Acquisitions as a real options bidding game

This paper uses a unified treatment of real options and game theory to examine the occurrence of bidding contests within a competitive environment of imperfect information and asymmetric bidders. Competing potential buyers may sequentially perform due diligence and incur costs (option premium) to become informed about their firm-specific target value (underlying value) before making a bid (exercise price). The first player’s bid reveals a signal on its own and the rival’s target value, thereby affecting the value of the rival’s option to bid on the target and the probability of a bidding contest. We find that bidding contests are more likely to take place between moderately correlated buyers, whereas rather diverse or just very similar buyers are less likely to compete.