Asymmetric Information and the Medium of Exchange in Takeovers: Theory and Tests

Abstract

In a model of takeovers under asymmetric information, we identify a separating equilibrium in which the value of the bidder firm is revealed by the mix of cash and securities used as payment for the target. The model predicts that the revealed bidder value is monotonically increasing and convex in the fraction of the total offer that consists of cash. We examine the model restrictions using data from Canada, where mixed offers are both relatively frequent and free of the confounding tax-related options characterizing mixed offers in the United States. We find that the average announcement-month bidder abnormal return in mixed offers is large and significant. However, maximum likelihood estimates of parameters in both linear and nonlinear cross-sectional regressions fail to support the model predictions.This research was in part performed while Eckbo was a Fellow of the Batterymarch Financial Management Corporation. We are grateful for the comments and suggestions of

Corporate acquisition process: Is there an optimal cash-equity payment mix?

“…On the theoretical side, Eckbo et al (1990) signal that mixed offers are considered an "enigma." Recalling that most mergers are non-hostile, the question of the optimal mode of payment arises independently of the existence of a competition between bidders.…”

Signalling to Dispersed Shareholders and Corporate Control

“…Proposition 1 contrasts with results from bilateral merger models where cash-equity offers can reveal the bidder's type (Hansen, 1987;Berkovitch and Naranayan, 1990;Eckbo et al, 1990). Our basic framework differs in two key respects.…”

“…In the case of diversion, by comparison, this is only true if no more than half of the total firm value can be diverted by a controlling shareholder. 25 …”

“…Also, while our result states that equity is not a viable signaling device in tender offers, it does not preclude the possibility that bidders might use equity for other reasons such as, e.g., liquidity constraints. 25 To address these issues -measurement and post-takeover incentives -earnout structures often imposes post-closing covenants on the buyer, requiring, e.g., (i) that the buyer keep books and records for the seller to inspect, (ii) that the buyer maintain a minimum level of working capital in the business, (iii) that the buyer abstain from any change of control or sale transaction, or (iv) that the buyer make a commercially reasonable effort to reach the earn-out targets. The monitoring necessary to enforce these covenants will be performed by the seller of a private firm but not by dispersed shareholders following a tender offer -precisely due to the free-rider problem.…”

“…Several papers show that cash-equity offers can overcome asymmetric information problems in mergers (Hansen, 1987;Berkovitch and Narayanan, 1990;Eckbo et al, 1990;Brusco et al, 2007;and Ferreira et al, 2007). These papers abstract from the free-rider problem, which plays a crucial role in undermining the signaling role of cash-equity offers in our setting.…”