Everybody likes to get the best deal possible and shareholders of public companies are no exception. Under US law, when the shareholders of a public company are “cashed out” of their interests as a result of a sale, its board is charged with getting the best price for the company. As a result, the board may negotiate to obtain the option to “shop” the merger agreement to other potential buyers for a brief period of time, usually between 30 and 50 days. If during this so-called go shop window the board secures a superior offer, it may terminate the merger agreement with the original bidder and pay a lower termination fee for backing out of the transaction than would have otherwise been payable had the superior offer been received after the go shop window expired. Options are not costless and go shop options are no exception. The questions are: how costly are these go-shop options, and under what circumstances should the board negotiate for a go-shop option in the merger agreement, despite its costs?
The option to shop offers several advantages to the board, including the possibility of attracting new offers and having stronger standing in court if shareholders sue the firm for failing to get a sufficiently high price — if a post-agreement “market check” attracts no better offers, then that provides powerful evidence that the negotiated transaction was fair.
On the other hand, shopping an offer has a chilling effect on bidding leading up to the merger agreement. Because potential buyers realize that their offers will be shopped, they tend to invest less in due diligence, are less likely to bid, and more likely to reduce the prices they are willing to pay.
Given these pros and cons, are go-shop clauses in merger agreements generally worth their costs? Professors Charles Calomiris and Donna M. Hitscherich, with Adonis Antoniades of the European Central Bank, found that they are not. After analyzing more than 300 announced transactions between 2004 and 2011, the researchers found that go-shop options are not likely to produce much better post-agreement offers, and that including a go-shop clause reduces the acquisition premium — the amount above market price the buyer is willing to pay to ensure the deal is attractive — that sellers receive in their initial merger agreements by at least 7 percentage points.
The researchers wondered then if reducing litigation risk could be the main benefit of including go-shops. If so, such gains would be reflected in higher market price reactions to merger announcements that include go-shops. But the authors’ analysis found no such identifiable effect.
If go-shops don’t pay, then why use them? The researchers find that the use of go-shops is strongly influenced by the degree of aversion for litigation risk present in the legal teams employed by target firms. When legal teams are excessively averse to litigation risk, they employ go-shop clauses even when they are not warranted.
Why would some legal teams tend to be excessively averse to litigation risk? The researchers hypothesize that lawyers face a conflict of interest. Incorporating contractual features such as go-shop clauses in their clients’ merger agreements that make it easier to win litigation may make the lawyers look good, and thus help them to attract other clients. “After all, it may be very hard for prospective clients to observe the size of the foregone acquisition premium that results from go-shop clauses,” Calomiris says, “and much easier to observe the superior litigation outcomes produced by go-shops.”
Charles Calomiris is the Henry Kaufman Professor of Financial Institutions in the Finance and Economics Division and the curriculum director of the Program for Financial Studies at Columbia Business School.
Donna M. Hitscherich is Senior Lecturer in Discipline in Business in the Finance and Economics Division and director of the Private Equity Program at Columbia Business School.
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