“Takeover Bidding with Signaling Incentives” by Tingjun LIU
Carnegie Mellon University
This paper studies takeover bidding when bidders with private synergy values have incentives to signal high values to the market. Such an incentive could arise if the winner sells part of the joint company or issues equity to finance the purchase after the takeover and the stock price includes his value. I show there are two ways a bidder communicates the private value. One way is with the initial bid, which results in separating equilibria and explains the stylized facts on jump bidding in takeovers. The initial bid fully reveals the private value, leading to efficient allocation and less volatility on the winner’s post-takeover stock price. Alternatively, pooling equilibria exist in which the opening bid is a constant and low, and the winner’s value is disclosed through the final price. The price does not reveal the exact value; therefore, the allocation is generically inefficient, leading to larger future resale. In addition, the winner’s post-takeover stock price volatility is larger. Furthermore, a high price signals a high value in the pooling equilibria. Therefore, bidders stay in the auction beyond their actual value, leading to a positive probability of overpayment. Empirically, these two types of equilibria can be distinguished by the size of the initial bid premium. The model predicts novel correlations between the initial bid premium and the winner’s post-takeover stock price performance, volatility, and future resale activity. In both types of equilibria signaling incentives reduce the profits of bidders and increase the profit of the target.