Freeze-out mergers: the case of shareholders with multiple shares

ABSTRACT

This paper investigates the role of freeze-out mergers in mitigating the free-rider problem in tender offers. In contrast to a framework in which each shareholder owns exactly one share, our model allows shareholders to have multiple shares. We find that a more aggressive freeze-out clause forces shareholders to tender more shares. Therefore, raiders capture a greater amount of surplus when the requirement for freeze-out mergers becomes easier to satisfy.

KEYWORDS:

• Tender offer
• free-rider problem
• freeze-out
• multiple shares

JEL CODES:

• G34
• K22

Acknowledgments

We wish to thank the editor (David Peel) and two reviewers for their helpful comments on our work. Any remaining errors are ours.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ It should be noted that Dalkır, Dalkır, and Levit (2019) examine the role of freeze-out mergers in mitigating the free-rider problem with the one-share-per-shareholder model. They find that raiders cannot capture any surplus because freeze-out mergers do not eliminate the free-rider problem. However, as mentioned in Holmström and Nalebuff’s (1992), the free-rider problem does not exclude raiders from obtaining surplus when shareholders have multiple shares. This suggests the possibility that the freeze-out mergers affect the part of the raiders’ surplus.

² The freeze-out thresholds vary significantly across jurisdictions. For example, in Canada and several European countries, the raider is allowed to freeze out minority shareholders only after obtaining more than 90% of shares (see Gomes 2012). In contrast, most U.S. states adopt a simple majority rule for freeze-out mergers.

³ As discussed in Holmström and Nalebuff’s (1992), this case implies that the total number of a firm’s shares is sufficiently large, whereas the number of shareholders is not.

⁴ For example, as pointed out by Oh and Baek (2015), the total fraction of tendered shares is random if the raider’s negotiation ability with the blockholder is not known to shareholders.

⁵ Following the previous studies on freeze-out mergers (e.g Dalkır, Dalkır, and Levit 2019; Gomes 2012), we assume that the freeze-out threshold is not a raider’s decision variable because jurisdictions specify freeze-out thresholds.

⁶ The increase in the raider’s expected surplus due to a more aggressive freeze-out clause is not too small. For example, if the freeze-out threshold goes to one-half, then it is optimal for shareholders to tender all shares (see equation (A1)(A1) $S^{\prime }(x_i)=\frac{s_i}{2\epsilon }\left\{(1-x_i)s_{i}p+p(f+\epsilon -\bar{T})+\frac{1}{2}-f\right\}.$(A1) in the proof of Proposition 1). Thus, the total fraction of tendered shares by shareholders equals one (i.e. $\bar{T}=1$), implying that the raider can capture all surplus from the merger by letting the offer price approach zero (i.e. $p\to 0$). In contrast, when $f=1$, it is not optimal for shareholders to tender all shares at a sufficiently small offer price. Thus, the raider can capture only a fraction of the surplus, as in Holmström and Nalebuff’s (1992).