Auctions and Sunk Costs in Tender Offers

In an article published last year, we argued that the wealth of both investors and society is increased if the managers of tender offer targets neither resist takeover bids nor seek competing offers for the targets' securities.' Our argument took the following form. Business consolidations may yield benefits from greater integration of production, more effective use of information, synergy, and other sources. These benefits usually are achieved by mergers, which are less costly than hostile tender offers and can be set up to avoid recognition of taxable gains. Many or most hostile tender offers thus must be responses to the failures of the target's managers, who might be running the target poorly or spurning profitable opportunities to merge. A tender offer gives the shareholders a chance to go over the heads of managers and replace them. Bidders monitor the target's managers and orchestrate the response to inferior management. The fact that the bid occurs at a premium over the market price indicates that revamping the target's structure or management would generate private and, in all likelihood, social gains. Resistance to the bid, if successful, frustrates the achievement of these gains. In most cases resistance reflects either mismanagement (to the extent it pointlessly denies shareholders the opportunity to obtain a premium) or manager's self-protection (to the extent its point is to preserve managers' jobs or sell their acquiescence in exchange for bonuses or promises of future employment). One possible response for a target's management is to facilitate