Introduction Model Analysis Other mechanisms for corporate control

Advanced Corporate Finance

Lecture 15: Takeovers - Large Shareholder

Alexander Schandlbauer

Autumn 2018

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Introduction Model Analysis Other mechanisms for corporate control

Outline

1 Introduction

2 Model

3 Analysis

4 Other mechanisms for corporate control

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Introduction Model Analysis Other mechanisms for corporate control

Shleifer and Vishny (JPE, 1986)

Large Shareholders and Corporate Control

Main idea of the paper:

Builds on Grossman and Hart (1980):
I Dilution, ϕ, . . .

Shleifer and Vishny: Not a necessary condition

I Raider holds shares
∗ Raider benefits on exactly those shares
∗ If the benefit ∼ amount of shares is large enough. Dilution is not
needed
I Raider holds no shares
∗ Must pay the shareholders the new improved price
∗ Need dilution to gain from takeover (to solve the hold-out problem)
The large shareholder has an incentive to monitor the current
management because he receives a part of the improved value!

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Introduction Model Analysis Other mechanisms for corporate control

Do we observe large shareholders?

Empirical evidence

Shleifer and Vishny (1986): 456 of the Fortune 500 firms

I 354
456
≈ 78% of the firms have at least one shareholder owing more
than 5%
I The average holding of the largest shareholder among the 456
firms is 15.4%
I The total average holding of the five largest shareholders is 28.8%
Faccio and Lang (JFE 2001), Western European Countries:
I 4806
5232
≈ 92% at least one shareholders has 5% of the voting rights
I 3300
5232
≈ 63% at least one shareholders has 20% of the voting rights
Evidence seems to point towards a positive answer
Who are the large shareholders?
I ...
I ...
I ...

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Introduction Model Analysis Other mechanisms for corporate control The setting Timing and information structure Conditions for an offer

The setting
Main focus: conditional cash tender offer

Single large + many small shareholders (all are risk neutral)

I Large shareholder L holds a fraction α < 1 of the firm’s shares
2
I Small atomistic shareholders: hold the fraction 1 − α of shares
Current management yields expected value of profits = q
L undertakes research to find improvement
I I: Probability of drawing an improvement
∗ Interpretation: think of I as research intensity
I Z is the increase in discounted profit by managerial replacement
∗ Z > 0, from a distribution F (Z ) on ]0, Zmax ]
∗ Zmax upper bound for how much improvement one can make
I c(I): costs of research, is assumed to be increasing and convex
∗ c 0 (I) > 0 and c 00 (I) > 0
L needs 21 of the shares to gain control can make a cash
tender offer for the missing 21 − α shares

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Introduction Model Analysis Other mechanisms for corporate control The setting Timing and information structure Conditions for an offer

Timing and information structure

L owns α shares
other s.h. own 1 − α

- L undertakes research
Z ∼ F (Z ) on (0, Zmax ]

- L invests C(I) → Z ; C is convex

Z is private information to L

- Corporate control: decision to make

tender offer for 12 − α shares

- S.h. decision to tender, information:

F (Z ), improvement distribution
L has profit ≥ 0 of an offer
- L’s bid determined

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Introduction Model Analysis Other mechanisms for corporate control The setting Timing and information structure Conditions for an offer

Conditions for an offer - the raider

Conditions for an offer are:
1 Raider is willing to bid
2 Shareholders are willing to tender
The raider:
Wants a non-negative profit
1
Invests c(I), gets Z , and needs 2 − α shares (by conditional offer)
Assume direct costs of tender offer are cT
1
Makes offer to buy 2 − α shares at a bid q + π iff:

L’s value if offer ≥ L’s value if no offer

Hence (blackboard)
 
1 1
Z− − α π − cT ≥ 0 (1)
2 2

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Introduction Model Analysis Other mechanisms for corporate control The setting Timing and information structure Conditions for an offer

Conditions for an offer - the raider

continued

Remarks:
1 π 6= bid price-(before takeover price)
| {z }
>q b/c takeover is anticipated
1
2 α% 2 ⇒ (1) → 12 Z ≥ cT
I When L’s holding of shares approaches 1 , L just needs his
2
“additional value” 21 Z to be larger than the direct tender costs to

make an offer

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Introduction Model Analysis Other mechanisms for corporate control The setting Timing and information structure Conditions for an offer

Conditions for an offer - the small shareholders

Small shareholders:
Don’t know the true Z
Must take expectations
Assume that shareholders tender if they are indifferent
I Technical remark: This implies that they obtain a pooling
equilibrium: From the bid π + q shareholders cannot get a
revealing signal about Z . If the assumption is changed, the result is
a separating equilibrium: Z is revealed through the bid, see also
Hirshleifer and Titman (1990).
When taking expectation shareholders take into account
I L has drawn an improvement from F (Z )
I L can cover takeover costs, pay 1 − α π above q, and still make a


2
non-negative profit
The shareholders are willing to tender iff: [Blackboard]
 
π − E z|z = (1 − 2α)π + 2cT = 0 (2)
Hence L bids q + π ∗ (α), where π ∗ (α) = arg minπ (2)
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Introduction Model Analysis Other mechanisms for corporate control The equilibrium Optimal research Propositions

The equilibrium

Theorem 1
If a tender offer for 12 − α shares and π ∗ (α) < Zmax is made,
then ∃! equilibrium (Perfect Bayesian Equilibrium)
In this equilibrium L bids q + π ∗ (α) if (1) holds and otherwise L
does not bid

Technical remarks
I Uniqueness: after refinement of the equilibrium ∼ Grossman-Perry
or Cho-Kreps criteria
I Refinement: Could obtain equilibrium with π ≥ π ∗ , but intuitively
π = π∗
I We’ll see something like this also in Leland and Pyle (1977)
FYI: We are considering so-called dynamic games of incomplete
information. You can read more about this in e.g. Robert
Gibbons’ book A primer in game theory/Game theory for applied
economists, ch. 4. Note: You are NOT required to read this book.

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Introduction Model Analysis Other mechanisms for corporate control The equilibrium Optimal research Propositions

Properties of the equilibrium

Effect of α (fraction of large shareholder)

Lemma 1
π ∗ (α) is decreasing in α, i.e. α ↑ ⇒ π ∗ (α) ↓

Proof: Blackboard
Interpretation?
1
Remark: What happens as α % 2 or α & 0?

Definition: Let Z c (α) be the cut-off level such that L is indifferent

between taking over or not

Lemma 2
Z c (α) is strictly decreasing in α, i.e. α ↑ ⇒ Z c (α) ↓

Proof: Blackboard
Note: a higher α increases the probability of a takeover

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Introduction Model Analysis Other mechanisms for corporate control The equilibrium Optimal research Propositions

∗
Optimal research, I (α)

Let B(I, α) be L’s expected benefit from research I (→ probability

of drawing an improvement)
  
1 1
B(I, α) = I · E max Z − ( − α)π ∗ (α) − cT , 0 (3)
2 2
= I · Pr(Z ≥ Z c (α)) · E |Z ≥ Z c (α)
 
αZ − cT
| {z } | {z }
prob. of takeover gain if takeover is done

b/c π ∗ (α) is the expected value improvement conditional on the

takeover being profitable (use iterated expectations)

Note: α ↑ ⇒ {Z c (α) ↓ and αZ ↑} ⇒ B ↑

I L profits only from his initial holding, α
I Hence: his expected marginal benefit from an extra unit of I
increases with α

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Introduction Model Analysis Other mechanisms for corporate control The equilibrium Optimal research Propositions

Effects of α
Lemma 3
L’s optimal choice of research intensity, I ∗ (α), is increasing in α,
i.e. α ↑ ⇒ I ∗ (α) ↑

Proof: Blackboard

Note: α ↑ ⇒ L has more shares to gain on if improvement is drawn

⇒ he is willing to pay to get Pr(“good” draw) ↑ (Lemma 3)
+ to have a lower cut-off level Z c (α) ⇒ Pr(takeover) ↑ (Lemma 2)
⇒ Pr(value increasing takeover) ↑

We can therefore consider the market value of the firm:

V (α, q) = q + I ∗ (α) · Pr(Z ≥ Z c (α)) · E[Z |Z ≥ Z c (α)] (4)

|{z} | {z }
value from current mgmt. expected value of improvement

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Introduction Model Analysis Other mechanisms for corporate control The equilibrium Optimal research Propositions

Effects of α
Definition of bid premium:
“Excess-bid” (know that improvement has been found) minus
expected value (future improvement)
Hence:
= E[Z |Z ≥ Z c (α)] − I ∗ (α) · Pr(Z ≥ Z c (α)) · E[Z |Z ≥ Z c (α)]
= 1 − I ∗ (α) · Pr(Z ≥ Z c (α)) · E[Z |Z ≥ Z c (α) ]
 
| {z } | {z } | {z }
↑ Lemma 3 ↑ Lemma 2 ↑

From Lemmas 1–3 one can see that: α ↑⇒ premium ↓

Lemma 4
α ↑⇒ Pr(Z ≥ Z c (α)) · E[Z |Z ≥ Z c (α)] ↑

It follows that α ↑⇒ V (α, q) ↑ (by Lemma 3+4)

Proof: do yourself

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Introduction Model Analysis Other mechanisms for corporate control The equilibrium Optimal research Propositions

Propositions
Proposition 1

bid premium ↓
α ↑⇒
V (α, q) ↑

Intuition: Small shareholders receive a lower premium, but they

are compensated by a higher probability of a takeover
Intuitively, we also have
Proposition 2

bid premium ↑
cT ↑⇒
V (α, q) ↓

Higher direct tender costs make a takeover less likely,

I thus, L needs “a higher α” to pay for the costs

Proposition 3
1
L would not bid for more than 2 − α of the shares even if he could

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Introduction Model Analysis Other mechanisms for corporate control

Other mechanisms for corporate control

Proxy fights: voting mechanism
probably not that effective

Jawboning: informal negotiation with current management

less effective than takeovers
gain to L = αβZ , β ∈ [0, 1)
L only makes tender offer if

1 1
Z − ( − α)π − cT ≥ αβZ > 0
2 2
β > 0: A tender offer signals that Z is “sufficiently” high to pay
the tender costs, bid and not to jawbone
jawboning option may be of negative value to L
I when his bids must be higher
I there may be fewer bids
I may also hurt the small shareholders

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Introduction Model Analysis Other mechanisms for corporate control

Conclusion
abstract of Shleifer and Vishny (1986)

In a corporation with many small owners, it may not pay

any one of them to monitor the performance of the manage-
ment. We explore a model in which the presence of a large
minority shareholder provides a partial solution to this free-
rider problem. The model sheds light on the following ques-
tions:
1 Under what circumstances will we observe a tender
offer as opposed to a proxy fight or an internal
management shake-up?
2 How strong are the forces pushing toward increasing
concentration of ownership of a diffusely held firm?
3 Why do corporate and personal investors commonly
hold stock in the same firm, despite their disparate tax
preferences?

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