A Bargaining Model of Friendly and Hostile Takeovers

AuthorYolanda Portilla,Gino Loyola
Published date01 June 2016
Date01 June 2016
A Bargaining Model of Friendly and
Hostile Takeovers
Department of Management Control, University of Chile, Santiago, Chile, and
School of Economics and Business, Catholic University of Chile, Santiago, Chile
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 benets, toehold
size, and breakup fees. Also established by the model are the conditions for
an efcient takeover. The proposed framework of strong management inu-
ence on takeover outcome, an alternative modeling of hostility and the
adoption of a negotiation procedure, rather than an auction setup with
strong shareholder inuence 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 classication: C72; D44; D82; G32; G34
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 managements trade-off between the higher
surplus it could extract from a hostile raider and the private control benets
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 managements response to a merger
© 2016 International Review of Finance Ltd. 2016
International Review of Finance, 16:2, 2016: pp. 291306
DOI: 10.1111/ir.12073
invitation (Betton et al. 2009), our formulation considers the buyers initial intentions
regarding the continuation or elimination of managementsprivatebenets.
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 managements 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 inuence 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 benets 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 efciencyissues. 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.
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
(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
as the value that
buyer iassigns to running the rm, 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 ts 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 nancial 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 justication
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

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