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Merger Negotiations and the Toehold Puzzle

48 Pages Posted: 26 May 2005 Last revised: 20 Oct 2008

Sandra Betton

Concordia University, Quebec - Department of Finance

B. Espen Eckbo

Tuck School of Business at Dartmouth; European Corporate Governance Institute (ECGI)

Karin S. Thorburn

Norwegian School of Economics; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Date Written: October 19, 2008

Abstract

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

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

Sandra Betton

Concordia University, Quebec - Department of Finance ( email )

Montreal, Quebec H3G 1M8
Canada
514-848-2783 (Phone)
514-848-4500 (Fax)

B. Espen Eckbo (Contact Author)

Tuck School of Business at Dartmouth ( email )

Hanover, NH 03755
United States
603-646-3953 (Phone)
603-646-3805 (Fax)

HOME PAGE: http://www.tuck.dartmouth.edu/eckbo

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Karin S. Thorburn

Norwegian School of Economics ( email )

Helleveien 30
N-5045 Bergen
Norway
+4755959283 (Phone)

HOME PAGE: http://www.nhh.no/cv/thorburn

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

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