A Bargaining Model of Friendly and Hostile Takeovers

• Author: Yolanda Portilla,Gino Loyola
• Published date: 01 June 2016
• Date: 01 June 2016
• DOI: http://doi.org/10.1111/irfi.12073

A Bargaining Model of Friendly and

Hostile Takeovers

GINO LOYOLA

†

AND YOLANDA PORTILLA

‡

†

Department of Management Control, University of Chile, Santiago, Chile, and

‡

School of Economics and Business, Catholic University of Chile, Santiago, Chile

ABSTRACT

A bargaining model is developed that characterizes the conditions under

which a takeover will either be friendly, hostile, or unsuccessful when the

target management can tilt the selling procedure toward a white knight.

The conditions considered mainly involve private control benefits, toehold

size, and breakup fees. Also established by the model are the conditions for

an efficient takeover. The proposed framework of strong management influ-

ence on takeover outcome, an alternative modeling of hostility and the

adoption of a negotiation procedure, rather than an auction setup with

strong shareholder influence as in most of the existing literature, delivers

new insights into the US market of corporate control, which are consistent

with the available evidence.

JEL classification: C72; D44; D82; G32; G34

I. INTRODUCTION

This article proposes a simple sequential bargaining model under complete

information, which characterizes the determinants of the takeover premium

and the conditions under which a takeover may be either friendly, hostile, or

unsuccessful. A central role in these results is played by two factors: (i) the level

of breakup fees and (ii) the target management’s trade-off between the higher

surplus it could extract from a hostile raider and the private control benefits

it would retain with a white knight buyout. Our model delivers testable impli-

cations, which are consistent with the evidence from the US market for corpo-

rate control in recent decades.

Existing theoretical works differ from our setup in three crucial aspects. First,

most of the received literature adopts an auction-based rather than a bargaining-

based procedure to model a takeover process (Loyola 2012a; Dasgupta and Tsui

2003; Hansen 2001), which is surprising given that according to the evidence,

at least half of takeovers are conducted under a negotiation format (Aktas et al.

2010; Boone and Mulherin 2007b). Second, whereas previous analyses classify

a hostile/friendly takeover only by the target management’s response to a merger

© 2016 International Review of Finance Ltd. 2016

International Review of Finance, 16:2, 2016: pp. 291–306

DOI: 10.1111/irfi.12073

invitation (Betton et al. 2009), our formulation considers the buyer’s initial intentions

regarding the continuation or elimination of management’sprivatebenefits.

Third, although the theoretical studies that most closely resemble our

approach have developed more complex bargaining frameworks than ours, such

models implicitly assume a strong corporate governance system in which either

shareholders and management’s interests are completely aligned (Dimopoulos

and Sacchetto 2014) or shareholders play an active role in the selling procedure

via an approval stage or a tender offer (Berkovitch and Khanna 1991; Calcagno

and Falconieri 2014). In contrast, we assume that takeovers are conducted under

a weak corporate governance environment in which the incumbent manage-

ment shapes the rules of the selling procedure in favor of its interest and exerts

a larger influence on the decision regarding which class of bidder (hostile or

friendly) the target is ultimately assigned to.

As a result of these differences from existing analyses, our simple negotiation

model is able to generate new insights and more direct implications regarding

the following: (i) the role played by private control benefits in determining take-

over premiums; (ii) the decline of both hostile and failed takeovers in the USA

over the last few decades; and (iii) the effects of breakup fees, managerial incen-

tives, and toeholds on these outcomes and their dynamics.

This paper proceeds as follows. Section II presents our takeover bargaining

model. Section III characterizes the equilibrium target premium and conditions

under which a takeover eventually either fails, is friendly or is hostile, and also

examines efficiencyissues. Section IV develops a comparative analysis with closely

related works,stressing the main contributionsof the model here proposed. Finally,

Section V discusses the empirical implications of our theoretical model for the US

corporate control market. All the proofs are collected in the Appendix.

II. A TAKEOVER NEGOTIATION GAME

Consider a company facing a takeover attempt from two possible risk-neutral

buyers, Aand B. The value of fully controlling the target to buyer iis v

i

∈(0, 1],

i=A,B. Because we assume that this value is common knowledge, the setup pre-

sented here is one of complete information. We interpret v

i

as the value that

buyer iassigns to ‘running the firm’, that is, an individual synergy iobtains from

taking over the target company and securing absolute control of it. Because this

synergy is idiosyncratic and not available to other buyers, our setting is one of

private values that fits well with strategic bidders (e.g., competitors, suppliers,

and customers) competing for a target. This contrasts with a common values

environment that better represents a takeover contest in which financial bidders

(e.g., private equity funds) can exploit gains available to all other bidders such as

cost-cutting, leverage restructuring, or selling off noncore assets. A justification

for this private values assumption is related to the timing of the takeover game

we adopt (detailed in the succeeding sections), in the sense that the process is

initiated by a buyer (not the target). On this point, Fidrmuc et al. (2012) report

International Review of Finance

© 2016 International Review of Finance Ltd. 2016292