Ample research has focused on bidding behavior and competition dynamics in mergers and acquisitions and how they affect takeover premiums, deal completion rates, and other economic outcomes (e.g., Aktas, de Bodt, and Roll (2010), Boone and Mulherin (2007, 2008), Jennings and Mazzeo (1993), Eckbo (1983), and Ruback (1983)). The analysis of changes in firm valuations around deal announcements is especially important to determining whether the market considers a deal as value-creating or value-destroying.
In a recent paper, I shed light on the private takeover process, the period between the time a deal is initiated and the date it is publicly announced. I contribute to the literature by suggesting a measure for the degree of competition among bidders during this private phase, based on reliable data from hand-selected official SEC EDGAR merger documents (S-4, 14D-9 and/or DEFM14A filings). My proposed measure, the Proposals-to-CA-Ratio, relates the number of private bids for the target to the number of signed confidentiality (non-disclosure) agreements with the target. This conversion ratio accounts for the depth and development of bidding over time and quantifies how great the demand is for a given target.
Historical Sketch and Related Literature
Prior research has characterized the 1980s as a very competitive decade involving often hostile takeovers fueled by high-yield (junk) bonds. One of the most prominent hostile takeovers was, of course, the November 1988 LBO of the tobacco and food products conglomerate RJR Nabisco, Inc., by private equity firm Kohlberg Kravis Roberts & Co. (KKR), valued at $24.53 billion on announcement. In the 1990s, however, perceived competition seems to have decreased, with Andrade, Mitchell, and Stafford (2001) characterizing the prototypical takeover as a friendly transaction with only one bidding firm. In a similar manner, Schwert (2000) argues that anti-takeover devices, such as poison pills and state anti-takeover laws, might have contributed to this “de-hostilization.” Under a traditional measure of competition, such as the number of public bidders for a target, this might be true.
Yet, as more recent studies show, public bids represent only the tip of the iceberg. The private phase of a takeover is remarkably competitive, and research interest in the details of this process has dramatically increased over the last two years. Analyzing a comprehensive sample from 1981 to 2015, Liu, Mulherin, and Brown (2018) show that deal negotiations have moved from the public sphere to the private one, that target boards are much more likely to initiate them, and that the length of the private takeover phase has significantly increased. Building on their findings, Eaton, Liu, and Officer (2020) report that, due to this extended private period, traditional one- and two-month target premium measures significantly underestimate the true premium, i.e., the mark-up paid on top of the stand-alone value of the target, unaffected by any early M&A-related events (e.g., takeover rumors, news articles, media speculation, 13D filings by a potential bidder and/or press releases by the target to seek strategic alternatives/hiring of an investment bank, see Liu and Officer (2020)).
Exploiting a representative sample of 780 public U.S. M&A transactions from 2004-2017, extended with comprehensive hand-collected data from the “background of the merger/tender offer” section in SEC EDGAR filings, I find that greater pre-public competition among bidders leads to higher target takeover premiums and lower announcement returns for the winning bidder in auctions: a one standard deviation increase of the Proposals-to-CA-Ratio corresponds to a statistically and economically significant 5.99 percent increase in the deal initiation premium (Eaton et al. (2020)) and 0.87 percent lower announcement returns for the winning bidder in auctions.
The former result seems logical: The more potential bidders who signed confidentiality agreements with the target and submit a proposal to buy target shares, the higher the demand for the target, and the more likely a higher bid premium.
The latter result does not seem obvious at first glance: It indicates overbidding by the announcing acquirer. Some researchers have suggested that, if pressured by competition, managers may overbid for a target (rational but entrenched CEOs, e.g., de Bodt, Cousin, and Roll (2018)), and some even exhibit “hubris” (overconfidence, Roll (1986)). If they do, shareholders of the acquirer should react negatively on announcement, which is what my results suggest. I find that this effect is even more pronounced if the acquirer bids for a target in a different industry, where the relative synergies are on average lower. In these cases, overbidding for targets might also be caused by less precise valuations made by acquirers.
Concerning post-announcement dynamics, I find that the higher the Proposals-to-CA conversion ratio, the more likely a competing bid by a rival bidder after announcement, and the less likely the consummation of the original bid. These findings are more pronounced if the announcement returns of the original bidder are positive, suggesting that rivals are lured by their belief that the target is probably value-enhancing for the original bidder.
Conclusion and Key Takeaways
In recent years, competition for targets has moved to the pre-announcement phase, shielded from public scrutiny. Notwithstanding its relevance, there is surprisingly little empirical work focusing on pre-public competition and its wealth effects for participating firms. The reason is in part that the unavailability of data makes this private process difficult to study: Widely known M&A databases do not collect detailed data about the private phase of a transaction. As recent studies such as Liu and Officer (2020) and mine show, however, this process is quite competitive, which helps to explain why we commonly observe large takeover premiums despite less perceived public competition since the late 1980s.
My results indicate that target boards fulfill their fiduciary duties by selecting the highest bids. This is consistent with the findings in Liu and Officer (2020), who show that the behavior of target managers in M&A negotiations appears consistent with shareholder wealth maximization rather than systematic agency problems.
The key takeaways are the following:
- Higher pre-public competition is associated with higher deal premiums, lower announcement returns for the winning bidder in auctions, and higher post-bid competition: Publicly announcing a takeover does not necessarily truncate the bidding process;
- Target stock price run-ups start earlier in auctions (approximately four months prior to public announcement) compared with exclusive one-to-one negotiations (where the run-up starts approximately three months prior): The more bidders involved early on, the more likely the leakage of information about the anticipated takeover and its incorporation in target firm’s stock price;
- Consistent with the findings in Liu et al. (2018) and Eaton et al. (2020), researchers and practitioners are advised to employ a premium measure that accounts for the extended private takeover process: to capture the “real” target share price premium paid above target’s stand-alone value, relating the offer per share to the stock price of the target firm one trading day prior to deal initiation (or five-six months prior to announcement, as a general rule) is recommended;
- If deals are structured as auctions, they are often initiated by the target. In one-to-one negotiations, however, the deal is usually initiated by the acquirer: Targets might try to stimulate competition, acquirers might try to suppress it;
- Target premiums are slightly higher in auctions than in one-to-one negotiations, but the difference is not statistically significant: In line with the results of Boone and Mulherin (2007, 2009), there does not seem to be one best way to sell a company.
Aktas, Nihat, Eric de Bodt, and Richard Roll, 2010, Negotiations under the threat of an auction, Journal of Financial Economics 98(2), 241–255.
Andrade, Gregor, Mark Mitchell, and Erik Stafford, 2001, New Evidence and Perspectives on Mergers, Journal of Economic Perspectives 15(2), 103–120.
Boone, Audra L., and J. Harold Mulherin, 2007, How Are Firms Sold?, Journal of Finance 62(2), 847–875.
Boone, Audra L., and J. Harold Mulherin, 2008, Do auctions induce a winner’s curse? New evidence from the corporate takeover market, Journal of Financial Economics 89(1), 1–19.
Boone, Audra L., and J. Harold Mulherin, 2009, Is There One Best Way to Sell a Company? Auctions Versus Negotiations and Controlled Sales, Journal of Applied Corporate Finance 21(3), 28–37.
De Bodt, Eric, Jean-Gabriel Cousin, and Richard Roll, 2018, Empirical Evidence of Overbidding in M&A Contests, Journal of Financial and Quantitative Analysis 53(4), 1547–1579.
Eaton, Gregory W., Tingting Liu, and Micah S. Officer, 2020, Rethinking Measures of Mergers & Acquisitions Deal Premiums, Journal of Financial and Quantitative Analysis, forthcoming.
Eckbo, B. Espen, 1983, Horizontal mergers, collusion, and stockholder wealth, Journal of Financial Economics 11(1–4), 241–273.
Jennings, Robert H., and Michael A. Mazzeo, 1993, Competing Bids, Target Management Resistance, and the Structure of Takeover Bids, Review of Financial Studies 6(4), 883–909.
Liu, Tingting, J. Harold Mulherin, and William O. Brown Jr., 2018, The Development of the Takeover Auction Process: The Evolution of Property Rights in the Modern Wild West, Working Paper, Iowa State University, University of Georgia, and University of North Carolina at Greensboro.
Liu, Tingting, and Micah S. Officer, 2020, Fundamental news, stock-market reactions, and bidding behavior in private merger negotiations, Working Paper, Iowa State University and Loyola Marymount University.
Roll, Richard, 1986, The Hubris Hypothesis of Corporate Takeovers, Journal of Business 59(2), 197–216.
Ruback, Richard S., 1983, Assessing competition in the market for corporate acquisitions, Journal of Financial Economics 11(1–4), 141–153.
Schwert, G. William, 2000, Hostility in Takeovers: In the Eyes of the Beholder?, Journal of Finance 55(6), 2599–2640.
This post comes to us from Richard Schubert, a PhD graduate at Karlsruhe Institute of Technology (KIT). It is based on his recent paper, “Measuring Competition in M&A Negotiations,” available here.