Optimal Toeholds in Takeover Contests
Indiana University - Department of Finance
Boston College - Finance Department; University of Pennsylvania - Wharton Financial Institutions Center; China Academy of Financial Research (CAFR)
In this paper we offer an explanation for the empirical anomaly that most raiders do not acquire the maximum possible toehold prior to announcing a takeover bid. By endogenously modeling the target value following an unsuccessful takeover we demonstrate that a raider may optimally choose to acquire a small toehold even if the toehold acquisition does not drive up the pre-tender offer target price. This occurs because although a large toehold increases profits if the takeover succeeds it also conveys a higher level of managerial entrenchment, and hence a lower firm value, if the takeover fails. In the paper we derive new predictions regarding how the optimal toehold and how target firm value following a failed takeover vary in the cross section. Extending the basic model we examine the impact of the presence of a rival bidder and of dilution on the initial bidder's toehold strategy.
Number of Pages in PDF File: 43
Keywords: Toehold, entrenchment, free-rider problem, takeover, tender offer
JEL Classification: G34, D8, K22working papers series
Date posted: August 3, 2003
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