Inside the Black Box of Private Merger Negotiations

Several authors (Boone and Mulherin, 2007[1]; Aktas, de Bodt, and Roll, 2010[2]) have noted a paradox in the mergers and acquisition (M&A) market since 1990. While there have been few competing public bidders, hostile offers, or public-offer price revisions, the average premiums paid to acquire target firms have been substantial. On the surface, the combination of friendly deals and high premiums seems puzzling, given that target management is more likely to negotiate private benefits at a cost to shareholders in friendly deals, while hostile offers are more likely to induce multiple-bidder auctions, which should theoretically yield higher premiums.

In a seminal paper in the M&A literature, Boone and Mulherin (2007) argue that competition to acquire a target occurs largely out of the public eye (at least in real time). Specifically, Boone and Mulherin show that, while there is relatively little public competition to buy a given target, there appears to be relatively robust competitive bidding in what the authors call the “pre-public” period before the public merger announcement in about half of all deals. Boone and Mulherin (2007) do not, however, provide perspective on how bidding proceeds in this pre-public phase of an acquisition, and this is the main contribution of our paper: Describing how, on average, bidding for the target evolves during this period shielded from public scrutiny.

We hand-gather data from SEC filings about the pre-public deal process for 1,324 acquisitions from 1994 to 2016 and collect both the incidence and value of bids submitted for the target in this pre-public phase. In the majority of the deals in our sample, the bidder submits its (non-binding) first offer for the target after signing a confidentiality agreement, accessing confidential information about the target firm, and having had (on average) more than 100 calendar days following deal initiation to evaluate the target. In other words, in the vast majority of cases, these bids, even though made in private and non-binding, are made following substantive analysis of the target by the bidder.  Consistent with the existing literature (Boone and Mulherin, 2007) we interpret these factors as indications of the commitment of both the bidder and target to the sale process, and the resulting veracity (or seriousness) of the submitted bids.

Similar to Boone and Mulherin (2007), we find each of the “auctions” and “negotiation” categories represents approximately half our sample. Auctions have significantly longer windows of time in the pre-public phase (199 days) relative to “negotiations” (134 days). Conversely, negotiations have longer windows of time between the first public announcement of a bid and the closing of the deal. The longer behind-closed-doors process for auctions and the longer period of time under the watchful eye of the markets for negotiations are potentially caused by the dissolution of the board’s fiduciary duty, which is more obvious following the private phase of an auction deal and therefore less time needs to be spent convincing shareholders that all possible price discovery has been exhausted.

What really distinguishes our paper from the existing literature (e.g., Boone and Mulherin, 2007) is that we keep track of the prices offered by the various bidders at various points in the pre-public deal process. While takeover price revisions during the public phase of bidding are relatively rare (we observe these in only 11 percent of cases in our sample), in the private negotiation window, before bids are known to the market, we observe takeover price revisions for well over 80 percent of the deals in our sample. The magnitude of bid revisions in the private phase of negotiations is also much larger (9 percent on average) compared with the magnitude of price revisions after the first public bid is made for a target firm (1 percent on average). Our evidence shows that there is clearly substantial price discovery in the pre-public phase of a deal’s life.

We next investigate potential determinants of price revisions during the pre-public phase of a deal. We first consider whether changes in the public-market value of the target during this period when private negotiations over the acquisition of that firm are taking place affects private bid revisions. By the nature of our data, all our targets are publicly traded firms: Thus, we can measure changes in public-market values after the submission of the first private bid and before the public announcement of the deal. We find that price revisions during the private negotiation window are significantly correlated with changes in target public-market values. While we acknowledge that, in theory, causality could go in either direction, we believe that the practicalities of the M&A market suggest a causal interpretation of this result. Because these bids are not known to the market during this pre-public window, and the market reacts to the bid when it is finally announced to the public, it is very unlikely that changes in the public-market value of the target’s stock in this pre-public window are being driven by the precise knowledge of bid revisions.

To further alleviate any concern about reverse causality, however, we form a sub-sample where the target firm has an earnings announcement after the first private bid submission but before the public announcement of the winning bid, and investigate how public-market value changes in the three days centered on that earnings release affects private bid revisions. We find strong evidence that public-market value changes around earnings announcement dates are significantly associated with private bid revisions. This result further increases our confidence that reverse causality is not likely to drive our results, because the three-day public-market value change around an earnings release is almost surely driven by the earnings announcement. When separating earnings releases into positive versus negative earnings shocks, we find that among the positive earnings subgroup, a 1 percent increase in public-market value around an earnings announcement during private takeover negotiations is associated with an approximately 0.8 percent increase in the private bid price. However, we do not find that bidders are able to reduce private offer prices following negative public-market value changes around earnings releases. Our interpretation of these results is that (at least on average) bidders increase their private offer prices in response to positive changes in the public-market value of target firms in the pre-public window (but are not able to negotiate their private prices downward in response to negative news).

Next, we investigate whether the nature of the bid process (auction vs. negotiation) has an impact on takeover price revisions in the pre-public phase of a deal. Interestingly, bids that are defined as auctions have significantly lower takeover price revisions (by three percentage points) in the private deal phase relative to bids that are defined as negotiations. Our interpretation of this evidence is that, even in bidding that is shielded from public view, bidders appear to bring competitive offers to the table for targets when they know the bidding process is competitive and are therefore less likely to need or want to raise those offers in competition with other bidders. On the other hand, the nature of the bid process does not seem to significantly affect the public phase of the life of a deal.

In the last part of our paper, we explicitly examine bids that are initiated privately by a bidder other than the winning bidder. These deal processes are relatively controversial in the academic literature. On one hand, these are amongt the most (privately) competitive deals we observe in our sample, as judged by number of bidders that the target’s investment banker contacts and the proportion of those bidders that move on in a tangible way in the bid process. In traditional auction theory, greater competition results in higher bid prices, and so we might expect to observe higher publicly-revealed deal prices in these auctions. On the other hand, another stream of literature suggests that managerial entrenchment after 1990 frequently caused target managers to seek out white knight bidders to secure private benefits, in the process sacrificing takeover premiums for their shareholders (e.g., Bebchuk, Coates and Subramanian, 2002[3]; Moeller, 2005[4]).

We show that the effect of competition prevails in the private bid period. On average, takeover premiums measured using the first publicly-revealed bid price for a target are 23 percent higher than premiums measured using initial private bid prices in the auctions initiated by third-party (i.e., non-winning) bidders. In other words, the process of finding an alternative bidder to buy a firm appears to increase the value provided to target shareholders by 23 percent on average. These results are inconsistent with the notion that target managers are systematically entrenched and seeking white knight bidders to meet their own preferences while sacrificing wealth for their own shareholders.


[1] Boone, Audra L., and J. Harold Mulherin, 2007. “How are firms sold?” Journal of Finance 62, 847-875.

[2] Aktas, Nihat, Eric de Bodt, and Richard Roll, 2010. “Negotiations under the threat of an auction.” Journal of Financial Economics 98, 241-255.

[3] Bebchuk, Lucian Ayre, John C. Coates IV, and Guhan Subramanian, 2002. “The powerful antitakeover forces of staggered boards: Theory, evidence and policy.” Stanford Law Review 54, 887-951.

[4] Moeller, Thomas, 2005. “Let’s make a deal! How shareholder control impacts merger payoffs.” Journal of Financial Economics 76, 167-190.

This post comes to us from Professor Tingting Liu of Iowa State University and Professor Micah S. Officer at Loyola Marymount University. It is based on their recent paper, “Inside the ‘Black Box’ of Private Merger Negotiations,” available here.