Takeover Contests with Asymmetric Bidders

Abstract

Target firms often face bidders that are not equally well informed, which reduces competition, because bidders with less information fear the winner’s curse more. We analyze how targets should be sold in this situation. We show that a sequential procedure can extract the highest possible transaction price. The target first offers an exclusive deal to a better-informed bidder, without considering a less wellinformed bidder. If rejected, the target offers either an exclusive deal to the less well-informed bidder, or a modified first-price auction. Deal protection devices can be used to enhance a target’s commitment to the procedure. (JEL G34, K22, D44) If a firm is to be sold, the seller’s problem is to identify the buyer who will pay the highest price. Negotiations with potential buyers are one way to discover who this buyer is and at what price a transaction can take place; auctions are an alternative method. Selling firms by inviting competitive bids has become increasingly popular in practice, and the announcement that a firm is ‘‘evaluating strategic alternatives’’ is commonly regarded as an invitation to submit competitive bids. 1 Bidders participating in an auction are not always equally well informed. Management bids are the clearest example: in many cases the target’s management team (or a subset of senior managers) declares an interest in purchasing the target, and their privately known value estimate must be more reliable than any other potential buyer’s. Similarly, a competitor should find it much easier to evaluate a target’s prospects than a bidder with no experience in the target’s line of business. Either way, a less well-informed bidder will be particularly worried about the