Merger negotiations and the toehold puzzle
The substantial control premium typically observed in corporate takeovers makes a compelling case for acquiring target shares (a toehold) in the market prior to launching a bid. Moreover, auction theory suggests that toehold bidding may yield a competitive advantage over rival bidders. Nevertheless, with a sample exceeding 10,000 initial control bids for US public targets, we show that toehold bidding has declined steadily since the early 1980s and is now surprisingly rare. At the same time, the average toehold is large when it occurs (20%), and toeholds are the norm in hostile bids. To explain these puzzling observations, we develop and test a two-stage takeover model where attempted merger negotiations are followed by open auction. With optimal bidding, a toehold imposes a cost on target management, causing some targets to (rationally) reject merger negotiations. Optimal toeholds are therefore either zero (to avoid rejection costs) or greater than a threshold (so that toehold benefits offset rejection costs). The toehold threshold estimate averages 9% across initial bidders, reflecting in part the bidder's opportunity loss of a merger termination agreement. In the presence of market liquidity costs, a threshold of this size may well induce a broad range of bidders to select zero toehold. As predicted, the probability of toehold bidding decreases, and the toehold size increases, with the threshold estimate. The model also predicts a relatively high frequency of toehold bidding in hostile bids, as observed. Overall, our test results are consistent with rational bidder behavior with respect to the toehold decision.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Betton, Sandra & Eckbo, B Espen, 2000. "Toeholds, Bid Jumps, and Expected Payoffs in Takeovers," Review of Financial Studies, Society for Financial Studies, vol. 13(4), pages 841-82.
- Bargeron, Leonce & Schlingemann, Frederick & Stulz, Rene & Zutter, Chad, 2007.
"Why Do Private Acquirers Pay So Little Compared to Public Acquirers?,"
Working Paper Series
2007-8, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
- Bargeron, Leonce L. & Schlingemann, Frederik P. & Stulz, René M. & Zutter, Chad J., 2008. "Why do private acquirers pay so little compared to public acquirers?," Journal of Financial Economics, Elsevier, vol. 89(3), pages 375-390, September.
- Leonce Bargeron & Frederik Schlingemann & Rene M. Stulz & Chad Zutter, 2007. "Why Do Private Acquirers Pay So Little Compared to Public Acquirers?," NBER Working Papers 13061, National Bureau of Economic Research, Inc.
- Sanford J. Grossman & Oliver D. Hart, 1980. "Takeover Bids, the Free-Rider Problem, and the Theory of the Corporation," Bell Journal of Economics, The RAND Corporation, vol. 11(1), pages 42-64, Spring.
- Shleifer, Andrei & Vishny, Robert W., 1986.
"Large Shareholders and Corporate Control,"
3606237, Harvard University Department of Economics.
- Hirshleifer, David & Titman, Sheridan, 1990. "Share Tendering Strategies and the Success of Hostile Takeover Bids," Journal of Political Economy, University of Chicago Press, vol. 98(2), pages 295-324, April.
- Officer, Micah S., 2003. "Termination fees in mergers and acquisitions," Journal of Financial Economics, Elsevier, vol. 69(3), pages 431-467, September.
- Eckbo, B. Espen & Thorburn, Karin S., 2009. "Creditor financing and overbidding in bankruptcy auctions: Theory and tests," Journal of Corporate Finance, Elsevier, vol. 15(1), pages 10-29, February.
- Jeremy Bulow & Ming Huang & Paul Klemperer, 1999.
"Toeholds and Takeovers,"
Journal of Political Economy,
University of Chicago Press, vol. 107(3), pages 427-454, June.
- Jeremy Bulow & Ming Huang & Paul Klemperer, 1996. "Toeholds and Takeovers," Finance 9608001, EconWPA.
- Paul Klemperer & Jeremy Bulow, 1998. "Toeholds and Takeovers," Economics Series Working Papers 1998-W04, University of Oxford, Department of Economics.
- Bulow, Jeremy I. & Huang, Ming & Klemperer, Paul, 1996. "Toeholds and Takeovers," CEPR Discussion Papers 1486, C.E.P.R. Discussion Papers.
- Jeremy Bulow & Ming Huang & Paul Klemperer, 1999. "Toeholds and Takeovers," Finance 9903005, EconWPA.
- Goldman, Eitan & Qian, Jun, 2005. "Optimal toeholds in takeover contests," Journal of Financial Economics, Elsevier, vol. 77(2), pages 321-346, August.
- Comment, Robert & Schwert, G. William, 1995.
"Poison or placebo? Evidence on the deterrence and wealth effects of modern antitakeover measures,"
Journal of Financial Economics,
Elsevier, vol. 39(1), pages 3-43, September.
- Robert Comment & G. William Schwert, 1993. "Poison or Placebo? Evidence on the Deterrent and Wealth Effects of Modern Antitakeover Measures," NBER Working Papers 4316, National Bureau of Economic Research, Inc.
- Audra L. Boone & J. Harold Mulherin, 2007. "How Are Firms Sold?," Journal of Finance, American Finance Association, vol. 62(2), pages 847-875, 04.
- Bris, Arturo, 2002. "Toeholds, takeover premium, and the probability of being acquired," Journal of Corporate Finance, Elsevier, vol. 8(3), pages 227-253, July.
- Burkart, Mike, 1995. " Initial Shareholdings and Overbidding in Takeover Contests," Journal of Finance, American Finance Association, vol. 50(5), pages 1491-1515, December.
- Ravid, S. Abraham & Spiegel, Matthew, 1999. "Toehold strategies, takeover laws and rival bidders," Journal of Banking & Finance, Elsevier, vol. 23(8), pages 1219-1242, August.
- Jennings, Robert H & Mazzeo, Michael A, 1993. "Competing Bids, Target Management Resistance, and the Structure of Takeover Bids," Review of Financial Studies, Society for Financial Studies, vol. 6(4), pages 883-909.
- Walkling, Ralph A., 1985. "Predicting Tender Offer Success: A Logistic Analysis," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(04), pages 461-478, December.
- Kathleen Fuller & Jeffry Netter & Mike Stegemoller, 2002. "What Do Returns to Acquiring Firms Tell Us? Evidence from Firms That Make Many Acquisitions," Journal of Finance, American Finance Association, vol. 57(4), pages 1763-1793, 08.
- Sudipto Dasgupta & Kevin Tsui, 2004. "Auctions with cross-shareholdings," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 24(1), pages 163-194, 07.
- Eckbo, B. Espen & Langohr, Herwig, 1989. "Information disclosure, method of payment, and takeover premiums : Public and private tender offers in France," Journal of Financial Economics, Elsevier, vol. 24(2), pages 363-403.
- Fishman, Michael J, 1989. " Preemptive Bidding and the Role of the Medium of Exchange in Acquisitions," Journal of Finance, American Finance Association, vol. 44(1), pages 41-57, March.
- Burch, Timothy R., 2001. "Locking out rival bidders: The use of lockup options in corporate mergers," Journal of Financial Economics, Elsevier, vol. 60(1), pages 103-141, April.
When requesting a correction, please mention this item's handle: RePEc:eee:jfinec:v:91:y:2009:i:2:p:158-178. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.