finance lecture 8. keating f&a 8-2 spring 2008 outline lecture 8 miscellaneous thoughts on...

Finance Lecture 8

Keating F&A 8-2 Spring 2008

Outline Lecture 8

• Miscellaneous Thoughts on Corporate Takeovers

• Google Goes Dutch


Target Firm Stockholders AlmostAlways Gain From Takeovers

• They are typically paid a considerable premium

• This is another stockholder-management principal-agent problem

Stockholders want to encourage a takeover Existing management wants to discourage it

• “Greenmail” – When existing management buys back stock from a potential acquirer at a higher-than-fair-market price• Greenmail is deeply contrary to stockholders’ interests


Existing Management Often TriesTo Rally Workers To Its Side

• Suggest workers might lose jobs as part of takeover

Demonize “corporate raiders”

• Indeed, this notion is not far-fetched as an acquirer would have to figure out some way to increase firm’s cash flow, e.g., cut costs


A “Regular” Stock Price DoesNot Include Managerial

Control• If you buy a share of a firm, as a practical matter, you get no say in how the firm is run

You get the present value of future dividends of the firm and that is it

• There can be a considerable Premium for Control required to, in fact, gain management control of a firm

To justify this premium, the acquiring firm must be able to implement “enhancements” There is an assumption new management can somehow do better than existing management


It Is Not Clear Acquiring

Firm Shareholders Gain• Target firm is typically bought at a premium

Competitive market for corporate control on the acquirer side appears to compete profits close to zero

• Principal-Agent, again: Why is my management acquiring other firms? How do I, the shareholder, gain from this?

If benefits of diversification are cited, I know it’s bogus


A Most Convincing Justification ForA Merger Runs Afoul Of Antitrust

Law• An obvious “enhancement” would be the opportunity to raise prices in an industry by reducing competition

A good justification as seen by shareholders A very bad justification as seen by the Department of Justice and the Federal Trade Commission

• Even if it is a real reason for a merger, it would invite scrutiny to suggest a merger is designed to increase prices and, hence, profits


Some Firms Are “Better Off Dead”

• Liquidation Value – Cash generated by selling assets individually

• Going-concern Value – Present value of expected cash flows generated by a business

• A firm with good assets but a bad labor situation might be best liquidated

United Airlines? Somewhat akin to a “teardown” house located on expensive real estate


Outline Lecture 8

• Miscellaneous Thoughts on Corporate Takeovers

• Google Goes Dutch


Back In Lecture 3, We TalkedAbout Alleged IPO

Underpricing• There have been some prominent cases of stock prices leaping immediately after IPOs

Bad news for issuing company: They “left money on the table” Investment banks were rumored to have distributed IPO shares to insiders/preferred customers who then harvested the gains


Some Analyses Assert Large“First Day Returns” on IPOs

Quarterly underpricing of IPOs in the U.S.: 1960-2003Source: Jovanovic and Szentes (2007), http://www.nyu.edu/econ/user/jovanovi/ipou.pdf


The Case For IPO Underpricing

Is Not Without Controversy• Estimating a new stock’s market value is highly uncertain

Myriad assumptions need to be made

• There may be a memory selection bias at work: IPOs that rocket in value are more salient than stable IPOs or IPOs that tank

• Irrespective of its underlying validity, IPO underpricing was perceived to be a real phenomenon

People want to “get in on IPOs”


Google Decided Its IPO Would Not

Involve Traditional Underwriting• Rather than selling shares to an underwriting syndicate then have the syndicate sell the shares into the open market, Google would instead run a “Dutch auction” (August 2004)

• A Dutch auction starts with a high price that is then ratcheted down until enough buyers announce they will pay that price

Tulip merchants in Amsterdam used to work this way Opposite of a traditional oral ascending auction


Google Asked ProspectiveShareholders To Submit Bids

• Market clears when there are enough bidders to buy the number of shares Google wanted to sell

• A winning bidder pays the lowest accepted bid – not necessarily that bidder’s bid

US Treasury bills are also auctioned this way


Google’s Dutch AuctionWas “Incentive Compatible”

• Incentive compatibility means a bidder has incentive to truthfully bid exactly what he or she thinks the stock is worth

• Example: Suppose you thought a Google share was worth $130. When market cleared at $85, you got your share for $85.

No need to shade bid down to account for “winner’s curse” Yet many bidders submitted multiple different bids, contrary to theory. ?


Google’s Price PromptlyLeapt To $100 After The IPO

Did Google “leave money on the table”?

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There Is Controversy As ToThe Legacy Of Google’s IPO

• Was Google just unlucky and/or the auction poorly timed?

• Would a future Dutch auction IPO go better as it would be less mysterious (and therefore less risky) to prospective bidders?

• Or perhaps the traditional underwriting approach has genuine value

Very competitive industry

• There have only been a handful of low profile IPO auctions since Google’s

finance lecture 8. keating f&a 8-2 spring 2008 outline lecture 8 miscellaneous thoughts on...

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