Study On The Corporate M&A And Asset Divestiture Based On The Real Option Approach

Merger and Acquisitions are the eternal themes of the capital market. The fundamental function of capital market is the allocation of resources, while IPO and M&A are the basic ways to do so. Most firm has only one chance of IPO, but may have more chances to engaged in M&A activity. China is in an era of economic reform, in which the market for M&A is especially important. M&As activities happened in a dynamic stochastic environment, as made the revenue of M&A was uncertain. M&A will incur irreversible cost, such as negotiation fees and financial consultant fees, so the participating sides had to decide the optimal timing to execute the M&A decisions, which can be better modeled and analyzed by real option approach. After reviewing of the related literature in theory of real option and M&A, this paper made contributions in several aspects.In section 3.1, I studied the affection of information asymmetry between principal and agent on asset divestiture decisions through ROA approach. Deducted the optimal contact and the optimal divestiture rule. It is showed that compared with symmetry information, asymmetry information lowered the execution corridor value of the asset, and induce loss to the principal in two different aspects, i.e. efficiency loss and information rent. Section 3.2 studied the divestiture decisions in a Nash bargaining framework. Analysis showed that when the buying side and selling side has different discount rate, the participating parties have to bargain not only on the price, but also on the timing of the transaction.Section 4.1 analyzed the option to acquire another firm when the buying side had the option to choose among the targeting firms with different sizes. It is proved that this option increased the value of acquire option and postponed the timing of acquiring. Section 4.2 Developed a pricing model of the option to acquire a target firm to which the buying side has an option to expand. Analyzed the parameters that affect value of the option. The main conclusions include: (1) owing the expansion option will increase the total value of the acquiring option, and lower the striking price in certain circumstances. (2) The option to expand will be executed when the cost to expand is lower than the cost to acquire, otherwise the acquiring firm will wait. In section 4.3, I studied vertical integration by real option approach. The return of vertical merge is uncertain when firms operated in an uncertain environment, the vertical merge decision is irreversible, thus a vertical merge has a real option feature. Analyzed vertical merge decision by real option approach, deducted the optimal merge trigger. The paper also analyzed the parameters that affect the merge decision.Section 5.1 analyzed the affect of manager private benefit on timing of M&A under an asymmetric information principal-agent framework. The private benefit considered include manager's wage, outside benefit and information rent about operating cost. Analysis showed that the wage do not affect timing of M&A, the outside benefit have an negative effect on M&A trigger value and the information value have positive effect on trigger value. Optimal compensation contract is derived, followed by the parameters analysis. Section 5.2 further assumed that the outside benefit is asymmetric information on the basis of section 5.1, studied M&A option investment in a two-dimensional information asymmetry framework. It is showed that the principal will increase M&A trigger value so as to decrease the information cost caused by the asymmetric information of operating cost and manager's outside benefit, but the M&A trigger value itself will be lowered by the outside benefit, the total effect of manager's private benefits on the M&A trigger value depend on the value of parameters.Section 6.1 discussed one of the limitations of RO approach. When the underlying asset is not tradable, and its risk can not be replicated by existing assets, the standard way is to use the Marketed Asset Disclaimer to pricing the real option, but doing so has neglected one problem, i.e. the risk associated with real option value. The paper analyzed the real option value risk theoretically and pointed out its implications in practice.Section 6.2 incorporated real option thinking into corporate strategy making. The goal of corporate strategy management is to guide the firm to do the right things. But in turbulent environments, nobody can tell what is right for all the time. Thus the responsibility of strategy management is to create and maintain flexibility, to prepare for the unexpected changes and to seize the opportunity. This paper combined the real option thinking into corporate strategy management, which then could be evaluated more properly.