Exchange ratio determination in a market equilibrium

Abstract

PurposeThe paper aims to present an exchange ratio for merging companies that incorporates the change in the level of riskiness.Design/methodology/approachThe paper is a theoretical one. Its main objective has been achieved exploiting standard modern finance results such as Capital Asset Pricing Model Capital Asset Pricing Model (CAPM).FindingsThe paper offers a formula that determines a risk‐adjusted exchange ratio that takes into account both risk and synergy.Research limitations/implicationsDue to the fact that CAPM is applied and beta factors are required, the formula is fully applicable only to companies whose stocks are traded on a financial market. Empirical test of the exchange ratio formula (using, for instance, an event‐study methodology) should be performed.Practical implicationsThe use of the formula allows the identification of whether the offered exchange ratio fully reflects the expected return/risk profile for stockholders of the merging companies.Originality/valueThe paper should be useful in both theoretical and managerial conditions. It carries a way to embed relative riskiness of two companies into a simple formula.