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Understanding reverse mergers: a first approach

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  • Arellano Ostoa, Augusto
  • Brusco, Sandro

Abstract

A reverse merger (RM) is a technique in which a private company is acquired by a shell or defunct public company via stock swap. As a result, the private company becomes public. The main difference between an IPO and a RM is that an IPO allows going public and also allows raising capital while the RM only allows going public. This paper addresses the following question: Why do some companies prefer a RM to an IPO? We construct a three-period model in which a company has uncertainty about the availability of a project and need to issue equity to finance it. The model predicts that under suitable conditions, a separating equilibrium exists in which a high-type firm will prefer IPO and a low-type firm will prefer RM. The empirical evidence supports these predictions. In addition, looking at the cost of RMs between 1990 and 2000 in the NYSE and NASDAQ and adding the cost of an additional SEO, we find evidence to support the idea that an IPO and a RM are equally costly.

Suggested Citation

  • Arellano Ostoa, Augusto & Brusco, Sandro, 2002. "Understanding reverse mergers: a first approach," DEE - Working Papers. Business Economics. WB wb021711, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
    • Handle: RePEc:cte:wbrepe:wb021711
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    Cited by:

    1. Pantisa Pavabutr, 2021. "White Knights or Machiavellians? Understanding the motivation for reverse takeovers in Singapore and Thailand," PIER Discussion Papers 153, Puey Ungphakorn Institute for Economic Research.
    2. Gheorghe HURDUZEU & Liviu Bogdan VLAD & Raluca HURDUZEU, 2012. "The Reverse Mergers Alternatives To Initial Public Offerings," Business Excellence and Management, Faculty of Management, Academy of Economic Studies, Bucharest, Romania, vol. 2(2), pages 71-78, June.
    3. Valérie Revest & Alessandro Sapio, 2016. "Graduation and sell-out strategies in the Alternative Investment Market," Discussion Papers 4_2016, CRISEI, University of Naples "Parthenope", Italy.
    4. Jog, Vijay & Otchere, Isaac & Sun, Chengye, 2019. "Does the two-stage IPO process reduce underpricing and long run underperformance? Evidence from Chinese firms listed in the U.S," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 59(C), pages 90-105.
    5. Pantisa Pavabutr, 2020. "White Knights or Machiavellians? Understanding the motivation for reverse takeovers in Singapore and Thailand," Review of Quantitative Finance and Accounting, Springer, vol. 55(3), pages 983-1001, October.
    6. James S. Ang & Zhiqian Jiang & Chaopeng Wu, 2016. "Good Apples, Bad Apples: Sorting Among Chinese Companies Traded in the U.S," Journal of Business Ethics, Springer, vol. 134(4), pages 611-629, April.
    7. Frederick Adjei & Ken Cyree & Mark Walker, 2008. "The determinants and survival of reverse mergers vs IPOs," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 32(2), pages 176-194, April.
    8. Masako Darrough & Rong Huang & Sha Zhao, 2020. "Spillover Effects of Fraud Allegations and Investor Sentiment," Contemporary Accounting Research, John Wiley & Sons, vol. 37(2), pages 982-1014, June.

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