How Does a Merger Affect Shareholders?

Corporate mergers are the union of two separate companies into a single legal entity. The purposes can be many, and they have a substantial financial and equity impact on shareholders—influencing ownership, governance, and corporate rights significantly. In this article we will analyze how does a merger affect shareholders before, during, and after the merger. The content is aimed at international contexts, not confined to a single area or jurisdiction. 

Understanding Mergers and Shareholder Roles

Mergers are transactions in which two companies combine to form a single entity. Unlike an acquisition, where one company absorbs another, a merger tends to be presented as a union of equals, although in practice one of the two companies often assumes operational control. 

There are different M&A negotiation strategies, but the reasons for mergers typically include expansion, cost reduction, increasing market share, or seeking new synergies. Shareholders, as partial company owners, are directly affected by these decisions. They are officially informed through corporate communications or meetings and, in many jurisdictions, have the right to vote on merger approval.

Immediate Effects of a Merger Announcement on Shareholders

As soon as a merger is announced, stock prices vary quickly. Usually the target company’s shares increase in price—considering the price offered in the deal—while those of the acquiring company vary depending on the perception of the deal. 

However, the market may react with high volatility due to the uncertainty—for example, raising doubts about the companies’ financial strength, cultural integration, regulatory approvals, etc.—and by its complexity. Several factors influence the impact of merger and acquisition on shareholders. The main ones include the transaction structure (cash, loan, hybrid), the deal details, and the target market.

Types of Mergers and Their Different Impacts on Shareholders

There are various types and M&A process steps, and each has a different impact on owners. The three main types are:

• Horizontal mergers: These occur between companies in the same industry and are often competitors. The advantage is economies of scale and a larger market share, which increases stock price.
• Vertical mergers: Typical of companies operating in the same supply chain (e.g., a supplier and a distributor). The impact on shares is less immediate but investors can benefit from improved productivity.
• Conglomerate mergers: In this case, two companies operating in different industries decide to merge. For stockholders, the benefit is risk diversification with, however, a consequent increase in complexity. 

Relying on merger and acquisition lawyers can help companies make the right decision. 

Voting Rights and Shareholder Approval Requirements

In many jurisdictions, stockholders must cast a formal vote to approve a merger. Merger shareholder approval requirements may vary according to corporate structure and local regulations, but a qualified majority—such as 66% or 75% of the votes—is often required. Ordinary shareholders have the right to be informed and participate in the vote, while in some special cases voting may be available only to certain groups of investors, such as those holding preferred stock.

Financial Impact of Mergers on Shareholders

M&A transactions have a significant financial effect on stockholders. In fact, depending on the deal, they may receive cash, stock, or a mixture of both. Cash payments usually represent a permanent exit from the company, whereas stock payments allow an active role in the company. 

In the case of cash payments, investors’ earnings are immediately taxed; if, on the other hand, compensation is in equity, taxation may be deferred until the subsequent transfer of the acquired shares.

Finally, it should be remembered that the percentage of ownership can significantly change following a merger, affecting the company’s decision-making power. 

Post-Merger Scenarios for Shareholders

Once the merger is completed, the original stocks are, as a rule, cancelled, converted, or redeemed. Stockholders can receive shares in the merged company, obtain cash compensation from investors, or get restructured or revalued shares. 

Obviously holding stock in a newly formed company can give great opportunities for growth and unexpected gains but also big risks related to initial instability—such as investment instability, uncertainty in the market, operational and management difficulties, etc. 

Risks and Benefits of Mergers for Shareholders

Like all complex operations, mergers have benefits and risks for each member. Among the main benefits:

• Increased company value: If the deal is perceived positively by investors, the company will increase in value resulting in a higher stock price.
• Increased company value: By joining forces with another company, market shares will inevitably increase by improving competitiveness.
• Growth prospects: By combining resources, companies can rapidly expand their business. 

As for risks, however:

• Dilution of ownership: Depending on the investment structure, existing stockholders may see their ownership percentage reduced.
• Reduction in dividends: Increased upfront investment may lead to a reduction in dividend payments.
• Integration challenges: Last but not least, M&A transactions require cultural and operational challenges with the risk of initial negative stock performance.

Impact of Mergers on Dividends and Earnings

A merger will also impact the company’s dividends and profits. In fact, in the short term, any investment will be directed toward the integration of the companies and their development. The impact on EPS depends on the merger structure. If the transaction is accretive, the combined group’s EPS increases. Conversely, EPS may initially fall in a dilutive merger, especially if the acquisition is financed by stock issues or expensive debt.

On the other hand, however, in the medium to long term due to an improved cost structure and greater synergies, dividends and EPS may grow.

How Mergers Affect Minority Shareholders

Minority shareholders hold a small share of capital and do not exercise control over company decisions. Following a merger, they are exposed to certain risks, the main ones being:

• Forced buyout risk: In some cases, majority stockholders may force minority stockholders to divest shares on non-negotiable terms.
• Reduction in ownership rights: After the merger, the percentage of stock held may be reduced with consequences for voting rights as well. 
• Undervaluation: Finally, it may happen that the shareholding value does not reflect the real market value.

To protect themselves, however, they can use some tools such as the right of objection, requesting independent valuations, or exercising legal action in cases of majority abuse.

FAQs

What happens to my shares after a merger is completed?

After a merger, stock can follow different paths such as share conversion in case these are converted (at a predetermined exchange ratio) into the merged company’s stock. Other options are cash out (obligation to liquidate one’s shares) and mixed instruments.

Will I have to pay taxes when my company merges?

In many cases, yes. If you receive a gain on the value of the stock, you may be subject to capital gains taxes, depending on your country’s tax laws.

Can shareholders block a merger?

Yes, but only if they hold a sufficient percentage of votes against or if they can prove that the merger is harmful or illegitimate.

What is the typical timeline for a merger to affect shareholders?

There is no predetermined time, but usually 3 to 12 months. It depends on the complexity of the deal and the subsequent implications.

Do shareholders automatically lose ownership during a merger?

No. Company’s ownership can change form, but shareholders retain a stake in the merged company unless they are liquidated or bought out.

References

Rani, N., Yadav, S. S., & Jain, P. K. (2015). Impact of Mergers and Acquisitions on Shareholders’ Wealth in Short-Run: An Event Study Approach. Vikalpa: The Journal for Decision Makers, 40(3), 293–312.

https://www.researchgate.net/publication/281241750_Impact_of_Mergers_and_Acquisitions_on_Shareholders’_Wealth_in_Short-Run_An_Event_Study_Approach

Ohrn, E., & Seegert, N. (2019). The Impact of Investor-Level Taxation on Mergers and Acquisitions. Journal of Public Economics, 172, 1–14. 

https://ideas.repec.org/a/eee/pubeco/v177y2019ic1.html

Becht, M., Polo, A., & Rossi, S. (2016). Does Mandatory Shareholder Voting Prevent Bad Acquisitions?. Review of Financial Studies, 29(11), 3035–3067.

https://academic.oup.com/rfs/article-abstract/29/11/3035/2583672