The market for corporate control
Hirshleifer 1995
Takeovers
• mergers
• acquisitions
Tender offers
• conditional/unconditional
• restricted/unrestricted
• unconditional and unrestricted: “any-or-all” offers
A model
Value of target firm
- in case of takeover
- in case of no takeover
v
0
Risk neutrality. No taxes. Conditional offers.
Success of takeover = Control of target firm
= Buying fraction > x of target firm. (Normally, x = 50%.)
Tore Nilssen – Economics of the Firm – Lecture 4 – slide 1
What should a shareholder in the target firm do?
Tender bid (sell share) if:
b > Pr(Success of takeover | shareholder sells)v
Is the shareholder pivotal?
Given the other shareholders’ decisions, if a single
shareholder’s decision to sell determines whether the buyer
obtains control of the firm, then this shareholder is pivotal.
In practice – many small shareholders: None of them
considers herself being pivotal.
Shareholders non-pivotal.
Why should a shareholder sell?
If takeover is successful, then value = v
So do not tender offer unless b ≥ v.
→ Free-rider problem.
0 < b < v: Shareholders retain their shares although,
collectively, they would gain from selling.
→ Bidder needs to bid b = v in order to gain control.
[Grossman & Hart, “Takeover Bids, the Free-Rider Problem and the Theory
of the Corporation”, Bell Journal of Economics 1980]
Tore Nilssen – Economics of the Firm – Lecture 4 – slide 2
The free-rider property hinges on all shareholders being
non-pivotal.
The free-rider problem makes the current shareholders the
winners – all the gain from the takeover accrues to them.
This fits well with empirical studies:
• Acquirers’ return from takeovers are close to zero
• Target shareholders’ return from takeovers are
abnormal
But: If bidding is costly, then takeovers will not take place.
Gains to the acquirer:
• initial (pre-bid) shareholding
• dilution of minority shareholders’ value
ƒ dilution factor δ
ƒ shareholders tender if b > (1 – δ)v
Acquirer’s net gain:
αv + (1 – α)δv – cB
where: α = acquirer’s initial shareholding
cB = bidding costs
Tore Nilssen – Economics of the Firm – Lecture 4 – slide 3
Private information about firm value after takeover
Suppose the acquirer knows v, the post-takeover value of
the firm, while current shareholders do not.
Is it possible for the shareholders to deduce this
information from the acquirer’s bid?
Two possibilities:
• The bid is the same whatever information the acquirer
has – a pooling equilibrium.
• The bid is higher, the higher is v – a separating
equilibrium.
Pooling equilibrium: uninformative bidding.
Acquirer’s strategy:
- Bid if v ≥ v*
Shareholder’s strategy:
- Tender bid if b ≥ b* = E[v | v ≥ v*]
Tore Nilssen – Economics of the Firm – Lecture 4 – slide 4
Separating equilibrium: informative bidding
Do all shareholders behave the same way?
Suppose, when indifferent, some of them tender, others do
not. [Or: mixed strategy]
This leads to the probability of success steadily increasing
in the bid: P(b), P’(b) > 0.
α - intial shareholding of bidder
ω - further shares needed to gain control
Bidder’s expected profit:
π = P(b)[αv + (v – b)ω]
First-order condition wrt b:
P’(b)[αv + (v – b)ω] – P(b)ω = 0
Total differentiation in FOC:
d 2π
P ' ( b ) [α + ω ]
db
= − dbdv
=
−
>0
d 2π
dv
P "( b ) ⎡⎣α v + ( v − b ) ω ⎤⎦ − 2 P ' ( b ) ω
db 2
→ db/dv > 0 – Private information revealed by the bid.
Tore Nilssen – Economics of the Firm – Lecture 4 – slide 5
Shareholders indifferent between accepting and not. →
b=v
(If b < v, then hold on.)
Insert into FOC:
P’(b)αb – P(b)ω = 0 →
P '(b )
P (b)
=
ω1
αb
Differential equation.
Boundary condition: P ( v ) = 1
⎛b⎞
→ P (b) = ⎜ ⎟
ω
α
⎝v ⎠
• α ↑ → P ↑: Initial shareholding increases the
probability of successful takeover
• ω ↑ → P ↓: Tougher control requirements decrease
the probability of successful takeover
• v ↓ → P ↑: More precise information about v
increases the probability of successful takeover
Tore Nilssen – Economics of the Firm – Lecture 4 – slide 6
Management defensive strategies
• poison pills, shark repellents
• White mail: The target firm issues a large amount of
shares at below-market prices, which the acquiring
company will then have to purchase if it wishes to
complete the takeover.
• The Macaroni Defense: The firm issues a large
number of bonds with the condition they must be
redeemed at a high price if the company is taken over.
• Golden-parachute contracts with current management
• Provisions of supermajority (> 50% to gain control).
• Leveraged capitalization: A strategy where a company
takes on significant additional debt with the purpose of
either paying a large dividend or repurchasing shares.
Defensive measures may or may not be good for current
shareholders
- may discourage takeovers
- but may also encourage a higher bid
Related notions:
- reservation price in an auction
- monopoly price above marginal costs
Tore Nilssen – Economics of the Firm – Lecture 4 – slide 7
Defensive measures may affect the asymmetry of
information
• scorched earth defense: the target firm sells off parts
of the firm
- reduces the post-takeover value of the firm, making
the target firm less attractive
- but also affects the informational asymmetry: may
make current shareholders less uncertain about v.
Other issues
• revision of bids
- makes it difficult to sustain informative equilibrium
- costs of revision?
• pivotal shareholders
- reduce the free-rider problem
- create a scope for profit to the bidder
• competitive bidding
- more than one bidder
- like an auction
- but: in practice, initial bids are high
o a lot of information to other bidders in first bid
o first bidder bids high to deter other bids
Tore Nilssen – Economics of the Firm – Lecture 4 – slide 8