A:

When a firm acquires another entity, there usually is a predictable short-term effect on the stock price of both companies. In general, the acquiring company's stock will fall while the target company's stock will rise.

The reason the target company's stock usually goes up is that the acquiring company typically has to pay a premium for the acquisition: unless the acquiring company offers more per share than the current price of the target company's stock, there is little incentive for the current owners of the target to sell their shares to the takeover company.

The acquiring company's stock usually goes down for a number of reasons. First, as we mentioned above, the acquiring company must pay more than the target company currently is worth to make the deal go through. Beyond that, there are often a number of uncertainties involved with acquisitions. Here are some of the problems the takeover company could face during an acquisition:

  • A turbulent integration process: problems associated with integrating different workplace cultures
  • Lost productivity because of management power struggles
  • Additional debt or expenses that must be incurred to make the purchase
  • Accounting issues that weaken the takeover company's financial position, including restructuring charges and goodwill

We should emphasize that what we've discussed here does not touch on the long-term value of the acquiring company's stock. If an acquisition goes smoothly, it will obviously be good for the acquiring company in the long run.

To learn more about this subject, check out The Basics of Mergers and Acquisitions.

RELATED FAQS

  1. How does additional paid in capital affect retained earnings?

    Find out how additional paid-in capital can impact a company's retained earnings, including an explanation of both financial ...
  2. How long does it take to execute an M&A deal?

    Read about the mergers and acquisitions process, and find out why the average M&A deal can take half a year to three years ...
  3. How often should a small business owner go through a bank reconciliation process?

    Learn about the bank reconciliation process, its purpose and how often it is recommended that small businesses perform a ...
  4. What is the difference between recurring and non-recurring general and administrative ...

    Understand the expenses involved in a company's general and administrative operating costs and the difference between recurring ...
RELATED TERMS
  1. Runoff Insurance

    An insurance policy provision that provides liability coverage ...
  2. Hunting Elephants

    The practice of targeting large companies or customers.
  3. Precedent Transaction Analysis

    A valuation method in which the prices paid for similar companies ...
  4. Poison Put

    A takeover defense strategy in which the target company issues ...
  5. Assented Stock

    A share of stock owned by a shareholder who has agreed to a takeover.
  6. Back-End Plan

    An anti-acquisition strategy in which the target company provides ...

You May Also Like

Related Articles
  1. Fundamental Analysis

    Which US Airlines Are Poised For Long-Term ...

  2. Stock Analysis

    The Delhaize/Ahold Merger: A Buy for ...

  3. Fundamental Analysis

    BP Settlement Makes It a Takeover Target

  4. Stock Analysis

    AT&T: Just Boring Or Bad?

  5. Stock Analysis

    How To Analyze Netflix's Income Statements

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!