Preemptive Bidding Research Articles

Preemptive Bidding, Target Resistance, and Takeover Premiums

We evaluate empirically two sources of large takeover premiums: preemptive bidding and target resistance. We develop an auction model that features costly sequential entry of bidders in takeover contests and encompasses both explanations. We estimate the model parameters by simulated method of moments for a sample of US takeovers. Our estimates imply that target resistance explains the entire magnitude of the premium in 74% of successful single-bidder contests. Simulation experiments show that initial bidders have, on average, a higher valuation for the target than rival bidders, so that a relatively low initial bid is sufficient to deter a rival from entry.

The Deal Process, Asymmetric Bidders and Target Premia

While half of all acquisition targets are sold in negotiated deals with only one buyer rather than by auction, the wealth effects for target shareholders are surprisingly similar in both auctions and negotiations. This begs the following questions: why do companies frequently avoid auctions and instead negotiate with just one buyer, and how can targets achieve comparable premia in negotiations? Drawing on Fishman's (1988) model of preemptive bidding and Povel and Singh's (2006) model of asymmetric bidders, I hypothesize that the sales procedure (i.e., auction, or negotiation) is most likely determined by the party that initiates the deal. When an acquirer initiates a deal, it prefers a negotiated deal and hence agrees to pay a high premium to preempt the target and other potential bidders from running an auction. I document detailed information on the private bargaining process for 598 deals. I find that most negotiation deals are in fact initiated by the acquirers and that most of the target-initiated deals use an auction, which indicates that targets are using an auction as a mechanism to discover the highest bidder. Moreover, I provide evidence that the targets receive higher excess returns in the deals initiated by the acquirers than in the deals initiated by the targets. I also provide further evidence of preemptive bidding and bidder asymmetry by studying the indicative bids and the business relations between the targets and the acquirers. Hence, target firms are willing to forgo the potential benefits of an auction and agree to a negotiated deal because they are already facing a bidder with a high valuation and are able to get a high price.

Why Do Sellers (Usually) Prefer Auctions?

We compare the most common methods for selling a company or other asset when participation is costly: a simple simultaneous auction, and a sequential process in which potential buyers decide in turn whether to enter the bidding. The sequential process is always more efficient. But preemptive bids transfer surplus from the seller to buyers. Because the auction is more conducive to entry—precisely because of its inefficiency—it usually generates higher expected revenue. We also discuss the effects of lock-ups, matching rights, break-up fees (as in takeover battles), entry subsidies, etc. (JEL D44, G34, L13)

Demand Reduction and Preemptive Bidding in Multi-Unit License Auctions

Multi-unit ascending auctions allow for equilibria in which bidders strategically reduce their demand and split the market at low prices. At the same time, they allow for preemptive bidding by incumbent bidders in a coordinated attempt to exclude entrants from the market. We consider an environment where both demand reduction and preemptive bidding are supported as equilibrium phenomena of the ascending auction. In a series of experiments, we compare its performance to that of the discriminatory auction. Strategic demand reduction is quite prevalent in the ascending auction even when entry by the newcomer imposes a (large) negative externality on incumbents. As a result, the ascending auction performs worse than the discriminatory auction both in terms of revenue and efficiency, while the two auction formats offer similar chances for newcomers to enter the market.

When are Auctions Best?

We compare the two most common bidding processes for selling a company or other asset when participation is costly to buyers. In an auction all entry decisions are made prior to any bidding. In a sequential bidding process earlier entrants can make bids before later entrants choose whether to compete. The sequential process is more efficient because entrants base their decisions on superior information. But pre-emptive bids transfer surplus from the seller to buyers. Because the auction is more conducive to entry in several ways it usually generates higher expected revenue.

The Drivers of Market Efficiency in Revlon Transactions

Drawing from practitioner interviews and Gilson & Kraakman's mechanisms of market efficiency, I present the argument that the Delaware Supreme Court's decision in Revlon v. MacAndrews & Forbes, Inc. would reduce incentives to search and therefore would reduce overall efficiency in the market for corporate control. I compare this theoretical prediction to the evidence from the past seventeen years of takeover activity, and find no evidence that deal activity for Revlon transactions has been reduced. I argue that three drivers of market efficiency might explain this finding: small net first-bidder costs, preemptive bidding, and heterogeneous buyers. I present some evidence that the market for corporate control was primarily a private-value game in the 1990s, implying that buyer heterogeneity was an important driver of market efficiency. This paper is part of a Symposium commenting on Gilson & Kraakman, The Mechanisms of Market Efficiency, 70 Va. L. Rev. 549 (1984).

Auctions of companies

Auctions of companies are conducted in ways that contradict received auction theory. The major puzzles are: (1) sellers restrict the number of bidders; (2) sellers restrict the number of bidders; (3) bidders are screened by an initial round of non-binding bids; and (4) bidders offer - and sellers sometimes accept - preemptive bids. Puzzles (1), (2), and (4) are explained by assuming that some information concerning the company can, if released, reduce the value of the company. Puzzle (3) is explained as a way for sellers to select the highest-valued bidders; equilibrium is maintained by using the initial bids to set a reserve price for the final bidding round.

Auctions of companies

Auctions of companies are conducted in ways that contradict received auction theory. The major puzzles are: (1) sellers restrict the number of bidders; (2) sellers restrict the number of bidders; (3) bidders are screened by an initial round of non‐binding bids; and (4) bidders offer ‐ and sellers sometimes accept ‐ preemptive bids. Puzzles (1), (2), and (4) are explained by assuming that some information concerning the company can, if released, reduce the value of the company. Puzzle (3) is explained as a way for sellers to select the highest‐valued bidders; equilibrium is maintained by using the initial bids to set a reserve price for the final bidding round.

A law and finance theory of strategic blocking and preemptive bidding in takeovers

This paper uses a law and finance approach to develop a new takeover theory that formalizes the idea that large target shareholders, who can block a takeover attempt, exercise a strategic influence on tender offer prices, and thereby, on the distribution of the takeover gain. The theory captures the interaction between legal rules, target ownership structure, bidder toehold and potential effects of arbitrageurs in an endogenously determined bargaining parameter that predicts a skewed distribution of the gain in favor of target shareholders. In a regression model, the parameter has significant explanatory power, specifically when the total takeover gain is positive.

A Sealed-Bid Auction That Matches the English Auction

This paper analyzes a two-stage sealed-bid auction that is frequently employed in privatization, takeover, and merger and acquisition contests. This auction format yields the same expected revenue as the open ascending (English) auction, yet is less susceptible to preemptive bidding and collusion. Journal of Economic Literature Classification Number: D44.

A Sealed-Bid Auction that Matches the English Auction

This paper analyzes a two-stage sealed-bid auction that is frequently employed in privatization, takeover, and merger and acquisition contests. This auction format yields the same expected revenue as the open ascending (English) auction, yet is less susceptible to preemptive bidding and collusion.

Determinants of bidder competition in corporate takeovers

The importance of bidder competition in the corporate takeover process has long been recognized in theoretical models. This paper provides empirical tests of those models. The results indicate that resistance by target management to an initial bid encourages multiple bidders. Competing bidders are less likely to enter in cases where the target is large, but more likely to arise when the initial bidder is highly levered. High initial bids (preemptive bids) are found to discourage entry by additional firms. Surprisingly, targets with high levels of free cash flow tend not to be the recipients of multiple bids.

Effects of competition on bidder returns

This study offers several new perspectives on the effects of competition in takeover contests on bidder returns. Using a more extensive database than existing studies and employing several different measures of success in takeovers, we find that success in competitive acquisitions decreases shareholder wealth relative to both failure and success in observed single-bidder takeovers. Further, we consider and test hypotheses regarding bidder returns, including hypotheses suggested by the preemptive bidding theory. In general, our results neither support the preemptive bidding theory nor the hypotheses linking the method of payment and the observed level of competition. We also test hypotheses relating to returns across the multiple events in a multiple-bid contest that competition among bidders generates. The results of these tests underscore the importance of timing as well as success of a bid to the bidder's subsequent performance.

Preemptive Bidding and the Role of the Medium of Exchange in Acquisitions

The medium of exchange in acquisitions is studied in a model where (i) bidders' offers bring forth potential competition and (ii) targets and bidders are asymmetrically informed. In equilibrium, both securities and cash offers are observed. Securities have the advantage of inducing target management to make an efficient accept/reject decision. Cash has the advantage of serving, in equilibrium, to competition by signaling a high valuation for the target. Implications concerning the medium of exchange of an offer, the probability of acceptance, the probability of competing bids, expected profits, and the costs of bidders are derived. IN STRUCTURING ITS OFFER to acquire a firm, an acquirer must, among other things, determine the medium of exchange of the offer. That is, an acquirer must choose whether the payment will be in the form of cash, debt, equity, or some combination. With symmetric information, no transactions costs, and no taxes, the medium of exchange is irrelevant. This is not the case, though, if these assumptions are not satisfied. This paper studies the role of the medium of exchange in acquisitions in a setting in which there is asymmetric information between a target and competing bidders. The focus of the paper is on the role of the medium of exchange in preempting competition. Consider a bidder that studies the profitability of an acquisition. If it makes a bid, other potential bidders will observe the bid, learn of the potentially profitable acquisition, and perhaps compete for it. A preemptive bid may be a way to eliminate this competition. Suppose a competing bidder's expected payoff is decreasing in the initial bidder's valuation for the target. When bidding against an initial bidder with a high valuation, a competitor may face a low probability of winning the bidding and a low expected payoff given that it does win. In this case, if the initial bidder could signal a sufficiently high valuation, it could deter the competition. As Fishman [7] and P'ng [18] have shown, a high bid can signal a high valuation and thus serve to preempt competition. Both studies, however, deal only with cash offers. (See also Giammarino and Heinkel [9] and Khanna [14].) A key difference between a cash offer and a (risky) securities offer is that a security's value depends on the profitability of the acquisition, while the value of cash does not. In the studies cited above, bidders, but not the target, have private

Preemptive Bidding and the Role of the Medium of Exchange in Acquisitions

ABSTRACTThe medium of exchange in acquisitions is studied in a model where (i) bidders' offers bring forth potential competition and (ii) targets and bidders are asymmetrically informed. In equilibrium, both securities and cash offers are observed. Securities have the advantage of inducing target management to make an efficient accept/reject decision. Cash has the advantage of serving, in equilibrium, to “preempt” competition by signaling a high valuation for the target. Implications concerning the medium of exchange of an offer, the probability of acceptance, the probability of competing bids, expected profits, and the costs of bidders are derived.