A:

A merger is an agreement to unite two existing companies into one new company. Mergers and acquisitions are commonly done to expand a company’s reach, expand into new segments, or gain market share in an effort to create shareholder value.

For example, back in August 2017, DowDuPont (DWDP) was formed after the merger of Dow Chemical and DuPont created the world's largest chemical company in terms of sales.

Mergers affect the shareholders of both companies in different ways and is influenced by several factors, including the prevailing economic environment, size of the companies and management of the merger process. However, the conditions of the merger may have different effects on the stock prices of each participant in the merger.

How Stock Price Is Affected

The merger of two companies causes significant volatility in the stock price of the acquiring firm and that of the target firm. Shareholders of the acquiring firm usually experience a temporary drop in share value in the days preceding the merger, while shareholders of the target firm see a rise in share value during the period.

The stock price of the newly merged company is expected to be higher than that of both the acquiring and target firms, and it is usually profitable for the target firm's shareholders, who benefit from the resulting stock price arbitrage. In the absence of unfavorable economic conditions, shareholders of the merged company usually experience greatly improved long-term performance and dividends.

Shareholder Voting Power and Dilution

The shareholders of both companies may experience a dilution of voting power due to the increased number of shares released during the merger process. This phenomenon is prominent in stock-for-stock mergers, when the new company offers its shares in exchange for the shares of the target company albeit at an agreed conversion rate. Shareholders of the acquiring company experience a marginal loss of voting power, while shareholders of a smaller target company may see a significant erosion of their voting powers in the relatively larger pool of stakeholders.

Changes in Management

After the merger has been completed, the new company will likely have at least a few noticeable changes in leadership. Certain concessions are usually made in merger negotiations, and the executives and board members of the new company will change to some degree, whether at the start or planned to change in the future.

RELATED FAQS
  1. What is a stock-for-stock merger and how does this corporate action affect existing ...

    First, let's be clear about what we mean by a stock-for-stock merger. When a merger or acquisition is conducted, there are ... Read Answer >>
  2. What is the difference between a merger and an acquisition?

    Learn about the legal differences between a corporate merger and corporate acquisition – terms used when companies are either ... Read Answer >>
  3. Why do companies merge with or acquire other companies?

    The reasons for company mergers and acquisitions include synergy, diversification, growth, improving competition, and supply ... Read Answer >>
  4. What's the difference between a merger and a hostile takeover?

    Understand the difference between a merger and a hostile takeover, including the different ways one company can acquire another, ... Read Answer >>
  5. What can shareholders vote on?

    Understand the usual voting rights of common stock shareholders, along with the importance of shareholders exercising their ... Read Answer >>
Related Articles
  1. Investing

    The Wonderful World Of Mergers

    While acquisitions can be hostile, these varied mergers are always friendly.
  2. Investing

    What Investors Can Learn From M&A Payment Methods

    How a company pays in a merger or acquisition can reveal a lot about the buyer and seller.
  3. Investing

    A Guide to Spotting a Reverse Merger

    A reverse merger is a type of corporate action that can be profitable for investors who know what to look for.
  4. Investing

    Reverse Mergers: The Pros and Cons of Reverse IPOs

    Reverse mergers can be excellent opportunities for companies and investors, but there are still risks. Find out the pros and cons of reverse IPOs.
  5. Investing

    How the Dow-DuPont Merger Affects Dividends (DOW)

    The impending merger between Dow Chemicals and DuPont could mean good things for both companies in future.
  6. Investing

    Dow-DuPont Deal May Face EU Objections (DOW, DD)

    EU regulators could issue a formal statement of objections next month for the proposed merger between Dow and DuPont.
  7. Small Business

    How To Profit From Mergers And Acquisitions Through Arbitrage

    Making a windfall from a stock that attracts a takeover bid is an alluring proposition. But be warned – benefiting from m&a is easier said than done.
  8. Small Business

    4 Cases When M&A Strategy Failed for the Acquirer (EBAY, BAC)

    Learn about four corporate mergers that were either unsuccessful or faced critical challenges. Discover which factors can cause an M&A strategy to fail.
RELATED TERMS
  1. Mergers and Acquisitions - M&A

    A merger is a combination of two companies to form a new company, ...
  2. Merger Arbitrage

    A hedge fund strategy in which the stocks of two merging companies ...
  3. Horizontal Merger

    A merger occurring between companies in the same industry. Horizontal ...
  4. Merger Of Equals

    A merger of equals is when two firms of about the same size come ...
  5. Proration

    Proration happens when available cash or shares are not sufficient ...
  6. Form S-4

    The Form S-4 must be submitted to the Securities and Exchange ...
Hot Definitions
  1. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  2. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  3. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  4. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  5. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
  6. Limit Order

    An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
Trading Center