What motivates minority acquisitions? We study the trade-off between minority acquisitions, involving less than 50% of the target, and majority acquisitions in the forthcoming Review of Financial Studies paper, “What Motivates Minority Acquisitions? The Trade-Offs between a Partial Equity Stake and Complete Integration.” Minority acquisitions have been shown to facilitate cooperation between two independent firms. For example, Allen and Phillips (2000) and Fee, Hadlock, and Thomas (2006) show that a minority acquisition can align the incentives of the acquirer with those of the target. However, similar benefits can also be achieved with a majority acquisition, suggesting that minority stakes are also motivated as a means to avoid certain costs associated with majority control.
Using a sample of 2,166 deals, we identify several key predictors in the choice between a minority or majority acquisition. The key insight provided in this paper is the importance of costs associated with the dilution to target managerial incentives following a majority acquisition in selecting the mode of acquisition. Evidence that firms are willing to forgo benefits to control to preserve target incentives speaks to the value of these incentives.
A majority acquisition typically precipitates a delisting of the target’s stock. The stock price of the merged firm will be a diluted signal of the performance of the acquired unit’s managers, decreasing the efficiency of any equity-based incentives provided to these managers. Furthermore, this dilution will be greater the relatively larger the acquirer as compared to the target. As predicted, the data shows firms are more likely to engage in minority acquisitions when the loss of a stock price is expected to lead to a greater dilution to target managerial equity incentives.
Although incentive considerations are important in these ownership decisions, other factors, such as target financing needs, also play a role. A minority acquisition can be used to provide financing directly to the target or to certify the target for other outside investors. Minority acquisitions are also more common when gains from a merger are most uncertain. Minority acquisitions can facilitate the flow of information between two firms, allowing the acquirer to better assess the value of the target and expected synergies before committing to purchasing a majority stake. Minority acquisitions may also be preferred if combining internal capital markets is expected to be inefficient or if consolidating earnings will lower earnings per share (EPS).
Although a majority acquisition may entail costs, some benefits can be fully realized only with a majority stake. For example, a majority acquisition can generate value for shareholders if the consolidation of control facilitates joint production maximization. Production efficiency gains are more likely when both the target and the acquirer operate in the same industry and can share valuable resources. Our data reveal horizontal acquisitions are more likely to involve a majority stake. We also find that firms that have excess capital and minimal internal investment needs are more likely to make majority acquisitions, consistent with the notion that agency conflicts at the acquirer may motivate some majority acquisitions.
In sum, minority acquisitions are primarily motivated by the benefits of preserving target managerial incentives, relieving financial constraints at the target, and providing an opportunity for the acquirer to gather more information before taking a majority stake. They also seem to help keep inefficient internal capital markets separate and avoid a dilution to EPS. Majority acquisitions, on the other hand, are driven by the ability to maximize joint production and benefits accruing to the acquiring firm’s management.
The full paper is available for download here.