Tender Offers and Leverage

Abstract

This paper examines the role of leverage in tender offers for widely held firms. We show that a leveraged bootstrap acquisition implements an outcome that - from an economic perspective - is quite similar to the outcome implemented by the Grossman-Hart dilution mechanism. To raise the funds for the takeover, the raider initially sets up a new acquisition subsidiary that issues debt backed by the target's assets and future cash flows. In the first step of the acquisition, the raider acquires a majority of the target's stock through a tender offer. In a second step, the target is merged with the raider's indebted acquisition subsidiary. The fact that the acquisition subsidiary is indebted lowers the combined firm's share value and thus the incentives for target shareholders to hold out in the tender offer. This allows the raider to lower the bid price, make a profit, and overcome the free-rider problem.