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Abstract Several studies argue that paying high acquisition premia is value destroying for acquirer shareholders. There are studies that have even used the size of premium as a measure of lowquality decision making. This paper departs from the earlier research and shows that acquisition premia may be justified when target firms' resources are difficult for the market to value. An analysis of a sample of 458 acquisitions demonstrates that although higher premia are paid for R&D-related assets, the premia do not cause negative abnormal returns. Abnormal returns are more strongly affected by the overall target price levels independent of premia. Journal Information Strategic Management Journal publishes original refereed material concerned with all aspects of strategic management. It is devoted to the improvement and further development of the theory and practice of strategic management and it is designed to appeal to both practising managers and academics. Strategic Management Journal also publishes communications in the form of research notes or comments from readers on published papers or current issues. Editorial comments and invited papers on practices and developments in strategic management appear from time to time as warranted by new developments. Overall, SMJ provides a communication forum for advancing strategic management theory and practice. Such major topics as strategic resource allocation; organization structure; leadership; entrepreneurship and organizational purpose; methods and techniques for evaluating and understanding competitive, technological, social, and political environments; planning processes; and strategic decision processes are included in the journal. Strategic Management Journal is currently published 13 times a year. Publisher Information Wiley is a global provider of content and content-enabled workflow solutions in areas of scientific, technical, medical, and scholarly research; professional development; and education. Our core businesses produce scientific, technical, medical, and scholarly journals, reference works, books, database services, and advertising; professional books, subscription products, certification and training services and online applications; and education content and services including integrated online teaching and learning resources for undergraduate and graduate students and lifelong learners. Founded in 1807, John Wiley & Sons, Inc. has been a valued source of information and understanding for more than 200 years, helping people around the world meet their needs and fulfill their aspirations. Wiley has published the works of more than 450 Nobel laureates in all categories: Literature, Economics, Physiology or Medicine, Physics, Chemistry, and Peace. Wiley has partnerships with many of the world’s leading societies and publishes over 1,500 peer-reviewed journals and 1,500+ new books annually in print and online, as well as databases, major reference works and laboratory protocols in STMS subjects. With a growing open access offering, Wiley is committed to the widest possible dissemination of and access to the content we publish and supports all sustainable models of access. Our online platform, Wiley Online Library (wileyonlinelibrary.com) is one of the world’s most extensive multidisciplinary collections of online resources, covering life, health, social and physical sciences, and humanities. Rights & Usage This item is part of a JSTOR Collection. The difference between the estimated value of the company and the actual purchase price What is Takeover Premium?Takeover premium is the difference between the market price (or estimated value) of a company and the actual price paid to acquire it, expressed as a percentage. The premium represents the additional value of owning 100% of a company in a merger or acquisition and is also known as the control premium. The control premium is the additional benefit an acquirer receives (compared to an individual shareholder) from having full control over the business.  Acquirers typically pay premiums for two main reasons:
1. The Value of ControlIt is advantageous for shareholders to have complete control over a business. For this reason, they are willing to pay more than an investor who only owns a small fraction of a company, and therefore has very limited influence. Benefits of full control and reasons for paying a takeover premium include the ability to:
2. The Value of SynergiesWhen an acquirer wants to purchase a company, it must find an estimate of the target company’s fair value. In addition to the estimated fair value, the acquirer must determine the potential synergies from the deal. Based on the two metrics mentioned above, the acquirer can determine the takeover premium. The premium should be paid only if the synergies created as the result of the deal exceed the takeover premium paid to the target company. However, the size of the premium also depends on other factors, such as the presence of other bidders, level of competition within the industry, and incentives of buyer and seller. The screenshot above shows the value of synergies, as explained in CFI’s M&A Financial Modeling Course. Accounting for the Takeover PremiumWhen an acquirer pays a takeover premium during an M&A transaction, goodwill is recognized on the acquirer’s balance sheet. Goodwill is an intangible asset that includes a target company’s brand name, client base, great customer and employee relations, and patents. In the case of unfavorable economic conditions or adverse events, the market value of goodwill may drop below the acquisition cost. Then the acquirer must recognize an impairment of goodwill. If the acquirer pays a discount for the acquisition, negative goodwill will be recognized. Example of a Takeover PremiumIn August 2017, online retail giant Amazon.com received regulatory approval to take over Whole Foods Market, Inc. in an all-cash deal valued at $13.7 billion or $42 per share. The deal’s value represented a 27% takeover premium on the Austin, Texas-based organic grocer’s latest closing price at $33.06 before the announcement of the transaction. More ResourcesCFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)® certification program for those looking to advance their career. To learn more and expand your career, check out the additional CFI resources below:
What is the main benefit of acquisitions?Diversification of the products, services and long-term prospects of your business. A target business may be able to offer you products or services which you can sell through your own distribution channels. Reducing your costs and overheads through shared marketing budgets, increased purchasing power and lower costs.
What is a premium in an acquisition?An acquisition premium is a figure that's the difference between the estimated real value of a company and the actual price paid to acquire it. An acquisition premium represents the increased cost of buying a target company during a merger and acquisition (M&A) transaction.
Why is the pricing of a premium critical to the success of a takeover?The premium represents the additional value of owning 100% of a company in a merger or acquisition and is also known as the control premium. The control premium is the additional benefit an acquirer receives (compared to an individual shareholder) from having full control over the business.
What values the acquirer should pay to acquire the other firm?An acquirer needs to be sure that there are enough cost savings and revenue generators—synergy value—to justify the premium so that the target company's shareholders don't get all the value the deal creates.
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Who benefits the most from the acquisition premium valued during an acquisition?
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