* Prosecutors widen investigation of former CEO, CFO
* Say won't complete probe before year-end
* Porsche: only 50 pct chance of merger with VW this year
* VW says still aims to merge, but it will take longer now
* Porsche shares drop 9.6 pct, Volkswagen down 2.2 percent
(Adds detail from Stuttgart prosecutor statement)
By Jan Schwartz and Josie Cox
HAMBURG/FRANKFURT, Feb 24 (Reuters) - Sports car maker Porsche dismayed investors by saying its planned merger with Volkswagen faced further delays because of a criminal investigation of its former CEO and finance head.
Shares in Porsche plunged as much as 11 percent on Thursday after the German carmaker cut the odds of it being absorbed by Volkswagen this year to 50-50.
However, Porsche said the delay would not scupper its planned 5 billion euro ($6.9 billion) rights issue, which it aims to complete by the end of May to cut its debt pile.
The legal probe is the latest in a series of setbacks to a merger of Porsche and Volkswagen. They had warned in October that legal and tax issues could slow down a tie-up.
"Many investors and managers believe that the longer it takes for the merger to begin, the smaller the chances of its success," said Markus Huber, a senior trader at ETX Capital.
Bankers had already struggled to find a convincing pitch for the capital increase given the reluctance by the Porsche and Piech families to surrender voting rights in Porsche's parent company and continued legal uncertainties.
Prosecutors in Stuttgart said they had widened their investigation of Porsche's former Chief Executive Wendelin Wiedeking and ex-Chief Financial Officer Holger Haerter and would not complete their probe before the end of the year.
The Stuttgart prosecutor's office said in a statement it had intensified a probe into market manipulation by former Porsche managers and opened a separate investigation into three people in Porsche's finance department, on suspicion of credit fraud.
These employees are alleged to have given "incomplete" or "incorrect" information to banks during negotiations for refinancing a Porsche credit line, the statement said.
Porsche in 2009 tried to take over Volkswagen using complex financial derivatives, but abandoned the bid when its debt mounted, eventually forcing it to accept a takeover by its much larger peer and leading it to sack its management team.
Wiedeking and Haerter have since been under investigation for allegedly manipulating the market in VW shares and were also the target of a U.S. lawsuit by hedge funds.
One aspect of the investigation, suspected manipulation of the market via trades, has been dropped, the prosecutors said.
But existing allegations of market manipulation by failing to provide accurate information had hardened, and they now also suspected the two executives of breach of trust as they may have put Porsche at risk of collapse, they added.
"There is suspicion former board members took existential risks for the company by doing share price hedging deals in connection with the attempt to take over Volkswagen," the Stuttgart prosecutors' office said.
Wiedeking said in an e-mailed statement that he was very happy that the allegation of manipulating the market through trades had been dropped.
"We will process the other allegations with much patience as well," he said.
Reuters was not immediately able to reach Haerter.
STRETCH TARGETS
Volkswagen said it was sticking with its agreement to combine with Porsche, though it could now take longer to determine how and under what conditions the deal would be done.
Porsche said it could not merge with Volkswagen until the investigation of Wiedeking and Haerter was completed because only the outcome of the probe would determine the valuation of damage claims raised against Porsche.
"This valuation must be made for purposes of the merger," it said in a statement, without being more specific.
The stock fell by as much as 11 percent on Thursday and was trading 9.6 percent lower at 56.69 euros by 1248 GMT, while Volkswagen shares were down 2.2 percent as investor hopes of a combination of the two German carmakers dwindled and analysts warned that the delay could hit earnings.
Some analysts, though, said the share price reaction appeared exaggerated as a merger in 2011 was always a stretch.
"Due to the unresolved tax issue, the likelihood for a merger in 2011 is down to about 30 percent anyway, with a postponement to 2013/2014 being the 50 percent base case," said Silvia Quandt Research analyst Albrecht Denninghoff. ($1=.7270 Euro) (Additional reporting by Christiaan Hetzner; Writing by Maria Sheahan and Edward Taylor in Frankfurt; Editing by Alexander Smith)