The Effect of Buyers' Valuation Uncertainty on the Seller's Choice of Selling Mechanism

Abstract

I examine the role of valuation uncertainty on a sellers’ choice between auction and negotiation in friendly takeovers. I construct a parsimonious measure of valuation uncertainty based on different sources of accounting quality. I find that sellers with high valuation uncertainty are more likely to choose negotiation, which allows the seller to mitigate the buyer’s valuation uncertainty at low cost, thereby alleviating the winner's curse. On the other hand, sellers with low valuation uncertainty are more likely choose an auction format, which allows the seller to benefit from competition among bidders. These results are consistent with the idea that the choice of selling mechanism involves a trade-off between competition among bidders and the cost of credibly disclosing information to multiple bidders. Further, I find that the effect of uncertainty on the selling mechanism choice is mostly driven by the asymmetric component of uncertainty (possible to be resolved through disclosure). In addition, I document that the impact of each component of uncertainty on takeover premium is consistent with the trade-off between benefits as a driver of the mechanism choice.

Keywords: Selling Mechanism, Valuation Uncertainty, Auction