The Optimal Strategy of the Initial Bidder in Takeover Contests: Theory and Empirical Evidence

Abstract

This paper investigates the optimal bidding strategy for the initial bidder in takeover contests. In the theoretical model, the initial bidder has the choice between making a low or a high preemptive initial bid. Both types of bids can lead to a competitive auction process among bidders, and both information and bidding costs are included in the analysis. Optimal strategies are specified following the Perfect Bayesian Equilibrium. The model predicts notably that the optimal strategy for the initial bidder is to make a high preemptive initial bid. This strategy deters potential bidders to compete for the same target. The empirical implications of the theoretical model are then examined on US data over the period 1990-1995. Among other results, the relation between the level of bid premiums and the degree of competition is found to be dependent on the type of offer, i.e. hostile or friendly.

Keywords: Takeovers, Competitive bidding, Bid premium

JEL Classification: G34, C72