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: email@example.com
ROBERT KIESCHNICKFederal Communications Commission, 2000 M Street N.W., Washington, D.C. 20554, email:firstname.lastname@example.org,(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
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-
Kluwer Journal@ats-ss2/data11/kluwer/journals/requ/v12n2art5 COMPOSED: 01/13/99 1:35 pm. PG.POS. 1 SESSION: 14
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.
172 DANIEL ASQUITH, ROBERT KIESCHNICK
Kluwer Journal@ats-ss2/data11/kluwer/journals/requ/v12n2art5 COMPOSED: 01/13/99 1:35 pm. PG.POS. 2 SESSION: 14
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