Economically Rational Corporate Takeovers

Project Start:01/2018
Researchers:Giuliano Curatola, Gustavo Grebler, Tobias Tröger
Category: Law and Finance
Funded by:LOEWE

This project provides a theoretical explanation for takeover bids that involve less than 100% of the target's shares and tests the hypothesis empirically. We use Modern Portfolio Theory (MPT) to propose (i) a function for the value of corporate control under the Market Rule (MR) and the Equal Opportunity Rule (EOR), and the logical relations underlying (ii) the relative (in-) efficiency of MR and EOR, (iii) the economically rational stake of corporate control (optimal control), and (iv) a sensitivity index to corporate takeovers (Takeover Sensitivity). We use empirical data to measure (v) the value of the optimal control in discretionary transactions, and (vi) the Takeover Sensitivity. We then test market adherence or deviation from our model empirically and present our conclusions. We treat MR and EOR portfolios as diversified and non-diversified, respectively. MR portfolio is treated as an efficient portfolio with one constraint, corresponding to target's marginal control (Efficiency Takeover Portfolio) in order to account for the covariance of weakly, negatively and uncorrelated cash flows the bidder can buy. Because economically rational controllers will deviate from the social optimum to the extent payoffs from non-internalized private benefits of control (PBC) are higher than those from diversification, we deduct PBCs from MR portfolio in order to establish relative efficiency.

We use the Efficient Takeover Portfolio to evince the optimum controlling stake, as any accumulation of target shares above that will reduce the present value of the takeover. We then combine target companies individual (i) optimal control, (ii) expected returns and (iii) standard deviations to derive the Takeover Sensitivity. We employ CAP-M to derive the value of MR and EOR portfolios empirically. We hold the discount factor constant and adjust cash flows upwards incorporating (i) cash flows informed by generally accepted industry sector specific services and (ii) those flowing from diversified securities. We strengthen our model using cash flows based on target's disclosed information to, holding it constant, adjust beta downwards to reflect diversification and find its present value. Discretionarily, we compare market transactions with the optimal controlling stake contained in our model and derive the value of optimal control. We then contrast actual controlling stakes in US regulated markets with the ones contained in our model and present our conclusions.