How Target Shareholders Benefit from Value-Reducing Defensive Strategies in Takeovers

Abstract

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.. Wiley and American Finance Association are collaborating with JSTOR to digitize, preserve and extend access ABSTRACT This paper shows that target shareholders can be made better off through the use of certain types of defensive strategies that reduce the value of the target by different amounts for different bidders. In many cases, simply the threat of such strategies can make target shareholders better off. Therefore, empirical tests based on stock price reactions at the adoption of defensive strategies may be underestimating the effect of such strategies. The paper also identifies the necessary characteristics that make these strategies effective and shows that many observed defenses possess similar properties. , and the discussant, M. Fishman, at the Western Finance Meetings in Napa, the editor, R. Stulz, and two anonymous referees for their many helpful comments. The usual disclaimer applies. They also acknowledge partial financial support of the Michigan Business School.'These arguments have been raised by Easterbrook and Fischel (1981) and Gilson (1982). The former also argue that defensive strategies serve only to redistribute synergy gains between targets and bidders and, thus, do not affect social welfare. Another argument against defensive strategies is based upon concerns that managers can abuse them to remain entrenched. We discuss these issues in Sections III and IV. 2 A more detailed description of these strategies is given in Sections I and V. 137 This content downloaded from 128.235.251.160 on Sun, 14 Dec 2014 01:59:58 AM All use subject to JSTOR Terms and Conditions 138The Journal of Finance a particular target. The acquisition is carried out through a tender offer, and each acquirer has to incur both search and bidding costs before making its first bid for the target. If a target manager is unable to use VRDS, an opening bidder can reduce competition for the target with a "low" preemptive bid. However, when the target manager can use VRDS, the opening bidder is forced to preempt with a higher bid. This is because, with VRDS, the target manager can reduce the value of the target to this bidder by a greater amount than to other bidders. This discriminatory reduction makes it more profitable for potential bidders to enter and compete with the opening bidder as they now expect to outbid it. Thus, the opening bidder needs to bid higher to reduce the incentive of the target to use VRDS against it. As a result, target shareholders gain even when their manager does not actually employ VRDS. When VRDS do get employed, the target's stock price reaction can be either positive or negative depending on what additional information is released to the market. This reaction, tho...

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