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Unformatted text preview: Industrial Organization: EC460 Spring 2009 Instructor: Thomas D. Jeitschko Some Class Notes on Acquisitions In class weve talked about the merger paradox for Cournot and for Bertrand markets. We have concluded for mergers to be worthwhile, in a Cournot market a substantial number of firms must merge for it to be conceivable to observe mergers. And in a Bertrand market, rivals would prefer their competitors to merge, rather than they merging themselves. Thus, it appears to be the case that mergers in the real world lead to increased efficiency. We now consider this second scenario with a twist. The twist being that even if you know that an efficiency gain can be achieved, a merger may not pay off if there is uncertainty about the underlying profitability of a company that one wishes to merge with, or take over. Acquiring a Company of Uncertain Value: A case of adverse selection and the winners curse Suppose that a current owner of a company values the enterprize at some value V . That is, V is the discounted sum of profits that the current owner can obtain by running the company. Suppose further that you are a manager in the same industry and you are certain that you are better qualified to run the company. In particular, you are pretty sure that you could make fifty percent more money that the current manager. Thus, if under the current owner the companys discounted sum of profits is indeed V , you can earn 1 . 5 V . The only problem that you face in deciding to make a take-over offer for the company is that you dont know the exact inner workings of the company (its customer base, its 1 internal policies, its detailed production techniques, etc.), whereas the current owner knows these details and therefore knows V . Therefore you are not sure what V is! For the sake of concreteness, suppose that you think the value of the company to the current owner is equally likely to lie anywhere between 0 (i.e., it may be worthless) and 100 thousand dollars. Formally this means that the distribution of V is uniform on the interval [0 , 100]....
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- Spring '08