48 Pages Posted: 26 May 2005 Last revised: 20 Oct 2008
Date Written: October 19, 2008
Surprisingly, bidders rarely acquire a target stake (toehold) prior to launching control bids, despite paying large takeover premiums. At the same time, toeholds are large when they occur, and toehold bidding is the norm in hostile takeovers. To explain these observations, we develop and test an auction-based takeover model in which toeholds antagonize some (rational) targets, causing these to reject merger negotiations. Optimal toeholds are either zero (to avoid rejection costs) or greater than a threshold so that toehold benefits offset rejection costs. We estimate the toehold threshold, which averages as much as 9\% across 10,000 initial control bids for U.S. public targets, and show that the probability of toehold bidding decreases in the threshold estimate as predicted. The threshold model is also consistent with higher toehold frequencies in hostile bids, and with the steady decline in toehold bidding since the 1980s.
Keywords: Bidding strategy, tender offer, merger, toehold, termination fee, bid failure
JEL Classification: G30, G32, G34
Suggested Citation: Suggested Citation
Betton, Sandra and Eckbo, B. Espen and Thorburn, Karin S., Merger Negotiations and the Toehold Puzzle (October 19, 2008). Tuck School of Business Working Paper No. 2005-16; ECGI - Finance Working Paper No. 85/2005; EFA 2006 Zurich Meetings; Journal of Financial Economics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=715601 or http://dx.doi.org/10.2139/ssrn.715601