The market for corporate control
Hirshleifer 1995
Takeovers
• mergers
• acquisitions
Tender offers
• conditional/unconditional
• restricted/unrestricted
• unconditional and unrestricted: “any-or-all” offers
A model
Value of target firm
in case of takeover v
in case of no takeover 0
Risk neutrality. No taxes. Conditional offers.
Success of takeover = Control of target firm
= Buying fraction > x of target firm. (Normally, x = 50%.)
Tore Nilssen – Economics of the Firm – Lecture 4 – slide 1

What should a shareholder in the target firm do?
Tender bid (sell share) if: b > Pr(Success of takeover | shareholder sells) v
Is the shareholder pivotal ?
Given the other shareholders’ decisions, if a single shareholder’s decision to sell determines whether the buyer obtains control of the firm, then this shareholder is pivotal .
In practice – many small shareholders: None of them considers herself being pivotal.
Shareholders non-pivotal.
Why should a shareholder sell?
If takeover is successful, then value = v
So do not tender offer unless b ≥ v .
→ Free-rider problem.
0 < b < v : Shareholders retain their shares although, collectively, they would gain from selling.
→ Bidder needs to bid b = v in order to gain control.
[Grossman & Hart, “Takeover Bids, the Free-Rider Problem and the Theory of the Corporation”, Bell Journal of Economics 1980]
Tore Nilssen – Economics of the Firm – Lecture 4 – slide 2

The free-rider property hinges on all shareholders being non-pivotal.
The free-rider problem makes the current shareholders the winners – all the gain from the takeover accrues to them.
This fits well with empirical studies:
• Acquirers’ return from takeovers are close to zero
• Target shareholders’ return from takeovers are abnormal
But: If bidding is costly, then takeovers will not take place.
Gains to the acquirer:
• initial (pre-bid) shareholding
• dilution of minority shareholders’ value
ƒ dilution factor δ
ƒ shareholders tender if b > (1 – δ ) v
Acquirer’s net gain:
α v + (1 – α ) δ v – c B
α c B
= acquirer’s initial shareholding
= bidding costs
Tore Nilssen – Economics of the Firm – Lecture 4 – slide 3

Private information about firm value after takeover
Suppose the acquirer knows v , the post-takeover value of the firm, while current shareholders do not.
Is it possible for the shareholders to deduce this information from the acquirer’s bid?
Two possibilities:
• The bid is the same whatever information the acquirer has – a pooling equilibrium .
• The bid is higher, the higher is v – a separating equilibrium .
Pooling equilibrium: uninformative bidding.
Acquirer’s strategy:
Bid if v ≥ v *
Shareholder’s strategy:
Tender bid if b ≥ b * = E[ v | v ≥ v *]
Tore Nilssen – Economics of the Firm – Lecture 4 – slide 4

Separating equilibrium: informative bidding
Do all shareholders behave the same way?
Suppose, when indifferent, some of them tender, others do not. [Or: mixed strategy]
This leads to the probability of success steadily increasing in the bid: P ( b ), P ’( b ) > 0.
α - intial shareholding of bidder
ω - further shares needed to gain control
Bidder’s expected profit:
π = P ( b )[ α v + ( v – b ) ω ]
First-order condition wrt b :
P ’( b )[ α v + ( v – b ) ω ] – P ( b ) ω = 0
Total differentiation in FOC: d 2 π db dv
= − dbdv d 2 π
= −
"
( ) α v
(
( ) [
) ω
]
− 2
( ) ω
> 0 db 2
→ d b /d v > 0 – Private information revealed by the bid.
Tore Nilssen – Economics of the Firm – Lecture 4 – slide 5

Shareholders indifferent between accepting and not. → b = v
(If b < v , then hold on.)
Insert into FOC:
P ’( b ) α b – P ( b ) ω = 0 →
( )
( )
=
ω
α
1 b
Differential equation.
Boundary condition: ( ) = 1
→
ω
α
• α ↑ → P ↑ : Initial shareholding increases the
• probability of successful takeover
ω ↑ → P ↓ : Tougher control requirements decrease the probability of successful takeover
• v
↓ → P ↑ : More precise information about v increases the probability of successful takeover
Tore Nilssen – Economics of the Firm – Lecture 4 – slide 6

Management defensive strategies
• poison pills , shark repellents
• White mail : The target firm issues a large amount of shares at below-market prices, which the acquiring company will then have to purchase if it wishes to complete the takeover.
• The Macaroni Defense : The firm issues a large number of bonds with the condition they must be redeemed at a high price if the company is taken over.
• Golden-parachute contracts with current management
• Provisions of supermajority (> 50% to gain control).
• Leveraged capitalization : A strategy where a company takes on significant additional debt with the purpose of either paying a large dividend or repurchasing shares.
Defensive measures may or may not be good for current shareholders
may discourage takeovers
but may also encourage a higher bid
Related notions:
reservation price in an auction
monopoly price above marginal costs
Tore Nilssen – Economics of the Firm – Lecture 4 – slide 7

Defensive measures may affect the asymmetry of information
• scorched earth defense : the target firm sells off parts of the firm
reduces the post-takeover value of the firm, making the target firm less attractive
but also affects the informational asymmetry: may make current shareholders less uncertain about v .
Other issues
• revision of bids
makes it difficult to sustain informative equilibrium
costs of revision?
• pivotal shareholders
reduce the free-rider problem
create a scope for profit to the bidder
• competitive bidding
more than one bidder
like an auction
but: in practice, initial bids are high o a lot of information to other bidders in first bid o first bidder bids high to deter other bids
Tore Nilssen – Economics of the Firm – Lecture 4 – slide 8