Behavioral merger and acquisition pricing: Application to Verizon mergers with AOL and Yahoo

Abstract

Mergers and acquisitions (M&A) are important to companies as it allows them to acquire capabilities that they cannot create internally and to grow quickly. M&A transaction pricing relates to the pricing of these M&A deals and this article analyzes if behavioral finance factors like risk aversion, optimism, and loss aversion have an impact on this pricing. Prospect Theory (Kahneman & Tversky, 1979) and Cumulative Prospect Theory (Kahneman & Tversky, 1992) are applied to an agent‐based model to solve this problem. Results of this article show that M&A transaction price does respond to a change in risk aversion and optimism traits of the acquirer and target companies respectively, as well as, loss aversion and certainty (probability of gains and losses). When, the acquirer is risk taking and target company is optimistic, the M&A transaction price increases. However, with increasing certainty of gains and reducing loss aversion (increasing loss aversion co‐efficient; as gains are perceived to have the same weight as losses), the M&A transaction price seems to reduce. These results are compared with the recent mergers of Verizon and AOL as well as Verizon and Yahoo, to understand if these results would occur in practice. Analyzing these mergers, it seems that the outcomes from this model does provide insight on the pricing of these M&A transactions. This article also analyzes how these behaviors would impact the pricing when three different acquirers are trying to take over a target company. Results show that loss aversion has a significant effect on this pricing with risk aversion and optimism also having some minor impact. But, the existence of multiple acquirers does positively increase the M&A transaction price.