Exchange Ratio

Exchange Ratio

What it is

The exchange ratio is the number of acquiring-company shares given for each share of a target company in a stock-based merger or acquisition. It translates ownership in the target into ownership in the combined company, preserving relative value for target shareholders.

Why it matters

• Determines how control and ownership are reallocated after a deal.
• Affects the dollar value each target shareholder receives (directly in floating structures; indirectly in fixed structures).
• Influences deal risk and investor strategies such as merger arbitrage.

How it works

An exchange ratio converts an offered dollar value per target share into a number of acquirer shares. The offered value typically includes any takeover premium. Because share prices move between announcement and closing, exchange ratios are structured to allocate price-change risk:

• Fixed exchange ratio: The number of acquirer shares per target share is fixed. The acquirer knows exactly how many shares it will issue and its post-deal ownership percentage; the target’s final dollar proceeds can vary with the acquirer’s share price.
• Floating exchange ratio: The dollar value received by target shareholders is fixed; the number of acquirer shares delivered varies with the acquirer’s share price. The target gets certainty of value; the acquirer faces variability in dilution.

Deals often include caps and floors on ratios to limit extreme outcomes if share prices move sharply.

Calculating the exchange ratio

Basic relationship:
Exchange Ratio = (Offered $ per Target Share) / (Acquirer Share Price)

If the acquirer expresses the offer as an implicit or explicit $ amount per target share (including premium), divide that dollar amount by the acquirer’s per-share market price to get how many acquirer shares are issued for each target share.

Example formulas:
– If acquirer offers $20 per target share and its stock is $10: Exchange Ratio = 20 / 10 = 2.0 (two acquirer shares per one target share).
– If the acquirer offers 0.5 of its shares per target share, the implied dollar offer per target share is 0.5 × (acquirer share price).

Numerical example

• Acquirer share price before deal: $10
• Target share price before deal: $15
• Exchange ratio: 2 acquirer shares for each target share

That implies the acquirer is offering an implied $20 per target share (2 × $10), a $5 premium over the target’s pre-deal price of $15.

If, pre-close, the target’s stock rises to $18 while the acquirer remains $10, a valuation gap appears: implied offer $20 vs. trading price $18.

Merger arbitrage example:
– Buy one target share at $18
– Short two acquirer shares at $10 each (receive $20)
– If deal closes, deliver the target share for two acquirer shares (which close the short), netting $20 − $18 = $2 profit (ignoring costs and risks).

Risks and protections

• Deal risk: regulatory blockage, shareholder rejection, market volatility, financing issues.
• Caps and floors: used to limit the number of shares exchanged or the effective dollar consideration to protect both parties from extreme price moves.
• Timing and liquidity: changes in either stock’s liquidity or volatility can widen spreads and increase execution risk for arbitrageurs.

Key takeaways

• The exchange ratio translates the economic offer into shares and determines how ownership is reallocated in stock-based deals.
• Fixed ratios give acquirers certainty over share issuance; floating ratios give targets certainty over dollar value.
• Caps and floors are common to limit extreme outcomes.
• Merger arbitrage seeks to capture valuation gaps created after an announcement but carries deal-closing risk and other market risks.