Optimal Toeholds in Takeover Contests
Indiana University - Kelley School of Business - Department of Finance
Shanghai Advanced Institute of Finance(SAIF), Shanghai Jiao Tong University; University of Pennsylvania - Wharton Financial Institutions Center; China Academy of Financial Research (CAFR)
Journal of Financial Economics, Vol. 77, No. 2, pp. 321-346, August 2005
We offer an explanation for why raiders do not acquire the maximum possible toehold prior to announcing a takeover bid. By endogenously modeling the target firm's value following an unsuccessful takeover we demonstrate that a raider may optimally acquire a small toehold even if the acquisition does not drive up the pre-tender target price. This occurs because although a larger toehold increases profits if the takeover succeeds it also conveys a higher level of managerial entrenchment and hence a lower firm value if the takeover fails. We derive new predictions regarding the optimal toehold and target value following a failed takeover. We also examine the impact of a rival bidder and dilution.
Keywords: Toehold, entrenchment, free-rider problem, takeover, tender offer
JEL Classification: G34, D8, K22
Date posted: August 2, 2005