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MN50324
Spring 2010
M and A: Game-theoretic Approaches:
•Grossman and Hart 1982
•Garvey and Hanka 1996
Capital Structure and Takeovers
• Garvey and Hanka:
• Waves of takeovers in US in
1980’s/1990’s.
• Increase in hostile takeovers => increase
in debt as a defensive mechanism.
• Decrease in hostile takeovers => decrease
in debt as a defensive mechanism.
Garvey and Hanka (continued)
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Trade-off: Tax shields/effort
levels/FCF/ efficiency/signalling
Vs financial distress
V
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D/E
D/E*
• Garvey and Hanka: Management of Corporate
Capital Structure.
• - Hostile takeovers, and US antitakeover laws of
1980’s.
• - dynamic defensive capital structure model.
• -Results• A. When takeover is easy => manager defends,
increasing leverage => increases firm value =>
reduces takeover threat.
• B. When takeover is more difficult => manager
reduces leverage to reduce financial distress.
• Optimal debt level maximises firm value.
• - Manager’s optimal debt level minimises the
threat of financial distress and minimises
takeover threat.
• - Investors’ Optimal debt level D*, maximises
firm value.
• - Firm has single terminal Cashflow: R
• If no takeover threat, manager chooses D < R
• - no financial distress.
• As takeover threat increases, manager
increases D towards D* => V increases =>
reduces takeover threat.
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Take-over Bids and the Freerider Problem (Grossman
and Hart (1982).
- Market value per share under current management = Q.
- Market value per share under optimal management = V.
Price per share offered by raider = P, with Q < P V.
Freerider problem - If shareholder accepts offer, he gets P.
If shareholder refuses, but bid succeeds, he gets V.
Therefore, all shareholders refuse - bid fails.
Eg: Q = 10, V = 100. P = 20.
Each shareholder will not tender for anything less than
100 -raid fails.
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Dilution - allows raider to take some of the firm’s value if
successful.
Eg: dilution = 10 (lump sum payment to raider).
Successful raid: net value to shareholders = 100 - 10 =
90.
Tender offer = 91. Bid succeeds.
Implication of Garvey and Hanka, and Grossman and
Hart.
-Corporate Governance (disciplining) role of Takeovers.
- Takeovers increase firm value (socially desirable).
- Takeovers may be difficult to achieve due to defensive
strategy, or freerider price ‘run-ups’.
- Successful takeovers - most of the gains go to the
target shareholders.
Effects of takeovers on stock prices of bidder
and target.
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Successful Bids
Unsuccessful Bids
Takeover Target
Technique
Tender
30%
Offer
Merger
20%
Bidders
Proxy
Contest
n.a
8%
4%
0
Jensen and Ruback JOFE 1983
Takeover Target
Technique
Tender
-3%
Offer
Merger
-3%
Bidders
Proxy
Contest
n.a
8%
-1%
-5%