Incentives and Free-Riding: The Social Value of Debt in the Market for Corporate Control
27 Pages Posted: 26 Mar 2020 Last revised: 10 Apr 2020
Date Written: February 15, 2020
We examine the link between incentive benefits of takeover debt and free-riding in tender offers and identify three roles that debt plays in the takeover process: It (i) spurs efficiency-enhancing equity concentration, (ii) can act as a Pareto-improving sharing rule between bidders and target shareholders, and (iii) makes bidding contests fiercer and more efficient. Our theory implies that high debt levels can be privately optimal and socially efficient even in excess of financing needs. Target shareholders may benefit most in highly leveraged takeovers, even though the debt is used to dilute their equity claims. This is reinforced by bidder competition, which induces bidders to take on more debt.
Keywords: Takeovers, Leveraged Buyouts, Free-Rider Problem, Bidding Competition
JEL Classification: G34
Suggested Citation: Suggested Citation