Termination Fees Research Articles

The Effect of Prohibiting Deal Protection in Mergers and Acquisitions: Evidence from the United Kingdom

AbstractSince 2011, the United Kingdom has prohibited all deal protections—including termination fees—in mergers and acquisitions (M&A) deals. We examine the effect of this regulatory change on deal volumes, the incidence of competing offers, deal-jumping rates, deal premiums, and completion rates in the United Kingdom relative to the other European Group of 10 (G-10) countries. We find that M&A deal volumes in the United Kingdom declined significantly in the aftermath of the 2011 reform (in absolute terms and relative to deal volumes in other European G-10 countries). We find no countervailing benefits to targets’ shareholders in the form of higher deal premiums or more competing bids. Completion rates and deal-jumping rates also remained unchanged. Our results suggest that deal protections provide an important social welfare benefit by facilitating the initiation of M&A deals.

Board involvement in the M&A negotiation process

This paper examines whether the active engagement of target firm directors in the sale process affects merger outcomes. Using data manually extracted from merger-related SEC filings, I create two measures of target board involvement in merger negotiations: the number of days it takes for the board to meet after the beginning of the sale process and the number of board meetings held throughout the entire process. I find that early board involvement in merger talks increases target shareholder returns and premiums, especially when shareholders have weak control over their firms and are thus in greater need of board protection. Although the two measures of target board activity do not affect acquirer cumulative abnormal returns or the likelihood of competition, such activity does reduce the likelihood of an excessive target termination fee. Robustness analyses dismiss an alternative explanation whereby attractive initial bids lead to both early board involvement and attractive final bids.

Harman International and Kkr (a)

When courted by KKR, Harman International was experiencing robust times. After several months of due diligence performed by KKR and its financial and legal partners, KKR announced that Harman International had agreed to be acquired in a private equity transaction valued at $8 billion. But by the time the documents pertaining to the Harman International/KKR transaction were on the table, the financial markets that had ridden on the enormous momentum from prior years into the first half of 2007, almost overnight experienced a cooling-off period of unprecedented magnitude. Unfortunately, Harman International's fourth quarter results released in August 2007 were disappointing, prompting some critical questions: What was the real intrinsic value of Harman International, and which financial metrics were most meaningful in assessing that value? Should KKR follow through on the proposed transaction or pay a required $225 million termination fee? Was going private still in the best interest of Harman International, or should the CEO abandon the transaction and have his company pay the termination fee? Followed by the B case, C-2311. Excerpt UVA-C-2305 Rev. Mar. 19, 2012 Harman International and KKR (A) On the morning of September 21, 2007, Sidney Harman and Henry Kravis sat at a conference table overlooking Central Park in the New York office of Kohlberg Kravis Roberts & Co. L.P. (KKR). The purpose of the meeting was to determine the fate of an $ 8 billion private equity transaction between a group led by KKR and the renowned audio-equipment maker Harman International Industries, Inc. (Harman International). It had been 10 months since Kravis first approached Harman about acquiring Harman International. Kravis, cofounder of one of the world's leading private equity firms, had made the first direct pitch to Harman in his Washington, DC, office. Kravis strongly believed the time was right for Harman International to go private. Harman was initially reluctant to sell because Harman International was experiencing robust times, as exemplified by its recent financial performance, and he enjoyed being at the helm of the company as executive chairman. “This is how I define myself. This is my life,” he said. Yet there were compelling reasons for him to consider Kravis's offer. Although vigorous at heart, Harman was 88 years old. He also recalled the difficult time replacing former CEO Bernie Girod. Girod, after more than 20 years with the company, had recently retired, but his successor had lasted only a few months. Harman also knew he would receive a financial windfall from the sale: He owned approximately 5% of the company's common stock, and the value offered by KKR and its partners would provide more than $ 400 million in financial security for him, his wife (U.S. Congresswoman Jane Harman of California), their extended families, and their many philanthropic interests. Harman International . . .

Why Have M&A Contracts Grown? Evidence from Twenty Years of Deals

Over 20 years, MA and reverse termination fees). New contract language also includes dispute resolution provisions (e.g., jury waivers, forum selection clauses) that are puzzling not for appearing new but in why they were ever absent. A final, notable set of changes reflect innovative deal terms, such as top-up options, which are associated with a 18-day (~30%) fall in time-to-completion and a 6% improvement in completion rates. Exploratory in nature, this paper frames a variety of questions about how an important class of highly negotiated contracts evolves over time.

No free shop: Why target companies sometimes choose not to buy ‘go-shop’ options

We study the decisions by targets in private equity and MBO transactions whether to actively “shop” executed merger agreements prior to shareholder approval. Targets can negotiate for a ‘go-shop' clause, which permits the solicitation of offers from other would-be acquirors during the “go-shop” window and may lower the termination fee paid by the target in the event of a competing bid. The decision to retain the option to shop is predicted by various firm attributes, including larger size and more fragmented ownership. Go-shops are not a free option. We exploit the impact of various characteristics of the firm’s legal advisory team and procedures on the probability of inclusion of a go-shop provision to establish a negative relationship between go-shop provisions and initial acquisition premia. Importantly, that loss to shareholder value is not offset by gains associated with new competing offers. We conclude that the increased-use of go-shops reflects excessive concerns about litigation risks, possibly resulting from lawyers’ conflicts of interest in advising targets.

The Effect of Prohibiting Deal Protection in M&A: Evidence from the United Kingdom

Since 2011, the U.K. has prohibited all deal protections – including termination fees – in M&A deals. Prior to 2011, the U.K. permitted termination fees up to 1% of deal value and there was no prohibition on other protection devices. We examine the effect of this regulatory change on deal volumes, the incidence of competing offers, deal jumping rates, deal premiums, and completion rates in the U.K., relative to the other European G-10 countries. We find that M&A deal volumes in the U.K. declined significantly in the aftermath of the 2011 Reforms, relative to deal volumes in the European G-10 countries. We find no countervailing benefits to target shareholders in the form of higher deal premiums or more competing bids. Completion rates and deal jumping rates also remained unchanged. We estimate that the incidence-rate ratio of U.K. deals to non-UK deals after the reform was approximately 50% the incidence-rate ratio of U.K. deals to non-U.K. deals prior to the reform. In addition, we estimate USD 19.3 billion in lost deal volumes per quarter in the U.K. relative to the control group due to the 2011 Reforms, implying a quarterly loss of USD 3.2 billion for shareholders of U.K. companies. Our results suggest that deal protections provide an important social welfare benefit by facilitating the initiation of M&A deals.

The Strange Career of Independent Voting Trusts in U.S. Rail Mergers

Voting trust arrangements have a long history at both the Interstate Commerce Commission and the Surface Transportation Board as devices to protect the incentives of acquiring firms and maintain the independence of acquiring and target firms during the pendency of regulatory investigation of the merger proposal. However, they are not without problems. The STB argued in 2001 that as Class I railroads have become fewer and larger, it may be difficult to find alternative purchasers for the target firm if the STB turns down the proposal. The Antitrust Division argued in 2016 that joint stock ownership creates anticompetitive and/or otherwise undesirable incentives, even if the independence of the voting trustee is complete. On the other hand, the functions served by voting trusts in railroad mergers are served by merger termination fees and other contractual “lockup” mechanisms in other parts of the economy, without the same incentive problems as voting trusts. Thus voting trusts may no longer serve a useful function in railroad merger deliberations.

Tax rules scuttle CF and OCI merger

CF Industries and OCI have canceled their $8 billion fertilizer merger in light of Treasury Department rules meant to discourage tax inversions, acquisitions in which U.S. companies lower their tax bills by domiciling overseas. CF is U.S.-based; OCI is Dutch. The combined company would have been the world’s largest publicly traded nitrogen fertilizer maker. The Treasury rules, announced in April, “materially reduced the structural synergies of the combination,” the companies say. CF will pay OCI a $150 million termination fee. The huge planned merger between Pfizer and Allergan was similarly scuttled by the new tax rules.

Learn From Breaking Up: The Effect of Acquisition Experience on Termination Fee Provisions

Research on acquisition experience has long debated whether and when this experience can improve acquisition performance. We contribute to this line of research by investigating learning that occurs in the strategic actions that acquirers take within the deal negotiation period. As an important tool to prevent breaking up with the target, we evaluated how acquirers use termination fee provisions in response to lessons learned from past success and failure as well as variations in the value of the target. Coding acquirer termination fee and target termination fee provisions from 3,974 agreements of U.S. public acquisitions from 1993 to 2014, we found that acquirers’ experience decreases the propensity to include both provisions in the agreement but this effect is driven by experiences with deals that are complete; a high proportion of experience with deals that are announced by not completed then increases the likelihood of using termination provisions. Moreover, when the target is more valuable, the negat...

How Much is Too Much? Large Termination Fees and Target Distress

We provide evidence that large termination fees mitigate contracting problems in acquisitions of targets with high information asymmetry. Large fees are more common if targets face financial constraints or distress. Deals with large termination fees are more likely to attract a competing bid, consistent with large fees allowing acquirers to recover bidding costs when facing a high risk of bid failure. We correct for the endogenous selection of large termination fees and present evidence that managers negotiate large fees in exchange for higher premiums. This contrasts prior evidence that suggests large fees result from managerial self-interest and harm target shareholders.

Net Neutrality and internet fragmentation: The role of online advertising

We investigate the relation between Net Neutrality regulation and Internet fragmentation. We model a two-sided market, where Content Providers (CPs) and consumers interact through Internet Service Providers (ISPs), and CPs sell consumers' attention to advertisers. Under Net Neutrality, a zero-price rule is enforced. By contrast, in the Unregulated Regime, ISPs make access to their subscribers for CPs conditional on payment of a termination fee. Multiple impressions of an ad on the same consumer are partially wasteful. Thus, equilibrium ad rates decrease when audiences overlap. We show that ISPs may strategically set termination fees to induce fragmentation. This takes place when advertising revenues are potentially large but strongly diminished by competition among CPs, and when consumers are not highly sensitive to content availability. We therefore identify an important link between termination fees, the online advertising market and Internet fragmentation. We extend the model to account for multi-homing consumers, vertically integrated ISPs, third-party advertising platforms and heterogeneous CPs.

Bidder contests in international mergers and acquisitions: The impact of toeholds, preemptive bidding, and termination fees

For international mergers and acquisitions we analyze the effectiveness of different bidder strategies, first in preventing bidder competition, and second in increasing the likelihood of success. We provide robust empirical evidence of the effectiveness of toeholds and termination fees in reducing the likelihood of competition and, if a contest occurs, increasing the probability of success, especially after controlling for bidder asymmetries. The effects of termination fees vary over time and legal origin. Overall, there is hardly any evidence that high initial offers can prevent contests. However, competition is preempted in civil law countries with a high initial premium. A higher percentage of cash payment also increases the probability of success in bidder contest. Moreover, latent competition is generally not sufficient to curb the influence of observable bidder competition on target and bidder wealth. Finally, serial acquirers are more likely to prevent bidder contests and experienced and reputably advised bidders are more successful in deal completion. Overall, we offer novel evidence for the success of different bidding strategies in international mergers and acquisitions.

Political Uncertainty and Cross-Border Acquisitions

We study the relation between political uncertainty and cross-border acquisitions using national elections as sources of variation in uncertainty. We find that political uncertainty affects the volume, deal structure, and outcome of cross-border acquisitions. Elections in acquirer country encourage firms to acquire targets abroad while elections in target countries deter foreign firms’ inbound acquisitions. At the transaction level, we show that the merging firms adjust termination fee, means of payment, and stakes sought-after prior to elections, consistent with the hypothesis firms mitigate potential risks due to political uncertainty. Overall, the results shed new light on the effects of political uncertainty by providing evidence through the cross-border acquisition channel.

Board Involvement in the M&A Negotiation Process

This paper examines whether the active engagement of target firm directors in the sale process affects merger outcomes. Using data manually extracted from merger-related SEC filings, I create two measures of target board involvement in merger negotiations: the number of days it takes for the board to meet after the beginning of the sale process and the number of board meetings held throughout the entire process. I find that early board involvement in merger talks increases target shareholder returns and premiums, especially when shareholders have weak control over their firms and are thus in greater need of board protection. Although the two measures of target board activity do not affect acquirer or combined cumulative abnormal returns or the likelihood of competition, such activity does reduce the likelihood of an excessive target termination fee. Robustness analyses dismiss an alternative explanation whereby attractive initial bids lead to both early board involvement and attractive final bids.

Net Neutrality, Exclusivity Contracts, and Internet Fragmentation

Net neutrality (NN) is believed to prevent the emergence of exclusive online content, which yields Internet fragmentation. We examine the relationship between NN regulation and Internet fragmentation in a game-theoretic model that considers the interplay between termination fees, exclusivity, and competition between two Internet service providers (ISPs) and between two content providers (CPs). An exclusivity arrangement between an ISP and a CP reduces the CP’s exposure to some end users, but it also reduces competition over ads among the CPs. Fragmentation arises in equilibrium when competition over ads among the CPs is very strong, the CPs’ revenues from advertisements are very low, the content of the CPs is highly complementary, or the termination fees are high. We find that the absence of fragmentation is always beneficial for consumers, because they can enjoy all available content. Policy interventions that prevent fragmentation are thus good for consumers. However, results for total welfare are more mixed. A zero-price rule on traffic termination is neither a sufficient nor a necessary policy instrument to prevent fragmentation. In fact, regulatory interventions may be ineffective or even detrimental to welfare and are only warranted under special circumstances.

How much is too much? Large termination fees and target distress

We provide evidence that large termination fees mitigate contracting problems in acquisitions of targets with high information asymmetry. Large fees are more common if targets face financial constraints or distress. Deals with large termination fees are less likely to be consummated, consistent with large fees allowing acquirers to recover bidding costs when facing a high risk of bid failure. We correct for the endogenous selection of large termination fees and present evidence that managers negotiate large fees in exchange for higher premiums. This is in contrast with prior evidence that suggests large fees result from managerial self-interest and harm target shareholders.

How Much is Too Much? Large Termination Fees and Merger Outcomes

We investigate the use and impact of large target termination fees in acquisitions. Large termination fees are associated with more post-bid competition and lower completion rates, suggesting high fees do not effectively lock-in friendly bidders. Large termination fees are more common in deals with small and distressed targets and deals with high advisory fees. Switching regression estimates predict that high-fee deals would receive lower premiums with reduced termination fees. Overall, our evidence suggests that targets use large termination fees to overcome contracting problems when bidders face high transaction costs and information risk. In contrast to prior literature, there is limited evidence that managerial self-interest motivates high fees, as target managers in these deals are not more likely to receive severance packages or employment with the bidder in high-fee deals.

Competition and dynamics of takeover contests

This paper investigates the effect of potential competition on takeovers which we model as a bargaining game with alternating offers where calling an auction represents an outside option for each bidder at each stage of the game. The model describes a takeover process that is initiated by an unsolicited bidder, and it aims to answer three main questions: who wins the takeover and how? when? and how much is the takeover premium?Our results explain why the takeover premium resulting from a negotiated deal is not significantly different from that resulting from an auction, and why tender offers are rarely observed in reality. We also show that when the threat of the initial bidder to call a tender offer is not credible, the takeover process might end with a private auction organized by the target. Conversely, when the tender offer threat is credible, the takeover process ends with a deal negotiated bilaterally between the bidder and the target. The takeover premium always depends on the degree of potential competition, while it is affected by the target resistance only for weak initial bidders.Finally, the model allows us to draw conclusions on how other dimensions of the takeover process, such as termination fees, control benefits and tender offer costs, affect its dynamics and outcome.

Holdups, Renegotiation, and Deal Protection in Mergers

We examine the contracting and negotiation process in mergers using an incomplete contracts framework. Our multi-period model allows for the arrival of new information and renegotiation after the signing of an initial merger agreement but before deal completion or termination. A properly designed initial contract solves the holdup problem during renegotiation and induces higher deal-specific effort, including the due diligence assessment of the deal. The contract grants an option to the target to terminate the merger, where the strike on the option compensates the acquirer’s deal-specific effort without imposing excessive costs on the target for pursuing non-merger alternatives. The option strike can be implemented by the use of deal protection devices, such as a target termination fee and/or an acquirer lockup. Employing a large sample of stock mergers, we find evidence supporting model predictions for the renegotiation of contracts, deal outcomes and the use of deal protection devices.

Termination fees revisited

We reconsider the question of the optimal level of termination fees between communication networks in the context of heterogeneous usage and elastic participation. The interaction between these two features yields new insights; in our model: i) The profit maximizing reciprocal termination fee is above marginal cost; ii) the welfare maximizing termination fee is also above cost; iii) the welfare-maximizing termination fee is below the profit-maximizing one in the absence of termination-based price discrimination, but can be above it otherwise.