Taking Finance Seriously: How Debt-Financing Distorts Bidding Outcomes in Corporate Takeovers
Robert P. Bartlett III
University of California, Berkeley - School of Law; University of California, Berkeley - Berkeley Center for Law, Business and the Economy
UGA Legal Studies Research Paper No. 07-012
Fordham Law Review, Vol. 76, Spring 2008
Economic analysis of corporate takeovers has traditionally advocated legal doctrines that ensure a target company in a takeover contest is acquired by the bidder willing to pay the most for it. The reason stems from the conventional assumption that a bidder's offer price should reflect its ability to put target's assets to productive use.
This Article challenges this assumption by turning to the success of private equity firms in outbidding publicly-traded, strategic bidders during the recent takeover wave. Using standard valuation modeling, the Article reveals how a critical component of any bidder's valuation of target stems from its source of acquisition financing. Specifically, a bidder's ability to finance a takeover with debt can lead to a significant increase in its valuation of target owing to a de facto government subsidy created by the deductibility of interest payments. Simultaneously, however, not every bidder has the ability to utilize debt-financing to the same extent - a point emphasized in forty years of finance research. The result is that during periods of robust credit markets such as occurred during 2004-2007, the highest bidders in takeover contests may often be those bidders such as private equity firms who are capable of using large amounts of debt-financing.
By highlighting the critical role of finance in explaining bidder valuations, this Article illustrates how accurate economic analysis of takeovers requires careful attention to bidders' divergent financing decisions. Indeed, by failing to take finance seriously, traditional takeover scholarship may very well be advocating legal rules that promote inefficient takeovers.
Number of Pages in PDF File: 49
Keywords: corporate takeovers, private equity, acquisition financing
JEL Classification: G32, K22
Date posted: October 21, 2007 ; Last revised: August 18, 2009