Journal of

CORPORATE
FINANCE
E L S E VI E R Journal of Corporate Finance 3 (1997) 141 - 165
Capital structure, asset structure and equi ty
t akeover premi ums in cash tender offers
Matthew T. Bi l l ett a,2, Mi ke Ryngaert b,,
Unit'ersity of Miami, Federal Deposit Insurance Corporation, Miami, FL, USA
b University of Florida, Gainest,ille, FL 32611, USA
Abs t ract
A model of t he equi t y t akeover pr emi um is devel oped t hat demonst r at es a di rect l i nk
bet ween t he per cent age pr emi um pai d to t ar get shar ehol der s and t he t ar get f i r m' s capi t al
st ruct ure and asset st ruct ure. We t est t he model usi ng a sampl e of 145 cash t ender offers
and f i nd t hat t ar get abnor mal r et ur ns i ncrease wi t h t he t ar get ' s l i abi l i t y to equi t y rat i o and
decr ease wi t h t he t ar get ' s f i nanci al asset to equi t y ratio. The addi t i on of t hese var i abl es
dr amat i cal l y i mpr oves t he expl anat or y power of r egr essi ons expl ai ni ng per cent age t akeover
pr emi ums pai d to t arget shar ehol der s.
JEL classification: G32; G34
Keywords." Takeovers; Tender offers; Target returns; Leverage; Co-insurance; Free cash flow
1. I n t r o d u c t i o n
Ta r g e t s h a r e h o l d e r s r e c e i v e d a v e r a g e p r e mi u ms o f r o u g h l y 3 0 % f or t he s a l e o f
t h e i r s h a r e s i n t a k e o v e r s d u r i n g t he 1970s a n d 1980s . 3 Th e r e wa s a l s o c o n s i d e r -
a b l e v a r i a t i o n i n t he t a k e o v e r p r e mi u ms , i n c l u d i n g c a s e s wh e r e s h a r e h o l d e r s
r e c e i v e d p r e mi u ms e x c e e d i n g 100%. Nu me r o u s s t udi e s h a v e s o u g h t t o e x p l a i n t he
* Corresponding author. Tel.: + 1-202-8988560.
We thank Dave Brown, Michael Bradley, Anand Desai, Mark Flannery, Jon Garfinkel, Robert
Hendershott, Joel Houston, Chris James, Eddie O' Neal, Paul Seguin, Subu Venkataraman, David
Walker, an anonymous referee, and the editor, Ken Lehn for helpful comments and discussions.
2 Tel.: + 1-202-8988560.
3 See Jarrell et al. (1988) for a summary of past research.
0929-1199/ 97/ $17. 00 Copyright 1997 Elsevier Science B.V. All rights reserved.
PII S 0 9 2 9 - 1 1 9 9 ( 9 6 ) 0 0 0 1 1 - 9
142 M.T. Billett, M. Ryngaert / Journal of Corporate Finance 3 (1997) 141 165
vari at i on in premi ums. In most cases, the f ocus has been on fact ors that affect a
t arget f i r m' s bargai ni ng power such as the number of potential or actual bidders in
a t akeover contest, the t akeover defenses of the t arget firm, and target manage-
ment ' s share ownershi p. 4 Ot her studies, like Servaes (1991), have linked the level
of t akeover pr emi ums to a measure like Tobi n' s Q that proxi es f or the pre-t ake-
over qual i t y of the t ar get ' s management . Thi s paper ext ends this literature by
i ncorporat i ng t wo l argel y i gnored fact ors that i nfl uence the percent age t akeover
pr emi ums paid to sharehol ders: the t ar get ' s capital structure and asset structure.
The hypot heses we l ay out are based on t wo si mpl e argument s. First, the use of
debt fi nanci ng serves t o i ncrease percent age t akeover pr emi ums pai d to sharehol d-
ers. Speci fi cal l y, pur chasi ng a maj ori t y of a f i r m' s c ommon st ock gi ves the
pur chaser the right t o manage all of that f i r m' s assets. The dol l ar cont rol pr emi um
pai d t o target fi rm c ommon sharehol ders is based on the degree to whi ch the
bi dder can i mpr ove the val ue of the t ar get ' s assets t hrough redepl oyment . I f the
dol l ar value of this i mpr ovement is i ndependent of how the fi rm fi nances its
operat i ons, then percent age equi t y t akeover pr emi ums shoul d increase wi t h the
t ar get ' s liability t o equi t y ratio, because the dol l ar t akeover pr emi um is spread
over a smal l er equi t y base. In ot her words, ' debt ' fi nanci ng levers equi t y t akeover
premi ums.
The second ar gument is that the pr emi um pai d for cont rol is sensitive to the
nature of the t ar get ' s assets. We conj ect ure that certain assets are mor e amenabl e
to val ue i mpr ovement vi a a t akeover. Speci fi cal l y, we argue t hat t akeovers of
non-fi nanci al firms general l y occur because the bi dder believes it can better utilize
the non-fi nanci al assets of the target as opposed to the t ar get ' s financial assets. For
exampl e, gains can result from such act i ons as i mpr ovi ng di st ri but i on of fi rm
product s, cl osi ng (and selling) obsol et e facilities, better i nvent or y management ,
and achi evi ng vari ous economi es of scope and scale. Whi l e bet t er utilization of
fi nanci al assets is possible, our conj ect ure is that the ability t o increase val ue by
r edepl oyi ng assets like market abl e securities, cash, recei vabl es and i nvest ment s in
ot her compani es is mor e limited. Thi s suggest s that, all else equal, t akeover
pr emi ums will be smal l er for fi rms with a hi gher ratio of fi nanci al assets to
c ommon equity.
Usi ng a sampl e of 145 cash t ender offers f or publ i cl y t raded compani es
initiated by ot her publ i cl y traded compani es duri ng the peri od 1980- 1989, we fi nd
that fi rm asset structure and capital structure have a si gni fi cant i mpact on
percent age t ender of f er pr emi ums pai d to shareholders. Tender of f er pr emi ums
increase wi t h a t arget f i r m' s liability t o equi t y ratio and decrease wi t h a target
f i r m' s fi nanci al asset t o equi t y ratio. The i ncl usi on of these vari abl es great l y
4 See for exampl e, Br adl ey et al. (1988), Comme nt and Schwer t ( 1995) , and St ul z et al. (1990).
.... I ....... ~ ~,t---I ....
M. T. Billett, M. Ryngaert / Journal o[" Corporate Finance 3 (1997) 141-165 143
i ncreases the expl anat or y power of regressi ons expl ai ni ng vari at i on in t ender of f er
pr emi ums.
In assessi ng these results it is useful to be cl ear about nomencl at ure. Theoret i cal
papers t hat l i nk t akeover pr emi ums t o capital structure are general l y di scussi ng
dol l ar pr emi ums rat her than pe r c e nt ag e premi ums. For exampl e, Israel (1991)
argues t hat val ue i ncreases in target assets associ at ed wi t h a t akeover will reduce
the defaul t risk f or bondhol der s of hi ghl y l ever aged targets. Thus, bondhol der s of
hi ghl y l ever aged targets will recei ve some of the benefi t s f r om a val ue i ncreasi ng
acqui si t i on. When a t akeover occurs, this leaves less f or the bi dder and target
sharehol ders, whi ch results in a l ower dol l ar t akeover pr emi um t o t arget sharehol d-
ers, even t hough t arget sharehol ders and debt hol ders combi ned get mor e of the
gai n f r om any acquisition. It does not l ogi cal l y fol l ow, however , that t he percent -
age pr emi um t o t arget sharehol ders decreases wi t h l everage, because the smal l er
dol l ar pr emi um pai d t o sharehol ders is spread over a smal l er equi t y base. 5
Fi nal l y, convent i onal wi s dom about t akeovers may s eem to run count er to our
empi ri cal results. It is oft en bel i eved that l ow debt levels and an abundance of
fi nanci al assets make a fi rm an attractive t akeover target, either because the fi rm
has excessi ve cash to wast e or may be payi ng t oo much in taxes. Hence, we mi ght
expect l arger per cent age equi t y pr emi ums for less l evered and mor e liquid firms. 6
Thi s argument , however , is mi sl eadi ng f or t wo reasons. First, most acqui si t i ons of
publ i cl y traded firms by ot her publ i cl y t raded fi rms are likely t o be f or strategic
reasons rather t han to force a t arget t o fully utilize debt capaci t y. 7 Second, even
if, all else equal, the dol l ar pr emi ums are l arger f or a less levered firm, it does not
necessari l y f ol l ow t hat the percent age equi t y pr emi um will be larger. Overall, our
evi dence suggest s that l ow debt levels and hi gh fi nanci al asset reserves were not
the pr i mar y dri ver of t arget sharehol der abnor mal returns f or our sampl e of 1980s
t ender offers.
5 Stulz (1988) also argues that capital structure can affect t akeover premiums. He shows that debt
can be used to repurchase stock from outside shareholders with a low reservation price and increase the
voting power of shares held by incumbent managers with higher reservation prices. As a result, bidders
must purchase control from shareholders with a higher reservation price. This effect is probably better
captured by exami ni ng the link between target management ownership and target premi ums as opposed
to exami ni ng the link bet ween capital structure and premiums.
~' See Kaufman (1988) and Wal kl i ng and Edmi st er (1985) for this argument. Kaufman (1988)
actually anal yzes the link between long term debt to equity ratios and t akeover premiums, but finds no
effect. Wal kl i ng and Edmi st er find a negat i ve relationship bet ween tender offer premi ums and the
trend in the t arget ' s debt to asset ratio for a sample of tender offers from the mi d 1970s. We devel op
and test different model specifications in this paper.
v Firms that are targeted due to inadequate l everagi ng can lever t hemsel ves up through a recapitaliza-
tion or leveraged buyout and avoi d any t akeover transaction by a third party acquisition. Consequently,
our results may not hold for t akeover transactions that may be more mot i vat ed by financial concerns
such as LBOs. See for exampl e Lehn and Poulsen (1989).
144 M.T. Billett, M. Ryngaert / Journal ~f" Corporate Finance 3 (1997) 141-165
The paper pr oceeds as fol l ows: Sect i on 2 devel ops a model of target equi t y-
hol der s' percent age pr emi um i ncorporat i ng fi rm asset and capital structure. Sec-
t i on 3 descri bes the met hodol ogy and data. Sect i ons 4 and 5 present and interpret
the results, and Sect i on 6 concl udes.
2. A simple model of equi t y takeover premi ums, capital structure and asset
structure
We assume initially that the dol l ar pr emi um pai d to target sharehol ders in an
acqui si t i on is some percent age of t arget non-financial assets. The reval uat i on of
fi rm assets is restricted to non-fi nanci al assets on the t heory that a bi dder acqui res
the t arget because it can i ncrease the val ue of the target by i mpl ement i ng changes
in the management of real assets (plant, propert y, inventories, intangibles, etc.),
but it cannot meani ngf ul l y i ncrease the value of the t ar get ' s fi nanci al assets (cash,
market abl e securities, recei vabl es, i nvest ment s in ot her fi rms) f ol l owi ng a t akeover.
Si nce the val ue of these assets are set (e.g., cash) or tied t o the effort s and
credi t wort hi ness of ot her parties, this assumpt i on seems reasonabl e, t hough we
relax it later. 8
The percent age pr emi um per dol l ar of t arget non-fi nanci al assets avai l abl e to
t arget sharehol ders is represent ed by p(X), where X is a vect or of variables,
excl udi ng capital structure variables, whi ch capt ures how much the bi dder can
reval ue the t ar get ' s non-fi nanci al assets and the relative bargai ni ng power of the
t arget and bidder. The dollar pr emi um pai d to target sharehol ders, assumi ng
non- equi t y cl ai mant s do not recei ve any of the pr emi um, can be expressed as
DPREM = ~ ( X ) * NFASSETS ( 1 )
wher e NFASSETS is the dol l ar val ue of the f i r m' s non-fi nanci al assets.
Di vi di ng bot h sides of Eq. (1) by the value of the t ar get ' s c ommon equi t y
yields:
DPREM NFASSETS
p ( X) * ( 2)
EQUI TY EQUI TY
where EQUI TY is the market value of the c ommon stock pri or to an acqui si t i on
bid. Eq. (2) defi nes the percent age pr emi um to the t arget f i r m' s c ommon equi t y-
hol ders pr ovi ded that hol ders of t arget liabilities do not capt ure any t akeover gains.
Since the val ue of non-fi nanci al assets equals the val ue of liabilities plus the value
s A r e va l ua t i on o f t he t a r ge t t hr ough a r e d e p l o y me n t of f i na nc i a l as s et s is pos s i bl e i f t he t a r ge t f i r m
is apt t o wa s t e f i na nc i a l r e s our c e s or i f ma n a g e me n t of r e c e i va bl e s c oul d be i mpr ove d.
M. T. Billett, M. Ryngaert / Journal of Corporate Finance 3 (1997) 141- 165 145
of equi t y less the val ue of fi nanci al assets, the c ommon sharehol ders' percent age
pr emi um can be expressed as a f unct i on of the f i r m' s fi nanci al structure:
DPREM ( E QUI T Y LI AB FI NASSETS )
E QUI T ~ - $ ( X) * EQUI T- ~ + EQUI T~ EQUI TY ( 3)
wher e LI AB is the market val ue of all liabilities issued by the fi rm ot her t han
c ommon stock, and FI NASSETS is the value of all fi nanci al assets hel d by the
firm. The percent age equi t y pr emi um i ncreases with target l everage, defi ned as
L I AB/ E QUI T Y, and decreases wi t h the fi nanci al asset to equi t y ratio.
Eq. (3) assumes t hat the val ue of t arget liabilities ot her t han c ommon equi t y is
unaffect ed by the acquisition. Thi s may be untrue. Expect ed changes in the val ue
of target debt (or preferred st ock) may cause the bi dder to decrease or i ncrease the
price offered f or t arget shares. Conver t i bl e securities will general l y appreci at e due
t o a t akeover because their val ue is related to c ommon st ock share price.
Addi t i onal l y, coi nsur ance of t arget debt occurs when the val ue of the assets
support i ng the debt i ncreases or when the vari ance of t he assets support i ng the
debt is reduced. Ei t her or bot h of these changes may result f r om an acqui si t i on
( Ki m and McConnel l , 1977; Israel, 1991). I f t arget debt is coi nsur ed or convert -
ible, t hen less of the total i ncrease in val ue remai ns t o be shared bet ween the t arget
sharehol ders and the bidder. Thi s shoul d lead t o a smal l er t arget c ommon equi t y
pr emi um t han predi ct ed by Eq. (3).
By cont rast , the val ue of out st andi ng liabilities may decrease i f a t akeover
t ransact i on si phons of f cash fl ows that mi ght ordi nari l y servi ce debt claims. For
i nst ance, i f a large amount of l everage is used in an acquisition, the bi dder mi ght
use t he t ar get ' s cash fl ows t o servi ce payment s on newl y issued debt claims. Thi s
i ncreases the probabi l i t y of defaul t on t he debt and reduces the val ue of the
t ar get ' s debt claims. 9 I f weal t h is expropri at ed f r om t arget debt hol ders in this
fashi on, t he bi dder can afford t o pay target equi t yhol ders a l arger pr emi um t han
predi ct ed by Eq. (3).
As s ume f or si mpl i ci t y t hat any weal t h t ransfer is a fi xed pr opor t i on of the
dol l ar val ue of the t akeover pr emi um that comes f r om liability f i nanced assets. For
the case of convert i bl e securities, this seems reasonabl e. For coi nsur ance and
expropri at i on this need not be true, t hough any change in value of t arget liabilities,
all else equal, shoul d be posi t i vel y rel at ed to val ue i ncreases t hat a bi dder can
bri ng about. Thi s assumpt i on i mpl i es that any weal t h t ransfer as a percent age of
equi t y equals
Weal t h Tr ansf er LI AB
= O( X) * A ( 3 ' )
EQUI TY EQUI TY
9 Thi s is ve r y mu c h e qui va l e nt t o i nc r e a s i ng t he di vi de nd p a y o u t o f t he t a r ge t f i r m t o t he f i r m' s ne w
100% s ha r e hol de r , t he bi dder . See Gal ai a nd Mas ul i s , 1976.
146 M.T. Billett, M. Ryngaert / Journal of Corporate Finance 3 (1997) 141 165
Subt ract i ng Eq. ( 3' ) f r om Eq. (3) we get the target equi t y pr emi um net of weal t h
transfers:
D PREM ( L IAB FINAS S ETS )
EQUI TY - t p ( X) * 1 + EQUI TY EQUI TY
( L IAB) ( L ,AB FINASSETS)
- t p ( X) * AEQUI TY = 4 J ( X) * 1 + / 3 E QUI T Y EQUI TY
( 4)
where /3 equals (1 - A).
I f the val ue of debt and preferred securities is unaffect ed by the t akeover, the
value o f / 3 equal s 1, as assumed in Eq. (3). I f debt and preferred st ockhol ders gai n
as a result of the acquisition, then /3 will be less than one. Similarly, i f t ender
of f er acqui si t i ons lead to expropri at i on of debt and preferred stock, t hen /3 will be
great er than one refl ect i ng the cont ri but i on of debt a n d / o r preferred value to the
c ommon equi t yhol der s' gain.
Of course, some acqui si t i ons will i nvol ve expropri at i on of bondhol der s ( bond
downgr ades) and some will i nvol ve coi nsur ance ( bond upgrades). So, Eq. (4) is a
simplification. We predict, however , that the presence of convert i bl e securities and
the combi ned i mpact of coi nsur ance and expropri at i on will lead t o a coeffi ci ent of
/3 less than one. We bel i eve that coi nsur ance will be mor e i mport ant f or firms
wi t h mor e liabilities, because firms with great er liabilities, all else equal, have
riskier debt and are cl oser t o t ri ggeri ng the limits of restrictive bond covenant s
wi t h respect to debt and di vi dend restrictions. Thus, expropri at i on is unl i kel y and
coi nsur ance is plausible. Fi rms with l ower levels of liabilities tend t o have hi gh
debt ratings al ready and their debt issues are less likely to be ' coi ns ur ed' and are
mor e likely to be expropri at ed.
I f our intuition about coi nsur ance and expropri at i on is correct, weal t h transfers
i nvol vi ng bondhol der s will allow bidders to pay slightly l arger dol l ar pr emi ums t o
modest l y l evered targets and slightly l ower dol l ar pr emi ums t o hi ghl y levered
targets. ~t~ Thi s will tend t o flatten out the slope relationship bet ween equi t y
percent age pr emi ums and liability to equi t y ratios.
Fi nal l y, we modi f y Eq. (4) to i ncorporat e the possi bi l i t y that a reval uat i on of
fi nanci al assets may occur i f these assets can be better depl oyed f ol l owi ng a
t akeover. For instance, a t akeover may bl ock pot ent i al l y poor i nvest ment s f i nanced
with cash on hand or lead t o bet t er management of receivables. Let ' s assume t hat
fi nanci al assets of the fi rm can be reval ued by a percent age amount equal to
m Empirical evidence consistent with this notion is presented in Section 4.
M.T. Billett, M. Ryngaert/ Journal (~f Corporate Finance 3 (1997) 141-165 147
05(X), wher e X is a vect or of t he t ar get f i r m' s char act er i st i cs. I ncor por at i ng t hi s
ext r a c ompone nt of t he pr e mi um to t he per cent age equi t y pr e mi um of Eq. (4)
r esul t s in
D PREM ( L IAB FINAS S ETS )
EQUI TY ~b ( X) * 1 +/31EQUIT-~Y EQUI TY
FINAS S ETS )
+ 05( X) * EQUI TY " ( 5)
For t r act abi l i t y, as s ume t hat ch(X)/tp(X)= 0 acr oss al l acqui si t i ons. Thi s
as s umes t hat any per cent age r eval uat i on of f i nanci al asset s is pr opor t i onal to t he
per cent age r eval uat i on of non- f i nanci al asset s. Subst i t ut i ng t hi s r el at i ons hi p i nt o
Eq. ( 5) yi el ds
D PREM ( L IAB FINAS S ETS )
EQUIT~-Y - t ~( X) * 1 + / 3 1 E QUI T ~ (1 - 0 ) EQUI TY " ( 6 )
Al l owi ng /32 = - ( 1 - 0) , we obt ai n t he es t i mat i ng equat i on
D PREM ( L IAB FINAS S ETS )
E QUI T ~ - ~0( X) * 1 + / 3 1 E QUI T ~ +/ 32 EQUI TY " ( 7)
I f t her e is no r eval uat i on of f i nanci al asset s, t hen 05(X) = 0 ~ 0 = 0 ~/ 3 2 = - 1.
I f f i nanci al asset s can be r eval ued but l ess t han non- f i nanci al asset s, t hen
05( X) < ~b( X) ~ 0 < 0 < 1 ~ 0 >/ 32 > - 1. I f f i nanci al asset s are r eval ued by
t he same amount as non- f i nanci al asset s, t hen 05(X) = t p ( X) ~ 0 = 1 ~/ 3 2 = 0.
Two f i nal poi nt s are wor t h maki ng about es t i mat i ng Eq. (7). Fi r st , t her e are
addi t i onal t heor et i cal gr ounds f or s us pect i ng t hat /31 wi l l be l ess t han one and /32
wi l l exceed negat i ve one. For i nst ance, f i r ms wi t h l i t t l e debt and abundant
f i nanci al asset s have mor e l e e wa y t o run t hei r f i r ms in a l ess ef f i ci ent manner
( Jensen, 1986). I f t hi s is so, t hen f i r ms wi t h mor e debt and f ewer f i nanci al asset s
wi l l r ecei ve l ower pr e mi ums per dol l ar of non- f i nanci al asset s. Si mi l ar l y, l ow debt
l evel s and hi gh f i nanci al asset l evel s ma y be s ub- opt i mal f i nanci al pol i ci es f r om a
t ax per s pect i ve. Cor r ect i ng t hese pol i ci es woul d l ead to s ome wha t hi gher pr emi -
ums f or l ow debt , hi gh f i nanci al asset f i r ms.
Second, t he act ual es t i mat i on of Eq. ( 7) cal l s for es t i mat es of l i abi l i t y to equi t y
r at i os and f i nanci al asset to equi t y r at i os. Whi l e we have mar ket val ues f or equi t y,
t he mar ket val ue of l i abi l i t i es and f i nanci al asset s is, f or t he mos t part , pr oxi ed f or
by account i ng book val ues. Thi s i nduces er r or in var i abl e t hat s houl d r esul t in
es t i mat es of /31 and /32 t hat are bi as ed t owar d zero. Hence, even wi t hout t he
e c onomi c r at i onal es ci t ed above, we woul d be s ur pr i s ed t o see Eq. (3) (/31 = 1 and
/32 = - 1) hol d empi r i cal l y.
148 M.T. Billett, M. Ryngaert / Journal of Corporate Finance 3 (1997) 141- 165
3. Met hodol ogy and data
Eq. (7) f r om Sect i on 2 can be est i mat ed usi ng nonl i near least squares in the
f ol l owi ng cross sect i onal regressi on:
(OPREM t ( I+ ( L IAO t (FINAS S ETS ))
EQUI TY j = 6 ( Xj ) * EQUI TY . j +] 3z EQUI TY i
(7' )
In the cross sectional est i mat i on of Eq. (7' ), ]3~ measures the ext ent to whi ch
the equi t y pr emi um is ' l ever ed up' t hrough non-equi t y fi nanci ng and ]32 measures
the extent to whi ch the t akeover pr emi um is l essened due to the presence of
financial assets. Previ ous studies have i mpl i ci t l y assumed that 131 and ]32 are zero.
We are interested in not onl y whet her these coeffi ci ent s di ffer f r om zero, but al so
whet her t hey differ f r om one and negat i ve one respect i vel y.
A sampl e of t ender offers was col l ect ed f r om a pri nt out of all t ender offers
suppl i ed by the U.S. Securities and Exchange Commi s s i on f or the peri od 1980-
1989. In an effort to create a homogeneous sample, tender offers i ncl uded in this
st udy must meet the f ol l owi ng sampl i ng criteria: (1) The t ender of f er is for cash
and pr ovi ded f or t he purchase of all shares either di rect l y t hr ough the t ender of f er
or t hrough a fi rm commi t ment to buy the remai ni ng shares in a mer ger transaction.
(2) The t arget is listed on the NYSE or ASE and its st ock returns are avai l abl e on
the Cent er for Resear ch in Securi t y Prices return tapes on the date of the of f er
announcement . (3) The target is f ol l owed by the value line i nvest ment survey.
Val ue line carries a number of dat a items needed f or the tests conduct ed. (4) The
t arget is not a fi nanci al company. Fi nanci al compani es are excl uded because their
l everage and asset structure is drast i cal l y di fferent f r om t ypi cal industrial firms.
Thi s el i mi nat es firms whose pr i mar y line of busi ness is leasing, banki ng, broker-
age, a n d / o r insurance. (5) No more than 200 t radi ng days exist bet ween t he date
the market di scovers that the target is an acqui si t i on candi dat e and the final t ender
offer. Thi s el i mi nat es firms wi t h l ong dr awn out acqui si t i on events. I n these cases,
the est i mat es of pr emi ums are very noisy. (6) The bi dder is a publ i cl y traded
domest i c corporat i on. Thi s el i mi nat es acqui si t i ons by l everaged buyout firms,
limited partnerships, and forei gn acquirers. Agai n, this is done to yi el d a rel at i vel y
uni f or m sampl e of t arget fi rms t~. (7) The t arget is not a regul at ed firm. Fi rms that
are regul at ed may have t o share any synergi st i c gains resul t i ng f r om a mer ger with
their cust omers. Hence, t ender of f er pr emi ums are effect i vel y capped f or these
firms. Thi s el i mi nat es targets f r om the pi pel i ne and power di st ri but i on and
generat i on businesses. (8) The target has no debt that was in i mmi nent danger of
it The tax treatment of the excluded acquisitions may vary considerably from the ones examined.
Furthermore, many buyouts by private firms may be, in part, motivated by a desire to change the
target' s capital structure.
M.T. Billett, M. Ryngaert/ Journal of Corporate Finance 3 (1997) 141-165 149
default. Thi s cri t eri a is met i f the fi rm has had no news stories di scussi ng a
pendi ng Chapt er 11 fi l i ng and no current exchange offers for debt securities to
avoi d a bankr upt cy fi l i ng. Si nce we wi l l be pr i mar i l y r el yi ng on book val ues of
debt to proxy for market val ues of debt, the book val ues of debt for fi rms with a
hi gh pr obabi l i t y of defaul t wi l l be dr amat i cal l y overstated. (Thi s cri t eri a el i mi nat ed
one obser vat i on from the sampl e, Pet r o- Lewi s ) . ~2
The result is a sampl e of 145 t ender offers. The next task is to accurat el y
measur e t akeover pr emi ums. Thi s requi res that any i ncreases in target price due to
i nf or mat i on l eaked about a pendi ng t ender offer be i ncorporat ed. Jarrell and
Poul sen (1989a) report that there are frequent news stories hi nt i ng at an i mpendi ng
t akeover bi d pri or to a formal t ender offer, and also report consi der abl e r un- up i n
target ret urns i n the t went y days pri or to a formal t ender offer. The Dow Jones
News Ret ri eval Servi ce was used to search for pr evi ous newswi r e stories about the
target and locate the first a nnounc e me nt of any corporat e cont rol event i nvol vi ng
the target firm. A corporat e cont rol event is defi ned as one of the f ol l owi ng: (1)
An a nnounc e me nt that the fi rm recei ves a t akeover bid. (2) An a nnounc e me nt that
an ent i t y unaf f i l i at ed wi t h the fi rm had purchased a stake or i ncreased a stake in
the c ompa ny' s stock. (3) An a nnounc e me nt that the fi rm is in mer ger talks, is
seeki ng to be acquired, or is seeki ng to sell off operat i ons consi st i ng of at least one
third of fi rm sales. (4) An a nnounc e me nt of any r umor that the fi rm is an
acqui si t i on target, unl ess the r umor was deni ed as false by the parties i nvol ved. (5)
A DJNRS story of an unusual target pri ce i ncrease i n the mont h pr ecedi ng any of
the above ment i oned event s.
In this paper, a r ol l i ng five mont h wi ndow is used to search for corporate
cont rol event s. ~3 The five mont hs pri or to the successful t ender offer announce-
ment were searched for any such event s. If an event was found, t hen the five
mont hs pri or to the event were searched. The process cont i nues unt i l no event s
were f ound i n a pri or fi ve mont h wi ndow. The wi ndow for est i mat i ng the t ar get ' s
abnor mal equi t y ret urn is t went y t radi ng days before the first corporate cont rol
event a nnounc e me nt to fi ve t radi ng days after the fi nal offer a nnounc e me nt
To est i mat e the target equi t y abnor mal ret urn dur i ng the event wi ndow, we first
est i mat e a modi f i ed market model 300 to 60 days pri or to the first corporate
cont rol event . The model al l ows us to est i mat e a current and l agged stock market
bet a as fol l ows
Rj , t = CeLl + t ~j , l gm, t + [ 3j , 2Rm, t_ 1 + ,Fj
(s)
Wher e R j, t is the ret urn to fi rm j at t i me t, Rm, , and Rm, t _ 1 are the current and
12 AS it turns out, Petro Lewis debt appears to have been trading for about 30 cents on the dollar.
13 A five month window is searched to insure any price run-up due to market expectations of a
control event are included. A shorter window may increase the precision of the premium estimates, but
may leave out an important portion of the premium (in the form of price run-up).
150 M.T. Billett, M. Ryngaert / Journal of Corporate Finance 3 (1997) 141- 165
l agged CRSP value wei ght ed market returns. The initial abnor mal return is
cal cul at ed as fol l ows:
FIN +5 ( ! R i., )
t =n- 20~, " -~
ARETj
FI N+5,=,,_20t 1( + (1 -/ 3#. , -/ 3#. 2) R/., +/ 3j . , g,,, ,, +/3j.2 g, , . , , )
(9)
where Rr. , is the three mont h t-Bill rate, N is the announcement day of the final
offer, and n is the announcement day of the initial corporat e cont rol event.
We empl oy this CAPM based abnor mal return measure rather t han s ummi ng
the abnor mal returns f r om a si mpl e market model for a number of reasons. First,
the errors i nvol ved in est i mat i ng the intercept t erm of a market model will t end to
be correl at ed wi t h our l everage measure. Fi rms t hat per f or m poor l y will t end t o
have negat i ve alphas and hi gher debt t o market equi t y ratios. Second, l agged betas
are i ncorporat ed to resol ve probl ems of bet a est i mat i on due to non- synchr onous
trading. Finally, this measure al l ows for compoundi ng of returns whi ch can be
i mport ant over l ong event wi ndows.
The abnor mal return defi ned by Eq. ( 7' ) is the dependent variable used in
est i mat i ng Eq. (7' ). A potential pr obl em in est i mat i ng Eq. ( 7' ) is t hat the error
terms are het eroskedast i c. Bot h the dai l y return vari ance and the number of dai l y
abnor mal returns used in est i mat i ng the t ar get ' s aggr egat e abnor mal return di ffer
across firms. Ther ef or e the vari ance of the abnor mal return will be obser vat i on
specific. To deal wi t h het eroskedast i ci t y, Eq. ( 7' ) is est i mat ed usi ng wei ght ed
nonl i near least squares. The wei ght used is equal to the inverse of the pr oduct of
the st andard devi at i on of the market model regressi on and the square root of the
number of days in the abnormal return wi ndow. 14
Details on the t arget f i r m' s fi nanci al structure are col l ect ed f r om 10 Qs, 8 Ks,
10Ks, and Val ue Line. 10Qs and 10Ks provi de quart erl y data on current assets,
i nvent ory, current liabilities, l ong t erm debt, shares out st andi ng, and the liquidat-
i ng value of preferred stock. 8 Ks are used to adjust asset and liability fi gures in
cases where a fi rm takes an act i on t hat can alter its fi nanci al statements bet ween
10Q filings. Further, Val ue Li ne and 10Ks pr ovi de detailed i nf or mat i on on the
convert i bi l i t y of debt and preferred securities. Dat a items selected are the latest
number s before the first cont rol event.
For the purposes of our anal ysi s, all cl ai ms ot her t han c ommon st ock const i t ut e
liabilities. Our l everage measure (liabilities to equi t y ratio) i ncorporat es book
14 This variance estimate is not exact, but it should be roughly proportional to the actual variance of
the abnormal return to target stockholders. The squared residuals from estimates of Eq. (7) were in fact
proportional to these variance estimates. Furthermore, other het eroskedast i ci t y adjustments usi ng the
correction of Whi t e (1980) and Whi t e' s correction in conjunction wi t h our current WLS adjustment
yi el d the same concl usi ons with respect to the magni t ude and significance of the variables of pri mary
interest in this paper.
M.T. Billett, M. Ryngaert / Journal ~f Corporate Finance 3 (1997) 141 165 151
val ues of current liabilities, l ong t erm debt, preferred stock, ot her l ong t erm
liabilities, and an est i mat e of of f - bal ance sheet operat i ng lease obl i gat i ons. For
details, see Appendi x A. Fi nanci al assets are measur ed as current assets less
i nvent or y (pri mari l y cash, account s recei vabl e and market abl e securities), plus
l ong t erm fi nanci al assets, plus i nvest ment s in affiliates. Agai n, f or details, see
Appendi x A.
The mar ket value of equi t y is cal cul at ed by t aki ng the shares out st andi ng
report ed in 10Q or the 10K report s and mul t i pl yi ng by the share price of the
t ar get ' s st ock 21 days pri or to the first corporat e cont rol event. All fi gures are
adj ust ed f or st ock splits, new equi t y issues, st ock repurchases and (where possi bl e)
acqui si t i ons or di vest i t ures that occur bet ween the 10Q dat e and the first corporat e
cont rol announcement . To obt ai n an accurat e measure of fi rm fi nanci al structure,
the mar ket val ue of equi t y is adj ust ed by assumi ng that all convert i bl e securities
that are in the money 21 days pri or to the first cont rol event are ef f ect i vel y
convert ed. These ' conver t ed' shares are i ncl uded in shares out st andi ng. Addi t i on-
ally, ef f ect i vel y conver t ed debt and preferred st ock is subt ract ed f r om the report ed
liabilities. The market val ue of equi t y is al so adjusted f or warrant s that are
' ef f ect i vel y' convert ed. Agai n, see dat a Appendi x A f or mor e detail.
The next task in est i mat i ng Eq. ( 7' ) is to speci fy the vect or of variables, X, that
affects the size of the percent age pr emi um pai d per dol l ar of non-fi nanci al assets.
We use t hose vari abl es identified in the pr evi ous empi ri cal literature on det ermi -
nants of t ender of f er premi ums.
Bradl ey et al. (1988) document t hat t arget abnor mal returns in t ender offers are
larger in t akeover cont est s i nvol vi ng mul t i pl e bi dders t han t hose i nvol vi ng a single
bi dder due t o enhanced compet i t i on f or cont rol of the target. We al so i ncl ude in
our speci fi cat i on whet her the t arget was sought by mul t i pl e bidders. A ' mul t i pl e
bi d' situation occur s i f the Dow Jones News search reveal ed t hat mor e than one
identifiable part y made an of f er to acqui re the t arget firm. Thi s i ncl udes LBO bids
f r om management gr oups and recapi t al i zat i on plans resembl i ng LBO' s pr oposed
by management as an al t ernat i ve t o a t akeover bid. t5
Br adl ey et al. (1988) al so fi nd that the t ar get ' s abnor mal equi t y return i ncreases
in the fract i on of t arget shares sought by the bidder. They not e that this is
consi st ent with an upwar d sl opi ng suppl y curve for t arget shares. We al so i ncl ude
the percent of shares sought in the of f er as an expl anat or y variable. Si nce our
sampl e onl y cont ai ns t ender offers with accompanyi ng mer ger agreement s, the
percent of shares sought is j ust t he percent age of shares to be pur chased with cash
with the r emai nder to be exchanged f or bi dder securities. Ni den (1993) reports that
t akeover pr emi ums are hi gher when payment is made in cash rather than securi-
15 Specifically, if the target offers cash through a dividend or tender offer that is greater than the
pre-offer value of the stock, the target is classified as being subject to multiple bids.
152 M.T. Billett, M. Ryngaert / . hmrnal of Corporate Finance 3 (1997) 141 165
t i es. So, t he gr eat er t he per cent of shar es sought in t he t ender offer, t he gr eat er t he
t ender of f er pr e mi um is expect ed to be.
Ser vaes ( 1991) f ound t hat t ar get s wi t h hi gher To b i n ' s Q r at i os ar e as s oci at ed
wi t h l owe r pr emi ums . Fi r ms wi t h l ower mar ket to book r at i os may have t he
pot ent i al for gr eat er t akeover i nduced val ue i mpr ovement s . Rat her t han use a
t r adi t i onal Q measur e, we est i mat e a mar ket to book rat i o for non- f i nanci al asset s
t o st ay consi st ent wi t h t he i dea t hat pr e mi ums are pai d for non- f i nanci al asset s.
Appe ndi x A pr ovi des det ai l s on the cal cul at i on.
The exact s peci f i cat i on of any Q t ype var i abl e is i mpor t ant in our anal ysi s. The
Q r at i o and l i abi l i t y to equi t y r at i o are hi ghl y cor r el at ed becaus e (1) f i r ms t hat ar e
pe r f or mi ng poor l y t end to become mor e l ever ed and ( 2) f i r ms t hat have gr eat er
gr owt h opt i ons ( hi gher mar ket to book) t end t o be l ess l ever ed. Gi ven t hat f i r ms
wi t h mor e r oom for i mpr ove me nt may have l ower mar ket to book r at i os, it is
i mpor t ant to i ncl ude t hi s var i abl e, but it is al so i mpor t ant to pur ge t he Q var i abl e
of s ys t emat i c di f f er ences not due to poor per f or mance, es peci al l y i f t hose di f f er -
ences are cor r el at ed wi t h l ever age. We es t i mat e a non- f i nanci al Q r egr es s i on usi ng
as i ndependent var i abl es: (1) R and D s pendi ng di vi ded by book non- f i nanci al
asset s and ( 2) f our t i me dummi e s ( 8 0 - 8 1 , 8 2 - 8 3 , 8 4 - 8 5 , 86- 87) . The r egr es s i on
par amet er s are used t o pr edi ct what t he non- f i nanci al Q r at i o shoul d be for each
t ar get fi rm. The r at i o of t he pr edi ct ed Q' s to t he act ual Q' s r educes to pr edi ct ed
mar ket val ue of non- f i nanci al asset s di vi ded by act ual mar ket val ue of non- f i nan-
ci al asset s. Lar ger val ues of t hi s var i abl e suggest pot ent i al for i mpr ove me nt and
s houl d r esul t in hi gher pr emi ums . ~
Jar r el l and Poul s en ( 1989b) f i nd t hat t ar get abnor mal r et ur ns are s mal l er when
t he t ar get is l ar ger r el at i ve t o t he bi dder . J7 Thi s can be i nt er pr et ed a number of
ways. For i nst ance, l ar ger bi dder s ma y have mor e ways to expl oi t t he asset s of t he
t arget , or al t er nat i vel y, bi dder s may be mor e apt to over pay in s mal l er acqui si t i ons
becaus e ove r pa yme nt wi l l have a smal l i mpact on t he bi dde r ' s share pr i ce. We
al so i ncl ude a meas ur e of t ar get r el at i ve si ze. We t ake t he nat ur al l og of t he val ue
of t he t a r ge t ' s non- f i nanci al asset s di vi ded by t he bi dde r ' s equi t y mar ket val ue 21
days bef or e t he fi rst bi d. Thi s cal cul at i on is det ai l ed in Appe ndi x A. We expect
t ar get abnor mal r et ur ns to decr eas e wi t h r es pect to t he t ar get r el at i ve si ze
var i abl e. J x
St ul z et al. ( 1990) ar gue t hat di f f er ent i al cont r ol benef i t s and t ax st at us of l ar ge
bl ockhol der s al t er s t he pr i ce at whi ch bl ockhol der s wi l l t ender t hei r shar es to a
bi dder . Bl ockhol der s i ncl ude i nst i t ut i onal i nvest or s, t ar get management , and t he
16 We al so empl oy r egr es s i on model s wi t h ot her Q t ype meas ur es such as t he r aw mar ket to book
rat i o, wi t h no meani ngf ul di f f er ence in resul t s.
~7 Hous t on and Rynga e r t ( 1994) document a s i mi l ar f i ndi ng for pr e mi ums pai d in ba nk mer ger s.
la Thi s var i abl e is i dent i cal to t hat used by Jarrel l and Poul sen except we r epl ace t ar get equi t y val ue
wi t h t he val ue of t he t a r ge t ' s non- f i nanci al asset s to ke e p wi t h t he i dea t hat pr e mi ums are pai d for t hese
asset s r at her t han for equi t y.
M.T. Billett, M. Ryngaert/Journal of Corporate Finance 3 (1997) 141-165 153
bi ddi ng fi rm. I nst i t ut i onal i nvest or s are conj ect ur ed to t ender at a l ow pr i ce
becaus e of t hei r l ow capi t al gai ns t ax rat e. ,9 Tar get manager s are hypot he s i z e d to
t ender at a hi gher pr i ce, becaus e manager s wi l l t ender onl y i f c ompe ns a t e d f or
t hei r f or gone cont r ol benef i t s. A l ar ger bi ddi ng f i r m i ni t i al st ake wi l l decr eas e t he
number of new shar es neces s ar y and pr e mi um r equi r ed for a successf ul acqui si -
t i on. For a s ampl e of t ender of f er s dur i ng t he per i od 1968- 1986, St ul z, Wa l kl i ng
and Song f i nd t hat pr e mi ums i ncr ease wi t h ma n a g e me n t ' s hol di ngs, and decr eas e
wi t h i nst i t ut i onal hol di ngs and t he bi dde r ' s pr e- t ender of f er shar e owner shi p.
We i ncl ude bl oc khol de r var i abl es s i mi l ar t o t hose used by St ul z et ah (1990).
I ns i der hol di ngs is t aken f r om t he val ue l i ne i nves t ment sur vey pr i or t o t he fi rst
act ual t a ke ove r bi d f or t he t ar get dat e. Whi l e owni ng a l ar ger pr opor t i on of t he
f i r m gi ves i nsi der s mor e bar gai ni ng power , goi ng f r om 40% to 50% has l ess
i mpact t han goi ng f r om zer o to 10%. At 40% i nsi der s can al r eady bl ock mos t bi ds
and i ncr eas i ng t hei r hol di ngs wi l l t r i vi al l y i mpact t hei r bar gai ni ng power . Any
i ncr ement to i ns i der hol di ngs above 50% does not i ncr ease bar gai ni ng powe r at
all. To r ef l ect t hi s, our i nsi der hol di ng var i abl e is t he squar e r oot of mi n( 50%,
val ue l i ne i ns i der hol di ngs) . 2o Si mi l ar l y, t he squar e r oot of t he per cent age of
st ock hel d by i nst i t ut i ons r epor t ed in t he S and P st ock gui de, and t he squar e r oot
of t he b i d d e r ' s st ock hol di ngs i n t he t ar get as r epor t ed in or i gi nal 14-d t ender of f er
f i l i ngs are al so used as expl anat or y var i abl es.
Co mme n t and Schwer t ( 1995) doc ume nt t hat f i r ms wi t h so cal l ed poi s on pi l l
t a ke ove r def ens es obt ai n hi gher t akeover pr e mi ums f or a s ampl e of f i r ms dur i ng
t he per i od 1986- 1991. Pi l l s gi ve t he t ar get manager s mor e negot i at i ng powe r to
ext r act hi gher t akeover pr e mi ums f r om bi dder s. We al so e mpl oy a poi s on pi l l
dummy var i abl e. We expect f i r ms wi t h pi l l s to get hi gher pr emi ums .
4. Re s ul t s
Tabl e 1 cont ai ns var i abl e means and st andar d devi at i ons. The aver age pr e mi um
is 61. 4%. Tabl e 1 al so de c ompos e s t he l ever age r at i o ( L I AB/ E QUI T Y) i nt o its
var i ous component s . Whi l e t he l ar gest c ompone nt s of t he l ever age r at i o are cur r ent
l i abi l i t i es and l ong t er m debt , net l ease obl i gat i ons ar e al so qui t e subst ant i al ( see
Appe ndi x A f or mor e det ai l on t he cal cul at i on of net l ease obl i gat i ons) . The
aver age l i abi l i t y to equi t y r at i o is 1.285 wi t h a st andar d devi at i on of 1.3835. Thus,
~9 Brown and Ryngaert (1992) illustrate that institutional investors decrease the slope of the supply
curve of target shares available to the bidder.
2o Stulz et ah (1990) use the square root of these measures, but they do not truncate insider holdings
at 50%. Insider holdings are those holdings defined as insiders, directors, and/or employee stock plans.
We also experimented with excluding ESOP holdings and including corporate holdings listed by Value
Line when the corporation had a representative on the target's board of directors. Redefining this
variable had virtually no impact on our results.
154 M.T. Billett, M. Ryngaert / Journal ~/ 'Corporate Finance 3 (1997) 141 165
Table 1
Summary statistics
Variable Mean Std. dev. No. obs.
Equity abnormal return: DPREM/ EQUI TY 0.6143 0,3717 145
Liabilities to equity: LIAB 1.2850 1. 3835 145
Long term debt to equity 0.4555 0.5713 145
Current liabilities to equity 0.5674 0.5108 145
Net lease obligations to equity 0.1724 0.3798 145
Other long term liab. to equity 0.0578 0.1906 145
Preferred stock to equity 0.0317 0.0943 145
Financial assets to equity 0.7172 0.4710 145
Convertible securities to equity 0.0748 0.1812 145
Target log relative size - 0. 890 1. 4472 145
Predicted non-financial Q divided by actual non-financial Q 1. 1687 0.4506 145
Insider holdings 0. 1411 0.1457 145
Institutional holdings 0.3803 0.1957 145
Acquirer' s foothold 0.0298 0.0631 145
% with multiple bidders a nd/ or hostile 42.07% 145
% with pill defense: PILL 24.83% 145
var i at i on in t hi s var i abl e coul d l ead to l ar ge changes in t akeover pr emi ums . The
f i nanci al asset to equi t y r at i o is 0. 7172 and al so has a si zabl e st andar d devi at i on of
0. 4710. Al s o, t hough not r epor t ed in Tabl e 1, t he f i nanci al asset to equi t y r at i o and
t he l i abi l i t y t o equi t y r at i o have a hi gh pos i t i ve cor r el at i on of 0. 636.
Tabl e 2 r epor t s t he r esul t s of var i ous r egr es s i ons expl ai ni ng t ar get equi t y
abnor mal r et ur ns wi t h and wi t hout f i nanci al st r uct ur e var i abl es as expl anat or y
var i abl es. Thes e r egr es s i ons do not i ncor por at e any of t he non- l i near i t i es t hat are
expl i ci t in Eq. ( 7' ) . Thi s al l ows us to check oll t he r obust ness of our r esul t s and to
make compar i s ons wi t h t he pr evi ous l i t er at ur e.
The fi rst t hree col umns of Tabl e 2 cont ai n t he r esul t s of t he wei ght ed l east
squar es r egr es s i on of t he t ender pr e mi um t hat do not i ncor por at e f i nanci al
var i abl es. The l ast t hr ee col umns i ncl ude f i nanci al var i abl es. For our pur poses, t he
most i mpor t ant r esul t is t hat t he coef f i ci ent s on bot h t he l i abi l i t i es to equi t y r at i o
and f i nanci al asset s to equi t y r at i o in al l s peci f i cat i ons are of t he hypot hes i zed si gn
and are hi ghl y st at i st i cal l y si gni f i cant . The i ncl us i on of t hese var i abl es al so
s i gni f i cant l y i mpr oves t he expl anat or y powe r of t he var i ous r egr essi on model s.
Thes e r esul t s suggest t hat per cent age equi t y t ender of f er pr e mi ums are si gni f i -
cant l y af f ect ed by capi t al st r uct ur e and asset st ruct ure.
Cons i s t ent wi t h past st udi es, t he coef f i ci ent on mul t i pl e bi dder s is posi t i ve and
t he coef f i ci ent on t ar get r el at i ve si ze is posi t i ve. Bot h coef f i ci ent s are st at i st i cal l y
si gni f i cant at t he 1% l evel in all r egr essi on model s. Consi st ent wi t h Ser vaes
(1991), al l coef f i ci ent s f or t he rat i o of t he pr edi ct ed non- f i nanci al Q to act ual
non- f i nanci al Q are al so si gni f i cant at t he 1% l evel . The coef f i ci ent s on t he i nsi der
hol di ngs meas ur e in model s 3 and 6 are s i gni f i cant l y negat i ve. Thi s r esul t di f f er s
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156 M.T. Billett, M. Ryngaert / &)urnal of Corporate Finance 3 (1997) 141-165
from St ul z et al. (1990) who fi nd a si gni fi cant posi t i ve coeffi ci ent , but is
consi st ent with the f i ndi ngs of Chapl i nsky and Ni ehaus (1994) for a sampl e of
1980s takeovers. The i nst i t ut i onal hol di ngs measure, the acqui r er ' s foothold, and
the poi son pill dummy vari abl e have coeffi ci ent s i ndi st i ngui shabl e from zero at the
5% si gni f i cance level.
Our results differ from previ ous studies l or a number of reasons. First, our
sampl e uses more recent data. 2~ Ar gnabl y, the i mpor t ance of hi gh i nsi der hol di ngs
for bar gai ni ng purposes may not be as i mpor t ant in the 1980' s with the i ncreased
avai l abi l i t y and use of ant i - t akeover defenses. 22 Second, our sampl e excl udes
part i al t ender offers wi t h no cl ean- up mer ger announcement accompanyi ng the
offer. Thi s excl udes many low pr emi um offers where frequent l y the bi dder has a
foot hol d and the percent age of shares sought is small. Thi rd, the i ncl usi on of all
the vari abl es from vari ous studies has a pr of ound i mpact on the owner shi p and
percent age sought coeffi ci ent s. Al t hough not reported, the coeffi ci ent s on i nst i t u-
t i onal hol di ngs and the acqui r er ' s foothold become si gni fi cant and consi st ent with
the past l i t erat ure when the poi son pill dummy, the Q vari abl e and the target
rel at i ve size vari abl e are excl uded.
Whi l e the results in Tabl e 2 demonst r at e the i mpor t ance of f i nanci al vari abl es,
the resul t i ng coeffi ci ent s say little about the degree to whi ch t akeover pr emi ums
are ' l ever ed up or down' by capital structure and asset structure. To shed l i ght on
this quest i on, we report our est i mat es of the nonl i near Eq. ( 7' ) in Tabl e 3. The
est i mat ed equat i on assumes that the percent age pr emi um pai d to non- f i nanci al
assets, ~0(x), is a l i near combi nat i on of a const ant and vari ous non- f i nanci al
expl anat ory vari abl es (e.g. mul t i pl e bi dders, i nsi der ownershi p, etc...). Thi s non-
f i nanci al asset pr emi um is t hen l evered up or down by the f i nanci al ratios in Eq.
(7' ). The coeffi ci ent on the l i abi l i t i es to equi t y variable, /3~, ranges from 0. 3546 to
0. 4754 dependi ng on the speci fi cat i on and is si gni f i cant l y di fferent from bot h zero
and one at the 1% level in each regressi on model . In other words, the results
suggest that a subst ant i al l everage effect exists, but the effect is si gni f i cant l y less
t han mi ght be expected. Si mi l arl y, the coeffi ci ent on the ratio of f i nanci al assets to
equi t y, /32, ranges from - 0 . 6 0 2 9 to - 0 . 6 2 7 4 dependi ng on the speci fi cat i on and
is st at i st i cal l y di fferent from bot h ~ et v and - 1 at the 1% l evel i n each regressi on
model .
One expl anat i on of why /31 and /32 may differ from one and negat i ve one
respect i vel y is the exi st ence of weal t h t ransfers to non- c ommon equi t y cl ai mant s.
21 For example, the sample in Stulz et al. (1990) consists of tender offers from 1968-1986.
22 Stulz et al. (1990) argue that managers are most likely to use control blocks to hold out fur larger
premiums when the private benefits from running the firm are high. They suggest that private benefits
are apt to be largest when their are multiple bidders trying to acquire the firm. To test this we delete the
current insider holding variable and instead interact the multiple bidder dummy with the insider holding
variable. This coefficient on this new variable is still negative, but not significantly different l'rom zero
at the 5% level. Our other results are unaffected by this change in specification.
M.T. Billett, M. Ryngaert / Journal of Corporate Finance 3 (1997) 141 165 157
Table 3
Wei ght ed nonl i near least squares est i mat i on of Eq. (7' ) expl ai ni ng target equi t y
145 t ender offers duri ng period 1980- 1989 (t-statistics in parent heses)
abnormal returns for
Variables in linear model of t 0(x) Model 1 Model 2 Model 3
Const ant 0. 3320 0.1251 0. 2472
(8.87) * * * (2.07) * * (1.75) *
Multiple bidders 0.2085 0.231 ! 0. 1997
(4.65) * * * (5.05) * * * (4.47) * * *
Target log relative size 0. 0608 0. 0742 0. 0770
( - 3 . 9 6 ) *** ( - 4 . 4 7 ) * * * ( - 4 . 4 6 ) ***
Fitted book to market divided 0.2435 0.2192
by actual book to market
(3,78) * * * (3.44) * * *
` / Mi n( i nsi der hol di ngs, 0. 5) - 0. 3584
( - 2 . 8 9 ) ***
, /Institutional hol di ngs - O. 1293
( 0 . 8 7 )
A~u i r e r ' s foothold - 0. 1404
( 0 . 7 9 )
Percent of shares sought 0.1173
(1.21)
Poi son pill dummy 0.0848
(1.57)
' L e v e r a g i n g ' o f p r e mi u m:
Liabilities to equi t y ratio: 0. 4754 0.3577 0. 3546
LIAB/EQUITY: ~1 (6.10) * * * (5.69) * * * (5.07) * * *
Financial asset s to equity ratio: - 0. 6029 - 0. 6274 - 0. 6168
FI NASSETS/ EQUI TY: /32 ( - 5 . 7 1 ) * * * ( - 7 . 4 8 ) * * * ( - 7 . 3 8 ) * * *
Adj. R 2 0.245 0.336 0.382
. . . . . . Denot e significance at the 1, 5, and 10% level, respectively.
An o b v i o u s s o u r c e o f we a l t h t r a n s f e r s i s t h e e x i s t e n c e o f c o n v e r t i b l e s e c u r i t i e s .
Al t h o u g h t h e l e v e r a g e a n d e q u i t y me a s u r e s a r e a d j u s t e d f o r c o n v e r t i b l e s e c u r i t i e s
i n t h e mo n e y p r i o r t o t h e i n i t i a l a n n o u n c e me n t , t h e r e ma i n i n g c o n v e r t i b l e s wi l l
e x p e r i e n c e c h a n g e s i n t h e i r v a l u e d u e t o c h a n g e s i n t h e t a r g e t f i r m' s e q u i t y p r i c e .
B e c a u s e t h e o p t i o n v a l u e o f c o n v e r t i b l e s e c u r i t i e s i n c r e a s e s a s t h e s h a r e p r i c e
i n c r e a s e s , we e x p e c t t h a t c o n v e r t i b l e s e c u r i t i e s a r e l i k e l y t o r e c e i v e a p o r t i o n o f
t h e p r e mi u m. T o c a p t u r e t h i s we c r e a t e a c o n v e r t i b l e t o e q u i t y v a r i a b l e d e f i n e d a s
t h e b o o k v a l u e o f ' o u t o f t h e mo n e y ' c o n v e r t i b l e s d i v i d e d b y t h e p r e - b i d ma r k e t
v a l u e o f e q u i t y .
S i mi l a r l y , n o n - c o n v e r t i b l e s e c u r i t i e s ma y g a i n f r o m a t a k e o v e r t h r o u g h c o i n s u r -
a n c e . T h e c o i n s u r a n c e p o t e n t i a l i s l i k e l y t o i n c r e a s e i n t h e a mo u n t a n d r i s k i n e s s o f
t h e t a r g e t ' s l o n g t e r m l i a b i l i t i e s . T h u s , we c r e a t e a c o i n s u r a n c e v a r i a b l e a s f o l l o ws .
158 M.T. Billett, M. Ryngaert / Journal q[' Corporate Fi nance 3 ( 1997) 141 - 165
We t ake t he r at i o of l ong t er m l i abi l i t i es ( net of conver t i bl e l ong t er m l i abi l i t i es) to
equi t y i nt er act ed wi t h val ue l i ne' s f i nanci al condi t i on r at i ng as a pr oxy f or
pot ent i al coi ns ur ance gai ns, COI N. Val ue l i ne rat es f i r ms f i nanci al condi t i on on a
scal e f r om A + + , t he best r at i ng, to C, t he worst . We assi gn a val ue of 0 to
A + + t hr ough 8 for C. For f i r ms wi t h agency r at ed debt or pr ef er r ed st ock, we
l bund t hat our val ue l i ne r at i ng var i abl e had a cor r el at i on in excess of 0. 8 wi t h a
numer i cal r at i ng scal e f or t hei r agency r at ed debt . 23 Addi t i onal l y, any f i r m t hat
has mor e f i nanci al asset s t han l i abi l i t i es is as s i gned a val ue of zer o f or COI N.
Such f i r ms are in l i t t l e pot ent i al danger of def aul t i ng on t hei r debt obl i gat i ons.
To cont r ol f or pos s i bl e weal t h t r ansf er s t o non- equi t y cl ai mant s, we modi f y Eq.
( 7' ) to become:
= * + [32 EQUI TY
DPREM ~( Xj ) 1 + [ 3 , EQUI TY /
EQUI TY i
( C ONVE R T I B L E S ) )
+ej
+/33 COI N + [34 EQUI TY i
I f conver t i bl e secur i t i es and COI N capt ur e t he maj or i t y of weal t h t r ansf er s, t hen
/31 and [32 wi l l become cl os er to one and negat i ve one r epect i vel y, and [33 and ]34
whi ch meas ur e t he mar gi nal ef f ect of conver t i bl e secur i t i es and coi ns ur ance
pot ent i al , wi l l be negat i ve. Tabl e 4 cont ai ns t he resul t s f r om es t i mat i ng t hi s
equat i on f or var i ous s peci f i cat i ons of t he pr e mi um to non- f i nanci al asset s, ~0(x).
The es t i mat ed coef f i ci ent on t he conver t i bl e r at i o is negat i ve but i ns i gni f i cant l y
di f f er ent f r om zer o at convent i onal l evel s, whi l e t he coef f i ci ent on COI N is
negat i ve and st at i st i cal l y di f f er ent f i om zer o at ei t her t he 5 or 10% l evel in t wo of
t he t hr ee speci f i cat i ons. Mor e i mpor t ant l y, however , t he coef f i ci ent on t he l i abi l i -
t i es t o equi t y r at i o i ncr eases, r angi ng f r om 0. 5763 to 0. 8013. Addi t i onal l y, t he
coef f i ci ent on t he f i nanci al asset s to equi t y rat i o decr eases, r angi ng f r om - 0 . 6 9 3 8
t o - 0 . 7 8 4 3 . Never t hel ess, except for t he most par s i moni ous model in col umn one
of Tabl e 4, we cont i nue to r ej ect at t he 5% s i gni f i cance l evel t he hypot hes es t hat
[3~ and [3z equal one and negat i ve one r es pect i vel y.
To pr ovi de a mor e di r ect t est of how t akeover r el at ed changes in de bt hol de r ' s
weal t h ma y af f ect t he es t i mat es of t he l ever agi ng of equi t y pr emi ums , we al so
exami ne a subset of 55 t ar get s t hat had at l east one debt or pr ef er r ed st ock i ssue
r at ed by t he St andar d and Po o r ' s r at i ng ser vi ce at t he t i me of t he t akeover and in
t he f ol l owi ng si x mont hs. In t he six mont hs al t er t he fi nal bi d dat e, 30 t ar get s had
at l east one i ssue downgr aded, 12 t ar get s had no r at i ngs changes, and 13 t ar get s
had at l east one i ssue upgr aded. Whi l e t hi s suggest s t hat mor e t ar get bondhol der s
wer e expr opr i at ed t han coi ns ur ed as a r esul t of t he t akeover s in our sampl e, t he
23 The debt rating scheme is taken from the Warga tapes. It rates debt quality on a scale from 1 to 23
based on letter S and P debt ratings.
M.T. Billett, M. Ryngaert/Journal of Corporate Finance 3 (19971 141-165 159
Tabl e 4
Wei ght ed nonl i near least squar es est i mat i on of model s expl ai ni ng target equi t y abnor mal ret urns is for
145 t ender offers duri ng peri od 198/ / - 1989 (t -st at i st i cs are in par ent heses) ( DPREM/ EQU1TY) j =
t 0(Xj ) * (1 +/ 3 ~( LI AB/ EQUI TY) i +/ 3 2 ( FI NASSETS/ EQUI TY) j +/ 33COI N +
/ 34( CONVERTI BLES/ EQUI TY) j ) + ej
Vari abl es in linear model of O( x ) Model 1 Model 2 Model 3
Const ant 0. 3210 0. 1249 0. 2009
(8. 60) * * * (2. I I ) * * (1. 55)
Multiple bi dders O. 1809 0. 2057 O. 1692
(4. 12) *** (4. 54) *** ( 3 . 8 8 ) * * *
Target log relative size - 0. 0587 - 0.0725 - 0. 0730
( - 4 . 0 7 ) * * * ( - 4 . 5 8 ) * * * ( - 4 . 4 6 ) * * *
Predicted non-fi nanci al Q divided 0. 2297 0.2005
by Actual non-fi nanci al Q
insider holdings, 0. 5)
~/lnstitutional holdings
~/ Acquirer's foothold
Percent of shares sought
Poi son pill dummy
' L e v e r a g i n g ' o f p r e m i u m :
Liabilities to equi t y ratio:
L1 AB/ EQUI TY: /31
Financial asset s to equity:
F I NAS S ETS / EQUI TY: /32
Potential f or coi nsurance:
COI N: /33
Conver t i bl es to equity: /34
Adj. R 2
(3. 62) *** (3. 23) ***
- 0. 2964
( 2 . 5 1 ) * *
- 0.1091
( - O. 7 8 )
- 0.1171
( - O.7O)
0.1205
(1. 34)
0. 1060
(2. 06) *~
0.8013 0.5763 0. 5789
( 4 . 2 6 ) * * * ( 3 . 9 6 ) * * * (3. 69) ***
0.7843 - 0.7331 - 0 . 6 9 3 8
( - 5 . 6 5 ) * * * ( - 6 . 4 2 ) * * * ( - 5 . 9 1 ) * * *
- 0. 0717 - 0. 0447 - 0. 0420
( - 2 . 0 9 ) * * ( 1. 70) * ( - 1 . 5 6 )
- 0. 1282 - 0.2461 - 0.3908
( 0 . 3 6 ) ( - 0 . 9 8 ) ( - 1.53)
0.261 0.344 0. 392
. . . . . . Denot e si gni fi cance at the l, 5, and 10% level, respectively.
mo r e i mp o r t a n t r e s u l t f o r t h e p u r p o s e s o f t h i s p a p e r a r e r e p o r t e d i n T a b l e 5. We
f i n d t h a t t a r g e t s wi t h u p g r a d e d i s s u e s h a v e h i g h e r l i a b i l i t y t o e q u i t y r a t i o s ( o r
l i a b i l i t i e s n e t o f f i n a n c i a l a s s e t s t o e q u i t y r a t i o s ) t h a n t a r g e t s wi t h d o wn g r a d e d
( a n d u n c h a n g e d ) i s s u e r a t i n g s . T h e u p g r a d e d t a r g e t s a l s o h a v e h i g h e r l e v e r a g e
r a t i o s t h a n t h e a v e r a g e t a r g e t i n o u r s a mp l e , a n d t h e d o wn g r a d e d t a r g e t s h a v e
l o we r l e v e r a g e r a t i o s t h a n t h e a v e r a g e t a r g e t i n o u r s a mp l e .
160 M. T. Billett, M. Ryngaert / Journal of Corporate Finance 3 (1997) 141- 165
Table 5
Sub-sampl e of 55 target fi rms that had public debt rated by Standard and Poor' s. The table cont ai ns
mean val ues of liabilities to equi t y ratio, and the liabilities less financial asset s to equity ratio
sub-grouped by whet her the rating on the t arget ' s public debt was downgraded, unchanged or upgraded
Rat i ngs action N Li ab. / equi t y ( Li ab. - f i nasset s) / equi t y
Downgraded 30 1.042 0.402
Unchanged 12 1.449 0.510
Upgraded 13 1.865 0.952
For l i ab/ equi t y: Reject equality bet ween downgraded and upgraded, and downgraded and unchanged
at the 5% significance level.
For (l i ab-fi nasset s)/ equi t y: Reject equality between downgraded and upgraded at the 5% significance
level.
This evidence again suggests why equity premiums are not as levered as we
might expect. Targets with below average leverage ratios appear to have expropri-
ation of bondholders, while targets with high leverage ratios appear to have
coinsurance of bondholders. These wealth transfers involving bondholders will
allow bidders to pay slightly larger dollar premiums to modestly levered targets
and slightly lower dollar premiums to highly levered targets. This will tend to
flatten out the slope relationship between equity percentage premiums and liability
to equity ratios.
Beyond probable model misspecification of wealth transfers, there are at least
two other reasons why premiums are not levered up or down more substantially in
our empirical estimates. First, a target fi rm' s financial structure may be correlated
with the size of potential acquisition gains. Jensen (1986) argues that managers of
firms rich in free cash flow have an incentive to suboptimally invest. Because debt
bonds managers to pay out cash t]ow, highly levered firms are less likely to
suboptimally invest than less levered firms. I f takeover gains stem from the
elimination of suboptimal investment then highly levered firms (and firms with
fewer financial assets) will have smaller dollar takeover gains than less levered
firms. Similarly, if leveraging up a target so as to fully exploit any tax gains from
debt financing is important, less levered firms might attract higher dollar premi-
ums.
While the above scenario is plausible, we believe the most likely explanation
for the inability to measure greater leveraging of equity takeover premiums is the
difficulty in accurately measuring the liabilities to equity ratio and the financial
assets to equity ratio. Interest rate fluctuations, default risk variations, and shifting
values of conversion options on convertible debt and preferred securities cause the
value of these securities to vary from their original book values. Default risk
variations are particularly troubling, because firms with higher leverage ratios are
the firms that have probably suffered the largest increases in default risk. So,
highly levered firms probably would have lower liability to equity ratios if market
debt numbers were available. Similarly, firms with a history of falling stock prices
I i
M.T. Billett, M. Ryngaert / Journal (~['Corporate Finance 3 (1997) 141 165 161
t end to have hi gh l i abi l i t y to equi t y r at i os whi ch wi l l be f ur t her over s t at ed in cases
wher e debt is conver t i bl e, becaus e we l l - out - of - t he - mone y conver t i bl e i ssues sel l at
di scount s to book val ue. Fi nal l y, of f bal ance sheet f i nanci ng f ur t her compl i cat es
t he me a s ur e me nt pr obl em. For i nst ance, many f i r ms have l ar ge amount s of
oper at i ng l eases or st ock opt i ons out st andi ng. Al t hough we at t empt to cal cul at e t he
debt equi val ent of l eases, t he met hod of f i nanci al r epor t i ng of such of f bal ance
sheet l i abi l i t i es l i mi t s accur acy. Si mi l ar l y, t he r epor t i ng met hods for st ock opt i ons
l i mi t t he abi l i t y t o adequat el y cor r ect f or t hei r effect . For t hese r easons, we bel i eve
t hat t he l i nk bet ween equi t y t a ke ove r pr e mi ums and f i nanci al r at i os is under s t at ed
by our anal ysi s.
5. Bi dde r r e t ur n re s ul t s
To t hi s poi nt , we have ar gued t hat t he negat i ve r el at i on bet ween t ar get t akeover
pr e mi ums and t he ext ent t o whi ch t he t ar get f i r m is c ompr i s e d of f i nanci al asset s
is cons i s t ent wi t h successf ul bi dder s bei ng unabl e t o i mpr ove t he val ue of f i nanci al
asset s to t he same ext ent t hat t hey can i mpr ove t he val ue of non- f i nanci al asset s.
However , t hi s negat i ve r el at i on is al so cons i s t ent wi t h Ro l l ' s hubr i s hypot hes i s
( Rol l , 1986). Rol l ar gues t hat di s per s i on among i ndi vi dual bi dde r es t i mat es of t he
val ue of a t ar get l eads to a wi nner s cur se wher e t he wi nni ng bi dder s over pay for a
t ar get fi rm. The sever i t y of t hi s wi nne r ' s cur se, and hence t he degr ee of over pay-
ment , i ncr eas es in t he var i ance of t he bi dde r s ' es t i mat es of t ar get val ue. In t he
cont ext of t hi s paper , t he var i at i on in bi dde r es t i mat es of t ar get val ue ma y be
s mal l er for f i r ms wi t h eas i er t o val ue f i nanci al asset s, l eadi ng to l ess over payment ,
s mal l er t akeover pr e mi ums and t he negat i ve r el at i on bet ween t he t a r ge t ' s t akeover
pr e mi um and its pr opor t i on of f i nanci al asset s.
I f hubr i s is dr i vi ng t hi s negat i ve r el at i onshi p, bi dder r et ur ns shoul d be i ncr eas-
i ng in t he pr opor t i on of t a r ge t ' s asset s t hat are f i nanci al , agai n consi st ent wi t h l ess
ove r pa yme nt f or mor e val ue t r ans par ent asset s. To t est t hi s conj ect ur e, we
e xa mi ne t he r el at i ons hi p bet ween bi dder abnor mal r et ur ns and t he r at i o of t ar get
f i nanci al asset s to t ot al asset s. 24 Us i ng wei ght ed l east squar es we r egr ess t he
b i d d e r ' s r et ur n on t he mul t i pl e bi dder dummy ( a meas ur e of compet i t i on f or t he
t arget ), t he per cent of shar es sought ( per cent of t akeover of f er t hat is cash) , and a
d u mmy var i abl e i f t he t ar get has a poi s on pi l l . In addi t i on, becaus e t ar get f i r ms
t hat are l ar ge r el at i ve to t he si ze of t he bi dde r wi l l l i kel y have a mor e subst ant i al
ef f ect on t he bi dde r ' s val ue, we i ncl ude t he r el at i ve si ze of t he mar ket val ue of t he
t a r ge t ' s t ot al asset s t o t he b i d d e r ' s mar ket val ue. We t hen i nt er act t hi s r el at i ve si ze
meas ur e wi t h t he rat i o of t ar get f i nanci al asset s to t ot al mar ket val ue of t ar get
24 The bidder abnormal returns are calculated in the same manner as the target abnormal returns. The
weighted least square mean bidder return is - 1.1%.
1 6 2 M.T. Billett, M. Ryngaert / , l ournal of Corporate Finance 3 (1997) 141 165
Tabl e 6
We i g h t e d l e as t s quar e s r e g r e s s i o n o f the bi dde r ' s abnor mal ret urn on c ont r ol v ar i abl e s and t he
i nt e rac t i on o f t he r e l at i v e s i z e o f t he t arget t o t he bi dde r and t he pr opor t i on o f t arget as s e t s c o mp r i s e d
o f f i na nc i a l as s e t s ( t - s t at i s t i c s are i n par e nt he s e s ) . D e p e nd e nt var i abl e - bi dde r a bno r ma l ret urn
V a r i a bl e Co e f f i c i e nt
Cons t ant - 0 . 0 5 5 6
( - 2 . 2 0 ) * *
Mul t i p l e bi dde rs - 0 . 0 2 6 9
( - 1 . 9 8 ) * *
Pe r c e nt o f s har e s s ought 0 . 0 5 3 3
( 1 . 9 7 ) *
Po i s o n pi l l d u mmy - 0 . 0 1 0 0
( - 0 , 6 6 )
Re l a t i v e s i z e : ( l i ab + e q u i t y ) ~, , ~t / ( e q u i t y ) h i d ~J ~. ~ 0 . 0 0 4 3
( 0 . 2 7 )
Re l a t i v e s i z e f i na nc i a l a s s e t s t ~ t / ( l i a b + equi t y) t . r z~c t 0 . 0 0 3 3
( 0 . 0 9 )
Ad j . R 2 0 . 0 4 8
* * * D e n o t e s i g ni f i c a nc e at t he 5 and 10c 5 l e v e l , r e s p e c t i v e l y .
as s et s . A pos i t i v e c oe f f i c i e nt on t hi s i nt eract i ve t e rm wo ul d be c ons i s t e nt wi t h
Ro l l ' s hubri s hypot he s i s . The resul t s are c ont ai ne d in Tabl e 6.
Wh i l e t he mul t i pl e bi dder d u mmy and percent o f shares s ought wi t h cas h are o f
t he ant i ci pat ed s i gn and margi nal l y s i gni f i cant , t he c oe f f i c i e nt s on t arget rel at i ve
s i z e and t he i nt eract i on be t we e n rel at i ve s i z e and t he proport i on o f t he t arget ' s
as s e t s that are f i nanci al are bot h s t at i s t i cal l y i ndi s t i ngui s habl e f r om z e ro. Thi s
s ugge s t s that the rel at i ons hi p be t we e n target f i nanci al structure and t arget abnor-
mal returns i s not due t o hubri s. 25
6. Co n c l u s i o n
For a s ampl e o f 145 cas h t ender of f ers t he i mpac t o f the t arget ' s capi t al
structure and as s et structure on the t arget ' s pe rc e nt age e qui t y p r e mi um i s e x a m-
i ned. We f i nd that t he t arget abnormal e qui t y return i s i ncreas i ng in t he target
l i abi l i t y t o e qui t y rati o and de c r e as i ng wi t h re s pe c t t o the f i nanci al as s et t o e qui t y
rati o. Thi s i s c ons i s t e nt wi t h t he i dea that bi ddi ng f i rms pay a p r e mi um f or c ont rol
o f t arget e qui t y bas e d on h o w muc h t hey be l i e v e t he y can re val ue the non- f i nan-
ci al as s e t s o f t he target f i rm. Thi s p r e mi um i s t hen l e ve r e d up or d o wn bas e d on
the f i nanci al structure o f t he f i nn.
25 Th e re s ul t s are q ua l i t a t i v e l y s i mi l ar wh e n t he rat i o o f t arget f i na nc i a l as s e t s t o t ot al as s e t s i s
s ubs t i t ut ed f or t he i nt e r ac t i v e t e rm or i s e nt e r e d wi t h o ut t he r e l at i v e s i z e var i abl e .
M.T. Billett, M. Ryngaert / Journal of Corporate Finance 3 (1997) 141 165 163
These results shoul d be of general interest t o empi ri ci st s in the corporat e
fi nance area. Whi l e many studies at t empt t o anal yze cross-sect i onal di fferences in
the per cent age reval uat i on of a f i r m' s equi t y as the result of some event, t he mor e
i mport ant quest i on mi ght be how much the f i r m' s assets or non-fi nanci al assets are
r eval ued as the result of some event. Di fferences in fi rm fi nanci ng mi ght obscur e
t hese di fferences as is hi ghl i ght ed in our anal ysi s of t akeover premi ums. Thi s is
especi al l y t roubl i ng to the ext ent t hat l everage t ype vari abl es are correl at ed wi t h
vari abl es that are bei ng used to expl ai n di fferent st ock market react i ons t o an
event.
Appendix A
Defi ni t i ons:
MVEQ = market value of equi t y at t went y days before ' put in pl ay dat e' based
on: ( l ) Shares out st andi ng at end of quart er before ' put in pl ay dat e' . (2) Shares
conver t ed t hr ough the assumed conver si on of convert i bl e debt and convert i bl e
preferred t hat has a conver si on val ue great er t han ori gi nal issue val ue of convert -
ible. (3) Val ue of in the money warrant s at t went y days before put in pl ay date.
Est i mat ed as c ommon st ock pri ce at t went y days before put in pl ay date less the
di scount ed present val ue of warrant exerci se price.
FI NASSETS = fi nanci al assets of firm. Equal to the sum of: (1) Current assets
less i nvent ori es. (2) Long t erm fi nanci al assets (recei vabl es and i nvest ment s). (3)
I nvest ment s in affiliates at equi t y (i ncl udes equi t y val ue of unconsol i dat ed fi nan-
cial subsidiaries such as l easi ng subsidiaries).
LI AB = liabilities of firm. Equal to the sum of: (1) Current liabilities. (2) Long
t erm liabilities (excl udi ng deferred i ncome taxes, preferred stock, and mi nor i t y
interests). (3) Preferred st ock at i ssuance val ue (general l y liquidating value). (4)
The present val ue of of f - bal ance sheet mi ni mum operat i ng lease rentals. Rent al s
are di scount ed at the pr i me rate. Rent al s after t he fifth year are assumed t o be
spread out evenl y over n + 1 years wher e n is the total rentals payment s due after
the fifth year di vi ded by the rental payment in year five. The amount of subl eases
are t hen assumed to f ol l ow a similar pattern of det eri orat i on as that of leases.
These payment s are netted out of lease payment s.
Non- f i nanci al Q ratio
( MVEQ + LI AB - F I NAS S E T S ) / ( T A + LI FO - FI NASSETS)
wher e LI FO is t he underst at ement of i nvent or y cost s due to usi ng LI FO as
opposed t o FI FO i nvent or y account i ng and TA = total assets of fi rm plus the
present val ue of of f - bal ance sheet mi ni mum operat i ng lease rentals less the book
val ue of mi nor i t y interest.
Predi ct ed non- f i nanci al Q ratio
For the 145 fi rms in the sampl e, a regressi on was run of the actual non-fi nan-
cial Q ratio agai nst the R &D spendi ng report ed in the fi rm 10K f r om the past
164 M. 7". Billett, M. Ryngaert / Journal of Corporate Fi nance 3 ( 1997) 141 - 165
two years divided by the fi rm' s non-financial assets and four time dummies
( 80- 81, 82- 83, 84- 85, and 86-87). Once the regression was estimated, the
parameters from the estimates were used to predict what the value of each fi rm' s
non-financial Q should have been.
Target log relative size = the natural log of the relative size of the target' s
non-financial assets to the market value of the bidder' s equity. The relative size is
defined as:
( MVEQ + LIAB - FI NASSETS) / ( Bi dder Equi t y)
where bidder equity is the bidder value at twenty days before ' put in play date'
based on shares outstanding of bidder at that time.
Sources: 10Qs, 10Ks, Compustat, and 8K pro-forma balance sheets, proxy
filings, Standard and Poor' s common stock guide and CRSP tapes.
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