Strategic and Financial Bidders in Takeover Auctions

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Wednesday April 14, 2010 at 9:30 am
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Editor’s Note: This post comes to us from Alexander Gorbenko, Ph.D. Candidate at Stanford University (Assistant Professor of Finance at the London Business School beginning in August of 2010), and Andrey Malenko, Finance Ph.D. Candidate at Stanford University.

In the paper, Strategic and Financial Bidders in Takeover Auctions, which was recently made publicly available on SSRN, we propose a structural empirical model of a takeover auction that studies asymmetries between strategic and financial bidders. A large portion of deals in the multi-trillion market for takeovers are done through the competitive auction. In these cases, the target has to decide on the set of participating bidders and the selling procedure. This task is complicated by the fact that potential bidders are asymmetric. Specifically, both academic and business literatures recognize two major groups of bidders, strategic and financial, that seem to be very different in their bidding and participation decisions. This paper studies how the two groups of bidders differ with respect to valuations of potential takeover targets and costs of participation in takeover auctions, and how these differences affect the outcome of a takeover auction. Understanding bidder asymmetries is an important step towards designing an optimal selling procedure for each particular target.

The standard data on takeover premiums alone is insufficient to estimate the average bidder valuations due to the sample selection problem. To overcome this problem, we manually collect data from SEC filings on formal and informal bids of all participating bidders, and their types (financial or strategic). We use these data to estimate the sensitivities of the bidders average valuations to the observed target characteristics and compute the magnitudes of the unobserved components. Our main findings are as follows. First, on average, strategic bidders value targets more than financial bidders. Specifically, an average strategic bidder is willing to pay a premium of 16.7% to the market value of the target, while the same number for an average financial bidder is 11.7%. Second, relative to the value of the target under the current management, financial bidders are willing to pay more for companies with low cash flows, as well as for companies sold after the declining performance of the market and in times of low cost of debt. On the other hand, strategic bidders are willing to pay more for companies of smaller size with large R&D expenses and internal cash balances. Third, values of strategic bidders are less tied to publicly observable target characteristics than values of financial bidders. The unobserved component of strategic bidders’ valuations is considerably more volatile than that of financial bidders, and seems to be an important reason why strategic acquirers on average pay larger takeover premiums.

Our results suggest that there exist fundamental differences between ex-ante average bidder valuations, expected revenues of the target, and the realized takeover premiums. In particular, strategic bidders consistently pay more than financial bidders conditional on acquiring the target even in cases when the average valuations of strategic bidders are lower.

In an extension of the paper, we attempt to jointly rationalize the observed competition and expected revenues by estimating costs of participation for the bidders. We find that on average, strategic participants have considerably higher participation costs. For example, our estimate of the median participation cost of a strategic bidder is 5.5% of the market value of the target, while the same number for a financial bidder is 2.1%. The costs of strategic bidders are highly positively correlated with their valuations and are particularly high if the target operates in the hi-tech industry.

The full paper is available for download here.


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