Game theory of takeovers

If you are a shareholder in a company that is the subject of a takeover bid then would you want the raider trying to acquire your company to promise to take millions out of the company once they gained control?

The natural reaction is to say ‘no’, of course you don’t want the value of your shares to be reduced after the takeover.

In fact, the promise to make a big payout might be necessary to make the deal happen in
the first place.

The corporate raider is presumably buying the company because he thinks he can add value to the business. This could be through following a different strategy or through running the existing business more efficiently. Either way he will be hoping to increase the value, and therefore the share price of the company after the takeover.

You are a small shareholder so you have effectively no influence on whether the takeover will happen or not. You see that if the takeover does happens then the price will be higher and you should wait until then to sell. Unfortunately, if all the shareholders think like that then no-one sells and no-one benefits from the higher share price.

This is a free rider problem. Everyone waits for someone else to sell, so no-one ends up selling. The only price that any shareholder would accept is the post-takeover price, but if the raider pays that then he makes no profit.

One of the ways round this is for the raider to promise to take a large payment for himself after the takeover. This will lower the post-takeover price to a point which is still higher than the current price, and so attractive to the current shareholders, but he gets his profit as well.

This problem was originally studied by Grossman & Hart in 1980.

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