STRUCTURING INITIAL TAKEOVER OFFERS: MANAGEMENT RESISTANCE, COMPETITION AND BID SUCCESS Daniel Chersky A thesis submitted in partial fulfillment of the requirements for the degree of Masters of Commerce (Honours) to the University of New South Wales 2004 CERTIFICATE OF ORIGINALITY I hereby declare that this submission is my own work and to the best of my knowledge it contains no materials previously published or written by another person, nor material which to a substantial extent has been accepted for the award of any other degree or diploma at UNSW or any other educational institution, except where due acknowledgement is made in the thesis. Any contribution made to the research by others, with whom I have worked at UNSW or elsewhere, is explicitly acknowledged in the thesis. I also declare that the intellectual content of this thesis is the product of my own work, except to the extent that assistance from others in the project's design and conception or in style, presentation and linguistic expression is acknowledged Daniel Chersky 11 ABSTRACT A current and comprehensive data set of 304 Australian takeover transactions, completed in the eight year period between January 1, 1996 and December 31, 2003, is employed in this thesis to address the question of how initial bidders can structure their offer so as to maximise, or at least increase, the likelihood of a profitable acquisition. An initial bidder will go a long way to achieving this aim if two transaction-specific hurdles are successfully negotiated: the securing of target management support and the deterrence of potential rival bidders from entering the takeover contest. Theoretical and empirical literature suggests that a bidder can increase his chances of achieving these two goals, as well as the ultimate goal of a successful acquisition, via the deliberate choice of bid structure. Using Logit and Bivariate Probit models, this thesis provides a comprehensive empirical test of this claim, focusing on the key bid structure elements of bid premium, medium of exchange, and bidder toehold. We find that higher-premium bids are associated with a lower likelihood of target management resistance and an increased probability of bid success, however, they do not appear to deter competing bidders. Neither the use of cash in the offer, nor the cost of acquiring information about a target, are correlated with the frequency of competition, resistance or bid success. However, ownership of large toeholds by initial bidders serves to deter competing bidders, reduce the likelihood of resistance and increase the probability of bid success. We also confirm the importance of target management support in takeovers by finding that in transactions where target management resist the initial bid, the likelihood of a competing offer emerging is significantly higher, while the probability of initial bid success is reduced significantly. iii ACKNOWLEDGMENTS Completion of this thesis would not have been conceivable without the enormous contribution of my supervisor, Dr. Sian Owen, whose enthusiasm and 'aim high' attitude motivated me to produce my best work. I am extremely thankful for her commitment to this thesis and the responsiveness and generosity with which she gave up large amounts of her time. I learnt a great deal from her expertise, whilst her accessibility and light-hearted nature made enjoyable what can often be stressful times. Needless to say, all errors are mine. I am also grateful to the helpful people at Bloomberg LP and Rubicon Partners for providing data used in the empirical analysis in this thesis. Additionally, I would like to thank the relevant people at JP Morgan, whose understanding was essential to the completion of this research. Finally, since this thesis is a culmination of nearly six years at UNSW, I would like to acknowledge those people who have provided me with tremendous support during this time. I am forever grateful to my parents for their ever-present love and constant support, both emotional and financial, without which any personal achievements would be unattainable. To Natalie, I rely on you greatly and you have never let me down over many years. I appreciate your unwavering support enormously and, needless to say, any successes are partly yours. To the rest of my family, my second family, the Fletchers, and friends too numerous to name, thanks for always being there and I look forward to celebrating bigger and better things in our lives. IV TABLE OF CONTENTS Certificate of Originality ... ................................................................... ii Abstract ... ....................................................................................... iii Acknowledgments ............................................................................ iv Table of Contents ... ........................................................................... v List of Tables ... ................................................................................ ix CHAPTER 1 INTRODUCTION ........................................................................................................ 1 1.1 INTRODUCTION ............................................................................................................................ 1 1.2 MOTIVATION AND CONTRIBUTION ............................................................................................... 3 1.3 THESIS OVERVIEW ....................................................................................................................... 5 CHAPTER 2 LITERATURE REVIEW ............................................................................................ 6 2.1 INTRODUCTION TOTAKEOVER LITERATURE ................................................................................ 6 2.2 CYCLICAL NATURE OFTAKEOVER ACTIVITY .............................................................................. 7 2.2.1 Merger Waves ...................................................................................................................................... 7 2.3 MOTIVATION BEHIND TAKEOVER ACTIVITY ...........................................................•................... 11 2.3.1 Synergy .............................................................................................................................................. 12 2.3.2 Target Undervaluation ...................................................................................................................... 13 2.3.3 Disciplinary Theory ........................................................................................................................... 14 2.3.4 Management Hubris Theory .............................................................................................................. 15 2.3.5 Free Cashflow Theory ....................................................................................................................... 16 2.4 PERFORMANCE AND RETURNS ISSUES .....................•.................................................................. 17 2.4.1 Pre-Takeover Performance ............................................................................................................... 18 2.4.1.1 Characteristics of Target Firms ................................................................................................. 18 2.4.1.2 Characteristics of Acquirer Firms ............................................................................................. 19 2.4.2 Announcement Period Returns .......................................................................................................... 19 2.4.2.1 Target Firm Shareholders .......................................................................................................... 19 2.4.2.2 Bidder Firm Shareholders.......................................................................................................... 20 2.4.2.3 Do Takeovers Create or Redistribute Wealth? .......................................................................... 21 2.4.3 Post·Takeover Performance .............................................................................................................. 22 2.4.3.1 Share Price Performance ........................................................................................................... 22 2.4.3.2 Operating Performance .............................................................................................................. 23 V 2.5 BID STRUCTURE AND TRANSACTION OUTCOMES ....................................................................... 24 2.5.1 Elements of Bid Structure .................................................................................................................. 25 2.5.1.1 Bid Premium Decision .............................................................................................................. 25 2.5.1.2 Payment Method Decision ........................................................................................................ 26 2.5.1.3 Toehold Acquisition Decision ................................................................................................... 28 2.5.2 Transaction Outcomes ....................................................................................................................... 29 2.5.2.1 Target Management Response ................................................................................................... 29 2.5.2.2 Bid Competition .......................................................................................................................