When a Buyer Gets Cold Feet: What is the Value of a Bidder Termination Provision in a Takeover?

Abstract

Bidder termination provisions enhance a bidder's ability to terminate a takeover but are only included in some deals, and bidder termination fees vary. We liken these provisions to real options on targets' assets. Including them can be optimal because they enable termination when targets become less valuable to bidders than on their own, but creates a trade-off because bidders may terminate deals that should be completed. The provisions appear in takeover agreements when they increase expected joint takeover gains and termination fees are increasing in the provisions' option value. Combined announcement returns are larger in deals with appropriately priced provisions.

Keywords: Mergers and Acquisitions, Takeovers, Termination Fees, Real Options

JEL Classification: G13, G34, K22