S Abraham Ravid, Matthew Spiegel
ABSTRACT
Prior to the announcement of a tender offer, the bidding firm is legally
allowed to acquire shares in the open market, subject to some limitations.
These pre-announcement purchases are known as toeholds. This paper presents
a simple model that describes the bidder's optimal toehold acquisition
strategy, within an environment that closely parallels the present legal
institutions. The model shows that toeholds and bids interact in a complex
manner even without the presence of asymmetric information. By examining
a simple environment the paper provides a useful alternative hypothesis
for tests of other, presumably more complex, models. One of the main implications
of our model is that if no competing bidders are expected, no toeholds
should be purchased. the paper demonstrates that the correct specification
of an empirical model can be critical. For example, under some parameter
values toehold purchases may exhibit a negative cross-sectional correlation
with the pre-announcement run up in the stock price. This occurs even though
prices are strictly increasing the size of the toehold. Several implications
concerning various aspects of merger legislation are considered. We show
that corporate charters that affect the number of shares necessary to complete
a merger will have an impact only if competition among bidders is expected.
The paper further shows that a rule similar to a 'fair price' provision
has the desirable property that a second bidder arrives and winds if and
only if he places a higher value on the target than the initial bidder.
Several additional comparative statics are derived as well.
Ravid: (973) 353-5540
Spiegel: 510-642-3421 spigel@haas.berkeley.edu
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