Holdups, Renegotiation, and Deal Protection in Mergers

48 Pages Posted: 22 Apr 2005

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

Multiple version iconThere are 3 versions of this paper

Date Written: July 2005

Abstract

This paper examines the contracting and negotiation process in mergers using an incomplete contracts framework. Our multi-period model allows for the arrival of new information and renegotiation subsequent to the signing of an initial merger agreement but prior to deal completion or termination. We show that a properly designed initial contract solves the holdup problem during renegotiation and induces higher deal-specific effort that increases expected payoffs from the merger. The contract grants an option to the target to terminate the merger, while the strike on the option compensates the acquirer's effort without imposing excessive costs on the target for pursuing non-merger alternatives. The option strike can be implemented by the use of deal protection devices, such as a target termination fee or an acquirer lockup. Employing a large sample of stock mergers, we find evidence supporting model predictions for the renegotiation of contracts, deal outcomes, and the use of deal protection devices.

Keywords: Holdup, renegotiation, merger, deal protection, termination fee, lockup.

JEL Classification: G34, C71, D8

Suggested Citation

Hotchkiss, Edith S. and Qian, Jun and Song, Weihong, Holdups, Renegotiation, and Deal Protection in Mergers (July 2005). Available at SSRN: https://ssrn.com/abstract=705365 or http://dx.doi.org/10.2139/ssrn.705365

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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