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

See all articles by Mike Burkart

Mike Burkart

Swedish House of Finance; London School of Economics and Political Science, Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Samuel Lee

Santa Clara University - Leavey School of Business; European Corporate Governance Institute (ECGI); Swedish House of Finance

Henrik Petri

University of Bath

Date Written: February 15, 2020

Abstract

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

Burkart, Mike C. and Lee, Samuel and Petri, Henrik, Incentives and Free-Riding: The Social Value of Debt in the Market for Corporate Control (February 15, 2020). Swedish House of Finance Research Paper No. 20-9, Available at SSRN: https://ssrn.com/abstract=3538825 or http://dx.doi.org/10.2139/ssrn.3538825

Mike C. Burkart

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

London School of Economics and Political Science, Department of Finance ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

HOME PAGE: http://www.cepr.org/default_static.htm

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Samuel Lee (Contact Author)

Santa Clara University - Leavey School of Business

500 El Camino Real
Santa Clara, CA California 95053
United States

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

Henrik Petri

University of Bath ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom

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