The Market for Corporate Control, Politecnico Di Torino Presentation

Agenda and Core Concepts

The Market for Corporate Control
Riccardo Calcagno
2024-25 Politecnico di Torino - Corporate Governance and Finance - 01TUOPHAgenda

• The main idea and the problems related to it
• Free-riding and market reactions

Agency Considerations

• Agency

Firm Sale Mechanisms

• How firms are sold?

Auction Processes

• Auctions
• Negotiations
• Anti-takeover defensesThe main idea

The Main Idea: Efficient Management and Takeovers

"The lower the stock price, relative to what it could be with more efficient
management, the more attractive the takeover becomes to those who believe
that they can manage the company more efficiently." (Manne, 1965)

• Efficient capital markets discipline management of corporations:
  • Poor managerial decisions are punished by shareholders, who sell their
    shares
  • Stock price declines
  • Cost of capital increases
  • Risk of bankruptcy or risk of being taken over increases
• The threat of takeover acts as an external governance mechanism
  3

Problems with the Takeover Idea

Problem 1: Shareholder Incentives and Value Creation

1. If the target shareholders anticipate the value creation due to
   synergy, they have no incentive to sell at a low price

• Value-enhancing takeovers are not profitable for acquirers

Problem 2: Acquirer Management Goals

1. What if the management of the acquiring company pursue
   goals different from improving efficiency when buying a
   target? (Jensen, 1986)

• Takeovers driven by agency reasons
  4

Free-Riding in Tender Offers

Tender Offer Mechanics

First problem: free - riding
Tender Offer = the acquirer makes a public offer for the target
shares at an offered price p
. Typically: the offer is conditional on the acquirer earning control of the
target (= 50% of the shares)

• Otherwise, the offer is not valid
• Suppose the target is owned by a large multitude of small
  shareholders (dispersed ownership)
• Example: N (very large) shareholders each owning 1 share
• Every shareholder believes the takeover outcome does not depend
  on his choice of tendering or not
• Atomistic or competitive behavior
  Current value of the target share = 10
• Post-takeover share value = 11 > V0

Shareholder Knowledge of Value

• Everybody knows v1
  5

Free-Riding Dynamics

Free - riding

• Probability of the offer being successful = TT
• Expected profit of the shareholder who tenders = pTt
• Expected profit from non-tendering the share = v11
  -> for any fixed It independent of shareholder' action, not to tender
  is optimal whenever p < v1
  . Alternatively: with p < 11 not-tender is weakly dominant:

	Offer successful	Offer not successful
Tender	p	0
Not tender	V1	0

• The individual shareholder tenders only if p ≥ 11 (he/she "free-
  rides" on other shareholders who tender their shares)
  " But if p ≥ 11 the bidder cannot make a profit!
  6

Shareholder Expectations and Dominance

Free - riding

• Strange result ... let us assume shareholders do not know v1
  . They know that a rational bidder offers p < 11. Given the observed
  offered price p they expect a post-takeover value equal to:
  E [V1/V1 > p] >p
• Not to tender is again weakly dominant:

	Offer successful	Offer not successful
Tender	d	0
Not tender	E[V1/V1 > p] >p	0

7

Free-Riding and Toeholds

Successful Tender Offers and Bidder Ownership

Free-riding and Toeholds

• But we do observe some successful tender offers!
• Suppose the bidder owns a quota a < 0.5 of the target before
  making the offer (toehold)
• It launches a tender offer conditional on buying (0.5 - a) shares of
  the target
  Now the bidder can offer p > 11 and make profits:
• Profit of the bidder if offer is successful:
  0.5v1-(0.5- a)p >0
  0.5
  p ‹
  0.5 - a
  V1

Aggressive Bidding and Hostility

• Toeholds induce «aggressive» bidding
  . Sometimes viewed as hostile: need to report to the regulator
  8

Toehold Statistics

Free-riding and Toeholds

• About 10% of 10,000+ initial bidders have a toehold (mostly
  long-term shareholders)
• About 2% of initial bidders purchase toeholds during the 6-months
  leading up to the bid
• When positive, toeholds are large (15%)
• When offer is hostile, 50% of them have toeholds
  9

Instant Polls and Free-Riding Solutions

Costly Tender Offers

Instant Polls

• Suppose that to organize a tender offer is costly. The cost (per-share)
  equals c > 0. Does this induce the (atomistic) shareholder to tender
  its shares for an offer price p < 11?Free - riding and leverage

Leverage Buyouts (LBOs)

• Another way to solve the free-riding problem and to facilitate
  takeovers: leverage through LBOs
  . A way to dilute current shareholders if takeover succeeds
• How does it work? The bidder sets up a holding, with mostly debt (e.g. d per
  share of the target)
• Uses the proceeds to launch an offer on the target (conditional on
  success)
• Merges Target with the holding if the offer succeeds
• Payoffs of the Target shareholder:

	Offer successful	Offer not successful
Tender	d	0
Not tender	V1 - d	0

10

Rational Shareholder Behavior with Leverage

Free-Riding and Leverage
A rational shareholder of the target company tenders his share to the
bidder if:
p≥11-d

• Offers with
  V1-d ≤p <v1
  are successful and profitable for the bidder!First problem more in general: market reactions

Market Reactions to Takeovers

Capital Market Discipline

• Remember the main idea:
• Efficient capital markets discipline management of corporations:
  • Poor managerial decisions are punished by shareholders, who sell their
    shares
  • Stock price declines
  • It becomes more likely that an alternative management team (= another
    company) takes over the target and replace the inefficient management
    . If the capital market is able to forecast the improvement in the
    target performance after a takeover, the target stock price
    increases, even if the current management is underperforming
    11

Case Study: Allergan Acquisition

Allergan Inc. Acquired by Actavis PLC - Feb 2015
AGN 160.66
YAHOO!
FINANCE
300.00
250.00
200.00
150.00
140.33
100.00
50.00
DDDDDD DD DD DD DD DD DD DD DD DD DD DD DD DD DD DD DD DD DD DD DD DD DIIDD DDDD DD DD DD DDDD DD DD DD DDDD DD DD DDDD DD DD DDDDD
DDDDDDDD I
0.00
4.38M
89
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
201
350.00
12

Impact of Efficient Markets on Acquisition Costs

Market reactions
. If the capital market is able to forecast the improvement in the
target performance after a takeover, the target stock price
approaches its post-deal valuation even before the acquisition is
completed

• Takeovers become then very expensive (or even not profitable)
  for acquiring companies
  The more "efficient" is the financial market, the more expensive the deal
  for the acquirer
  13

Bidder Gains Analysis

Bidders' gains are very small on average
D: Aggregate dollar abnormal returns
50
0
Billions, constant 2000 $
-50
-100
3 -150 -
-200
-250
1
-300
1980
1985
1990
1995
2000
2005
Year of initial control bid
14

Average Cumulative Abnormal Stock Returns

Bidders' gains are very small on average
% average cumulative abnormal stock returns to targets and initial bidders from
day -40 through day 10 relative to initial control bid
28%
23%
18%
13%
8%
3%
-2%
40
-35
-30
-25
-20
-15
-10
-5
0
5
10
MARRE Bidder, private target (N=9,480)
Bidder, public target (N=6,210)
Target, private bidder (N=3,017)
Target, public bidder (N=5,193)
.. ..
15

Summary of Market Anticipation Effects

Summarizing

• If the stock market anticipates the increase in target value due to a
  takeover generating synergies, the target stock price increases
  before such a takeover takes place
• Two consequences:
  1. The target stock price might not decline even in periods of 'bad'
     management
  2. Acquiring public companies is extremely expensive, often unprofitable
     even for acquirers who can generate value through the acquisition
     16

Second Problem: Agency Reasons for Takeovers

Second problem: Agency

• What if the management of the acquiring company pursue
  goals different from improving efficiency when buying a
  target? (Jensen, 1986)
• Takeovers driven by agency reasons (see lecture on M&As)
  17

Agenda and Takeover Process Overview

Agenda
" The main idea and the problems related to it
" Free-riding and market reactions

• Agency
• How firms are sold?
  • Auctions
• Negotiations
• Anti-takeover defensesThe takeover process in general

Stages of Takeover Process

Private Takeover Process
Public Takeover Process
Private initiation
Public announcement
Resolution
(Completion)
Initiation (by seller or by bidder)
Bidders expressing interest (IOIs) sign
confidentiality agreements
Other contractual elements:

• standstill agreements
• termination fees
  Formal bids are submitted
  Preparation of the final offer
  The offer period for shareholders to
  accept
  Legal and regulatory documents
  25

Private Phase: Auctions and Negotiations

Auctions in Takeovers

Private phase: auctions and one-to-one negotiations

1. Auctions: the target firm receives more than one formal offer

• Selling firm hires an investment banker and considers the number of
  potential bidders to contact
  More than one bidder submits a binding offer
• Auctions are used both in seller- and in buyer-initiated deals

One-to-One Negotiations

1. One-to-one negotiations: the target receives only one formal offer

• Other bidders might have expressed IOI, signed confidentiality agreements,
  made non-binding offers
  48

Other Takeover Processes

Tender Offers

1. Tender offers: the acquirer makes a public offer to the target's
   shareholders to acquire their shares at a stated price (above the
   current market price). Tender offers tend to be hostile to the target
   management
   A tender offer allows a bidder to bypass the target's board
   of directors and seek approval directly from shareholders

Proxy Contests

1. Proxy contests (proxy fights): the acquirer asks target shareholders
   to elect a board proposed by the acquirer to replace the incumbent
   board
   If elected, the new board will disable the antitakeover
   defenses and allow the acquisition to go forward
   26

Economic Theory of Negotiations and Auctions

Focus on one-to-one negotiations and
auctions

• Can we learn something about these processes looking at
  the economic theory?
• Auctions: auction theory
• One-to-one negotiations: bargaining theories
  28

Auctions: A Brief Introduction

Auction Mechanisms and Types

Auctions: a brief introduction

• (In general) Sale mechanism: First-Price, Second-Price, Ascending
  or Descending price, many others ...
• One-Unit and Multi-Unit
• Private value and common value auctions
  49

Takeover Auction Characteristics

Takeover Auctions

• Very «free» protocol -> difficult to categorize and to model
• Private-value or common-value?
• They all have one important characteristics: the value of the outside option
  matters
  . Let's play some auctions
• The value of the target (= the object which is sold) for any individual bidder is independent of
  every other bidder's valuation: you are bidder i and your own valuation equals vi
• Example: synergies with the target are unique to each bidder
• The auction is an ascending price (= English) auction
• Quitting the auction has economic consequences for the bidder (e.g. a competitor may buy
  the target, the bidder can use the funds for another acquisition)
  50

Optimal Bidding Strategy

Outside option value = 0

• Bid!
• Suppose b < vi. Quit or stay?
• Stay. Quitting you get zero profit. Staying (as long as b < vi) gives you the chance of winning
  and making a profit
• Suppose b > Vi. Quit or stay?
• Quit. Bidding b > Vi implies a loss if you win and zero profit if you lose
• Optimal bid: b = vi
• The most efficient (= highest valution) bidder wins
  51