An Empirical Analysis of Exchange Ratio Determination Models for Merger: A Note

This paper examines the empirical validity of two exchange ratio determination models for merger, the Larson and Gonedes (LG) PE model and the Yagil dividend growth model. These two models formulate exchange ratios as a function of a different factor: expected post-merger price-earnings multiple and expected post-merger dividend growth, respectively. While the LG model has been tested in previous studies, the Yagil model has yet been subject to empirical testing. This paper finds empirical support for the LG model but finds weak support for the Yagil model. In particular, the results show that the number of stock mergers that result in wealth gains for both acquiring and target firms and hence conform to the rationality assumption of each model is substantially greater for the LG model than for the Yagil model. Regression analysis provides confirmatory evidence on the empirical validity of the LG model that PE-related variables play a more significant role in explaining the actual exchange ratios than growth-related variables.