Who’s Cheating Whom in Mergers and Acquisitions?

Most mergers and acquisitions involve at least four parties with competing interests — acquiring firm shareholders, acquiring firm management, target firm shareholders, and target firm management. We consider the choice between hostile and friendly takeovers in this context and offer an explanation for the prevalence of friendly mergers between large acquirers and small targets. Negotiated mergers, by virtue of the ability to make side payments to the target managers, allow the target manager to be better compensated for his loss of private benefits while simultaneously mitigating the agency conflict in the bidder firm. The direct cost of the side payment is borne by the target shareholders, but they benefit indirectly from the bidding manager having an increased incentive to investigate takeover targets. Target shareholders, therefore, accept the lower payoffs in a negotiated merger to increase the odds that a merger occurs. When the private benefits accruing to the bidding manager are correlated with size, bidder shareholders grant the manager relative autonomy in negotiating small mergers and monitor large mergers more closely. This induces the bidding manager to prefer to expend resources investigating small targets. The model generates specific predictions about the relation between principal-agent conflicts of both the bidder and the target firm and the division of gains from mergers. First Draft: July 2001 ∗We thank Andres Almazan, Jay Hartzell, Sheridan Titman and seminar participants at UT Austin for helpful comments. All errors are our own. Correspondence to: Tyrone Callahan, McCombs School of Business, The University of Texas at Austin, Austin, TX 78712. email: [email protected]. Thomas Moeller, Jesse H. Jones Graduate School of Management, Rice University, 6100 Main Street, Houston, TX 77005. email: [email protected].