An Economic Analysis of Rights of First Refusal
New York University School of Law; European Corporate Governance Institute
New York University, Center for Law and Business, Working Paper No. 99-009
A right of first refusal requires the owner of a property to offer the property to the rightholder on the same terms as those offered by that third party before the owner can sell the property to a third party. A right of first offer requires the owner of a property to let the rightholder make an offer to purchase the subject property; if the owner rejects that offer, the owner can sell the property to a third party only at a price above the one offered by the rightholder.
This paper models the value of such first purchase rights at the time of their potential exercise. Modeling this ex post value is important since: the factors that determine the ex post value of first purchase rights also affect how much one should pay or accept for such rights ex ante, at the time when they are contracted; the model highlights the significance of certain features in the design of these rights, certain environmental features, and the relation of design and environmental features to each other; the ex post value of a right determines the amount of damages payable if the right is breached; and the model sheds light on why such rights are granted and how they enhance efficiency.
The main results are:
(i) Rights of first refusal are more valuable than rights of first offer.
(ii) If transaction costs are compensable, first purchase rights have the highest value when bargaining skills are relatively evenly distributed.
(iii) The fact that transaction costs are uncompensable increases the value of first purchase rights; this increase is more pronounced for a right of first refusal than for a right of first offer.
(iv) Imperfect information by rightholder over the value placed on the subject property by a third party reduces the value of a right of first offer and has no effect on the value of a right of first refusal
(v) Imperfect information by a third party on the value placed on the subject property by rightholder may increase or reduce the value of a right of first refusal and has no effect on the value of a right of first offer.
(vi) First purchase rights may enhance efficiency by: reducing seller's incentives to engage in strategic search for certain third-party buyers, improving rightholder's incentives to take certain steps to increase the value of the property, and reducing the costs associated with strategic bargaining.
Number of Pages in PDF File: 25
Date posted: September 29, 1997