Toehold Acquisitions, Market Reaction, and Corporate Control

Abstract

This paper presents a takeover model with symmetric information regarding post-tender offer target values, and provides a solution to the empirical puzzle of zero or small toeholds acquired before tender offers. With endogenous market adjustment of pre-tender offer target price, we show that a risk-averse bidder forgoes an aggressive toehold strategy in order to minimize losses following failed takeovers due to target defense, and that a toehold does not solve the free-rider problem of target shareholders. When there is perfect information regarding the possible post-takeover target values, and that the profits and losses from toehold offset each other, then the optimal toehold is zero. But if acquiring a toehold benefits the risk-averse bidder beyond the payoffs from the takeover, for instance, to serve the bidder's portfolio risk reduction motive, or to generate profits from selling to rival bidders in a control contest, then a positive toehold is part of the equilibrium. We also study how the optimal toehold varies in both diversifying and related acquisitions, and how the presence of rival bidders affects the initial bidder's toehold strategies.