Excess Takeover Premiums and Bidder Contests in Merger & Acquisitions: New Methods for Determining Abnormal Offer Prices

Abstract

We investigate for mergers and acquisitions in Europe and the USA whether the size of the takeover premium offered by the first bidder prevents a second bidder from making a competing offer. Previous studies find only mixed evidence for the relationship between the size of a takeover premium and the occurrence of a takeover contest. Because the size of the premium varies over time and between merger waves and usually differs between countries and industries, it is essential to use the excess premium instead of the standard premium. We introduce and compare different methods for calculating the excess premium and test for the 1990–2012 period whether or not bidders can prevent a takeover contest when the initial offer includes an excess takeover premium. We calculate the excess premium as the percentage (a) above the pre-offer market value of the target, (b) over the industry mean, or (c) over the country mean. We then analyze whether these different methods provide results more consistent with the expected effect of excess premiums on the occurrence of takeover contests. The results suggest that the method used to calculate the excess premium significantly affects the size of the excess premium in takeover contests. We provide empirical evidence that when using the industry excess premiums, offering an above average premium reduces the probability of a takeover contest, especially in cash deals, whereas the standard method does not correctly discriminate between average and excess premiums. Consequently, only excess premiums are adequate for properly testing the effects of the premium size on the occurrence of takeover contests.