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Does Patience Pay? Empirical Testing of the Option to Delay Accepting a Tender Offer in the US Banking Sector

Does Patience Pay? Empirical Testing of the Option to Delay Accepting a Tender Offer in the US Banking Sector. Rachel Campbell Roman Kr ä ussl. Overview. Empirical predictions of real option-pricing model Application to M&A behavior US banking industry

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Does Patience Pay? Empirical Testing of the Option to Delay Accepting a Tender Offer in the US Banking Sector

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  1. Does Patience Pay? Empirical Testing of the Option to Delay Accepting a Tender Offer in the US Banking Sector Rachel Campbell Roman Kräussl

  2. Overview • Empirical predictions of real option-pricing model • Application to M&A behavior • US banking industry • Target bank’s size & free cash flow important variables in determining the size of the final premium paid • Does patience pay? • 5 significant results

  3. Quick Glance at the Results • Patience pays • Winners curse • Hubris and overconfidence • Low earnings matter • Size matters

  4. Literature I • Empirical evidence: Acquiring companies overpay • Moeller, Schlingemann and Stultz (2004, JFE) • 12,023 acquisitions, 1980 to 2001 • Negative effect • Size effect: Larger negative effect for larger acquiring-firm shareholders • Moeller, Schlingemann and Stultz (2003, NBER WP) • Acquiring firm shareholders lost $240 billion at the announcement of acquisitions during 1998-2001; 12 cent loss for every dollar spent • 1980s: “just”1.6 cent loss for every dollar spent • Fuller, Netter & Stegemoller (2002, JF) • Bidder firm shareholders gain (lose) when buying a private (public) firm

  5. Literature II • Why do acquiring companies overpay? • Hubris • Roll (1986, JB): also greater for larger firms • Demsetz and Lehn (1985, JPE): greater share ownership for larger firms • Managerial optimism • Heaton (2002, FM): behavioral finance; wrong perceptions of decision-makers • Malmendier and Tate (2005, JF): CEO overconfidence; investment of overconfident CEOs is significantly more responsive to cash flow • Free Cash Flow • Jensen (1986, Midland CF Journal): too much excess cash flow available after funding all projects with NPV; managers have incentives to expand their firms beyond the size that maximizes shareholder wealth

  6. Literature III • Management resistance to takeover • Baron (1983, JF) • Schwert (2000, JF) • Retain control • Offer doesn’t reflect the true value • Or simply wait for a better offer • How effective is this strategy? • And what is the value of this strategy to the target company’s shareholders?

  7. Main Idea • We know: Tendency for bidder management to overpay plus resistance of targets to be taken over • We ask: Is it a valuable option to delay accepting a tender offer?

  8. Data • US Banking Industry • 1997-2005 • 424 M&A • SDC Platinium • Public tender offers • Same currency, cash • Accounting data on both target and acquisition company • CRSP, Compustat • Mean option premium is 12.5%

  9. Real Option Model • Tender offer at time t • Share worth St • Offer price Pt • Gain Pt -St • Shareholders may wait until time T in the hope of a higher second or third offer, P2, P3… PT where:PT –ST > Pt –St • Option value V is the maximum of the present value of the payoffs

  10. Parameters • Value of underlying asset = V • Variance of the stock price, σ2 • Exercise price = investment made to acquire the underlying asset, X, =Pt –St • Transaction completed, time T • Discount rate, r, corresponding to the life of the option • Dividend yield, δ

  11. Intermediate Variables • Lattice approach (Quigg,1993 JF; Trigeorgis,1993 JFQA) • Nodes, n • Time step, k • Drift,μ • State Step, H • Probability, p • Terminal boundary • Option Payoff • Option value at time of announcement

  12. Summary Statistics

  13. Option Premiums

  14. Patience Pays! Result 1 • Positive premium 12.45% • Advantageous to wait as long as possible in accepting the bid • Accepting the offer straight away means sacrificing this option to delay

  15. Winners Curse! Result 2 • Competitor in the bidding process results in additional premium of 10%

  16. Acquiring Firm Variables

  17. Hubris and Overconfidence Result 3 • Insignificant relationship between all enterprise variables from the acquiring companies’ as explanatory variables in determining the size of the option premium

  18. Target Firm Variables

  19. Low Earnings Matter! Result 4 • Significant relationship between the target companies earning per share and the size of the option premium

  20. Size Matters! Result 5 • Significant negative relationship between the size of the price to book value of the target company and the size of the option premium

  21. Conclusions • Descriptive value of a real option model for pricing the value to delay accepting a tender offer • Empirical evidence of a 12.5% premium for US banking industry M&A behavior • Greater value for the target the smaller its earnings per share and its price to book value (low R2) • Other non-firm specific characteristics • For target shareholders – Patience always pays!

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