paper shows how a mergers and acquisition (M&A) deal may be optimally structured as a real options swap by including managerial flexibility of both the acquiring and target firms when stock prices are volatile. Using a recent acquisition case example from US banking industry the paper illustrates how the proposed exchange ratio swap optimize deal value and avoids earnings per share (EPS) dilution to both parties. Appropriate valuation of managerial flexibility is important given the historical premiums paid in takeovers. While the fact that such premiums exist lends some credibility to the idea that at least implicitly managerial flexibility is valued, the real options approach allows for more explicit valuation of such flexibility.
The rise in hostile corporate takeover attempts during the 1980s motivated many states to pass antitakeover legislation, often after lobbying by the management of affected…
The rise in hostile corporate takeover attempts during the 1980s motivated many states to pass antitakeover legislation, often after lobbying by the management of affected firms. Empirical attempts to assess the impact of such statutes on firm value have yielded mixed results finding either no effect or a significant negative effect. We hypothesize that, while there may be a negative market reaction associated with state antitakeover legislation, the effect is temporary. In empirically examining the effects from the actions of nineteen states, we find that any negative market reactions tend to be followed by roughly equal positive counter‐reactions, suggesting a market overreaction.
Despite many efforts to develop a universally accepted theory of capital structure, observed capital structures do not appear to conform to existing theories. The…
Despite many efforts to develop a universally accepted theory of capital structure, observed capital structures do not appear to conform to existing theories. The objective of this research is to empirically examine capital structure decisions in terms of the relationship of debt policy with explanatory variables designed to capture the asset structure of each firm, the degree to which each firm is diversified, the agency relationships between management and owners, the level of business risk and the impact of alternative tax shields. The results suggest that the most influential factors are the asset type, the degree of firm diversification and the availability of alternative tax shields.
The global banking environment is experiencing significant change as regulatory and geographical barriers to competition are reduced. As these barriers are removed…
The global banking environment is experiencing significant change as regulatory and geographical barriers to competition are reduced. As these barriers are removed, greater integration of banking services is developing throughout the world affecting the performance and structure of banking institutions. This research examines the stock returns and volatility of stock returns for a sample of banks in the United States, Europe, Canada and Japan. The general focus is to identify factors influencing the return and risk and to examine cross‐country differences in these factors. The results suggest that while size does not affect return volatility for any of the categories of banks, it does affect returns for banks in Japan, the U.S. and other non‐universal banking systems. Likewise, the investment in fixed assets appears consistently to adversely affect returns. A number of differences are found across country borders and across type of institutions (i.e. universal versus non‐universal banks).
The flexibility of managers to respond to risk and uncertainty inherent in business decisions is clearly of value. This value has historically been recognized in an ad hoc…
The flexibility of managers to respond to risk and uncertainty inherent in business decisions is clearly of value. This value has historically been recognized in an ad hoc manner in the absence of a methodology for more rigorous assessment of value. The application of real option methodology represents a more objective mechanism that allows managers to hedge against adverse effects and exploit upside potential. Of particular interest to managers in the merger and acquisition (M&A) process is the value of such flexibility related to the particular terms of a transaction. Typically, stock for stock transactions take more time to complete as compared to cash given the time lapse between announcement and completion. Over this period, if stock prices are volatile, stock for stock exchanges may result in adverse selection through the dilution of shareholder wealth of an acquiring firm or a target firm.
The paper develops a real option collar model that may be employed by managers to measure the market price risk involved to their shareholders in offering or accepting stock. We further discuss accounting issues related to this contingency pricing effect. Using an acquisition example from U.S. banking industry we illustrate how the collar arrangement may be used to hedge market price risk through flexibility to renegotiate the deal by exercising managerial options.