An Examination of Initial Shareholdings in Tender Offer Bids

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  • Review of Quantitative Finance and Accounting, 12 (1999): 171188 1999 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands.

    An Examination of Initial Shareholdings in TenderOffer Bids

    DANIEL ASQUITHDeloitte & Touche, 1000 Wilshire Blvd, Los Angeles, CA 90017, email:

    ROBERT KIESCHNICKFederal Communications Commission, 2000 M Street N.W., Washington, D.C. 20554,,(Corresponding Author)

    Abstract. We examine the initial shareholdings taken by bidders prior to making tender offer bids (toe-holds) in order to test predictions of selected models of tender offers. Our data suggest a significantly negativerelationship between first bidder premia and toeholds, which is consistent with the models of Shleifer and Vishny(1986) and Hirshleifer and Titman (1990), but inconsistent with the models of Harrington and Prokop (1993),Chowdhry and Jagadeesh (1994), and Burkart (1995).

    Key words: Toeholds, tender offers, beta regression analysis

    1. Introduction

    The initial shareholding of a bidder in the target firm prior to bidding for the firm (thetoehold) is a critical variable in a number of theoretical papers (e.g. Chowdhry andJagadeesh (1994)). The bidder is likely able to acquire the toehold at a substantially lowerprice per share than necessary to acquire the remaining shares in a takeover. Therefore,absent other considerations, the failure to acquire a sizable toehold would appear to beforgoing a profitable opportunity. However, in practice, we observe a wide range oftoeholds, with a substantial fraction of bidders acquiring no shares in the target prior totheir bidding.

    The ability of bidders to acquire toeholds is limited by legal and market constraints. Theprimary legal constraint is the Williams Act. The Williams Act requires that anyone whopurchases a beneficial interest of 5% or more of the shares of a company has to file a form13d with the Securities and Exchange Commission (SEC) disclosing his holdings andintentions within 10 business days.1 Any substantial increase or decrease in these hold-ings, or change in intentions, require the prompt filing of an amended 13d. In practice, a1% change in holdings is considered substantial. Under the Williams Act, the initiation ofa tender offer requires the filing of a form 14d, which is the original source of toehold dataused in this paper. Once the form 14d is filed, no additional shares may be purchased onthe market. The Williams Act requires that tender offers remain open for at least 20business days, during which time shareholders may reverse their decision to tender. Fur-

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  • ther, shares tendered in an over-subscribed offer are accepted on a pro-rata basis, and anyincrease in offer price is given to all lendering shareholders.

    Market constraints on a bidders acquisition of a toehold include the increase in pricethat large buying may cause and the ability to keep such buying secret before the threshold5% is reached and disclosure under the Williams Act is required. Bagwell (1992), in workon Dutch auction repurchase tender offers, has estimated that on average, for a firm topurchase 15% of its own shares, the firm must offer a premium of 9.1%. Bagwells workis consistent with an upward sloping supply curve for shares. Under this presumption,purchases by a potential bidder might increase the firms share price and thereby reveal thefirm to be a takeover target. If the firm is suspected to be a takeover target, any stockpurchased would have to incorporate expectations about the potential takeover bid pre-mium. On the other hand, Kyle and Vila (1991) have discussed how the presence of noisetraders may enable a bidder to acquire an initial shareholding without fully revealing theintention to bid, strengthening the theoretical argument for large initial shareholdings.

    This paper examines whether or not selected theories of bidding strategy in tenderoffers are consistent with publicly available data by focusing on bidder toeholds in asample of filed tender offers. Previous research has included the toehold acquired as anindependent variable in studies of the success of a tender offer (Walkling (1985)), thepremium paid in a tender offer (Walkling and Edmister (1985)), whether the offer wasresisted by target management (Walkling and Long (1984)), and on the increase in targetstock price prior to the offer being filed (Jarrell and Poulsen (1989)). However, unlikeprior research, we examine influences on the distribution of first bidder toeholds andtherefore treat first bidder toeholds as endogenously determined. Such a presumption isconsistent with Chowdhry and Jegadeeshs (1994) model of takeovers.

    To examine influences on the distribution of first bidder toeholds, we are confrontedwith an interesting statistical problem that is shared by a number of empirical studies infinance. Specifically, the toehold is a proportion of a total that by definition ranges over theinterval [0,1].2 Prior regression analyses of such dependent variates have been conductedby either assuming that the conditional distribution is a normal distribution or by assum-ing that the conditional distribution is a censored normal distribution. Neither of thesedistributional assumptions are conceptually appropriate.

    A toehold, before scaling, is only defined over the interval [0,1]. Therefore a toehold isneither normally distributed, nor the result of censoring. At best, the results of applyingregression strategies based upon these distributional assumptions to these data are that theestimators are inefficient. At worst, the estimators are biased and inconsistent.3 In eithercase, the results of applying these regression strategies to such data are potentially mis-leading. Consequently, in order to examine influences on first bidder toeholds, we mustdevelop an appropriate statistical model for bidder toeholds.

    To accomplish this and address the research issues of interest, we organize the paper asfollows. In Section 2, we set out salient features of the models to be tested. In Section 3,we describe our sample and the data. In Section 4, we present univariate statistical tests ofkey hypotheses. In Section 5, we develop a regression model for toehold data based uponthe beta distribution and report the results from applying this model to our data. Finally,in Section 6, we provide a summary of our results and conclusions.


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  • Our study suggests two important results. First, we find a significantly negative uncon-ditional and conditional correlation between first bidder premiums and first bidder toe-holds, which is inconsistent with the implications of the models of Harrington and Prokop(1993), Chowdhry and Jagadeesh (1994), and Burkart (1995). Such results are, however,consistent with the models of Shleifer and Vishny (1986) and Hirshleifer and Titman(1990), and the results reported in Walking and Long (1984) and Betton and Eckbo(1994).

    Second, we find evidence that the relationship between first bidder toeholds and premiamay be more complex than captured in the models of Shleifer and Vishny (1986) orHirshleifer and Titman (1990). Specifically, we find that target firm size moderates therelationship between first bidder toeholds and premia. One explanation for this effect isthe influence of firm size on bidder competition. However, we find evidence that biddercompetition does not influence first bidder toeholds in a manner consistent with thisexplanation. Consquently, additional research is required to explain the influence of firmsize on the relationship between first bidder toeholds and premia.

    2. Theories related to toeholds

    Grossman and Hart (1980) formulated a free rider problem in tender offers by modelinga bidder who requires control of the firm to improve the value of the firm.4 To induceshareholders to tender their shares the bidder must offer a premium over the currentmarket price. However, the shareholders know that in order for the bidder to profit, thisoffer price must be less than the value of the firm under the bidders control. The choicefacing an individual shareholder is whether to tender his shares at a premium over themarket price represented by the offer or to retain his shares. If the offer fails, the share-holder retains his shares, whether he tenders them or not. If the offer succeeds and hetenders, then he receives the offer price. If the offer succeeds and the shareholder retainshis shares (does not tender), he will have shares worth more than the offer price. If theshareholder is small enough that his individual decision to tender does not affect thesuccess of the offer, then not tendering is a weakly dominant strategy. However, if allshareholders individually follow the strategy of retaining their shares, then the offer willfail, despite the fact that all shareholders would be better off if the offer succeeds.Grossman and Hart suggested that to mitigate the free rider problem, shareholders ofpotential targets could allow a successful bidder to dilute the value of minority share-holders. This would enable bidders to induce shareholders to tender and resolve the freerider problem.

    Shleifer and Vishny (1986) modeled a means for the bidder to profit on a tender offerdespite the free rider problem and without dilution. The bidder cannot expect to profit onthe shares acquired in the tender offer because of the free rider problem. The bidder can,however, profit on the increase in value of the shares the bidder owns prior to making theoffer (the toehold). Shleifer and Vishny assume that the value of the improvement thebidder can make to the firm is private knowledge of the bidder, but that other shareholderscan infer the expected dollar value of this improvement from the size of the bidders


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  • toehold and the fact that a bid is made. Shleifer and Vishny assume all other shareholderswill tender their shares if the bid is at least as great as the expected share value. Inequilibrium, because of the assumption that indifferent shareholders always tender, theexpected value is determined by the marginal bidder who will lose the same amount onthe shares acquired in the bid as he gains on his toehold. The bidder always bids thisexpected value (which, conditional on a bid being made and the toehold, is a constant), sothe expected profit on these shares is zero, the shareholders always tender, and all bidssucceed.

    While the bidder toehold is an essential variable in Shleifer and Vishnys model, it is nota strategic variable. In their model, a bidder with a smaller toehold requires a largerminimum dollar improvement to bid. Consequently, Shleifer and Vishnys model impliesthat bidder toeholds should be negatively correlated with bidder premia in observed tenderoffers. Further, in Shleifer and Vishnys model, a bidder with a zero toehold would haveto bid the maximum premium to convince existing shareholders to tender. Thus, a bidderwith zero toehold can not profit, and so will not bid. However, a large percentage of tenderoffers have a zero toehold: 62% in Bradley, Desai, and Kim (1988) and 28.82% for all firstbidders in this study.5 These data suggest a problem with Shleifer and Vishnys model.

    Hirshleifer and Titman (1990) do not assume that indifferent shareholders tender withprobability one in their model. As a result, in their mixed strategy equilibrium, offerssometimes fail. A higher bid increases the probability of the offer succeeding; thus, theamount of the premium bid becomes a signal of the bidders valuation of the firm undernew ownership. In equilibrium, the bidder bids the true dollar value of his expectedimprovement, conditional on a bid being made, and the amount bid is independent of thesize of the toehold. As in Shleifer and Vishnys model, the toehold is an essential, but nota strategic variable. Larger toeholds, nevertheless, allow bidders with smaller improve-ments to profit on their bid. Consequently one should expect larger toeholds to be corre-lated with smaller premia in observed tender offers. However, Hirshleifer and Titmansmodel implies a smaller negative correlation than Shleifer and Vishnys model does,because within their model, for a given offer, the premium is independent of the toehold.So one would expect a more dispersed pattern of premia relative to toeholds.

    In contrast to the above models, Chowdhry and Jegadeesh (1994) make the toehold astrategic variable of the bidder. They make the same basic assumptions as Hirshleifer andTitman, but assume that the bidder can secretly acquire a toehold. They argue that theacquisition of a toehold will change the price at which shareholders will tender theirshares if the size of the toehold affects the shareholders beliefs about the value they willreceive if they retain their shares. Chowdhry and Jegadeesh derive an equilibrium inwhich acquiring a smaller toehold credibly signals a smaller improvement, which inducesshareholders to accept a lower offer price. Similarly, in equilibrium, bidders with a largerimprovement will both acquire a larger toehold and bid higher. A bidder with a largerimprovement does not try to acquire a smaller toehold and bid lower, because this in-creases the probability the offer will fail. A bidder with a smaller improvement does notacquire a larger toehold because this increases the necessary bid causing him to lose onthe acquired shares. Therefore, their model predicts smaller toeholds are associated withsmaller premia, a larger toeholds are associated with larger premia.


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  • The models of Harrington and Prokop (1993) and Burkart (1995) also predict a positiverelationship between bidder toeholds and premia, but are structured quite differently thanthe above models and do not focus on first bidder strategies. Rather, Burkart (1995)focuses upon the bidding strategies of two bidders competing for a target. Burkart showsthat the greater a bidders toehold, the greater a bidders tendency to overbid for the firmand thereby dissipate gains on the toehold. In contrast, Harrington and Prokop (1993)model a multistage bidding process, whereby a bidder revises his or her bid after failingto buy enough shares to acquire the firm. Thus a bidders toehold alternatively influencesand is influenced by a bidders premia.

    3. Description of the data

    3.1 Sample selection and data sources

    The sample for this study was based upon the 19801986 Tender Offer Statistics collectedby Douglas Austin & Associates, Inc. This consists of 827 records of tender offers...