Termination Fees in Mergers and Acquisitions: Protecting Investors or Managers?

Abstract

Institutional investors closely monitor termination fees in mergers and acquisitions (M&A). We argue that their magnitude reflects either agency problems or efficiency considerations. Focusing on M&A involving Canadian targets between 1997 and 2004, we assess the determinants and market impact of termination fees. Our findings show that the Thomson's SDC Platinum [TM] "Worldwide Mergers""&""Acquisitions Database" underestimates their extent. Results suggest that termination fees are essentially an efficient mechanism as they are relatively higher in M&A with high merger costs, a cash component and expected operating synergies. Stock market returns surrounding the deal announcement do not differ across levels of relative termination fees. Copyright 2007 The Authors Journal compilation (c) 2007 Blackwell Publishing Ltd.

Termination fees and bilaterally efficient merger contracts

“…Statement (i) is consistent with the Hotchkiss et al () report that the termination fee decreases when the target has better non‐merger alternatives. The bidder's valuation m of the merger includes the merger's synergies, so statement (ii) is consistent with the Andre et al () conclusion that termination fees are found to be higher if the transaction entails operating synergies.Proposition If the bidder and the target are risk‐neutral, then the contract (p *e ,f *e ) generates a consummation probability larger than that generated by the contract (p nf , 0). is independent of the inspection cost c and the bargaining cost b. …”

“…Hotchkiss et al () report, from an examination of US mergers between 1994 and 1999, that the target termination fee decreases when the target has better expected non‐merger alternatives. Andre et al () examine mergers of Canadian firms from 1997 to 2002 and report results that are mostly consistent with termination fees being an efficient mechanism that enhances the attractiveness of the transaction for the target firm's shareholders. Bates and Lemmon () report that “the provision of target fees is positively correlated with proxies for negotiation and bidding costs” (p. 471), that “analysis regarding the endogenous determination of premiums and target fees utilizing simultaneous equations suggests that these terms, like other attributes of the deal, are determined jointly during deal negotiations” (p. 471), and that Officer () concludes, as do we, that termination fee grants are negotiated optimally as an incentive to encourage bidding and the revelation of private information.…”

The Effect of Prohibiting Deal Protection in Mergers and Acquisitions: Evidence from the United Kingdom

“…This limitation is compounded by the fact that there is no systematic data on the full array of protections that the reform prohibited and even for the available data, the information from Thomson Financial is not entirely reliable. Boone and Mulherin (2007) and André, Khalil, and Magnan (2007), for example, find that, relative to a careful review of SEC filings, Thomson underreports the incidence of breakup fees and other forms of deal protections. Casual observation, in fact, suggests that some of the deal protections that are not reported by Thomson might have been quite frequent before the 2011 Reform.…”

How much is reasonable? The size of termination fees in mergers and acquisitions

“…Then, using both a univariate test and multiple regressions, we examine whether fee size reflects target managers' self interest or is consistent with the efficient contractual device hypothesis. 7 Andre et al (2007) study this issue using 218 Canadian merger observations. 8 According to a reply from the SDC data team, termination fees in the SDC database are computed based on the Freeman imputed fee data provided by Thomson Financial and Freeman & Co. 9 The figures are similar to Officer (2003) who shows the mean and median of target termination fees as a percentage of deal value are 3.80% and 3.27%, respectively.…”