On the look-out for a white knight: options-based calculation of probability and expected value of increased bids in hostile takeover battles

Abstract

Takeover bids provide an option right to the target's shareholders; they guarantee the offered price but maintain the chance of higher offers. Using Option Pricing Theory (OPT) we estimate the probability and expected value of higher bids from target stock prices.

Notes

¹We consider the Dofasco's example with more complex scenarios in Section IV.

²For simplicity, we consider an interest rate of 0%.

³Duan (1994) considers the valuation of securities for bank deposits as well as the estimation of the Vasicek model (1977) of the term structure of risk-less interest rates.

⁴Data about the terms of the takeover bids are drawn from circulation bids published in the System for Electronic Document Analysis and Retrieval (SEDAR) database of the Canadian Securities Authority.

⁵When Thyssen-Krupp matched Arcelor's bid (C$63 per share) on 9 January 2006, the probability of a higher offer went down to 94% as market expectations of higher offers dropped.

Fig. 1. Probability and expected value of a higher offer in the Dofasco's example