Strategic Decisions in Takeover Auctions

Abstract

This essay reviews selected theories and empirical evidence describing how bidders and targets navigate four complex decisions involved in any corporate takeover attempt: (1) deal initiation, (2) pre-offer toehold acquisition, (3) offer price and revisions, and (4) the method of payment. We focus in particular on how first-price or English (ascending price) auctions with two competing bidders and a single (pivotal) seller help understand bidder and target incentives in each of these strategic decisions. While largely descriptive of tender offers for control, the auction framework also helps explain choices made in takeover negotiations where the outside option is the outcome of an open auction. Empirical findings include the following key observations: (1) A large fraction of control bids for public targets - about 50% - are initiated by the target and not the bidder. (2) Notwithstanding takeover premiums averaging 40+%, only a small fraction (less than 5%) of bidders acquire a partial ownership position (a toehold) in the target prior to bidding. However, when they do acquire a toehold, it is large (on average 20%). (3) Rival bids are observed in less than 10% of the contests, suggesting that the initial public bid deters further competition. When rival bidder do enter the auction, they do so surprisingly quickly - within two weeks of the initial bid on average - suggesting that bidder valuations are correlated. Bid jumps are large (around 30%), consistent with significant bidding costs. The evidence also supports the hypothesis that the pre-offer runup in the target's stock price includes an element of rational deal anticipation by the market, and that the runup is understood as such by the two parties in merger negotiations. (4) Contrary to theories of bidder opportunistic behavior, the likelihood that a given deal is paid in bidder stock is higher when the target is highly informed about the bidder's operations and so able to value the bidder shares more precisely. This evidence supports the (nested) alternative theory that the bidder's preference to pay in stock rather than in cash is driven by concerns with adverse selection on the target side of the deal. Also, the initial market reaction to the stock payment decision is such that there is no evidence of subsequent abnormal long-run performance for long-short portfolios sorted on cash- versus stock as the payment method.