In
corporate finance
Corporate finance is an area of finance that deals with the sources of funding, and the capital structure of businesses, the actions that managers take to increase the Value investing, value of the firm to the shareholders, and the tools and analy ...
,
Contingent Value Rights (CVR) are
rights
Rights are law, legal, social, or ethics, ethical principles of freedom or Entitlement (fair division), entitlement; that is, rights are the fundamental normative rules about what is allowed of people or owed to people according to some legal sy ...
granted by an
acquirer to a company’s
shareholders
A shareholder (in the United States often referred to as stockholder) of corporate stock refers to an individual or legal entity (such as another corporation, a body politic, a trust or partnership) that is registered by the corporation as the ...
, facilitating the transaction where some uncertainty is inherent.
CVRs may be separately
tradeable securities;
they are occasionally acquired (or
shorted) by specialized
hedge fund
A hedge fund is a Pooling (resource management), pooled investment fund that holds Market liquidity, liquid assets and that makes use of complex trader (finance), trading and risk management techniques to aim to improve investment performance and ...
s.
Forms
These rights typically take either of two forms:
(1) Event-driven CVRs compensate the owners for yet to eventuate positive developments in their business - hence protecting the acquirer against the
valuation risk inherent in overpaying.
(2) Price-protection CVRs are granted when
payment is share based - protecting the acquired company, by providing a
hedge against downside
price risk
Market risk is the risk of losses in positions arising from movements in market variables like prices and volatility.
There is no unique classification as each classification may refer to different aspects of market risk. Nevertheless, the mo ...
in the acquirer's equity.
In the first case, CVRs are granted
[ Motley Fool (2018)]
''What Is a Contingent Value Right?''
/ref>
in scenarios in which the acquiring company does not wish to pay for a product that might not work, has a limited market, or might need significant investment;
whereas on the other side, the acquired company “wants to get full value for its assets”.
The CVR then “helps bridge this negotiation”.
Under these rights, shareholders will receive additional cash, securities, or benefits if a specific and named event occurs
- one where the value of the firm significantly increases
- within a specified timeframe.
CVRs are common in the biotech
Biotechnology is a multidisciplinary field that involves the integration of natural sciences and engineering sciences in order to achieve the application of organisms and parts thereof for products and services. Specialists in the field are kn ...
and pharmaceutical industries
(see );
they are also often granted to shareholders in companies facing significant, value accretive restructuring.
For an example see Media General / Nexstar Media Group
Nexstar Media Group, Inc. is an American publicly traded media company with headquarters in Irving, Texas, Midtown Manhattan, and Chicago. The company is the largest television station owner in the United States, owning 197 television station ...
.
In the second case, protection against price risk is facilitated by specifying that payment will be made at an averaged, as opposed to final, share price; a floor may also be set.
Valuation
Under both, the CVR is in function, a form of option.
The first case: analogous to a call option
In finance, a call option, often simply labeled a "call", is a contract between the buyer and the seller of the call Option (finance), option to exchange a Security (finance), security at a set price. The buyer of the call option has the righ ...
, the payout to the CVR holder will be triggered by the event occurring, and will be zero otherwise.
To determine the value of these rights,
analysts will apply a modified option pricing model based on the probability of the event, the time horizon specified, and the corresponding payout rules;
see Contingent claim valuation, Real options valuation
Real options valuation, also often termed real options analysis,Adam Borison (Stanford University)''Real Options Analysis: Where are the Emperor's Clothes?''
(ROV or ROA) applies option (finance), option Valuation of options, valuation technique ...
, and .
[ Aswath Damodaran (ND)]
''Valuation: Approaches & Discounted Cash Flow Models''
/ref>
The second: the CVR takes the form of a modified Asian option
An Asian option (or ''average value'' option) is a special type of option contract. For Asian options, the payoff is determined by the average underlying price over some pre-set period of time. This is different from the case of the usual European ...
.[Sris Chatterjee (2003)]
''Contingent Value Rights in Acquisitions: Theory and Empirical Evidence''
EFA 2003 Annual Conference Paper No. 897
See also
* Strip financing
*Hold-up problem
In economics, the hold-up problem is central to the theory of incomplete contracts, and shows the difficulty in writing complete contracts. A hold-up problem arises when two factors are present:
# Parties to a future transaction must make non ...
* Earnout
References
External links
CVR on InvestopediaCVR on Motley FoolShadowy Shares: The Dark Side of Contingent Value Rights, Forbes.com
(Michael Stocker, Iona Evan. 2011)
{{Corporate finance and investment banking
Corporate finance
Mergers and acquisitions
Valuation (finance)
Securities (finance)
Real options
Equity securities
Venture capital