Fixed-Dollar Value Collar

What Is a Fixed-Dollar Value Collar?

The fixed-dollar value collar refers to a strategy that a company acquired during a merger may apply. Through this method, the company can safeguard itself from fluctuations in the share price of the acquiring company.

A collar refers to an options trading strategy where the trader holds a long put position, a short call position, and is long shares of the underlying stock. The protective mechanism involves holding shares of a given stock, while also purchasing protective puts and selling call options against the holding. Both the puts and calls are out-of-the-money (OTM) options, with the same expiration month and equal in the number of contracts purchased.

How a Fixed-Dollar Value Collar Works

A fixed-dollar value collar is one of two types of collars useful during mergers and acquisitions (M&A) deals. It is meant to protect the target company's assets, delivering a consistent dollar value for each of the seller's shares even if the acquiring company's stock price should drop. The aim of the fixed-dollar value collar is to be a circuit breaker, which might forestall significant losses. By setting a floor and ceiling on the stock component of an acquisition deal, the company doing the purchasing will commit to delivering a fixed-dollar value of its stock for each share of the company that is to be acquired.

Fixed-dollar value collars set the exchange ratio for the merger or acquisition deal. The ratio determines the share exchange level for the company being bought to exchange its shares for the shares of the acquiring company. This exchange ratio will fluctuate within the collar, as the strategy provides a floor and cap — minimum and maximum levels for the exchange.

Considerations With Fixed Dollar Value Collars

An article in 2014 from Harvard Law School explored some aspects of M&A strategies. "A number of factors play into the renewed appeal of stock deals, including an increasingly bullish outlook in the C-level suite and higher and more stable stock market valuations, as well as deal-specific drivers like the need for a meaningful stock component in tax inversion transactions," researchers wrote.

"Some of the potential pitfalls inherent in a fixed value structure are immediately clear — absent additional protections, if the acquirer’s stock price drops between signing and closing, the acquirer is at risk of suffering the dilutive effects of issuing more stock than originally anticipated."

The experts added that such a dilutive effect could make an acquisition less attractive to the buyer. Also, it could result in "enough shares being issued to require approval by buyer stockholders under stock exchange voting requirements or by causing sufficient dilution to trigger change of control provisions in debt, incentive equity or other key agreements.

"On the flip side," they wrote, "an exchange ratio that varies based on value could also cause issues if an acquirer’s stock price increases meaningfully — e.g., by causing the number of shares to be issued to fall below thresholds relevant to achieve a desired tax treatment."