Ch. 3: Auctions in Corporate Finance 111
whereARuis the average abnormal return conditional on the offer being unsuccess-
ful. Here,ARsandARuare estimated as regression parameters in a cross-sectional
regression involvingallsample bids, whether ultimately successful or not.^21 Using the
right-hand side of equation(27), they conclude that the expected value of the initial
bid (conditional onx) is statistically indistinguishable from zero. As in the earlier lit-
erature, targets expected returns are positive and significant, as is the value of the sum
of the gains to targets and bidders. Thus, the data do not support theories predicting
value-destruction.
Betton, Eckbo and Thorburn also report that the magnitude and distribution of abnor-
mal returns to bidders and targets depends significantly on whether they are private or
publicly traded companies. Bidder gains are larger, and target premiums smaller, when
the bidder is public but the target is a private firm. Moreover, private bidder firms have
a significantly lower probability of succeeding with their bids for public targets. They
also report that, in contests where no bids succeed, the target share price reverts back
to the level where it was three calendar months prior to the initial bid in the contest.
As noted byBradley, Desai and Kim (1983)as well, this share price reversal is what
one would expect if the market conditions the initial target stock price gain on a control
change in fact taking pace (where control may be acquired by either the initial or some
rival bidder).
Overall, the evidence suggests that auctions tend to yield great results for targets but
that competition in the auction (or something else) tends to ensure that gains to bidders
are at best minimal. From the standpoint of auction theory, this is surprising: certainly in
a private values context, and even in a common value context, the strategic equilibrium
of an auction should still yield an expected profit for the winning bidder. The fact that
gains to bidders are minimal suggests that the pure auction models do not capture the
richness of the process, and that other forces are likely at play. AsBoone and Mulherin
(2003)suggest, the evidence is in favor of two-stage models such as that ofFrench and
McCormick (1984)which analyze costly entry. While pure auction models imply an
expected surplus for participating bidders, entry of additional bidders will cause that
expected surplus to be dissipated through costly entry.
Roll (1986)first used the idea of the winner’s curse to explain the empirical evidence
that acquiring firms appear to over-bid for targets in that acquiring firms’ stock prices
fall (or stay at best constant) upon announcement of acquisitions. If bidders ignore the
winner’s curse, they may well over-pay (in a common value setting, which is not unrea-
sonable in the corporate acquisition market). The problem, of course, is that equilibrium
theory does not permit expected over-bidding, so Roll is relying upon acquirers making
mistakes. Proponents of behavioral finance will find it quite convincing to think that
bidders may not properly adjust their strategy for the pitfalls inherent in common value
(^21) The estimation is in three steps: (1) estimateARiusing time series of returns to the bidder up to the first
bid announcement, (2) estimatep(x)using the cross-section of bids, and (3) run regression(27)to produce
ARsandARu.