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Hostile Takeovers
Bubbles
David McAdams 2
Hostile Takeovers
David McAdams 4
Macy’s vs. Campeau
You are shareholders of Federated,
whose share price is $100.
David McAdams 5
Macy’s vs. Campeau
If less than 50% tender to him, then each
gets $110 per share.
If X% > 50% tender to him, then each
gets a “blended price” of
David McAdams 6
Macy’s vs. Campeau
Do you:
Tender to Macy’s
OR
Tender to Campeau?
David McAdams 7
Qwest Bond Swap
“Today a federal judge will decide whether Qwest
can proceed with an exchange offer in which
institutional investors (in a $1.5B issue) are being
asked to exchange each $1,000 bond for a new
one with face value $545. The offer is a coercive
one that will leave bondholders who do not accept
it in the back of line for repayment if Qwest goes
broke…”
- “A Bond Swap Available Only to Big Players”, NY Times, December 18, 2002.
David McAdams 8
Qwest Bond Swap
“If Judge Chin allows the offer to go ahead,
institutional investors who own bonds will
find themselves in a position with some
resemblance to the classic ‘prisoners’
dilemma’... If no one tendered, then Qwest
would be in the same position as before the
offer, and any bondholder would be no worse
off. But if a lot of holders tender, those who
refuse will be worse off than they were.”
- “A Bond Swap Available Only to Big Players”, NY Times, December 18, 2002.
David McAdams 9
Qwest Coercive Bond Swap
David McAdams 10
Qwest: Some Simple Cases
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Qwest: Less Simple Cases
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Qwest Continued: When All
Bonds aren’t Created Equal
In reality, Qwest had many different bond
issues it wanted to retire through these
swaps, with different repayment priority.
Qwest also didn’t issue its swap offers for
all of its issues at once but rather
staggered the offers
Does the order matter?
Should Qwest swap high-priority bonds
first or low-priority ones?
David McAdams 13
Zwest Game
Fictional firm Zwest has three
bondholders A,B,C each owed $3M.
There is some uncertainty about Zwest’s
future assets: Zwest will have $5 million
with 66.7% and $8 million with 33.3%.
Absent any tendering, A gets repaid first
followed by B, then C.
• Since assets are always less than $9 million, Zwest
always goes bankrupt and has equity value of $0.
David McAdams 14
Zwest Game
Zwest will offer A,B,C each to exchange
their $3M bond for a priority $2M bond.
Those who tender will have higher priority
than those who don’t, but priority
rankings are preserved between those
that tender and those that don’t.
• Example: if only B tenders, then B is paid $2M first
then A is paid $3M then C is paid either $0M or $3M,
depending on whether asset value is $5M or $8M.
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Zwest Game #1 (A first)
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Zwest Game #2 (C first)
David McAdams 17
Play Zwest Games!
Group into three pairs to play (you and a
partner will play together)
• Roll a die to see who is A, B, C
With your partner decide which game you
would rather be playing (in your role),
and write this down with your names and
a brief explanation
• Your choice will not affect which game you
ultimately play
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Play Zwest Games!
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Commitment
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Game within a Game
So far, we have examined hostile
takeovers as a voting game played
among the target’s stockholders
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Bitter Pills
Numerous ways for entrenched
management to increase the cost of
a takeover (“Shark Repellant”)
• “Poison Pills”
• “Macaroni Defense”
… and for raiders to fight back
• “Lady MacBeth Strategy”
• “Saturday Night Special”
David McAdams 23
Saturday Night Specials
“From the hostile bidder’s perspective, the most
critical element – in contrast to substantive
matters such as the price offered and the number
of shares sought – is speed … If the hostile bidder
can structure its offer so that target shareholders
must decide to tender before a competitive bid
can be arranged, a substantial advantage will be
secured”
- Source, Gibson and Black (1995), “The Law and Finance of Corporate
Acquisitions”
David McAdams 24
Game within a Game within
a Game (within a Game)
Management needs shareholders to
approve a Poison Pill. Thus, shareholders
and management play a game long
before raider arrives.
Yet one layer deeper: Poison Pills remove
management’s incentive to take more
drastic, self-destructive behavior
• If management can commit to adopt such a
“Scorched-Earth Policy”, then shareholders will be
more willing to grant a Poison Pill
David McAdams 25
Role of Regulation
Players may strategically commit to
strategies that reduce overall gains from
the game.
Beneficial regulation shapes the options
available to players so that the options
they will likely choose lead to better
outcomes.
• Saturday Night Specials were made illegal by the
Williams Act of 1968, which stipulated that any
tender offer must be kept open for at least 20 days.
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Bubbles
3. Bubble Game
David McAdams 28
Newspapers, academics, and
crystal balls …
Spotting trends
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Spotting trends
“__ is typically a strong month for stocks”
“__ tends to be a good month for stocks”
“__ has historically been a strong month”
“__ is usually a great month for stocks”
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Spotting Trends
David McAdams 32
January Effect
Tendency of the stock market to rise
between December 31 and the end of the
first week in January.
David McAdams 33
Sampling of Research
(USA data up to 80s)
In equally-weighted portfolio, average
return 3.5% in January, only .5% in others
• Excess returns not seen in DJIA, so effect limited
to and more pronounced in small stocks
• Over half of excess return on small stocks in Jan.
Excess returns greatest for small firms
whose prices have declined previous year
• Excess returns in first five days not observed for
“winners” of previous year
David McAdams 34
Sampling of Research
(non-USA data up to 80s)
January returns exceptional in 15/16
countries studied.
• In Belgium, Netherlands, Italy, January return
exceeds the return for the whole year!
Taxes appear confirmed as part of story
• Britain has April effect, Australia has July effect.
January itself seems significant
• Effect in Japan (where no capital gains) as well as
Britain and Australia.
David McAdams 35
What Should You Do?
Careful research has shown that
there was a January effect from
1900-1980.
David McAdams 36
January Defect?
Source: The Independent Adviser for Vanguard Investors,
December 10, 2002
David McAdams 37
Most Recent Research
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Bubbles
What is a bubble?
David McAdams 39
A Simple Model of Bubbles
A structural change leads unsophisticated
investors to conclude there is a “new economy”
with permanently higher growth (and
permanently rising prices!).
• South Sea bubble in 1700s
• Tech bubble in 1990s
BUT sophisticated investors know that the
growth spurt is temporary and will return to
normal levels
• Still, no one knows how long high growth will last
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A Simple Model of Bubbles
Sophisticated investors begin to realize
that the growth spurt has ended after the
fact and not all at the same time.
As long as a majority of sophisticated
investors stay invested, price continues to
increase at a high rate. (This is an assumption.)
• For our purposes, “bubble” = majority of
sophisticated investors know that growth has
stopped, but still a majority stays invested.
BUT once a majority of sophisticated
investors have sold, the naïve realize
their error and the bubble bursts.
David McAdams 41
How Do Bubbles Start?
You are an investor in the early
1700s.
The masses believe that the South
Seas Company’s price is sure to rise
at high rates permanently.
To your surprise, you learn that
South Seas trade is a dud!
Should you sell immediately?!
David McAdams 42
Bubble Game: Rules
5 players
10 periods. Decide Buy/Sell in each
• After period 10, Price will revert to Value
Price process
• Price = Value = $1 at start
• Price doubles each period until 3 or more sophisticates
have sold
Player payoffs
• Once you Sell, you are done and get current price.
• If you still own when 3 others have sold, you get current
Value
David McAdams 43
Bubble Game: Rules
Value process
• Value doubles each period during the growth period.
• I will flip a coin each period to determine whether growth has
ended (beginning after round 1).
• Example: If growth stops after round 3, then value = price ($1,
$2, $4) in periods 1,2,3 but value = $4 in all periods T > 3
whereas price keeps on doubling. When bubble bursts, price
falls back to $4.
Information process
• Once growth ends, one randomly chosen player will
immediately learn that it has ended
• The next period, a second player will learn that it has ended,
and so on
• Note: Upon learning, you don’t know if you were the first to
learn, the second, … or the last!
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Sell Immediately Upon
Learning: Nash Equilibrium?
Suppose that all others are following
the strategy of selling immediately
upon learning that growth has
stopped (but not before)
David McAdams 45
How Do Bubbles Persist and
Burst?
Play the Bubble Game to find out!!
Form groups of four or five so that there
are ten groups total
• Select one from among you to represent your group.
• Discuss among yourselves how to play – no discussion
will be allowed once game begins
• Consult hand-out for more detailed info on game
We will play two iterations of the Bubble
Game, then discuss for lessons learned
David McAdams 46
News and “Overreaction”
We have seen that bubbles can exist even when
there are numerous rational players
BUT bubble can only persist when these players
are relatively uncertain about when others are
going to sell
Even small news events can serve as
coordinating devices that allow / force the
rational investors all to escape the bubble
The response is not an “overreaction” to the
news but the bubble bursting
• Note: This does not explain why the stock market moves a lot
with every news story.
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