# Presentation: 263343

- Comments by Larry D. Wall*
- On
- “**Does Patience Pay? Empirical Testing of the Option to Delay Accepting a Tender Offer in the U.S. Banking Sector **”
- by
- Rachel A. Campbell and
- Roman Kräussl
- Federal Reserve Bank of Atlanta.  Opinions are those of the discussant and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System

## Overview of Paper

- Goal is to estimate the potential gain to target shareholders of delaying acceptance of a takeover offer for their bank
- Method is to treat the potential for delay as a real option.
- The paper assumes initial takeover proposal takes the form a tender offer
- Shareholders then have the option of accepting this tender offer or waiting to see if a better one if it arrives
- Thus, paper revolves around determining the value of this real option

**Notes:**
Goal is to estimate the potential gain to target shareholders of delaying acceptance of a takeover offer for their bank
Method is to treat the potential for delay as a real option.
The paper assumes initial takeover proposal takes the form a tender offer
Shareholders then have the option of accepting the initial offer or taking a better one if it arrives
Thus, paper revolves around determining the value of this real option
I have two bigger picture comments on the paper and two comments on the implementation of the estimation

## CommentsTender offer assumption

- The assumption that the initial takeover proposal comes in the form of a tender offer is crucial to use of option framework
- Ordinarily the buyer of an option pays an up front purchase price
- Thereafter the buyer has no further risk of loss
- Tender offer is essentially a free option to accept that offer or accept a better offer if one arises
- But in negotiated deals the target does not have a firm offer until both sides agree to the takeover
- As a result the price in negotiated deals could go up or down
- Options pricing questionable for looking at negotiated deals

**Notes:**
The assumption that the initial takeover proposal comes in the form of a tender offer is crucial to use of option framework
Ordinarily the buyer of an option pays an up front purchase price 
Thereafter the buyer has no further risk of loss
Tender offer is essentially a free option to accept that offer or accept a better offer if one arises
But in negotiated deals the target does not have a firm offer until both sides agree to the takeover
As a result the price in negotiated deals could go up or down

I do not have SDC but I have access to the SNL Securities bank mergers database.  I found over 600 bank takeovers in the US but only 16 that were revised transactions during this period.  Partial search found 1 price increase and two (or three) price cuts.  Also, the paper says it focuses on “cash transactions” but I found less than 300 deals involving cash and even then stock was more than 1⁄2 of the compensation in a large fraction of the deals. 

PNC Financial cut its offer for Riggs National from $24.25 to $20.00 in 2005

Capital One reduced its price for Hibernia from $33 to $30.49 in 2005

Options pricing questionable for looking at negotiated deals

## CommentsTender offer assumption

- How common are tender offers in bank mergers?
- In my experience in US banking they are rare
- Tender offers frequently used in hostile takeover situations
- Hostile offers are very rare in commercial banking
- Vast majority are negotiated in my experience
- Implication is that delay is likely not a free option in almost all bank takeovers

**Notes:**
How common are tender offers in bank mergers?
The paper provides not information on this question
In my experience in US banking they are rare
Tender offers frequently used in hostile takeover situations
Hostile offers are very rare in commercial banking
I looked at the S-4 SEC filings for around 100 deals from this period’s and all of them were negotiated.  I searched Google for “tender offer” and “bank” and found one or two deals.
Negotiated deals can see price cuts after the initial deal but before consummation.
Implication is that ability to renegotiate is not a free option to target shareholders

## CommentFocus of the exercise

- Delay could result in an higher offer
- The intrinsic value of the target may increase between the initial offer and the final offer
- Later takeover proposals may propose a higher premium over the target’s intrinsic value
- First potential acquirer could offer a higher premium
- Another potential acquirer could offer a higher premium
- The paper appears to examine only changes in intrinsic value
- Key parameter is volatility and this is estimated “directly” which implies from historic data that would be dominated by changes in intrinsic value

**Notes:**
Delay could result in an higher offer
The intrinsic value of the target may increase between the initial offer and the final offer
Later takeover proposals may propose a higher premium over the target’s intrinsic value 
First potential acquirer could offer a higher premium
Another potential acquirer could offer a higher premium The paper appears to examine only changes in intrinsic value
Key parameter is volatility and this is estimated “directly” which implies from historic data that would be dominated by changes in intrinsic value

## CommentsPeriod of time for option calculation

- The time to expiration (or maturity) of an option is an important determinant of its value.
- The value of the option monotonically increase with its time to maturity
- The paper calculates this time as:
- 	“the announcement and closing dates of the deals were obtained in order to calculate the time to maturity.”
- Procedure has errors on both sides
- Negotiations begin before the announcement
- This assumption appears to have the effect of including all regulatory based delays in the valuation

**Notes:**
The time to expiration (or maturity) of an option is an important determinant of its value.  
The value of the option monotonically increases with its time to maturity 
The paper calculates this time as:
	“the announcement and closing dates of the deals were obtained in order to calculate the time to maturity.”
Procedure has errors on both sides which won’t necessarily cancel out
Negotiations begin before the announcement
This assumption appears to have the effect of including all regulatory based delays in the valuation
Such as the mandatory 30 day period for DOJ review

## CommentTreatment of Dividends

- Dividends are treated as a cost of delay in the real options model.  The paper states
- 	Dividends represent a cash-outflow of the underlying asset that cannot be captured anymore by the holder of the option and the value of the option decreases.
- This is certainly true if the shareholder and the option holder are different people
- But in this case the shareholder receiving the dividend is also the person that has the option to sell at a higher price
- Hence its not obviously a cost of delay

**Notes:**
Dividends are treated as a cost of delay in the real options model.  The paper states
	Dividends represent a cash-outflow of the underlying asset that cannot be captured anymore by the holder of the option and the value of the option decreases.
This is certainly true if the shareholder and the option holder are different people
But in this case the shareholder receiving the dividend is also the person that has the option to sell at a higher price
Hence its not obviously a cost of delay

## SuggestionPaper Values Risk due to Lags

- The lag between time negotiations start and consummation of takeover add risk to both parties
- Target may increase in value benefiting target shareholders and hurting acquirer
- Or target may decrease in value which benefits the acquirer at the expense of the target
- Net cost if both parties are risk averse
- Relevance
- Target and acquire have incentive to minimize the cost of the lags
- Including negotiating when values are more stable
- Help measure part of the costs due to lags in supervisory approval process (including DOJ)

**Notes:**
The lag between time negotiations start and consummation of takeover add risk to both parties
Target may increase in value benefiting target shareholders and hurting acquirer
Or target may decrease in value which benefits the acquirer at the expense of the target
Net cost if both parties are risk averse
Relevance
Target and acquire have incentive to minimize the cost of the lags
Including negotiating when values are more stable
Help measure part of the costs due to lags in supervisory approval process (including DOJ)

## CommentMinor comments

- Target SIC codes includes 6082
- The OSHA web site defines 6082 as “Branches and Agencies of Foreign Banks” which do not seem relevant to this study
- What exactly is *ST*?  Is *ST* known at time *t* or is it a random variable? Given that the *St *is share price before the acquirer made the tender offer, the natural interpretation of *ST* is that it is the share price in the market at time *T*, in which case it would be a random variable.