Ch. 3: Auctions in Corporate Finance 115
terminated.^25 Another possibility is for the target board to refuse to rescind poison pills
for any but the declared winning bidder. While it is unclear whether the courts will
allow such poison pills to stand, the legal costs of challenging the poison pills and the
possibility that the board might switch to an ascending auction (so that the challenger is
by no means assured of winning the contest) may deter further challenge from a losing
bidder.
Third, formal or informal auctions are much more common than is usually assumed.
Boone and Mulherin (2006a)analyze a sample of 400 takeovers of U.S. corporations
in the 1989–1999 period and find evidence consistent with the idea that boards act as
auctioneers to get the best price for the shareholders in the sale of a company. Based
on information from the SEC merger documents, the authors provide new information
on the sale process. The most important evidence is that there is a significantprivate
takeover market prior to the public announcement of a bid. The authors document that
almost half of firms in their sample were auctioned among multiple bidding firms, and
the rest conducted negotiations with a single bidder. A third of the firms in the former
category went through a formal auction, in which the rules were clearly laid out. In all
cases, the process usually began with the selling firm hiring an investment bank and
preparing a list of potential bidders to contact. After the bidders agreed to sign a con-
fidentiality/standstill agreement, they received non-public information. Subsequently, a
subset of the bidders indicating preliminary interest was asked to submit sealed bids.^26
Another issue relevant for the applicability of auction models to control contests
concerns the complexity of the environments in which takeovers are conducted, com-
pared to the standard auction environments. Auction models are nicely classified as
belonging to different value environments, and results differ depending on which value
environment is under consideration. The takeover environment is considerably more
complicated. The motives for takeover bids could be varied. The early takeover models
(e.g.,Grossman and Hart, 1980) assumed that the benefit from a takeover comes from
an improvement in the operational efficiency of the target company. As the authors
showed, this could lead to a “free-rider” problem and the market for corporate control
could fail. However, later models have focused on “merger synergies” as the source
of gain from takeovers. If the synergies accrue to the bidding firm, then the standard
auction environment is more applicable. Here, however, there are issues about whether
“private values” or “common values” assumptions are more relevant. Since bidders are
different and the synergies are likely to have idiosyncratic components, a private val-
ues model does not appear unreasonable. However, common value elements will also
undoubtedly exist. Synergies can have common value components if their magnitudes
(^25) For example, Viacom’s initial offer for Paramount in 1993 was associated with (a) an option to buy 20% of
Paramount’s outstanding shares and (b) a termination fee of $150 million plus expenses, should the transaction
not be concluded.
(^26) Betton, Eckbo and Thorburn (2005)show that of the 12,000 contests, about 3,000 (25%) start out as tender
offers (which subsequently turn into auctions). Some initial merger bids also end up in auctions, so the overall
percentage of auctions maybe closer to 30%.