In a merger there are two parties with asymmetric information, that is, when they come to the

negotiation table one party has information the other party does not and vice versa. For example,
top management has better information about the strengths and weaknesses of the firm, knows
about major structural changes in the firm, or is knowledgeable about a major expansion of the
firm into new foreign markets. The information in appendices 1 and 2 reflects the type of
information only the top management of firm posses.
FLINDER VALVES AND CONTROLS INC.
Confidential Supplementary Information for Management of Flinder Valves and Controls
As Bill Flinder neared retirement, the idea of selling FVC to a bigger firm seemed almost
necessary. He had a good top-management team, but he didnt think any one of them could step
in and run the show alone. He found stability in the RSE International combination that was
worth something to him. In the increasingly global market place with more costly development,
FVC needed a deep-pocketed partner to expand and to bankroll more research. Flinder believed
that the company would also benefit from gaining access to a large marketing and distribution
network. As the company continued to grow, it would need to gain production know-how for
high-volume manufacturing. Flinder Valves did not have this kind of expertise. Finally, there had
been an increasing trend of consolidation in Flinder Valves industry over the last year. Flinder
feared that without a well-financed partner, the company would be swamped by competition. He
was intrigued with the possibility that Flinder Valves might be more fully valued if it were part
of a larger, more diversified enterprise. Thus, when the merger opportunity with RSE
International Corporation came along in 2007, Flinder determined to make it work as best as he
could.
Flinder believed that FVC had alternatives to this deal. Rockheed-Marlin Corporation, a
large defense contractor (or any of a number of others), might be induced to make an offer for
Flinder Valves, though Flinder preferred RSE International Corporation as a merger partner. FVC
and RSE might establish a joint venture of some sort, though Flinder suspected that joint
ventures faced the same kinds of integration problems as did acquisitions; as a result, he thought
joint ventures were an inferior alternative. FVC could move forward alone, but that would
require raising large sums of new debt and equity to finance the rapid expansion of the firms

widening gyre program. Flinder was concerned that he might lose voting control of the firm
regardless. It seemed to him that doing a deal with a known and friendly partner today would
prepare the way for an orderly transition for himself and the firm.
Flinder expected the merger to generate significant cost gains. RSEs greater purchasing
power would lower the cost of materials and components for FVC. RSEs new resourcemanagement system could be expected to reduce FVCs in-process costs. Estimates from FVCs
accounting group had identified pretax constant-dollar cost savings of $2 million in the first year
of operation and $4 million thereafter. He also recognized other synergy gains that arose from
RSEs stronger marketing clout, cross-selling with other RSE products, and its deep financial
pockets. He believed that the widening-gyre project could have a broad application in nautical,
aerospace, and automotive products. Based on the investment required to bring such technology
to market, he estimated the economic value at between $10 and $18 million
Bill Flinder had known Tom Eliot for several years, having been introduced at an industry
conference where they were both speakers. As founders and significant stockholders in their
respective firms, they liked and respected each other. Flinder hoped that RSE would recognize
the fair value of his company.

Appendix 2
FLINDER VALVES AND CONTROLS INC.
Confidential Supplementary Information for Management of RSE International
Flinder Valves was the first among several potential targets identified by Catherine
MacAvity, RSEs vice president of Business Development, and the architect of the acquisition
program. Eliot approved the choice and believed a smooth and successful acquisition of FVC
was critical to RSEs expansion plans. Recent news in the U.S. credit markets had been grim.
MacAvity worried that the news in the financial markets might chill the ongoing talks. If the
merger fell through after going this far, Eliot feared his board might become discouraged. On the

other hand, if FVC was acquired at too high a price or failed to produce adequate returns, the
RSE board would be unlikely to give its full support to future mergers.
In planning RSEs expansion, Eliot had considered several companies as possible
acquisition candidates. Eliot was seeking a small, well-managed manufacturer that could offer
RSE strong growth opportunities and bring it more specialized, higher-technology products that
would be less susceptible to succumbing to the competition. Although RSE had done well, Eliot
felt the company lacked the ability to be innovative. No new products had been developed over
the past two years, and Eliot personally felt that the research and development (R&D) group at
RSE International had fallen behind its competitors. FVC, with its proven management and
engineering skills, seemed to offer the R&D capabilities and growth prospects that Eliot sought.
Eliot realized that time was of the essence, especially since other competitors were also
interested in Flinder Valves. Nonetheless, he wanted to be certain that acquiring it would truly
place RSE in a better competitive position. One concern was how well FVCs employees would
handle the transition from working in a small, entrepreneurial company to a much bigger place
like RSE. The two companies possessed quite different cultures. Another concern was about the
earnings dilution that RSE might incur from the acquisition. In fact, two directors had cautioned
Eliot against impairing the firms forecasted growth in earnings per share.
Eliot and MacAvity expected the merger to generate significant cost gains. RSEs greater
purchasing power would lower the cost of materials and components for FVC. RSEs new
resource management system could be expected to reduce FVCs in-process costs. Estimates
from RSEs due-diligence process had identified pretax constant-dollar cost savings of $1.5
million in the first year of operation and $3 million thereafter. They also recognized other
synergy gains that arose from RSEs stronger marketing clout, cross-selling with other RSE
products, and its deep financial pockets. But for the sake of conservatism, they chose not to
include these in the valuation. They believed that the widening-gyre project could have a broad
application in nautical, aerospace, and automotive products. Based on the investment required to
bring such technology to market, they estimated the economic value at between $5 and $15
million

Tom Eliot had known Bill Flinder for several years, having been introduced at an
industry conference where they were both speakers. As founders and significant stockholders in
their respective firms, they liked and respected each other. Eliot hoped that RSE could put
together a deal that not only worked for the two founders but made broad economic sense.
The information below is for your own knowledge if you ever have to negotiate a merger or any
other form of financial transaction.
Supplemental Technical Note: Valuation and Merger Negotiation
Experienced financial decision-makers know that valuation is imprecise. Too many
parameters are uncertain, which renders any particular point estimate uncertain. This situation
leads to two important questions for negotiators of mergers and acquisitions: (1) What role can
quantitative analysis play? (2) How can one negotiate rationally and advantageously amidst this
uncertainty?
The Role of Quantitative Analysis
Two classic naive responses are made to the uncertainty of valuation: (1) to assert (with a
straight face) that the point estimate is the true value of the company, and (2) to chuck the
quantitative analysis out the window and to rely on some other method of guidance. The more
sophisticated response is to embrace the uncertainty and focus not on point estimates of value but
on a range of value. Quantitative analysis is essential for determining this range. The classic
ways of setting the range include:

Sensitivity analysis: Here, one identifies the key value drivers of a firm and determines
the variation in value as the drivers vary. One must take care to do this sensibly because
quickly generating a blizzard of numbers is easy.

Scenario analysis: This analysis is similar to the sensitivity analysis, but acknowledges
that many assumptions will tend to vary together. In this approach, one estimates values
of a company associated with different views of the future. These scenarios could simply
be based on a general sense of how things will turn out (i.e., optimistic, pessimistic, etc.)
or could be tied to specific events that have a competitive foundation (e.g., a major

foreign competitor enters your domestic market) or a political/economic foundation (e.g.,

Britain endures a long recession). Here also one must take care to do the analysis sensibly
because as the saying goes, garbage in, garbage out. Also, almost any scenario may be
framed in such a way as to produce the results that one wants.

Break-even analysis: At the least, knowing what assumptions are necessary to produce a
target value will be extremely useful. This approach explicitly solves the valuation in
reverse and leaves it to the decision maker to judge whether the break-even assumptions
are reasonable.

Using these methods to produce a negotiating range, bounded on one side by the opening price
and on the other by the walk-away price, provides vital discipline for a negotiating team and may
help the team in its assessment of new information that could appear in the negotiations.
In short, quantitative analysis serves an important role in merger negotiations. The
sophisticated user acknowledges the uncertainty of value estimates and can use the insights
derived from careful analysis as a foundation for negotiation strategy.
Negotiating Well
Research on merger negotiations conducted in laboratory experiments suggests that 30% to 50%
of merger outcomes represent a significant adverse deviation from what the negotiators actually
wantedwalking away from negotiations where a satisfactory outcome was feasible or closing a
deal beyond the walk-away price. This finding is attributable to a significant psychological
influence on what, in theory, is a simple economic event. The psychological phenomena include
the following, adapted from Negotiating Rationally:
1. Irrationally escalating to an initial course of action, even when it is no longer the most
beneficial choice
2. Assuming your gain must come at the expense of the other party and missing
opportunities for trade-offs that benefit both sides
3. Anchoring your judgments on such irrelevant information as the initial offer

4. Being overly affected by the way that information is presented to you.

5. Relying too much on readily available information, while ignoring more relevant data
6. Failing to consider what you can learn by focusing on the other sides perspective
7. Being overconfident about attaining outcomes that favor you
The lessons of most studies of financial negotiation include the following:

Know thyself. Know thy counterparty. Risk aversion, optimism (or pessimism) about the
future, the desire to settle, and an expectation of settling are influential on bargaining
outcomes.

Do not abandon sound quantitative analysis. Do your homework before negotiating.

Estimate bargaining ranges; set walk-away prices.

Be disciplined in negotiating. Stick to predetermined walk-away prices unless you have

significant new information or other sound reasons for abandoning them.

Mastery of negotiating tactics pays. Anchoring or framing the other partys expectations,
the number of proposals, the pattern of concessions, the use of time, the use of
interruptionsall these affect outcomes.

Negotiate based on several attributes, such as price and terms, rather than one. Oneattribute negotiation often leads to deadlock.