The Holdup Game in the Merger and Acquisition Context

Hotchkiss, Edith S., Qian, Jun and Song, Weihong, “Holdups, Renegotiation, and Deal Protection in Mergers” (April 2005)

http://ssrn.com/abstract=705365

This paper fits neatly with the previous post in discussing the holdup game in mergers and acquisitions.

Abstract:

This paper examines the contracting and negotiation process in mergers. Within the incomplete contracts framework, our multi-period model allows for the arrival of new information and renegotiation subsequent to the signing of an initial merger agreement. We show that a properly designed initial contract solves the holdup problem and induces higher deal-specific effort that increases expected payoffs from the merger. The contract grants an option to the target to terminate the merger, while the strike on the option compensates the acquirer’s effort without imposing excessive costs on the target for pursuing non-merger alternatives. The option strike can be implemented by the use of deal protection devices, such as a target termination fee or an acquirer lockup. Employing a large sample of stock mergers, we find evidence supporting model predictions for the renegotiation of contracts, deal outcomes, and the use of deal protection devices.