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Game Theory in M&A: Navigating Synergy Valuation and Negotiations

Mergers typically happen because at least one party believes that synergies exist – where the combined value of the two enterprises is greater together than when separate. When both the acquiring firm and the target agree on the size of the synergies, then the merger becomes a negotiation problem. If the acquisition price rises, then the target gets a larger share of the surplus, whereas a lower acquisition price is lower benefits the acquirer with the surplus.

Where things get difficult and interesting is when the two sides have different beliefs about the magnitude of the synergies. For instance, if the target believes that the synergies are greater than what the acquirer does, it might hold out for a higher acquisition price to obtain a reasonable share of the surplus that it believes exists. Thus, if beliefs diverge substantially, the merger might fail because the target’s asking price exceeds what the acquiring firm is willing to pay.

This dynamic raises some interesting strategic questions involving game theory: How transparent should you be when disclosing the value of synergies? To what extent should you trust what your counterparty says about these synergies?

If you are the acquirer, your incentive is to downplay the value of the synergies to justify a lower payment. Conversely, as the target, your incentive is to overstate the value of the synergies to receive a higher payment. It’s equally important to recognize your counterpart’s incentives to selectively disclose information and shape your perceptions about the synergies.

This underscores the significance of having an experienced advisor is so important to navigate this process: an advisor will help you understand the true value of the synergies, determine what to reveal to the counterparty, and understand what the counterpart’s incentives are, in order to achieve a profitable outcome.

It is worth noting that this that this divergence in incentives explains the appeal of stock-based, or ownership-based, acquisitions. In such an acquisition, the price the acquiring firm pays increases only if the synergies materialize – since the value of their equity will increase.

Why CDI Global

CDI Global has strategically advised companies on mergers and acquisitions (M&A) worldwide for almost 50 years.

Whether you have a company already in your sights or you are looking for guidance for new opportunities, our cross-border industry expertise will help you find and execute the best deals. We combine M&A advisory, due diligence, macroeconomic forecasting, and financial structuring to provide complete solutions for our clients. Our teams on the ground in more than 30 countries have the local knowledge to follow market shifts and suss out both opportunities and pitfalls in potential mergers and acquisitions to ensure transactional success.

By TJ Dale, Associate

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