Holdups, Renegotiation, and Termination Fees in Mergers

50 Pages Posted: 18 Nov 2004

See all articles by Edith S. Hotchkiss

Edith S. Hotchkiss

Boston College - Carroll School of Management

Jun Qian

Fanhai International School of Finance, Fudan University; University of Pennsylvania - Wharton Financial Institutions Center

Weihong Song

Independent

Date Written: November 14, 2004

Abstract

We examine contracts used in mergers from the announcement of initial definitive agreement to the completion or termination of the deal, and the renegotiation process in between. We build a model that allows for renegotiation following the arrival of new information, and demonstrate that a properly designed contract solves the holdup problem and induces higher deal-specific efforts that increase the synergy of the merger. The contract grants an option to the target to terminate the merger, while the strike price can be regarded as the "termination fee" paid by the target. The optimal target termination fee compensates the acquirer's deal-specific effort without imposing excessive costs on the target for pursuing non-merger alternatives. With a sample of stock mergers from 1994 to 1999 we find: 1) termination fees are used more frequently on the target side than on the acquirer side because the target's holdup problem is more severe; 2) an acquirer's lockup option or a toehold are also devices to solve target's holdup problem; 3) target termination fee increases when measures of acquirer's deal-specific effort increase, but it decreases when measures of the target's non-merger alternatives increase; and 4) renegotiation of the initial agreement ensures that the merger decision is efficient at the time of merger completion or termination.

Keywords: Holdup, renegotiation, merger, termination fee, lockup, toehold

JEL Classification: G34, C71, D8

Suggested Citation

Hotchkiss, Edith S. and Qian, Jun and Song, Weihong, Holdups, Renegotiation, and Termination Fees in Mergers (November 14, 2004). AFA 2005 Philadelphia Meetings. Available at SSRN: https://ssrn.com/abstract=620442 or http://dx.doi.org/10.2139/ssrn.620442

Edith S. Hotchkiss

Boston College - Carroll School of Management ( email )

140 Commonwealth Avenue
Department of Finance Fulton Hall, Room 330
Chestnut Hill, MA 02467
United States
617-552-3240 (Phone)
617-552-0431 (Fax)

Jun Qian (Contact Author)

Fanhai International School of Finance, Fudan University ( email )

Shanghai
China
86-21-63895501 (Phone)
86-21-62934572 (Fax)

HOME PAGE: http://www.fisf.fudan.edu.cn/show-65-69.html

University of Pennsylvania - Wharton Financial Institutions Center

2306 Steinberg Hall-Dietrich Hall
Philadelphia, PA 19104
United States

HOME PAGE: http://fic.wharton.upenn.edu/fic/

Weihong Song

Independent

No Address Available

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