Holdups, Renegotiation, and Deal Protection in Mergers
46 Pages Posted: 9 Oct 2017 Last revised: 14 Oct 2017
Date Written: September 1, 2017
We examine the contracting and negotiation process in mergers using an incomplete contracts framework. Our multi-period model allows for the arrival of new information and renegotiation after the signing of an initial merger agreement but before deal completion or termination. A properly designed initial contract mitigates the potential holdup problem during renegotiation and induces higher deal-specific effort, including the due diligence assessment of the deal. The contract grants an option to the target to terminate the merger, where the strike on the option compensates the acquirer’s deal-specific effort without imposing excessive costs on the target for pursuing non-merger alternatives. The option strike can be implemented by the use of deal protection devices, such as a target termination fee and/or an acquirer lockup. Finally, we provide empirical description for a large sample of cash and stock mergers that demonstrates the nature of contract renegotiation and how the use of deal protection devices can alleviate holdup problems.
Keywords: Holdup, renegotiation, merger, deal protection, termination fee, lockup
JEL Classification: G34, C71, D8
Suggested Citation: Suggested Citation