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Abstract
During takeover battles, a tender offer provides a call option right to the target’s shareholders: it guarantees the offered price but maintains the chance of a higher offer. We present an options-based approach to estimate the probability and expected value of higher competing takeover bids using target stock price data. Analysing Canadian takeover battles in the period 1997 to 2007 we find that during the 5 trading days prior to the occurrence of an increased takeover bid, the estimated probability of a higher bid exceeds 80% on average and the expected value of a potential competing bid almost matches the realized value.
Notes
1. Duan (Citation1994) uses this approach to estimate the value of insurance contracts of bank deposits. He provides a maximum likelihood approach to estimate the model parameters from observed market data. This approach purely relies on the model assumptions and avoids some problems of other estimation approaches used in the literature, where additional assumptions are required for the estimation.
2. While the number of competitive takeovers seems to be decreasing recently, Boone and Mulherin (Citation2007) reveal the fact that a large part of takeovers targets is sold in private, pre-public negotiations.
3. See Schwert (Citation2000) for advances in distinguishing between hostile and friendly bids.
4. See Keown and Pinkerton (Citation1981), Meulbroeck (Citation1992), and Jabbour et al. (Citation2000).
5. See Mulherin and Boone (Citation2000), Andrade et al. (Citation2001), and Aktas et al. (Citation2004, Citation2007). The results of Aktas et al. (Citation2007) suggest that after M&A announcements informative trading is important which is according with our finding that after takeover bids stock prices contain information on possible improved bids. Cao et al. (Citation2005) find evidence that informed trading takes place in stock options of target stocks prior to the takeover announcement.
6. In our empirical analysis in Section IV we focus on Canadian tender offers with binding takeover bids that satisfy this assumption.
7. Competing bids may be made because of strategic considerations and reactions of competitors of the initial bidder or because other firms value the shares of the target higher. The bidder may value the target higher after placing an initial bid if positive events occur or new positive information is released after the offer was made. Also better offers may be made since the initial bidder notices that the target shareholders value their shares higher and will not sell their shares at the initially offered price.
8. We assume perfect capital markets with zero transaction costs. For simplicity, we consider an interest rate of 0%. Our framework, unlike a standard Binomial event, does not assume risk neutrality; instead, we assume that the risks are diversifiable, which is a weaker assumption.
9. See Fama (Citation1970) for a discussion on information efficiency.
10. Although idealized, these assumptions are well accepted and used in many applications.
11. In addition, the expected drift, µS, must be determined.
12. A similar approach was firstly proposed in Duan (Citation1994) and applied to estimate the value of insurance contracts for bank deposits and the parameters of the Vasicek (Citation1977) model.
13. We also exclude stock swap offers because in these cases the strike price (takeover bid) is not fixed but changes with the value of the acquirer’s stocks. Therefore, we only include 100% cash offers in our options-based framework that fulfil the assumption of a constant strike price.
14. An increase of the initial offer by the initial bidder is interpreted as a new offer, as explained in Section II. A description of our competing bids sample can be found in Appendix.
15. Several bids were made before this offer: by PC Docs in December 1998, by Solution 6 in February 1999 and by Hummingbird Com. Ltd in March 1999. These offers are not considered here, because they do not match the criteria given by our assumptions: The first was not a formal bid (takeover bid circular) and, hence, the contractual features of an option, especially the maturity and the strike price, were not given with certainty. The latter were stock swap agreements, which imply a variable offer price.
16. This relatively high value for the drift reflects the strong increase in the expectations about the value of a higher offer, which was finally proved to be right. However, one has to reconsider that the drift refers to 1 year as the unit of time, whereas we consider single days in our illustration. The drift per day would be approximately 0.0034.
17. At this time the probability of a higher bid is about 60% as discussed below.
18. The bulk around day -11 does not result from worsening of the old observations, but because for this time span some new observations were included in the calculation of the average, whose failures are worse than the older examples.
19. The results are available from the authors upon request.
20. For simplicity we change the notation, replacing the time indices t0,…, tn ,…, tN by 0,…, n,…, N.