Ch. 3: Auctions in Corporate Finance 119
design, where steepness refers, roughly, to the rate of change of a security’s value in
relation to the underlying true state. This paper also compares auction formats in a
world where bids can be non-cash; it turns out that revenue equivalence does not always
hold. Overall the paper concludes that the optimal auction is a first-price auction with
call options as the means-of-payment.
Ex-post pricing mechanisms also yield benefits in common-value contexts. The rea-
son for this follows from the return of the adverse selection problem inherent in the
winner’s curse: the problem arises because the price for the asset is being determined
before the value of the asset is known. Any kind of pricing mechanism that determines
all or part of the price ex-post can alleviate the problem. Using the acquiring firm’s
stock is an ex-post pricing mechanism, for that stock’s value will depend upon the actual
value of the target firm.Hansen (1986)builds on this insight and shows that stock and
cash/stock offers can be used efficiently in mergers and acquisitions. However, in offer-
ing stock as the means-of-payment, acquiring firms bring in their own adverse selection
problem—acquiring firms may offer stock when they have information that their own
value is low. Taking into account both the ex-post pricing advantage of stock and the
“reverse” adverse selection problem, it turns out that higher-valued acquirers will offer
cash while low-valued acquirers offer stock.Fishman (1989)reaches a similar conclu-
sion, in that non-cash offers induce the target firm to make more efficient sell/don’t sell
decisions, but that cash offers have an advantage in pre-empting other bids.^31
Several studies on U.S. data show results consistent with Hansen and Fishman’s work,
that acquirers’ returns are higher for cash offers than for stock offers (seeEckbo, Gi-
ammarino and Heinkel, 1990, for a brief summary). The first paper to explicitly model
the choice of mixed offers isEckbo, Giammarino and Heinkel (1990). These authors
prove the existence of a fully separating equilibrium in which the market’s revaluation
of the bidder firm is increasing and convex in the proportion of the offer that is paid in
cash. Since one can estimate the revaluation, and since the proportion paid in cash is
observable, this theory is testable. Using over 250 Canadian takeovers (where tax issues
do not confound the choice of payment method), the authors find empirical support for
the “increasing” part but not for convexity.
4.4. Toeholds
Recently, a number of theoretical papers have examined how toeholds affect takeover
bidding. The main result that emerges from this literature is that the presence of makes
bidders more aggressive, with the result that bidders can bid above the value of the
object. The result holds for the second-price auction in both the independent private
values as well as a common value environment.
(^31) Rhodes-Kropf and Viswanathan (2000)consider a general model of non-cash auctions for a bankrupt firm.
We discuss this model later.