Target-initiated takeover with search frictions

Abstract

Although most takeover theories presume the acquirers initiate the transactions, many transactions are in reality initiated by targets. This paper attempts to understand such a target’s sellout timing and pricing decisions by developing a target-initiated model, in which the firm randomly and periodically meets high- and low-type acquirers and makes take-it-or-leave-it price offers. The model captures the illiquidity and heterogeneity of sellout opportunities. Optimally, the firm takes either a high-price strategy—making only a high-price offer in a good economic state— or a flexible strategy—even making a low-price offer in a very good economic state— based on a tradeoff between sellout pricing and timing efficiency. With higher frequency and heterogeneity of acquirers, the firm makes a high-price offer more eagerly and a low-price offer more restrictively. With asymmetric information, where the acquirer types are unobservable, the firm reduces the acquirer’s information rent by making a high-price offer more eagerly and restricting a low-price offer more severely. With higher economic state volatility, the low-type sellout probability increases because the economic state has a higher potential to increase beyond the low-price sellout threshold. The jump in firm value at the sellout time (i.e., target stock price reaction) is not monotonic with respect to the economic state and arrival rate due to the interactions between the sellout price and timing.