No Free Shop

The following post comes to us from Charles Calomiris, Professor of Finance at Columbia University.

In the paper, No Free Shop: Why Target Companies in MBOs and Private Equity Transactions Sometimes Choose Not to Buy ‘Go-Shop’ Options, which was recently made publicly available on SSRN, my co-authors (Adonis Antoniades and Donna Hitscherich) and I study the decisions by targets in private equity and MBO transactions whether to actively “shop” executed merger agreements prior to shareholder approval.

We construct a theoretical framework for explaining the choice of go-shop clauses by acquisition targets, which takes account of value-maximizing motivations, as well as agency problems related to conflicts of interest of management, investment bankers, and lawyers. On the basis of that framework, we empirically investigate the determinants of the go-shop decision, and the effects of the go-shop choice on acquisition premia and on target firm value, using a regression methodology that explicitly allows for the endogeneity of the go-shop decision. Our sample includes data on 306 cash acquisition deals for the period 2004-2011.

We allow many aspects of target firms to enter into their go-shop decision, including the nature of their legal counsel, their ownership structure, their size, and various other firm, and deal characteristics. We find that legal advisor characteristics, ownership structure, and the extent to which the transaction was widely marketed prior to the first accepted offer all matter for the go-shop decision.

Our paper is the first of which we are aware that explicitly considers potential conflicts of interest between target shareholders and the attorneys that represent target firms. To investigate the potential importance of such conflicts, we employ legal advisor characteristics, which capture differences in the identity and structure of the legal team advising the target board of directors, as instruments when analyzing the effects of go-shop decisions on target acquisition premia and value. These characteristics play an important role in predicting targets’ use of go-shop provisions.

We find, as predicted in our theoretical review, that go-shops result in lower acquisition premia, ceteris paribus. In other words, when targets insist on including a go-shop provision, they receive a lower offer. The adverse effect of go-shop provisions on the initial acquisition premium is large. Estimates range widely (between -24% and -41%), depending on the specification of the model, which is roughly the size of one standard deviation of the merger premium. Given the size of the standard errors of our estimates, across all of these various specifications, it seems clear that the effect of go-shop choice on the acquisition premium is negative and large (at least -7%).

Our theoretical framework has an ambiguous prediction about the effects of go-shop choice on target firm valuation. Whether the go-shop choice should increase the value of a target should depend on a combination of the motivations underlying the go-shop choice (that is, whether it arises from value-maximizing considerations or agency problems, such as attorneys’ conflicts of interest). Our examination of the effect of go-shop clauses on the propensity for “jumpers” indicates that there is a small but statistically insignificant improvement in attracting post-agreement bidders.

Nevertheless, the large adverse effect on the initial acquisition premium cannot be plausibly offset by the prospect of attracting additional bidders, which indicates that go-shop choices have tended to be value-destroying for targets. Using CARs, we find some evidence of a positive post-announcement effect for CARs related to go-shop choice, but this effect is not robust to controlling for endogeneity.

The full paper is available for download here.

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