Investigating the role of real option in mergers and acquisitions

Abstract

In the thesis, I analyse the role of real option in mergers and acquisitions (M&A) in two essays. In the first essay, I examine the motivation and paring characteristics of M&A in the perspective of real option. Bradley et al. (1988) suggested that synergy is created through the capitalization of combined investment opportunities. In another aspect, the real option literature suggests that managerial discretion (or managerial flexibility) and investment opportunity are two major representative forms of real option. Therefore, I conjecture that real option must play an important role in determining synergistic value which in turn affects the acquirer's choice of targets. Applying Grullon et al.'s (2012) rationale to the estimation of a firm's real option level in the context of M&A, I find that the real option level of the acquirer gradually declines from three years to one year prior to the merger. In addition, the real option level for the target from the one year prior to the merger is significantly higher than that for the acquirer. These findings suggest that firms undertaking M&A due to lack of inherent growth usually acquire targets with more real option to facilitate future growth. In the second essay, I uncover how the firm's strategic matching characteristics impose a positive impact on the merger pairing and transaction incidence using a large M&A dataset over the period 1980 to 2006. I first show that firms with higher levels of real option are more likely to become the target while the level of real option does not determine the chance to become an acquirer. Then I show that firms with a similar real option level are more likely to form a merger. I further illustrate these findings by developing another strategic match measure based on strategic orientation and find that firms with the same strategic orientation (oriented in intellectual assets, relational assets or none of the above) are more likely to form a merger. In summary, I show that firms with similar strategic match characteristics are more likely to pair up in M&A.