Friendly Takeover Offers for Public Corporations: Interim Uncertainty, Reserve Prices, and Bustup Fees
Bernard S. Black
Northwestern University - Pritzker School of Law; Northwestern University - Kellogg School of Management; European Corporate Governance Institute (ECGI)
Robert A. Dam
University of Colorado at Boulder - Department of Finance
March 15, 2012
Legal restrictions create a material delay between the announcement of a friendly acquisition of a public firm and the deal’s final approval by target shareholders: a month for a takeover with a first step cash tender offer, longer for a merger. During this time target values may change, perhaps dramatically. While a target can accept new bids if its value rises, bidders usually cannot back out if the target’s value falls. We also observe that most takeovers occur at a significant premium to the target’s prior market price. Prior models of takeover bidding ignore the law-induced delay and resulting asymmetry between bidder and target, and generally assume that targets (if for sale) will accept zero-premium offers. We develop a model that incorporates delay-induced asymmetry and reserve prices. Principal new predictions include: targets often optimally set reserve prices higher than the current market price; first bidders may value the target for more than the target’s reserve price, yet be unwilling to bid because they expect a loss after accounting for the implied put option they provide the seller; the likelihood of a bidder making a bid is generally decreasing in the reserve price, the interim uncertainty, and the number of potential competing bidders; optimal reserve prices are decreasing in the interim uncertainty and number of potential new bidders, and can be below the target’s current price in extreme cases; (if the target offers a bustup fee to the first bidder, this increases the (conditional on the bustup fee) optimal reserve price, but reduces the target’s expected profit. Our predictions on the effect of bustup fees provide theoretical support for legal limits on bustup fees and other deal protections.
Number of Pages in PDF File: 34
Keywords: mergers and acquisitions, reserve price, bustup fee, termination fee
JEL Classification: G34, G38
Date posted: March 24, 2012
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