In
corporate finance
Corporate finance is the area of finance that deals with the sources of funding, the capital structure of corporations, the actions that managers take to increase the value of the firm to the shareholders, and the tools and analysis used to all ...
a stock swap is the exchange of one equity-based asset for another, where, during the
merger or acquisition, the swap provides an opportunity to
pay with stock rather than with cash; see .
Overview
The acquiring company essentially uses its own stock as cash to purchase the business. Each
shareholder
A shareholder (in the United States often referred to as stockholder) of a corporation is an individual or legal entity (such as another corporation, a body politic, a trust or partnership) that is registered by the corporation as the legal o ...
of the acquired company will receive a pre-determined number of shares from the acquiring company.
Before the swap occurs each party must accurately value their company so that a fair "
swap ratio
In corporate finance, the swap ratio is an exchange rate of the shares of the companies that undergo a merger;
see Stock swap and .
The swap ratio determines the control that each group of shareholders of the companies shall have over the ...
" can be calculated. The
valuation of a company is complicated in general; here though, additional to
fair market value
The fair market value of property is the price at which it would change hands between a willing and informed buyer and seller. The term is used throughout the Internal Revenue Code, as well as in bankruptcy laws, in many state laws, and by sever ...
, the
investment- and
intrinsic value are to be determined as well.
After the valuation is complete, the parties will agree upon the swap ratio; this will determine the number of shares that each shareholder will receive.
In theory, a fair ratio is such that shareholders in both previous companies now own a pro-rated share of the new company: value-wise or re
earnings per share
Earnings per share (EPS) is the monetary value of earnings per outstanding share of common stock for a company. It is a key measure of corporate profitability and is commonly used to price stocks.
In the United States, the Financial Accounti ...
.
The acquiring company may also need to add an extra incentive in the form of shares to ensure that the
board of directors
A board of directors (commonly referred simply as the board) is an executive committee that jointly supervises the activities of an organization, which can be either a for-profit or a nonprofit organization such as a business, nonprofit orga ...
of the acquired company approve the takeover.
In
South Korea
South Korea, officially the Republic of Korea (ROK), is a country in East Asia, constituting the southern part of the Korea, Korean Peninsula and sharing a Korean Demilitarized Zone, land border with North Korea. Its western border is formed ...
, the merger ratio is defined by a certain formula according to the law, if both companies are listed on the
KRX.
When this swap is realised, the shareholders receive the new stock and own a share in the new company. Sometimes, a part of the agreement will not allow the new shareholders to sell for a certain time period to avoid a sudden drop in share price. This is a form of a
shareholder rights plan or
poison pill strategy that is used to combat
hostile takeovers. When all things come together and are fair, then the takeover will proceed without incident.
Internal swap
Stock swaps can also happen internally within a company.
Starbucks has used this strategy in the past. When the stock options they offered to their employees dropped so low in price that they became virtually worthless, Starbucks offered a swap option. The company allowed the employees to swap their worthless shares for more that had a higher value.
[Merrit, Cam. Demand Media. The Nest. Web. July 21st, 2014. http://budgetting.thenest.com/stock-swaps-work-22564.html]
References
{{Authority control
Accounting terminology
Corporate finance
Mergers and acquisitions