Understanding Reverse Mergers: A First Approach

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Understanding Reverse Mergers: A First Approach

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Augusto Arellano-Ostoa ()
Sandro Brusco ()

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Sandro Brusco

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.

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Paper provided by Universidad Carlos III, Departamento de Economía de la Empresa in its series Business Economics Working Papers with number wb021711.

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Date of creation: May 2002
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Handle: RePEc:cte:wbrepe:wb021711

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This paper has been announced in the following NEP Reports:

NEP-ALL-2003-03-10 (All new papers)

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

Hsuan-Chi Chen & Jay R. Ritter, 2000. "The Seven Percent Solution," Journal of Finance, American Finance Association, vol. 55(3), pages 1105-1131, 06. [Downloadable!] (restricted)
Fortin, Pierre & Keil, Manfred & Symons, James, 2001. "The," Oxford Economic Papers, Oxford University Press, vol. 53(1), pages 67-93, January.

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Frederick Adjei & Ken Cyree & Mark Walker, 2008. "The determinants and survival of reverse mergers vs IPOs," Journal of Economics and Finance, Springer, vol. 32(2), pages 176-194, April. [Downloadable!] (restricted)

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