A Study On The Retrntion Ratio Of Premium Risk Control In M&A

With the increasing number of M&A activities,many problems arising from mergers and acquisitions are gradually exposed,especially the value overestimation of target firms.Due to the policy restriction of the valuation method of our country,the acquiring firms can only adopt the asset-based method,the market method and the revenue method when valuing the target firms.However,these methods have certain defects,the true value of the target firm cannot be reasonable,combined with the subjective factors exist in the valuation of mergers and acquisitions as well as the asymmetric information of both mergers and acquisitions,the risk of mergers and acquisitions premium is inevitable.As of 2016,341 listed companies in our country were impaired in goodwill due to excessively high merger price.The total amount of impaired value reached 10,124 million yuan.How to control the risk of merger and acquisition premium has become a problem which the acquiring firms have to consider in mergers and acquisitions.At present,the most effective way to control the risk of M&A premium is the Earn-outs,which is developed on the basis of performance commitments and still belongs to a kind of valuation adjustment mechanism.However,it changed the payment link of performance commitments that make the M&A payment from prepayments to installments according to the profitability of the target enterprises.The existing literatures focus on the effectiveness of the control premium risk in the study of the Earn-outs,but there is little research on the value of the Earn-outs and the quantification of the retention ratio.Therefore,this paper considers the Earn-outs as a protective put and valuates it using the real option theory.The committed profit of the target firm is equivalent to the underlying asset price of the option,the retained premium is equivalent to the strike price of the option,and the reporting date is equivalent to the option maturity date.Aiming at the quantification of the premium retention ratio,based on the consideration of the Earn-outs option price,this paper establishes a premium retention ratio model according to the risk-neutral pricing theory,and uses Matlab to do the numerical simulation and sensitivity analysis of the premium retention ratio model,draw the following conclusions:First,there is a risk-neutral premium retention ratio for the profitability payment plan.By using Monte Carlo simulation to simulate the actual profit of target firms,the actual merger returns can be calculated under risk-neutral conditions,and then the maximum return of actual merger returns can be found to find the corresponding ratio of retained premiums.With the number of simulations increase,so that the ratio of retained premiums that maximizes the actual acquisition benefits tends to be stable.Second,the acquiring firms can improve acquisition return through accurate the basic parameters.Since the premium retention ratio can only guarantee that the acquiring firms achieve the maximum return under the risk-neutral condition,so the premium retention ratio is not optimal for each commitment period.If the acquiring firms want to enhance acquisition return,they must be realized by adjusting the ratio of retained premium.How to adjust the ratio of retained premium is according to the specific situation,if the acquiring firms believe that the target firms havea higher probability of realizing the promised profit,the ratio of retainedpremiums can be reduced accordingly.If the acquiring firms believe that the target firms have a low probability of realizing the promised profit,it is necessary to properly raise the premium retention ratio.The premium retention ratio is closely related to the target firms' profit volatility,average return,base period actual profit,commitment profit and risk-free interest rate and other basic parameters.