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Publisher : Elsevier - Science Direct (الزویر - ساینس دایرکت)
Journal : Journal of Financial Economics, Volume 69, Issue 3, September 2003, Pages 431–467
The paper provides evidence on the effects of including a target termination fee in a merger contract. I test the implications of the hypothesis that termination fees are used by self-interested target managers to deter competing bids and protect “sweetheart” deals with white knight bidders, presumably resulting in lower premiums for target shareholders. An alternative hypothesis is that target managers use termination fees to encourage bidder participation by ensuring that the bidder is compensated for the revelation of valuable private information released during merger negotiations. My empirical evidence demonstrates that merger deals with target termination fees involve significantly higher premiums and success rates than deals without such clauses. Furthermore, only weak support is found for the contention that termination fees deter competing bids. Overall, the evidence suggests that termination fee use is at least not harmful, and is likely beneficial, to target shareholders.
Almost two-thirds of the merger agreements announced between 1997 and 1999 included a target termination fee clause. A target termination, or breakup, fee clause requires that the target pay the bidder a fixed cash fee if the target does not consummate the proposed merger. Termination fees are of current interest in the area of mergers and acquisitions in light of the large termination fee recently paid by Pfizer/Warner-Lambert to American Home Products (AHP), following Warner-Lambert's decision to cancel its merger with AHP in favor of a union with Pfizer. Natural questions stem from the publicity surrounding this fee (see, for example, The Wall Street Journal, February 7, 2000, p. A3), such as what target managers hope to gain by agreeing to pay a termination fee to the bidder, and in particular whether the use of a termination fee benefits or harms target stockholders on average. This empirical setting has the potential to contribute to the extensive literature devoted to ascertaining, usually from the stock market reaction, whether decisions made by corporate managers appear to be motivated by “managerial entrenchment” or “shareholder interest.” One particularly fertile area for studying entrenchment versus efficiency is mergers and acquisitions, as the act of selling a firm typically entails the selling managers losing their jobs, or at least sacrificing some degree of control. Evidence of behavior indicative of managerial entrenchment or shareholder interests in mergers and acquisitions is mixed. On the one hand, Hadlock et al. (1999) interpret high rates of management turnover following bank acquisitions as evidence that target managers actively oppose takeover attempts, and Chang (1990) finds that firms adopting ESOPs as takeover defenses suffer significant stock price declines, supporting the entrenchment hypothesis. Furthermore, Harford (1999) finds that cash-rich firms are more likely to make diversifying, value-destroying acquisitions with poor post-acquisition performance. On the other hand, Mulherin and Boone (2000) report evidence of positive wealth effects associated with acquisitions and divestitures, inconsistent with managerial entrenchment. Moreover, Schwert (2000) concludes that target managerial “hostility” towards potential acquirers is associated with outcomes that are most consistent with “strategic bargaining” on the part of target managers, and that this bargaining strategy is beneficial to target shareholders on average. Comment and Schwert (1995) reach a similar conclusion about the adoption of poison pill anti-takeover provisions. As a target termination fee agreement could be considered prima facie evidence that target managers have distorted the acquisition process to the detriment of their shareholders, the incidence of termination fee use has the potential to provide further evidence on the entrenchment and efficiency hypotheses. In this context, the entrenchment hypothesis presumes that termination fees are effective deterrents to competing bids for the target firm, and therefore allow entrenched target managers to selectively deal with one particular bidder in return for some benefit (for example, job security). The agency cost to target shareholders is the assumed loss of takeover premium resulting from the curtailment of a full auction for the target firm. The alternative “shareholder interests” hypothesis is that target termination fees serve a less exploitative role as contractual devices that efficiently solve contracting problems between the bidder and target. For example, a bidder could be reluctant to reveal valuable private information about its post-merger plans for the target's assets if another bidder is able to free ride on such information and submit a more valuable proposal, or reluctant to commit to pre-merger integration with the target without a tangible commitment that the merger will proceed. Target termination fees can protect these deal-related investments made by the bidder and increase the willingness of the bidder to make such investments, potentially to the benefit of target shareholders. My evidence suggests that, on average, target termination fee use is not detrimental to target shareholders’ interests. Specifically, target termination fee use is associated with approximately 4% higher takeover premiums after controlling for correlated deal characteristics. Furthermore, target termination fees increase the likelihood that the deal is successfully completed by almost 20% on average. Hence target shareholders receive the premium more often when a target termination fee is included in the merger terms. There is some evidence that the average incidence of competing bids is lower (by 3%, compared to a full sample average competition rate of 5%) following merger bids including a termination fee. However, several factors diminish the importance of competing bid deterrence of this magnitude. First, this effect appears to be largely driven by correlated deal and bidder characteristics (namely the fact that termination fees are more likely to appear in friendly deals) rather than the nature of the fees per se. Second, the economic impact on the value of the target's shares (from a 3% lower probability of receiving a competing offer) is small when second bid jumps only average around 14% of the target's market value of equity (Betton and Eckbo, 2000). Two extant papers, Burch (2001) and Coates and Subramanian (2000), empirically examine the role of lockup options and termination fees in merger bids. Stock or asset lockup options (generically referred to as “lockups”) are similar to target termination fees. The difference between the two is that in a lockup the incumbent bidder is granted a call option on either the common shares or some important asset of the target firm, exercisable only if the target initiates termination to pursue a merger with another bidder. Coates and Subramanian show that the median stock lockup is priced slightly in-the-money, with the bulk of the distribution priced at-the-money and few lockups priced out-of-the-money. Furthermore, the median stock lockup represents an option on 19.9% of the target's equity, because most major exchanges require a stockholder vote on contractual provisions affecting more than 20% of the firm's equity capital. While Burch (2001) does not specifically examine termination fees, his study of lockups is relevant to this paper. Burch finds that deals including a stock lockup result in higher abnormal announcement returns for target shareholders than those that do not, consistent with the shareholder interests hypothesis. Furthermore, the target abnormal return results are robust to controlling for other factors that could be correlated with lockup use, such as the size of the target and target managerial attitude towards the bid. Burch also examines one hundred randomly selected merger agreements from 1988 and 1989 for evidence of “abusive” (i.e., detrimental to target shareholders) use of lockup options. He reports that secretly negotiated lockup deals containing evidence of such abuse (for example, guaranteeing target managers employment in the merged firm) are actually associated with higher average target returns than comparable deals with a lockup. Burch concludes that while lockups can be employed to benefit managers in a way that harms shareholders, lockups are not systematically used by target managers in this exploitative fashion. This evidence supports the contention that lockups are employed to improve the bargaining position of the target. In a theoretical corporate law paper, Fraidin and Hanson (1994) appeal to the Coase Theorem to argue that a termination fee will not deter a higher-valuing bidder from competing to acquire the target (i.e., termination fees will not affect allocative efficiency) as long as the transaction costs of arranging a deal with an incumbent lower-valuing bidder are not prohibitively high. Coates and Subramanian (2000) test this hypothesis against several “buy side” distortions. They claim that these distortions diminish the incentive for low-valuing bidders protected by a termination fee to cede control of the target, even if such an action would increase the low-valuing bidder's profit from bidding. One example of a buy side distortion is bidder agency costs, where managers at an incumbent publicly held bidder accept a lower payoff from the bidding process simply because winning control of the target increases the size of the enterprise under their control. Coates and Subramanian's (largely univariate) results demonstrate that both lockups and, particularly, termination fees are significantly associated with increases in the probability that the incumbent bidder acquires the target firm, but not with bid competition. They also examine the determinants of lockup and termination fee use and find that target termination fees are more likely to be used in pooling-of-interests deals, mergers involving large targets, and deals in which a tender offer was one of the modes of acquisition used by the bidder. My focus is solely on termination fees, partly because Coates and Subramanian (2000) report that lockups are used approximately half as often as cash termination fees in merger agreements. This paper is one of the first to provide direct evidence on the effect of these devices on the target premium. This is also the first paper to provide multivariate evidence on the effect of termination fee use on the incidence of competing bids and offer success.1 Evidence on premiums, competition, and offer outcome is important in determining whether, on average, the use of target termination fees is detrimental or beneficial to target shareholders. Furthermore, evidence on each of these outcomes individually has the potential to significantly increase our understanding of the merger negotiation process compared to the inferences from an examination of abnormal returns (as in Burch, 2001). I also attempt to control for the endogeneity problems that are largely ignored in prior literature. Endogeneity is a concern in this setting because the bid premium and the contractual clauses included in the merger agreement are both decided during merger negotiations between the bidder and target. Therefore, neither is truly exogenous, and simple OLS regression coefficients could be biased and inconsistent. Specifically, while a positive association between bid premiums and termination fee use will show up in a regression with either as the dependent variable, considerable care must be taken when inferring causality from such models. I use a simultaneous equations system to demonstrate the robustness of the directional relation between termination fee use and premiums, namely that target managers appear to be able to improve their bargaining position and extract higher premiums from bidders through the use of a target termination fee. The paper proceeds as follows. Section 2 describes the contractual structure and legal ramifications of termination fees. My principal hypotheses are discussed in Section 3. Section 4 describes my sample and provides descriptive statistics while the main results are discussed in Section 5. Section 6 discusses some endogeneity issues, and Section 7 concludes the paper.
نتیجه گیری انگلیسی
I provide empirical evidence on effects of, and motivations for, the inclusion of target termination fees in merger agreements. The conventional wisdom is that target termination fees can be used by self-serving target managers to ensure that the target is acquired by a selected bidder offering target managers continued employment. The assumed cost to target shareholders under this hypothesis is the loss of takeover premium because the imposition of a termination fee deters potential competing bidders resulting in a lower price paid for the target's shares. However, target termination fees can also serve a less exploitative role by enabling the target to commit to a particular bidder in order to induce that bidder to invest fully in the acquisition process. In particular, a termination fee can be used to encourage the bidder to reveal valuable private information in bilateral negotiations with the target. Bidders would be reluctant to reveal, for example, post-takeover plans for the target's assets if other bidders could free ride on such information and submit a more valuable competing bid. Termination fees internalize the public good component of a takeover bid by forcing competing bidders to pay for the information revealed by an incumbent bidder. The evidence presented in this paper is supportive of the more benign explanation for target termination fee use. Controlling for deal, bidder, and target characteristics that could influence the cross-sectional distribution of premiums, I find that takeover premiums are not lower when a target termination fee is included in the merger terms and are potentially as much as 7% higher. However, univariate averages do suggest that bidders do not offer target shareholders a competition premium when a merger agreement with a target termination fee (potentially a white knight bid) is announced subsequent to an existing bid for the target firm. The evidence that termination fees deter bid competition is surprisingly weak. While deterrence is evident in univariate results, termination fee deals do not involve significantly lower rates of post-bid competition once I control for the publicly revealed attitude of target managers towards the bidder (see Schwert, 2000). Furthermore, conditional on the inclusion of a target termination fee in a merger agreement, the size of the fee does not appear to deter competing acquirers. Weighing the implications of the point estimates presented in this paper suggests that termination fees offer a net benefit to target shareholders. Specifically, Betton and Eckbo (2000) report that the average competing second-bid jump is a 31% increase in the premium from an initial premium of roughly 45%. Back-of-the-envelope calculations suggest that the average premium gain from termination fee use (approximately 4%) is an order of magnitude higher than the average expected loss of premium resulting from the diminished probability of an auction (roughly 0.4%).18 Overall, therefore, my evidence on the effects of termination fee use on deal outcomes suggests that target termination fees are not detrimental to target stockholders. This conclusion is consistent with the hypothesis that target termination fees are used to induce the bidder to make investments in a deal with the target the public benefit of which cannot be fully internalized. From a policy perspective, while specific instances of abuse may occur, on average target shareholders (and by extension the courts) have little to fear from the inclusion of a target termination fee in a merger contract per se.