Toehold Strategies, Takeover Laws and Rival Bidders
Journal of Banking and Finance
Posted: 14 Feb 1999
There are 2 versions of this paper
Toehold Strategies, Takeover Laws and Rival Bidders
Abstract
Prior to a takeover bidders have the option to purchase a toehold in the target firm at market prices. Yet, despite the availability of this option empirical studies show that in many cases firms purchase very small or no toeholds. This is somewhat puzzling since current theoretical models indicates that this is suboptimal. Why do bidders routinely ignore what appears to be a readily available profit opportunity? This paper proposes an answer via a detailed analysis of the legal environment in which tender offers take place. Essentially, toeholds drive up the preoffer price which in turn drives up the legally required "clean up" price, that is the price paid for shares that are not taken up in the initial tender offer. As a result, we show that firms will purchase toeholds only if rival bidders are expected. Comparative statics demonstrate how optimal toeholds change in response to changes in the legal and economic environment. The paper also shows that toeholds provide the initial bidder with both low cost shares and insurance in the event that a rival bidder enters and purchases the target. However, the while toeholds do provide some insurance to losing bidders it is incomplete. Initial bidders always do better when a rival does not appear. Further analysis of the model also shows that "fair price" provisions always allow the most efficient rival to win a takeover battle, despite any toeholds the first bidder may have. Finally, using simulations, we show how some of the more puzzling results in the empirical literature can be explained by the model. For example, there appears to exist a negative correlation between toeholds and stock prices. The simulations show that this may be due to correlations among the model's deeper parameters that have not been controlled for in the current empirical literature.
Note: This is a description of the paper and is not the actual abstract.
JEL Classification: G3, G34
Suggested Citation: Suggested Citation