The Timing and Terms of Takeovers Under Uncertainty: A Real Options Approach

Abstract

This paper presents a dynamic model for the timing and terms of mergers, stock offers and cash offers when the output price for firms is stochastic and when firms have complete information. We show that takeovers motivated by increased returns to scale or by decreased unit production costs are procyclical. Mergers are modelled as the outcome of a Nash equilibrium in which both companies simultaneously determine the timing and terms of the restructuring, whereas stock and cash offers are the outcome of a Stackelberg leader follower equilibrium in which the target first fixes its reservation bid premium and the acquirer subsequently decides on the timing of the takeover. For mergers, each firm's cumulative return consists of a synergy effect that rises with the increase in its production scale parameter. With tender offers, the target's synergy effect is augmented by a bid premium that is increasing in the output price volatility, the acquirer's return and the bidder to target size ratio. The timing of mergers is shown to be globally efficient. Separation of the timing decision and the terms decision causes stock offers and cash offers to happen inefficiently late. Pure cash offers happen even later than stock offers because the acquirer's payoff has optionlike features, whereas the target's has not. Delaying the restructuring therefore favors the acquirer at the expense of the target.