Fixed vs Floating Exchange Ratios and Collars

Between the day a stock-for-stock merger is signed and the day it actually closes, weeks or months can pass — and either company's stock price can move a lot in the meantime. The exchange ratio, which sets how many acquirer shares each target share converts into, has to handle that gap somehow, and the way it does so determines who bears the risk of price moves before closing.

Fixed vs floating

With a fixed exchange ratio, the merger agreement states something like "each target share converts into 0.75 acquirer shares," full stop. If the acquirer's stock rises before closing, the target shareholders benefit — their fixed number of shares is now worth more. If the acquirer's stock falls, target shareholders are worse off, receiving less value than was implied at signing. Fixed ratios are the more common structure, and they mean target shareholders are exposed to the acquirer's stock price movement between signing and closing.

With a floating exchange ratio, the agreement instead promises a fixed dollar value — say, "$40 worth of acquirer stock" — and the number of shares delivered adjusts up or down right before closing to match whatever the acquirer's price is at that point. This protects target shareholders from acquirer stock-price risk, but it means the acquirer's shareholders bear all the dilution risk: if the acquirer's stock has fallen, more shares must be issued to deliver the same promised dollar value, diluting existing acquirer shareholders more than planned.

Collars

A collar is a compromise: the exchange ratio floats to preserve a fixed dollar value, but only within a band. Outside that band, the ratio reverts to fixed. This caps how much dilution the acquirer will accept, and how much value shortfall the target will accept, in either direction.

Worked example

At signing, an acquirer trades at $80 and the deal is meant to deliver $40 of value per target share, implying a 0.5 fixed exchange ratio.

• Fixed ratio, acquirer stock falls to $60 by closing: target shareholders still receive 0.5 shares, now worth 0.5 \times \60 = $30 — \10 less than the $40 implied at signing. The acquirer's shareholders are unaffected on a per-share basis; they issued the agreed 0.5 shares regardless.
• Floating ratio (fixed at $40 value), same price drop to $60: the exchange ratio adjusts to \40 / $60 \approx 0.667 shares per target share, so target shareholders still get their \40 of value. But the acquirer now issues more shares than planned to deliver that value, diluting its own existing shareholders more than the deal originally assumed.

What this means in practice

Fixed ratios are far more common in practice because acquirers generally don't want open-ended dilution risk, and boards prefer the simplicity of a stated ratio. Floating ratios and collars appear more often when the target specifically needs protection against acquirer stock volatility — for instance, in industries prone to sharp swings, or when the deal timeline to closing (which depends heavily on antitrust review) is expected to be long.