Due Diligence

57 Pages Posted: 20 Nov 2020

See all articles by Brendan Daley

Brendan Daley

Johns Hopkins University

Thomas Geelen

Copenhagen Business School - Department of Finance; Danish Finance Institute

Brett Green

Washington University in St. Louis - John M. Olin Business School

Date Written: October 2, 2020

Abstract

Due diligence is common practice prior to the execution of corporate transactions. We propose a model of the due diligence process and analyze its effect on prices, the division of surplus, and efficiency. In our model, if the seller accepts an offer, the winning buyer (the acquirer) has the right to gather information and chooses when (if ever) to execute the transaction. Our main result is that the acquirer engages in “too much” due diligence relative to the social optimum. Nevertheless, allowing for due diligence can improve both total surplus and the seller’s payoff compared to a setting with no due diligence. The optimal contract involves both a price contingent on execution and a non-contingent transfer, resembling features such as earnest money or break-up fees that are commonly observed in transactions involving due diligence.

Keywords: Learning, Dynamic Games, Asymmetric Information

JEL Classification: D82, D86, G34

Suggested Citation

Daley, Brendan and Geelen, Thomas and Green, Brett, Due Diligence (October 2, 2020). Available at SSRN: https://ssrn.com/abstract=3702560 or http://dx.doi.org/10.2139/ssrn.3702560

Brendan Daley

Johns Hopkins University ( email )

Baltimore, MD 20036-1984
United States

Thomas Geelen

Copenhagen Business School - Department of Finance

Solbjerg Plads 3
Copenhagen, Frederiksberg 2000
Denmark

Danish Finance Institute ( email )

Brett Green (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

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