M&A Pricing Based On Real Option And Game Theory

Based on the analysis of existing merger & acquisition pricing methods, the author applies option theory and game theory in M&A pricing in order to set up a scientific framework for M&A valuation and pricing.Firstly, this paper analyses the limitation of traditional valuation methods. Slavish devotion to traditional valuation methods often ignores future managerial flexibility. Applying real option theory in the valuation of the target company overcomes this problem. Secondly, it uses the disperse time model and continuous time model respectively to calculate the value of options that the acquiring company may have in the context of M&A, namely, the expending option, the abandoning option and the compounded option;then it uses sensitive analysis to modify the results, thereby it works out the value of the target company as it to the acquiring company, which is theoretically the highest price the acquiring company should pay. Furthermore, the paper discusses how the two parties finalize the takeover price using game theory. Sequential Bargaining model and Sealed-bid First-price Auction model are examined.The uncertainty of project value and the asymmetric information are the two main problems facing by the acquiring company. Thinking of the M&A in terms of options allows uncertainty to be taken into account more efficiently. Game modeling provides a better tool that aids to finalize the takeover price under asymmetric information. The purpose of this paper is to develop a scientific M&A valuation and pricing framework to make the M&A activity a process of rational reallocation of resources among the businesses.