Image caption The two firms would stay listed on their separate stock exchanges

UK defence contractor BAE Systems has said that it is in talks with European aerospace firm EADS over a possible merger.

"Both companies would operate as one group by means of equalisation and other agreements but would be separately listed on their existing exchanges," BAE said in a statement.

In a potential tie-up, BAE would own 40% and EADS 60% of the new firm.

Speculation that talks were ongoing sent BAE shares up 8% on Wednesday.

BAE and EADS said that a merger "offers the prospect of significant benefits for customers and shareholders of both companies".

EADS, which is a consortium of aerospace and defence manufacturers from France, Germany and Spain, owns the planemaker Airbus.

On Wednesday, shares in EADS dropped 5.6%.

"Given the nature of the companies' activities we would of course want to ensure that the UK's public interest was properly protected," a UK government spokesperson said.

"We are working with the companies to ensure that this is the case. Given the market sensitive nature of transactions of this sort we would not want to comment further at this stage."

Dividend differences

EADS' US rival, Boeing, responded that the merger could increase the Europeans' presence in the US because of BAE's work in the country.

"I have a pretty deep and abiding faith in our company's strength, so I don't see this as something that is going to threaten us fundamentally," chief executive Jim McNerney said.

"I think this may be a matter of, from an EADS standpoint, maybe some increased US market access."

Under the code of the UK's Takeover Panel, the two parties must now announce a decision on the outcome of their talks by 17:00 BST on 10 October.

"BAE Systems confirms its intention to request an extension to the deadline from the panel if it and EADS are still in discussions at that time," it said.

BAE usually pays shareholders a higher proportion of its earnings as a dividend than EADS.

As a result, if the merger were to go ahead, EADS would pay £200m to its shareholders before completion.

BAE and EADS' normal dividend for the current year would be unaffected.

"Today's news has come totally out of the blue for the workforce and our first priority will be to safeguard jobs and skills," said the Unite union.

"The new company would be the largest manufacturing company in the UK, employing tens of thousands of people in critical defence manufacturing and at Airbus. It is vital that the government ensures these jobs are protected in the UK before approving the merger."

In May, BAE announced it will cut more than 600 jobs and close its Newcastle factory.