Target Shareholders Research Articles

Can Hedge Funds Predict Takeover Offers and Outcomes?—The Influence of Hedge Fund Ownership on Takeover Likelihood and Offer Success

Abstract This study investigates the impact of a company’s shareholder structure, particularly hedge fund ownership, on its likelihood to become target of a takeover offer. Additionally, it explores the consequences of such an offer within the context of the German takeover market. In line with prior research, we find that the presence of a hedge fund stake increases the likelihood of a firm receiving a takeover offer. However, the underlying reasons for this correlation remain a subject of debate in the academic literature, specifically whether it is due to hedge funds’ superior investment strategies, their role as activists, or their access to private information. We find that ownership structure is the primary predictor of takeover activity, while publicly available data offers limited predictive power. These findings, supported by supplementary tests, lend credence to the hypothesis that hedge funds profit from private information. In relation to the outcome of a takeover offer, we observe that unique characteristics of German corporate law, particularly the high level of minority protection, empower hedge funds to employ strategies beyond the conventional speculation on a takeover offer. A prevalent strategy among hedge funds in German takeovers entails the speculation on higher compensation through subsequent structural measures, such as the signing of a domination agreement or a squeeze-out following a successful offer. This creates a particular prisoner’s dilemma for hedge funds as target shareholders: to maximize gains, they should refrain from tendering their shares, while other shareholders must tender theirs for the offer to succeed. Our results on the impact of pre-offer hedge fund ownership reflect this tension: we find some evidence of a positive impact on offer success, though this effect becomes insignificant when focusing on conditional offers with a minimum acceptance threshold. Furthermore, our findings imply a negative relationship between pre-offer hedge fund ownership and the offer premium, thereby supporting the view that bidders anticipate hedge funds’ low sensitivity to premium increases when deciding whether to tender their shares. In conclusion, our results underscore the growing influence of hedge funds in German takeover offers.

The Cost of Equity: Evidence from Investment Banking Valuations

Abstract Using manually compiled cost of equity (COE) estimates disclosed in takeover regulatory filings, we provide novel evidence on how investment bankers estimate discount rates. COE estimates are related to several risk proxies, such as beta and size. Other firm characteristics are unrelated to COE estimates or provide relations contradicting academic evidence. We also explore the role of incentives. For example, banks use significantly higher COEs in management buyouts, which potentially underestimates target value, making the bid more attractive for target shareholder approval.

Holistic bidding strategies: Addressing target shareholders’ behavioral resistance in M&As

Holistic bidding strategies: Addressing target shareholders’ behavioral resistance in M&As

The Role of Lockups in Stock Mergers

We document the frequent use of stock lockup agreements in mergers and acquisitions (M&As) paid in stock and examine the corporate determinants and consequences of the use and duration of lockups. Lockup agreements prohibit target shareholders from selling shares issued by the acquirer as a means of payment for a prespecified period. We find support for the hypothesis that target shareholders agree to lockups to precommit to hold on to the acquirer’s stock if they believe the merger’s long-term fundamentals are strong. Consistent with our hypothesis, lockups come with larger acquirer announcement returns, particularly when acquirer valuations are high; ex ante, lockup adoption likelihood increases with acquirers’ valuation. Lockups also come with higher deal completion likelihood, shorter merger negotiations, and higher long-term operating performance. We conclude the market interprets lockups as a signal of strong fundamentals, particularly when acquirers’ valuations are high. This paper was accepted by Bo Becker, finance. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2023.00993 .

NAV Ratios and REIT Takeovers: The Role of Public and Private Deal Premiums

We investigate how net asset values (NAVs) impact equity real estate investment trusts (REITs) in the market for corporate control. REITs trading at discounts to NAV are more likely to be acquired than those trading at premiums to NAV. For each acquisition, there is a public deal premium (the deal value relative to stock price) and a private deal premium (the deal value relative to NAV). REITs trading at discounts to NAV command larger public deal premiums and smaller private deal premiums. Shareholders of targets respond more favorably if the REIT is trading at a discount to NAV. Three-day cumulative abnormal returns (CARs) around acquisition announcements are 11% higher for targeted REITs that are trading below a price-to-NAV ratio of 0.95 than those trading at a price-to-NAV ratio above 1.05. The sale of a REIT trading at a discount to NAV appears to be a productive transaction for both acquirers and targets.

Prospect theory in M&A: Do historical purchase prices affect merger offer premiums and announcement returns?

Prospect theory in M&A: Do historical purchase prices affect merger offer premiums and announcement returns?

The cost of corporate social irresponsibility for acquirers

Few studies have examined the reputational damage of environmental and social (E&S) scandals ex-post. Using an international sample of mergers and acquisitions (M&A) across 18 countries, we examine whether heightened E&S risks arising from acquirers’ E&S incidents affect the cost of acquisition. We find that the severity of the incident increases acquisition premium and this effect is explained by incident acquirers compensating target shareholders for heightened reputation risks, rather than seeking to repair their reputation through the acquisition. At the country level, incident acquirers in countries with stronger E&S standards and policies also experience higher premium. Further analysis shows that E&S incidents reduce shareholder value upon the announcement of an M&A and increase the time taken for M&A completion. Firms are less likely to make acquisitions after experiencing an E&S incident, but this decision depends on the cost of delay. Finally, we show that the adverse impact on acquisitions dissipates after six months.

Toeholds and information quality in common‐value takeover auctions

AbstractIn this article I analyze the effect of the sensitivity of firm value on the information available to potential acquirers in common‐value takeover auctions with toeholds. I show that the quality of information does not affect equilibrium when bidders have equal toeholds but has a significant effect when toeholds are different. My article demonstrates that increasing the relative information quality of the bidder with a smaller toehold makes both bidders bid more aggressively and leads to a higher price. I also analyze the combined effect of toeholds and information quality on equilibrium bidding strategies and discuss ways target shareholders can increase the expected final price.

Takeovers, Freezeouts, and Risk Arbitrage

This paper develops a dynamic model of tender offers in which there is trading on the target’s shares during the takeover, and bidders can freeze out target shareholders (compulsorily acquire remaining shares not tendered at the bid price), features that prevail on almost all takeovers. We show that trading allows for the entry of arbitrageurs with large blocks of shares who can hold out a freezeout—a threat that forces the bidder to offer a high preemptive bid. There is also a positive relationship between the takeover premium and arbitrageurs’ accumulation of shares before the takeover announcement, and the less liquid the target stock, the stronger this relationship is. Moreover, freezeouts eliminate the free-rider problem, but front-end loaded bids, such as two-tiered and partial offers, do not benefit bidders because arbitrageurs can undo any potential benefit and eliminate the coerciveness of these offers. Similarly, the takeover premium is also largely unrelated to the bidder’s ability to dilute the target’s shareholders after the acquisition, also due to potential arbitrage activity.

Board reforms and M&A performance: international evidence

This research employs a difference-in-differences framework to study the impact of major board reforms on the performance of mergers and acquisitions (M&As). Using an international sample of board reforms implemented in 61 countries from 1985 to 2021, we document a drastic redistribution of wealth from target shareholders to acquirer shareholders after the board reforms in target countries. This effect is most pronounced in M&A transactions that involve the sale of controlling shares, thereby supporting the hypothesis that corporate board reforms mitigate the private benefits of control in the target firm. Furthermore, these reforms increase expected deal synergies, in that deal-level announcement returns are higher after the implementation of the reforms. When country-level institutional quality and legal protection of shareholders are greater, it reinforces the reform effects. Overall M&A activity remains unchanged following the reforms, yet financial bidders complete fewer transactions, implying a reform-induced squeeze-out of financial bidders from the M&A market in the target country. Collectively, these international results are consistent with the predictions of the private benefits of control theory and underscore the role of institutional quality and investor protection in reinforcing the effects of board reforms worldwide.

The value of economic freedom in cross-border mergers

The value of economic freedom in cross-border mergers

Bolstering creditor and shareholder protection under the South African and Zimbabwean amalgamation or merger regulatory regimes: Suggestions for company-law reform

This article critically assesses the efficacy of the South African and Zimbabwean merger regulatory regimes in providing suitable shareholder and creditor protection. The article seeks to balance competing goals. On the one hand, merger opportunities should be promoted by reducing regulatory barriers to merger regulation by, for instance, facilitating the implementation of mergers through a less complex procedure and with reduced court interference. On the other hand, the merger regimes ought to guarantee the appropriate and adequate protection of creditors and shareholders, including minority shareholders’ interests. The article focuses on the two comprehensive target shareholder protections — participatory and remedial rights — and two creditor remedies — the creditors’ notice and the solvency and liquidity test. The study establishes that South Africa offers better protection to creditors and shareholders than Zimbabwe. However, in some respects, both jurisdictions can seek lessons from other progressive jurisdictions, including the United States of America, with the state of Delaware as a particular example, and the United Kingdom.

The Development of the Takeover Auction Process: The Evolution of Property Rights in the Modern Wild West

Using a unique, hand-collected sample of US acquisitions, we study the interaction between the legal system and the takeover auction process from 1981 to 2020. We associate the strengthening of the property rights of targets’ boards after the 1989 Time Inc. decision with fundamental changes in the takeover auction process. This strengthening of the boards’ property rights has moved the auction process from a public one to a behind-the-scenes one in which targets’ boards control both the number of bidders and the flow of information. Targets’ boards are more likely to initiate the auction themselves, and the length of the private negotiation process has significantly lengthened. This fundamental change has benefited target shareholders.

The Consequence of Takeover Methods: Schemes of Arrangement vs. Takeover Offers

This paper examined the effect of two selling processes in the UK market: takeover offers and schemes of arrangement. The latter is argued to allow a bidder to acquire a target company more cheaply and easily because schemes provide a lower threshold of the target company’s shares before “squeeze-out” procedures may be used. To address potential self-selection bias arising from bidders’ ability to choose their acquisition method, the propensity score matching methodology was applied to 803 takeovers of listed-target firms from 1995–2018. The results showed that the scheme of arrangement significantly reduces the target shareholders’ gain relative to the takeover offer.

Appraisal rights and corporate disclosure during mergers and acquisitions

Appraisal rights and corporate disclosure during mergers and acquisitions

The Devolution and Inevitable Extinction of the Continuity of Interest Doctrine

The continuity of interest doctrine, in its present form, is the extrastatutory requirement that the historic shareholders of a target company must retain a quantum of equity interest in the acquiror in order for an acquisition to qualify as a reorganization entitled to tax-free treatment. If sufficient stock of the acquiror is not retained by the target's shareholders for a long enough period, the transaction is not a tax-free reorganization, and the target corporation and target shareholders (including those that did retain the acquiror's stock) are subject to tax on their gains. On the other hand, because the doctrine is not an anti-abuse rule, if the continuity of interest requirement is not met, the target and its shareholders are entitled to recognize any loss on the transaction.This summary of the doctrine and its consequences is, of course, greatly simplified. Every aspect of the continuity of interest doctrine carries with it a formidable array of complex issues. For example, for how long must the target's shareholders have held their stock to be considered "historic" shareholders? What types of interests in the target qualify as equity for purposes of the test? What type and quantum of continuing interest in the acquiror is required, and for how long and in what form must it be retained? Some of these questions have recently attracted significant attention as a result of a Tax Court case, J.E. Seagram Corp. v. Commissioner, newly issued regulations under section 338, and an announcement that the Internal Revenue Service is considering a comprehensive reassessment of the doctrine.

Collective Action Problems in Chinese Takeover Rules: Deficiency and Difficulty in Protecting Target Shareholders in a Hybrid Regime

China is in a process of upgrading its corporate law and corporate governance regime. The reform involves a learning process of incorporating corporate governance norms from other jurisdictions. In the field of takeover rules, China’s hybrid regime is a combination of some elements from both the US model and the UK model, reflecting China’s pragmatic approach towards rule of law and legislative reform. Though flexible and pragmatic, this transplant approach without taking into account China’s own economic, social and even political scenarios is of little help to address the agency problem embedded in China’s concentrated shareholding model faced by its SOEs and family–controlled enterprises let alone the shareholder protection rules investors are keen to have. A comparative study is conducted in this article to investigate the collective action problems the Chinse takeover rules fail to address. Autonomy of sport, Private International Law, Public-private Governance, Corruption, Transnational Legal Order, Sports Economy, Legal Status of Sporting Organisations, Audit, Managerial Transparency, Economic Monitoring, International Sporting Convention

Law Firm expertise and shareholder wealth

AbstractThis paper examines the impact of law firm expertise on bidder and target shareholder wealth gains during mergers and acquisitions. After controlling for endogeneity in the matching between the mandating firm (bidder or target firm) and the law firm, we find that top‐tier law firms increase the wealth of bidder shareholders by an average of 2.00% ($30.80 million) to 3.07% ($47.28 million). This does not hold for target firm shareholders. Interestingly, we find no evidence that the reputation of the investment bank is related to bidder or target shareholder wealth gains. Our findings suggest that top‐tier lawyers are effective “transaction cost engineers.” They create value for their clients by structuring deals to minimize transaction and regulatory costs.

Strategic Nondisclosure in Takeovers

ABSTRACTWe examine takeover auctions when an informed bidder has better information about the target value than a rival and target shareholders. The informed bidder's information is either hard or soft, and only hard information can be credibly disclosed. We show that withholding information creates a winner's curse, thereby serving as a preemption device that deters the rival's participation. In turn, an endogenous disclosure cost arises that induces the informed bidder to optimally withhold favorable information to minimize the acquisition price—breaking down the standard unraveling result, even if his information is always hard. Perhaps surprisingly, stronger competition from the uninformed bidder can reduce the target shareholders' payoff and increase the payoff of the informed bidder while unambiguously improving social welfare. Moreover, “hardened” information can reduce the gains to trade, decreasing welfare, but increasing shareholders' payoff. Our results provide a cautionary note to promoting more competition and more disclosure.JEL Classifications: D44; D82; G34; M41.

Institutional cross-ownership, heterogeneous incentives, and negative premium mergers

Cross-owners, investors who have stakes in both the acquiring and target firms, are likely to focus on the total portfolio wealth effects from mergers and acquisition transactions, rather than the wealth effects of the target or bidder. Cross-owners may be less concerned with value destroying deals because their lack of gains, or even losses, as ownership in the acquiring firm can be offset by benefits derived from their ownership in the target firm. In contrast, shareholders with no cross-ownership, but own shares in either the target or the acquiring firm only, consider the value prospects for the target, thus producing heterogeneous incentives among shareholders to accept an offer. We investigate this heterogeneity within targets of 481 US negative premium deals and find substantial heterogeneity in acquisition incentives within the target firm shareholder base. Target shareholders in negative premium acquisitions experience negative wealth effects, but institutional cross-owners of negative acquisition premium deals realize positive wealth effects. We also find strong evidence of a size effect, where the observed wealth effects are amplified in larger deals. The divergent interests within the target shareholder base, with the attendant heterogeneous incentives to support deals, limits the monitoring capacity of institutional owners in negative premium deals.