Getting to know each other: The role of toeholds in acquisitions

Abstract

We analyze the role of toeholds (non-controlling but significant equity stakes) as a source of information for a bidder. A toehold provides an opportunity to interact with the target and its management and in the process get a better sense of the possible synergies from a merger or takeover. A bidder considering taking over a target will take a toehold beforehand if the informational benefits are large. Our model makes the following predictions: (i) a toehold is more beneficial if a target is opaque, i.e., if it is generally harder to value potential synergies with the target; (ii) a toehold is incrementally more beneficial if a bidder initially finds it harder than others to assess the value of potential synergies; (iii) that incremental benefit is less important, however, if the target is opaque; and (iv) the benefits from having a toehold are smaller if the number of potential rival bidders is higher. We test these predictions using a large sample of majority acquisitions of private and public companies for which we have information regarding whether the acquirer had a toehold in the target company prior to the majority acquisition. We find evidence consistent with our hypotheses, and thus with the idea that potential acquirers of a target use toeholds to improve their information about possible synergies with the target.