The Toehold Puzzle
52 Pages Posted: 12 Oct 2005
Date Written: May 2005
Although takeover premiums are large, only 2% of twelve thousand bidders initiating control contests for publicly traded targets acquire target shares (toehold) shortly prior to the bid. We argue that, because toeholds deter competition, toehold bidding may trigger target resistance. If resistance simply means withholding a termination agreement, it takes a toehold of 8% to compensate for the opportunity loss of a typical agreement. As predicted, we find that toehold bidding is significantly more likely when this implied toehold threshold is low. Toehold costs may also arise when target resistance eliminates all bids. We show, however, that the expected marginal toehold effect is positive because toeholds increase the probability of success. Finally, toehold purchases may cause a pre-bid target stock price run-up and increase total takeover costs (markup pricing). However, we find that bidder gains are increasing in both the target run-up and in the toehold. We conclude that friendly bidders appear to abstain from toeholds primarily to avoid toehold-induced target resistance.
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