How does a merger affect the shareholders?

A merger is an agreement to unite two existing companies into one new company. Mergers and acquisitions are commonly done to expand a company’s reach, expand into new segments, or gain market share in an effort to create shareholder value.

For example, back in August 2017, DowDuPont (DWDP) was formed after the merger of Dow Chemical and DuPont created the world's largest chemical company in terms of sales.

Mergers affect the shareholders of both companies in different ways and is influenced by several factors, including the prevailing economic environment, size of the companies and management of the merger process. However, the conditions of the merger may have different effects on the stock prices of each participant in the merger.

The merger of two companies causes significant volatility in the stock price of the acquiring firm and that of the target firm. Shareholders of the acquiring firm usually experience a temporary drop in share value in the days preceding the merger, while shareholders of the target firm see a rise in share value during the period.

The stock price of the newly merged company is expected to be higher than that of both the acquiring and target firms, and it is usually profitable for the target firm's shareholders, who benefit from the resulting stock price arbitrage. In the absence of unfavorable economic conditions, shareholders of the merged company usually experience greatly improved long-term performance and dividends.

The shareholders of both companies may experience a dilution of voting power due to the increased number of shares released during the merger process. This phenomenon is prominent in stock-for-stock mergers, when the new company offers its shares in exchange for the shares of the target company albeit at an agreed conversion rate. Shareholders of the acquiring company experience a marginal loss of voting power, while shareholders of a smaller target company may see a significant erosion of their voting powers in the relatively larger pool of stakeholders.

After the merger has been completed, the new company will likely have at least a few noticeable changes in leadership. Certain concessions are usually made in merger negotiations, and the executives and board members of the new company will change to some degree, whether at the start or planned to change in the future.