A Reference Point Theory of Mergers and Acquisitions

by Jim Naughton, for The Harvard Law School Forum at Harvard Law School, December 23, 2009.

In our recently updated working paper A Reference Point Theory of Mergers and Acquisitions, we propose a “reference point” view of mergers which holds that salient but largely irrelevant reference point stock prices of the target help to explain several aspects of mergers and acquisitions, involving both the pricing and the types and quantities of firms traded.

The standard textbook story on mergers emphasizes synergies. The offer price starts with an estimate of the increased value of the combined entity under the new corporate structure, deriving from a variety of cost reductions. This value gain is then divided between the two entities’ shareholders according to their relative bargaining power. In theory, all of this leads to an objective and specific price for the target’s shares. In practice, however, valuing a company is subjective. A large number of assumptions are needed to justify any particular valuation of the combination. In addition, relative bargaining power may not be fully established. These real-life considerations mean the appropriate target price cannot be set with precision, but established only to be within a broad range…(continue reading)


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