# Presentation: 520000

## Does Patience Pay? Empirical Testing of the Option to Delay Accepting a Tender Offer in the US Banking Sector

**Rachel Campbell**
**Roman Kr****ä****ussl**

## Overview

- Empirical predictions of real option-pricing model
- Application to M&A behavior
- US banking industry
- Target bank’s size & free cash flow important variables in determining the size of the final premium paid
- Does patience pay?
- 5 significant results

## Quick Glance at the Results

- Patience pays
- Winners curse
- Hubris and overconfidence
- Low earnings matter
- Size matters

## Literature I

**Empirical evidence: Acquiring companies overpay**
- Moeller, Schlingemann and Stultz (2004, *JFE*)
- 12,023 acquisitions, 1980 to 2001
- Negative effect
- Size effect: Larger negative effect for larger acquiring-firm shareholders
- Moeller, Schlingemann and Stultz (2003, NBER WP)
- Acquiring firm shareholders lost $240 billion at the announcement of acquisitions during 1998-2001; 12 cent loss for every dollar spent
- 1980s: “just”1.6 cent loss for every dollar spent
- Fuller, Netter & Stegemoller (2002, *JF*)
- Bidder firm shareholders gain (lose) when buying a private (public) firm

## Literature II

**Why do acquiring companies overpay?**
- Hubris
- Roll (1986, *JB*): also greater for larger firms
- Demsetz and Lehn (1985, *JPE*): greater share ownership for larger firms
- Managerial optimism
- Heaton (2002, *FM*): behavioral finance; wrong perceptions of decision-makers
- Malmendier and Tate (2005, *JF*): CEO overconfidence; investment of overconfident CEOs is significantly more responsive to cash flow
- Free Cash Flow
- Jensen (1986, *Midland CF Journal*): too much excess cash flow available after funding all projects with NPV; managers have incentives to expand their firms beyond the size that maximizes shareholder wealth

## Literature III

- Management resistance to takeover
- Baron (1983, *JF*)
- Schwert (2000, *JF*)
- Retain control
- Offer doesn’t reflect the true value
- Or simply wait for a better offer
**How effective is this strategy?**
**And what is the value of this strategy to the target company’s shareholders?**

## Main Idea

- We know:
*	**Tendency for bidder management to overpay plus resistance of targets to be taken over*
- We ask:
- 	*Is it a valuable option to delay accepting a tender offer?*

## Data

- US Banking Industry
- 1997-2005
- 424 M&A
- SDC Platinium
- Public tender offers
- Same currency, cash
- Accounting data on both target and acquisition company
- CRSP, Compustat
- Mean option premium is 12.5%

## Real Option Model

- Tender offer at time *t *
- Share worth *S**t*
- Offer price *P**t*
- Gain *P**t **-S**t*
- Shareholders may wait until time* T*
*	**in the hope of a higher second or third offer, P**2**, P**3**... P**T*
*	**where:** **P**T **–S**T * > *P**t **–S**t *
*Option value V is the maximum of the present value of the payoffs*

## Parameters

- Value of underlying asset = *V*
- Variance of the stock price, *σ**2*
- Exercise price = investment made to acquire the underlying asset, *X, =P**t **–S**t *
- Transaction completed, time *T*
- Discount rate, r, corresponding to the life of the option
- Dividend yield, δ

## Intermediate Variables

- Lattice approach (Quigg,1993 *JF; *Trigeorgis,1993* JFQA*)
- Nodes, *n*
- Time step,* k*
- Drift,* **μ*
- State Step,* H*
- Probability,* p*
*Terminal boundary*
*Option Payoff*
*Option value at time of announcement*

## Summary Statistics

## Option Premiums

## Patience Pays!

**Result 1**
- Positive premium 12.45%
- Advantageous to wait as long as possible in accepting the bid
- Accepting the offer straight away means sacrificing this option to delay

## Winners Curse!

**Result 2**
- Competitor in the bidding process results in additional premium of 10%

## Acquiring Firm Variables

## Hubris and Overconfidence

**Result 3**
- Insignificant relationship between all enterprise variables from the acquiring companies’ as explanatory variables in determining the size of the option premium

## Target Firm Variables

## Low Earnings Matter!

**Result 4**
- Significant relationship between the target companies earning per share and the size of the option premium

## Size Matters!

**Result 5**
- Significant negative relationship between the size of the price to book value of the target company and the size of the option premium

## Conclusions

- Descriptive value of a real option model for pricing the value to delay accepting a tender offer
- Empirical evidence of a 12.5% premium for US banking industry M&A behavior
- Greater value for the target the smaller its earnings per share and its price to book value (low R2)
- Other non-firm specific characteristics
- For target shareholders – Patience always pays!