Security Design for Private Acquisitions

Abstract

We propose a security design model in which a potential acquirer approaches a firm with a value-add plan. The target has a single owner, who possesses private information: he knows whether his firm is compatible with the plan, or not. The seller agrees the acquirer will add value but not as much as what the acquirer expects. Although the acquirer can choose any monotone limited liability security to offer along with cash, we show that, under general conditions, if a security is employed, it takes the form of non-recourse junior debt provided by the seller.