What is the Price of Hubris? Using Takeover Battles to Infer Overpayments and Synergies

Abstract

We present a framework for determining the information that can be extracted from stock prices around takeover contests. In only two types of cases is it theoretically possible to use stock price movements to infer bidder overpayment and relative synergies. Even in these two cases, we argue that it is practically difficult to extract this information. We illustrate one of these generic cases using the takeover contest for Paramount in 1994 in which Viacom overpaid by more than $2 billion. Our findings are consistent with managerial overconfidence and/or large private benefits, but not with the traditional agency-based incentive problem. When a merger is announced, three different pieces of information affect the stock prices of the target and bidder. The announcement contains information about the potential synergies arising from the combination, the stand-alone value of the firms involved in the merger, and how the value will be split between the target and the bidder(s). It is seldom possible to distinguish among these three effects in a particular takeover contest. For example, if the announcement reveals favorable (unfavorable) information about the target and bidder, the combined change in bidder and target stock values will exceed (not exceed) the synergies arising from the merger. Similarly, if the bid reveals favorable (unfavorable) news about the stand-alone value of the bidder, the change in bidder stock value will overstate (understate) the benefit of the transaction to the bidder. In this article, we develop and apply a classification scheme that identifies those situations in which it may be possible to disentangle the sources of price changes. In the first part of the paper, we identify two generic cases in which synergy, overpayment, and information effects can be disentangled to solve for the estimated overpayment by the bidder. One case occurs when the acquisition is not consummated; the other occurs when the acquisition is a takeover contest that comprises only two bidders. We also discuss the additional (information) conditions that must be satisfied in practice to enable bidders to disentangle the different effects. Even for these two generic cases, we point out that most such takeovers will not satisfy the necessary information conditions. In the second part of the article, we analyze the takeover contest for Paramount. This contest is representative of one of the generic cases and comes close to satisfying the required information conditions. The Paramount contest involved exactly two bidders: QVC, led by Barry Diller, and Viacom, led by Sumner Redstone. The unusual structure of the contest allows us to estimate