When Do Bidders Purchase a Toehold? Theory and Tests

Most of the theoretical literature on tender offers has been devoted to illustrating the positive effects of the toehold on the bidder's profits. Empirical research, however, shows that a high proportion of bidders do not trade on the target's shares prior to the tender offer announcement. This paper presents a model in which the bidder trades in the open market before announcing a tender offer and the incumbent shareholders form beliefs about the rival's quality given the order size. Market liquidity allows the potential bidder to partially hide her trade, and thus insiders are not able to ascertain whether an increase in volume indicates toehold acquisition. Stock price prior to the announcement date and market perception about the probability of a takeover are therefore contingent on players actions. We show that in some situations no trade will be optimal, and a negative relationship between takeover premium and toehold size arises. Interestingly, stock liquidity and initial stake are positively related. Our results also provide a theoretical basis for the observed pre-bid stock price dynamics. In particular, we show that the ratio between price runup and bid premium is increasing in the toehold size. The model's implications are then tested with a sample including tender offers in the US and the UK, estimating a bivariate generalization of the tobit model. We find a broad support for the model and significant differences across countries. We show that toeholds and probability of an acquisition are negatively related, and that companies in which the appropriation of private benefits of control is more