Merger negotiations with stock market feedback

Merger negotiations routinely occur amidst economically significant a target stock price runups. Since the source of the runup is unobservable (is it a target stand-alone value change and/or deal anticipation?), feeding the runup back into the offer price risks "paying twice" for the target shares. We present a novel structural empirical analysis of this runup feedback hypothesis. We show that rational deal anticipation implies a nonlinear relationship between the runup and the offer price markup (offer price minus runup). Our large-sample tests confirm the existence of this nonlinearity and reject the feedback hypothesis for the portion of the runup not driven by the market return over the runup period. Also, rational bidding implies that bidder takeover gains are increasing in target runups, which our evidence supports. Bidder toehold acquisitions in the runup period are shown to fuel target runups, but lower rather than raise offer premiums. We conclude that the parties to merger negotiations interpret market-adjusted target runups as reflecting deal anticipation.Merger negotiations; stock market feedback

Pervasive liquidity risk

While there is no equilibrium framework for defining liquidity risk per se, several plausible arguments suggest that liquidity risk is pervasive and thus may be priced. For example, market frictions increase the cost of hedging strategies requiring frequent portfolio rebalancing. Also, liquidity risk is likely to play a role whenever the market declines and investors are prevented from hedging via short positions. Using monthly return data from 1963–2000, and a broad set of test assets, we examine six candidate factor representations of aggregate liquidity risk, and test whether any one of these are priced. The results are interesting. First, with the surprising exception of the recent measure proposed by Pastor and Stambaugh (2001), liquidity factor shocks induce co-movements in individual stocks’ liquidity measure (commonality in liquidity). The commonality is similar to that found in the extant literature (Chordia, Roll, and Subrahmanyam (2000)), which so far has been restricted to a single year of data. Second, again with the exception of the Pastor-Stambaugh measure, the liquidity factors receive statistically significant betas when added to the Fama-French model. Third, maximum-likelihood estimates of the risk premium are significant for the measure based on bid-ask spreads, contemporaneous turnover, as well as the Pastor-Stambaugh measure, which exploits price reversals following volume shocks. Overall, the simple-to-compute, "low-minus-high" turnover factor first proposed by Eckbo and Norli (2000) appears to do as least as well as the other factor measures

The leverage-profitability puzzle resurrected

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Corporate restructuring

We survey the empirical literature on corporate nancial restructuring, including breakup transactions (divestitures, spin-o s, equity carveouts, tracking stocks), leveraged recapitalizations, and leveraged buyouts (LBOs). For each transaction type, we survey techniques, deal nancing, transaction volume, valuation e ects and potential sources of restructuring gains. Many breakup transactions are a response to excessive conglomeration and reverse costly diversi cation discounts. The empirical evidence shows that the typical restructuring creates substantial value for shareholders. The value-drivers include elimination of costly cross-subsidizations characterizing internal capital markets, reduction in nancing costs for subsidiaries through asset securitization and increased divisional transparency, improved (and more focused) investment programs, reduction in agency costs of free cash ow, implementation of executive compensation schemes with greater pay-performance sensitivity, and increased monitoring by lenders and LBO sponsors. Buyouts after the turn of the century created value similar to LBOs of the 1980s. Recent developments include consortiums of private equity funds (club deals), exits through secondary buyouts (sale to another LBO fund), and evidence of persistence in fund returns. LBO deal nancing has evolved towards lower leverage ratios. In Europe, recent deals are nanced with less leveraged loans and mezzanine debt and more high-yield debt than before. Future research challenges include integrating analyses across transaction types and nancing mixes, and producing unbiased estimates of the expected return from buyout investments in the presence of limited data on portfolio companies that do not return to public status

Corporate Restructuring

We survey the empirical literature on corporate financial restructuring, including breakup transactions (divestitures, spinoffs, equity carveouts, tracking stocks), leveraged recapitalizations, and leveraged buyouts (LBOs). For each transaction type, we survey techniques, deal financing, transaction volume, valuation effects and potential sources of restructuring gains. Many breakup transactions appear to be a response to excessive conglomeration and attempt to reverse a potentially costly diversification discount. The empirical evidence shows that the typical restructuring creates substantial value for shareholders. The value-drivers include elimination of costly cross-subsidizations characterizing internal capital markets, reduction in financing costs for subsidiaries through asset securitization and increased divisional transparency, improved (and more focused) investment programs, reduction in agency costs of free cash flow, implementation of executive compensation schemes with greater pay-performance sensitivity, and increased monitoring by lenders and LBO sponsors. Buyouts after the 1990s on average create value similar to LBOs of the 1980s. Recent developments include consortiums of private equity funds (club deals), exits through secondary buyouts (sale to another LBO fund), and evidence of persistence in fund returns. LBO deal financing has evolved toward lower leverage ratios. In Europe, recent deals are financed with less leveraged loans and mezzanine debt and more high-yield debt than before. Future research challenges include integrating analyses across transaction types and financing mixes, and producing unbiased estimates of the expected return from buyout investments in the presence of limited data on portfolio companies that do not return to public status. DOI:10.1561/050000002

Creditor Financing and Overbidding in Bankruptcy Auctions: Theory and Test

We present unique empirical tests for auction overbidding using data from Sweden\u27s auction bankruptcy system. The main creditor (a bank) can neither bid in the auction nor refuse to sell in order to support a minimum price. However, we argue that the bank may increase its expected revenue by financing a bidder in return for a joint bid strategy, and we show that the optimal coalition bid exceeds the bidder\u27s private valuation (overbidding) by an amount that is increasing in the bank\u27s ex ante debt impairment. We find that bank–bidder financing arrangements are common, and our cross-sectional regressions show that winning bids are increasing in the bank-debt impairment as predicted. While, in theory, overbidding may result in the coalition winning against a more efficient rival bidder, our evidence on post-bankruptcy operating performance fails to support such allocative inefficiency effects. We also find that restructurings by bank-financed bidders are relatively risky as they have greater bankruptcy refiling rates, irrespective of the coalition\u27s overbidding incentive

Gains to Bidder Firms Revisited: Domestic and Foreign Acquisitions in Canada

We present large sample evidence on the performance of domestic and U.S. (foreign) bidder firms acquiring Canadian targets. Domestic bidders earn significantly positive average announcement period abnormal returns, while U.S. bidder returns are indistinguishable from zero. Measures of pre- and post-acquisition abnormal accounting performance are also consistent with a superior domestic bidder performance. Domestic bidder announcement returns are, on average, greatest for offers involving stock payment and for the bidders with the smallest equity size relative to the target. Neither direct foreign investment controls, horizontal product market relationships, nor acquisition propensities explain why domestic bidders outperform their U.S. competitors

How Costly is Corporate Bankruptcy for the CEO?

We examine chief executive officer (CEO) career and compensation changes for large firms filing for Chapter 11. One-third of the incumbent CEOs maintain executive employment, and these CEOs experience a median compensation change of zero. However, incumbent CEOs leaving the executive labor market suffer a compensation loss with a median present value until age 65 of $7 million (five times pre-departure compensation). The likelihood of leaving decreases with profitability and CEO share ownership. Furthermore, creditor control rights during bankruptcy (through debtor-in-possession financing and large trade credits) are associated with CEO career change. Despite large equity losses (median$11 million for incumbents who stay until filing), the median incumbent does not reduce his stock ownership as the firm approaches bankruptcy

Automatic Bankruptcy Auctions and Fire-Sales

We test for fire-sale tendencies in automatic bankruptcy auctions. We find evidence consistent with fire-sale discounts when the auction leads to piecemeal liquidation, but not when the bankrupt firm is acquired as a going concern. Neither industry-wide distress nor the industry affiliation of the buyer affect prices in going-concern sales. Bids are often structured as leveraged buyouts, which relaxes liquidity constraints and reduces bidder underinvestment incentives in the presence of debt overhang. Prices in “prepack” auctions (sales agreements negotiated prior to bankruptcy filing) are on average lower than for in-auction going-concern sales, suggesting that prepacks may help preempt excessive liquidation when the auction is expected to be illiquid. Prepack targets have a greater industry-adjusted probability of refiling for bankruptcy, indicating that liquidation preemption is a risky strategy