A Dynamic Analysis of Takeover Deals with Competition and Imperfect Information

This article develops an equilibrium framework for the joint determination of the timing and the terms of takeovers in the presence of competition and imperfect information. The model analyzes takeovers as exchange options and derives equilibrium restructuring strategies by solving option exercise games between bidding and target shareholders. In the model, outside investors have incomplete information and can update their beliefs by observing the behavior of participating firms. In equilibrium part of the uncertainty remains unresolved until the takeover anouncement, thereby inducing abnormal announcement returns. The returns resulting from the equilibrium strategies derived in the paper are consistent with the available empirical evidence. In addition, the model generates new predictions relating these returns to the drift, volatility and correlation coefficient of the bidder and the target stock returns.