No less than two years ago, had one tried to initiate a conversation with a Private Equity Sponsor or an M&A lawyer regarding M&A “reps and warranties” insurance (i.e., insurance designed to expressly provide insurance coverage for the breach of a representation or a warranty contained in a Purchase and Sale Agreement, in addition to or as a replacement for a contractual indemnity), one might have gotten a shrug of the shoulders or a polite response to the effect of “let’s try to negotiate around the problem instead.” Perhaps because it was misunderstood or perhaps because it had not yet hit its stride in terms of breadth of coverage, reps and warranties insurance was hardly ever used to close deals. Like Harry Potter, it was the poor stepchild often left in the closet.

Today that is no longer the case. One global insurance broker with whom we work notes that over $4 billion in reps and warranties insurance worldwide was bound last year, of which $1.4 billion thereof was bound in the US and $2.1 billion thereof was bound in the EU. Such broker’s US-based reps and warranties writings nearly doubled from 2011 and 2012. Reps and warranties insurance has become an important tool to close deals that might not otherwise get done. This post is meant to highlight how reps and warranties insurance may be of use to you in winning bids and finding means of closing deals in today’s challenging environment.

…continue reading: M&A Representations and Warranties Insurance: Tips for Buyers and Sellers

Recent news coverage has suggested that the Staff of the U.S. Securities and Exchange Commission (the “SEC”) has taken a position interpreting its tender offer rules that represents a significant new development. In actuality, however, the Staff has for some time taken the position that the satisfaction of a financing condition in a tender offer for an equity security subject to Regulation 14D constitutes a material change to the tender offer requiring that it remain open for at least five business days following this change. Though nothing new, the Staff’s recent reiteration of this position serves as a reminder to bidders who are financing their offers that they may be required to extend the tender offer period and that their financing papers and merger agreement should be drafted to take this into account.

…continue reading: Got Financing? You May Have to Extend Your Tender Offer

In my article on Inefficient Results in the Market for Corporate Control: Highest Bidders, Highest-Value Users and Socially-Optimal Owners, I argue that, unlike in most other markets, in the market for corporate control allocating resources to the highest bidder will often not produce an efficient result. That is, because of unusual features of that market, the party willing to pay the highest price to acquire the target (the highest bidder), the party who would derive the greatest private benefit from owning the target relative to the status quo (the highest-value user), and the party whose ownership of the target produces the greatest net social benefit (the socially-optimal owner) need not be, and often will not be, the same party. Consequently, allocating the target to the highest bidder will often produce an inefficient result.

The argument begins from the observation that, for most target companies, there are multiple potential strategic acquirers. In general, such parties are willing to pay to acquire the target because ownership of the target’s assets will confer on them a competitive advantage in their product markets and thus increase their future profits. Each such bidder will thus value the target at the present value of the incremental future profits that it expects to earn if it acquires the target, with the bidder having the highest such valuation being the highest-value user of the target.

…continue reading: Inefficient Results in the Market for Corporate Control

In a second Chancery transcript ruling on the subject in recent weeks, Chancellor Leo E. Strine, Jr. has made clear that Delaware has no per se rule against “Don’t Ask, Don’t Waive” standstill provisions (which prohibit a party subject to a standstill, including a losing bidder in an auction, from requesting a waiver from its standstill obligations). The Chancellor also provided guidance for using such a provision as an “auction gavel” to secure the best price reasonably available to a target company involved in a sales process. The ruling in In Re Ancestry.com is a welcome clarification that will help maintain the vitality of auctions where a target wants to incentivize bidders to come forth with their highest bid.

…continue reading: “Don’t Ask, Don’t Waive Standstills” Revisited (Rapidly)

A recent transcript ruling in the Delaware Court of Chancery could have a significant impact on the market for control of public companies, particularly in an auction context, if broadly adopted.

Vice Chancellor Laster’s bench decision in In Re Complete Genomics, Inc. Shareholder Litigation questions the enforceability of a standstill agreement that prohibits the bidder from privately requesting a waiver to make a topping bid, which he labeled a “Don’t Ask, Don’t Waive” standstill. The Vice Chancellor did not object to the bidder being prohibited from publicly requesting a waiver (which he understood would clearly circumvent the standstill), but held that directors have a continuing duty to be informed of all material facts, including whether the rejected bidder is willing to offer a higher price. By analogy to cases holding that a board that has agreed to sell the company may not close its ears to the possibility of higher bids, he suggested that “a Don’t Ask, Don’t Waive Standstill is impermissible because it has the same disabling effect as the no-talk clause, although on a bidder-specific basis.” While this may seem favorable for bidders, it raises questions about the protections afforded by typical standstill arrangements and the willingness of targets to engage in transaction discussions if they have doubts about those protections. The ruling also raises questions about its potential extension to standstill agreements in joint ventures and other commercial contexts, which could undermine the value of contractually bargained-for protections.

…continue reading: Don’t Ask, Don’t Waive Standstills

In our recent NBER working paper, CEO Preferences and Acquisitions, we test whether target CEOs’ retirement preferences affect the incidence, the pricing, and the outcomes of takeover bids. If mergers force target CEOs to retire early, then the CEOs’ private merger costs are the forgone benefits of staying employed until the planned retirement date. Though retirement plans differ across individuals, research in labor economics shows that a disproportional fraction of workers retires at the age of 65 (we observe the same phenomenon for CEOs). This age-65 effect cannot be fully explained by monetary incentives, including social security benefits or Medicare, which suggests behavioral explanations related to customs or social norms. If CEOs similarly favor 65 as retirement age, this preference should be reflected in their private merger costs, and – provided that these costs affect merger decisions – in the observed merger patterns. Specifically, one should observe an increase in merger activity as CEOs approach 65, or a discrete jump in this activity at the age-65 threshold.

We find strong evidence that target CEOs’ retirement preferences affect merger patterns. In data on U.S. public firms from 1992 to 2008, the likelihood of a takeover bid increases sharply when the target CEO reaches age 65. Controlling for CEO and firm characteristics, the implied probability that a firm receives a takeover bid is close to 4% per year for CEOs below the retirement age (e.g., in age groups 56-60 and 61-65), but it increases to 6% for the retirement-age group (above age 65). This corresponds to a 50% increase in the odds of receiving a bid, and the effect is statistically significant at the 1% level. The increase in takeover activity appears abruptly at the age-65 threshold, with no gradual increase as CEOs approach retirement age. The effect is similar whether all bids or only successful bids are included, and it remains economically large and significant even when CEO age and age squared are included separately as controls. These results show that bidders are more likely to target firms with retirement-age CEOs, possibly due to these CEOs’ weaker expected resistance against takeover bids.

…continue reading: CEO Preferences and Acquisitions

The literature on mergers and acquisitions, starting with Roll (1986) has often addressed the issue of managerial hubris leading to overpayment in acquisitions. For example, the observation of statistically and economically significant negative bidder returns for public bidder acquisitions is frequently attributed to the winner’s curse, managerial overconfidence, and thus overpayment. However, in our paper, Bidder Hubris and Founder Targets, which was recently made publicly available on SSRN, we argue that positive bidder gains are not necessarily inconsistent with overpayment, nor are negative bidder returns always a direct consequence of overpayment.

Insofar as managerial hubris leads to overpayment in acquisitions, it is important to note that this overconfidence derives from two non-mutually exclusive sources: (i) the target’s stand-alone value under bidder’s control is overestimated or (ii) synergies from the combined entity are overestimated. To the best of our knowledge, this is the first paper that tries to disentangle these two factors, while not relying on proxies for overconfidence or focusing exclusively on average bidder gains as evidence of managerial hubris. In this paper, we provide a unique test of the first source of overpayment by isolating a part of the target’s ex-ante value that is attributable to a founder CEO and relating this to bidder gains.

…continue reading: Bidder Hubris and Founder Targets

In the paper, Who Writes the News? Corporate Press Releases During Merger Negotiations, which was recently made publicly available on SSRN, we show that firms manipulate their stock prices during merger negotiations in order to affect the terms of the transaction. We argue that this strategy is made possible by the loose regulation of corporate disclosure. In particular, U.S. federal laws generally do not require firms to publicly disclose all material corporate events when they occur. Instead, firms have significant flexibility with respect to the content and timing of their press releases. We show that firms strategically exploit the flexibility afforded by the law to influence their stock prices precisely when they benefit the most from short-term manipulation.

To identify firms with incentives to manage their stock prices, we focus on stock acquisitions, a setting where a short-term change in firms’ stock prices has a long-term effect on merger outcomes. If an acquirer in a stock acquisition can temporarily raise its stock price during a short time window when the stock exchange ratio is determined (usually several weeks), it can issue fewer of its shares for each target share and reduce the true cost of the takeover. To establish causal evidence of price manipulation, we exploit the difference in the time period when the terms of the merger are determined in fixed-exchange ratio vs. floating-exchange ratio stock acquisitions. These two groups of transactions are very similar along firm and deal characteristics, but have a clear dichotomy in the timing of media management incentives.

…continue reading: Do Firms Manipulate Their Stock Prices? Causal Evidence from M&A

Financial bidders like private equity firms often compete with corporate bidders for the same target. Over the last 27 years, financial sponsors made 23 percent of all competing bids. In our paper, It Pays to Follow the Leader: Acquiring Targets Picked by Private Equity, forthcoming in the Journal of Financial and Quantitative Analysis, we examine how the presence of financial sponsor competition affects corporate buyers. Financial bidders are considered experts in the business of identifying undervalued targets. Gains from acquiring an undervalued firm pursued by private equity may accrue to any winning bidder that pays a similar premium for the target. Moreover, existing research shows that financial bidders have lower average valuations than strategic bidders. Thus, a corporate acquirer competing with a financial bidder (which is typically private) may win the auction at a lower premium than when it competes with another public corporate firm.

We find that corporate acquirers who purchase targets that are sought after by financial buyers outperform corporate acquirers who buy targets bid on by corporate firms only or those without competition. These results are robust to alternative measures of acquirer performance and different performance windows. A battery of tests shows that deal characteristics, acquirer abilities, and observable target characteristics cannot explain this difference in returns.

…continue reading: It Pays to Follow the Leader

In the paper, The Power to Issue Stock, recently made publicly available on SSRN, I study the new but increasingly common practice of target management granting top-up options to bidders. The paper analyzes the mechanics and recent case law involving top-up options, as well as the more general implications of managers’ substantial power to issue stock.

A top-up option is given by a target to a bidder to reduce judicial scrutiny of the planned acquisition. Once the bidder succeeds in getting at least 51% of the shares, the bidder exercises the top-up option and is issued enough shares to bring its holdings up to 90%. At that point, the bidder can proceed with a short-form merger, freezing out dissenting shareholders. The bidder must offer all of the shareholders the same price at the tender offer, as required by federal regulations, and usually undertakes, as part of the top-up option agreement, to pay the same price also to the dissenters at the back-end squeeze-out to prevent judicial scrutiny for a potentially structurally coercive offer. The price that will convince holders of 51% of the shares to tender, however, may well be substantially lower than the price needed to cause the holders of 90% of the shares to sell. Dissenters’ only recourse is appraisal, which many believe is a weak form of protection.

…continue reading: The Power to Issue Stock