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Investment-banking contracts in tender offers
Journal
of Financial
Economics
28 (1990) 209-232.
Investment-banking in tender offers
North-Holland
contracts
An empirical analysis Robyn M. McLaughlin* Boston College, Chestnut Hill, MA 02167, USA Received
July 1988, final version
received
October
1990
Empirical analysis reveals that investment-banker advisory fees in tender offers average 1.29% of the value of a completed transaction, far below the levels often alluded to in the business press. Most fees are contingent on offer outcome, with target-firm fees typically contingent on transaction value and bidding-firm fees on the number of shares purchased. Although these contingent contracts motivate investment bankers to satisfy some client objectives, many also create conflicts of interest between banker and firm. These incentive problems are apparent in offer evaluation, in hostile offers, and in the price paid by bidding firms.
1. Introduction
The role of investment bankers in corporate control contests is controversial, both because of the compensation they allegedly receive and because of potential conflicts of interest between the bankers and their client firms. This paper addresses these concerns by examining the size of banker fees in tender offers and the contract terms governing them. There are three primary results. First, measured properly, banker advisory fees are substantially smaller than what the business press reports. Second, most fee contracts are substantially contingent on offer outcome. Third, the contracts *I thank Paul Asquith, Larry Benveniste, Thomas Downs, Robert Merton, John Parsons, John G. Preston, Elizabeth Strock, Robert Taggart, Hassan Tehranian, Nickolaos Travlos, Jerry Viscione, and William Wilhelm for helpful discussions. I have benefited from the extensive comments of an anonymous referee and editors Michael Jensen and Richard Ruback. Hollyce States provided valuable editorial assistance. Any remaining errors are my own.
0304-405X/90/$03.50
0 1990-Elsevier
Science
Publishers
B.V. (North-Holland)
210
R.M. McLaughlin, Investment-banking contracts in tender offers
create potential for conflicts of interest between bankers and client firms, particularly in offer evaluation, hostile offers, and the price paid by bidding firms. The paper’s major findings are summarized in table 1. Press coverage creates a distorted impression of investment-banking fees by concentrating on sensational offers and fees, often including compensation for financing and other related services. Total investment-banker fees excluding financing fees, however, actually average only $7.96 million, or 1.29% of the offer’s value for completed transactions, in tender offers between 1980 and 1985. For offers valued over $1 billion, the average total fee is $17.73 million and the percentage of offer value drops to 0.60%. For transactions of comparable value, tender-offer fees are roughly half the size of investment bankers’ fees for underwriting. Most fees in the sample are contingent on the outcome of the offer. In the average contract, over 80% of the fee is paid only if an acquisition is completed. Typically, the fee for the target firm’s banker is a function of offer value and the fee for the bidding firm’s banker is a function of the number of shares purchased. Both types of contract create the potential for conflicts of interest because the payoffs to bankers and shareholders are misaligned. The paper is organized as follows. The sample is described in section 2. In section 3, the size of investment bankers’ fees is examined. The sample contracts are described in section 4. Contract incentives and alternative contract forms are discussed in section 5, and a summary and conclusions are presented in section 6. 2. Data 2.1. The sample The sample comprises fee contracts between investment bankers and client firms for 195 tender offers between 1978 and 1985. The contracts are obtained from the Securities and Exchange Commission (SEC) Schedule 14d filings required in tender offers. The original list of tender offers, compiled from the January 1978 to December 1985 issues of the SEC News Digest, was reduced to samples for target and bidding firms satisfying the following selection criteria: (1) The target firm is listed on the New York Stock Exchange. (2) The offer does not involve a> a firm’s bid for its own shares, b) a bidding group that includes members of the target firm’s current management, or c) firms bidding for each other’s shares. (3) For the bidding-firm sample, the offer is initiated between January 1978 and December 1985. (4) For the target-firm sample, the offer is initiated between January 1980 and December 1985.
R.M. McLaughlin, Investment-banking contracts in tender offers
211
Table 1 Summary of major findings on investment-banker advisory fees in tender offers for a sample of 132 target firms from January 1980 to December 1985 and 195 bidding firms from January 1978 to December 1985. Fees are calculated from the terms of the contract between the banker and the client firm and do not include financing, underwriting, legal or accounting fees, or out-of-pocket expenses. Averages are equally-weighted. If the fee is a function of the terms of the offer, it is calculated using the terms of the final offer. The final offer for a target firm is the successful offer or, if the target firm is not acquired, the highest offer. The final offer for a bidding firm is the successful offer or, if the bidding firm is not successful, the highest offer it makes. If the offer consists of more than one step, the value of each step is included in the final offer’s value. If the offer involves both cash and securities, the two components are summed to calculate final-offer value. The total fee is the sum of the contracted investment-banker fees for the target firm and all bidding firms. The averages are for offers for which contract information is available for the target firm and all bidding firms.
Average contract fees for a completed acquisition Contract form
Potential incentive problems
132 Target firms
195 Bidding firms
116 Total fees
4.21 million 0.77% of acquisition value
2.70 million 0.57% of acquisition value
$7.96 million 1.29% of acquisition value
80% of fee contingent on transaction value
80% of fee contingent on completing the transaction
NA
Conflicts of interest in offer evaluation
Conflicts of interest in offer evaluation
Incentive to complete a transaction in hostile offers
No incentive to minimize price paid
NA
The second restriction eliminates 23 observations that either do not represent arms-length transactions (for example, self-tenders and leveraged buyouts) or in which the roles of target and bidding firm are ambiguous. The third and fourth restrictions result from changes in SEC filing requirements. Schedule 14dl filings were mandatory for bidding firms throughout the sample period, whereas Schedule 14d9 filings were first required of target firms in December 1979. 170 observations in the target-firm sample and 237 observations in the bidding-firm sample meet the criteria. There are fewer targets than bidders because of the shorter sampling period and because of competitive bidding. When a firm is the object of multiple bids, a single contract covers all offers for the target and is listed only once in the target-firm sample. Contracts for each of the competing bidders, however, are included in the bidding-firm sample. Since the SEC does not specifically require disclosure of banker and fee-contract information, some observations are incomplete, resulting in final
212
R.M. McLaughlin, Investment-banking contracts in tender offers
samples of 134 target contracts and 195 bidding contracts. Dates of public announcement, changes in offer terms, and offer outcomes are obtained from the Wall Street Journal and the Wall Street Journal Index. Proxy statements for firms involved in completed tender offers are searched to compare the fees actually paid with those calculated from the terms of the contracts listed in the Schedule 14d filings. 2.2. Contract-fee calculation
The fees reported in this paper are calculated from the terms of the contracts between investment bankers and their client firms. For this reason, the fees are estimates and do not necessarily equal actual compensation. Available data suggest, however, that the estimates closely approximate the fees actually paid. For many tender offers that result in a merger, actual investment-banker compensation can be determined from merger proxy statements. For the 56 target firms with available data, the fees actually paid are within 20% of the estimated contract fees, and 51 of the 56 are within 10%. For 32 of 33 bidding firms, the actual fees are within 5% of the estimated contract fees. The differences are evenly divided between positive and negative values and the average difference is zero. The fees I analyze are for tender-offer management and advisory services only. They do not include fees for financing, underwriting, asset divestitures after the offer, or legal or accounting services. Reimbursements for out-ofpocket expenses are also excluded. Financing and underwriting fees are excluded because they compensate bankers at least in part for bearing financial risk in providing investment capital, a service that is not unique to tender offers. Financing fees are not a significant issue for this sample because explicit, simultaneous contracting with the banker for both advisory and financing services occurs for only eight of the bidding firms. Financing fees have become more important since 1985, however, because of the increased use of junk bonds and bridge loans provided by investment bankers. 3. Distribution
of investment-banker
fees
Investment-banker fees reported in the business press are sensationally large. For example, an article in Fortune [Petre (198611 highlights several offers with total fees over $15 million, and the press reported fees of over $100 million for Pantry Pride’s 1985 acquisition of Revlon, Inc. [see, for example, Hertzberg (198511. The average of $7.96 million for total advisory fees in table 1 is in sharp contrast to these amounts. As shown in table 2, for transactions of similar value, these fees are roughly one-half the size of the underwriting compensation reported by Smith (1977). This comparison with underwriting fees allows only limited inferences. Since the banker’s services
213
R.M. McLaughlin, Investment-banking contracts in tender offers
Table 2 Comparison of investment-banker
underwriting fees and tender-offer contract fees.
Transaction value ($ millions)
Smith: Fees in underwritten equity offers (% of offer vaIueIa
Tender offers: Total target- and bidding-firm contract fees for a completed acquisition t% of offer vaIuejb
Ratio: tender-offer fees to fees for underwriting
0 to 50 50 to 100 100 to 500
5.29% 3.97 3.81
3.15% 1.92 1.51
0.55 0.48 0.40
“These data are summarized from table 1 in Smith (1977, p. 277). bThese data are summarized from table 3, panel C, section 2.
are so different for the two activities, it is not possible to determine what the relative fee levels should be. Underwriting is the only other investment-banking activity with sufficient compensation data available, however, to provide a crude comparison with tender-offer fees. Press reports often include banker compensation for financing, underwriting, and asset divestiture. For example, in the Revlon offer, financing fees and fees for the sale of assets after the offer totaled $78 million of the more than $100 million reported. Even after adjustment for financing fees, however, reported advisory fees are typically several times greater than the $7.96 million average in table 1. Three features of investment-banker tender-offer fees explain the remaining differences: (i) Fees increase with the value of the offer, although not proportionally. (ii> Fees vary widely for offers of comparable value. (iii) Fees are substantially higher for completed transactions. Since press coverage concentrates on the highest-valued, completed acquisitions with the highest fees, the fees reported in the press are substantially above the norm. Investment-banker advisory fees are summarized in table 3, with target-firm fees in panel A, bidding-firm fees in panel B, and total fees in panel C. The contract fee to be paid if the tender offer fails is included in the first section of each panel, and the fee if the offer is completed in the second section.’ In each section, average fees are presented by category of final-offer value. The ‘For example, Technicolor, Inc. is the target in a tender offer with a value of $99 million. Technicolor’s investment banker, Goldman Sachs, is to receive $100,000 if no transaction takes place and $625,000 if an acquisition is completed. The $100,000 contract fee is included (in panel A, section 1) in the average no-transaction fee for offers valued between $50 million and $100 million. The $625,000 fee is included (in panel A, section 2) in the average acquisition fee for offers valued between $50 million and $100 million.
investment-banker
advisory contract
Table 3 fees for 134 target firms and 195 bidding
firms in tender
offers from 1978 to 1985.
Min
0.31% 0.00 0.04 0.00 0.00 0.00 0.00
0.47% 0.17 0.14 0.14 0.10 0.08 0.26
0.71% 0.23 0.14 0.09 0.06 0.03 0.09
0.91% 0.23 0.17 0.11 0.10 0.05
0.18
All offers
of offer value
0.00
0 to 50 50 to 100 100 to 250 250 to 500 500 to 1000 over 1000
1.83 Fees as a percentage
$0.02 0.00 0.09 0.00 0.00 0.00
0.25
$0.14 0.13 0.21 0.61 0.74 3.25
0.79
0 to 50 50 to 100 100 to 250 250 to 500 500 to 1000 over 1000
banker
Dollar value of fees ($ millions)
to be paid to the investment
Std. dev.
All offers
fees - Fees contracted
Median
Percentiles
1 .oo
0.10
0.02
0.29
1.58% 0.39 0.21 0.19 0.16 0.06
$0.30 0.25 0.30 0.75 1.00 2.00
0.47% 0.04 0.07 0.00 0.02 0.01
Max
1.58
1.58% 0.56 0.69 0.56 0.40 0.31
14.20
134
9 24 24 24 19 34
134
24 19 34
2.50 3.00 14.20
0.50 1.13
9 24 24
N
$0.50
shares or assets are purchased
80th
$0.08 0.03 0.10 0.00 0.10 0.13
if no target-firm
20th
contract fees, January 1980 to December 198.5
$0.18 0.15 0.25 0.30 0.40 1.00
1: No-transaction
Mean
target-firm investment-banker
$0.20 0.17 0.27 0.47 0.66 2.07
Section
Final-offer value” ($ millions)
Panel A: Estimated
Fees are expressed in dollars and as a percentage of final-offer value.* Fees are estimated from the terms of the contract between the banker and the client firm. If the fee is a function of offer terms, it is estimated using the terms of the final offer. The contract fee does not include financing, underwriting, legal or accounting fees, or out-of-pocket expenses. The sample is partitioned by target firm, bidding firm, and total fees and, within each category, by offer outcome. Averages are equally-weighted.
Estimated
P : 3
; a P f: 2. 3 B
2 Ft : 00 * =: ,31 2 E % 3 2 F z g s’
$
4.21
1.65% 1.15 0.89 0.86 0.47 0.34
0.77
0 to 50 50 to 100 100 to 250 250 to 500 500 to 1000 over 1000
All offers
$0.37 0.84 1.55 3.15 3.10 10.44
0.63
1.54% 1.00 0.97 0.86 0.49 0.33
2.50
$0.33 0.75 1.65 2.97 2.59 7.04
fees - Fees contracted
All offers
0 to 50 50 to 100 100 to 250 250 to 500 500 to 1000 over 1000
Section 2: Acquisition
banker
0.59
1.26% 0.63 0.34 0.38 0.27 0.14
Fees as a percentage
6.01
$0.30 0.53 0.73 1.48 2.09 8.81
0.04
0.31% 0.19 0.08 0.09 0.04 0.07
of offer value
0.02
$0.02 0.15 0.11 0.45 0.25 2.50
Dollar value of fees ($ millions)
to be paid to the investment
2.42% 1.51 1.18 1.11 0.69 0.49 1.12
0.32
6.14
$0.67 1.13 2.13 4.30 5.58 14.51
0.57% 0.62 0.69 0.57 0.17 0.21
0.73
$0.06 0.48 9.23 2.25 1.24 4.28
if the target firm is acquired
4.47
4.47% 2.99 1.55 1.67 0.95 0.65
46.22
$0.77 2.60 3.05 6.94 7.50 46.22
by the final offer
8
132
23 24 24 18 35
i 9
3
E
E
All offers
0.14
0.49% 0.27 0.15 0.09 0.07 0.04
50 100 250 500 1000 1000
0 to 50 to 100 to 250 to 500 to over
$0.10 0.19 0.24 0.32 0.48 1.02
0.45
50 100 250 500 1000 1000
All offers
0 to 50 to 100 to 250 to 500 to over
Mean
Median
Std. dev. Min 20th
80th
MaX
0.61
0.25
0.00
$0.05 0.00 0.00 0.00 0.00 0.15
0.28% 0.26 0.10 0.05 0.05 0.05 0.18
0.42% 0.21 0.14 0.08 0.05 0.02 0.09
0.0
0.19% 0.00 0.00 0.00 0.00 0.01
Fees as a percentage of offer value
$0.04 0.19 0.17 0.21 0.47 0.99
$0.10 0.15 0.20 0.25 0.33 0.70
Dollar value of fees ($ millions)
0.04
0.22% 0.10 0.07 0.05 0.04 0.01
0.15
$0.08 0.09 0.11 0.15 0.25 0.50
1.01% 1.29 0.57 0.21 0.24 0.27 1.29
0.20
4.50
0.50 0.32% 0.41 0.20 0.12 0.08 0.05
$0.20 1.00 0.85 1.00 2.00 4.50
$0.12 0.25 0.32 0.50 0.58 1.00
Section 1: No-transaction fees - Fees contracted to be paid to the investment banker if no target-firm shares or assets are purchased
Final-offer valuea ($ millions)
Percentiles
Panel B: Estimated bidding firm investment banker contract fees, January 1978 to December 1985
194
11 31 42 37 30 43
194
31 42 37 30 43
11
N
“h
$
2
k
0.84% 0.83 0.68 0.59 0.46 0.24
0.57
0 to 50 so to 100 100 to 250 250 to 500 500 to 1000 over 1000
All offers
$0.21 0.62 1.10 2.04 2.96 6.70
2.70
50 100 250 500 1000 1000
All offers
0 to 50 to 100 to 250 to 500 to over
0.52
0.86% 0.79 0.67 0.54 0.43 0.21
1.70
$0.20 0.58 1.00 2.00 2.82 5.00 0.08
$0.08 0.10 0.08 0.25 0.95 1.00
0.33
0.31% 0.28 0.32 0.26 0.20 0.14 0.02
0.42% 0.18 0.07 0.05 0.13 0.02
Fees as a percentage of offer value
3.15
$0.14 0.27 0.54 0.94 1.54 4.28
Dollar value of fees ($ millions)
0.27
0.57% 0.62 0.41 0.32 0.31 0.13
0.70
$0.10 0.41 0.73 1.25 1.92 3.55
0.81
0.99% 1.05 0.90 0.79 0.59 0.37
4.00
$0.37 0.90 1.51 2.66 3.67 10.00
1.74
1.58% 1.51 1.74 1.28 1.07 0.54
20.00
$0.51 1.27 2.50 4.85 9.40 20.00
Section 2: Acquisition fees - Fees contracted to be paid to the investment banker if the target firm is acquired by the final offer
R $
44 195
& S
h g !$ P ; s.
9 $
44 195 11 31 42 37 30
E P ““s 9 p c 3 11 31 42 37 30
20th 80th
MaX
_N
E 8E
All offers
0.30 0.21
1.25% 0.56 0.29 0.17 0.23 0.08
1.63% 0.49 0.35 0.20 0.19 0.11
0 to 50 to loo to 250 to 500 to over
so 100 250 500 1000 1000
0.68
$0.33 0.39 0.50 0.55 1.28 2.50
1.56
$0.38 0.37 0.55 0.84 1.31 3.55 0.00
$0.23 0.00 0.20 0.00 0.00 0.15
0.38
0.71% 0.25 0.20 0.16 0.12 0.11 0.00
0.94% 0.00 0.08 0.00 0.00 0.01
Fees as a percentage of offer value
2.36
$0.13 0.20 0.29 0.75 0.98 3.58
0.07
0.98% 0.21 0.17 0.06 0.08 0.05
0.30
$0.28 0.18 0.29 0.18 0.49 0.93
0.44
2.45% 0.67 0.47 0.33 0.27 0.14
2.11
$0.56 0.55 0.73 1.55 2.08 6.55
2.49
2.49% 0.80 0.90 0.62 0.47 0.59
14.78
$0.60 0.65 1.48 2.75 3.50 14.78
g f
21 14 22 18 32
; g q 4 3
14 21 22 18 32 112
5
$ 2 $
112
C$
8
5
c
P
so 100 250 500 1000 1000
All offers
0 to so to 100 to 250 to 500 to over
Min
3’
Median
Percentiles
Dollar value of fees ($ millions)
Mean
Std. dev.
Section 1: No-transaction fees - Fees contracted to be paid to the investment banker if no target-firm shares or assets are purchased
Final-offer value” ($ millions)
Panel C: Estimated total investment-banker contract fees, January 1980 to December 1985
The total fee is the sum of the contracted investment-banker fees for the target firm and all bidding firms. The averages are for offers for which contract information is available for the target firm and all bidding firms.
3.20% 2.02 1.61 1.42 0.93 0.60
1.29
0 to 50 50 to 100 100 to 250 250 to 500 500 to 1000 over 1000
All offers
banker
9.17
4.79
1.16% 0.72 0.60 0.55 0.31 0.25 0.82
2.54% 2.13 1.68 1.40 0.95 0.56 1.10
Fees as a percentage
$0.36 0.53 1.06 2.20 2.46 11.48
0.14
2.49% 0.64 0.40 0.30 0.48 0.14
of offer value
0.28
$0.28 0.50 0.75 1.45 3.25 7.10
Dollar value of fees ($ millions)
to be paid to the investment
$0.85 1.42 2.89 4.97 5.83 14.42
fees - Fees contracted
0.57
2.49% 1.41 1.05 0.96 0.59 0.42
2.11
$0.37 0.93 1.65 3.22 3.58 8.46
if the target
5.17% 3.08 2.83 2.72 1.53 1.37 5.17
1.91
64.22
11.50
4.80% 2.81 2.10 1.83 1.23 0.76
$1.22 2.33 4.44 10.29 11.52 64.22
by the final offer
$1.19 2.11 3.46 6.60 7.87 24.30
firm is acquired
114
5 14 21 22 18 34
114
5 14 21 22 18 34
aIf a firm completes a transaction, the final offer is the successful offer. If a target firm is not acquired, the final offer is the highest offer made for it. If a bidding firm does not acquire the target, its final offer is the highest offer it makes. If an offer consists of more than one step, the values of each step is included in the value of the final offer. If the offer involves both cash and securities, the two components are summed to calculate final-offer value.
7.96
$0.83 1.47 2.68 5.24 5.99 17.73
All offers
0 to 50 50 to 100 100 to 250 250 to 500 500 to 1000 over 1000
Section 2: Acquisition
220
R.M. McLaughlin, Investment-banking contracts in tender offers
final offer is the successful offer if a firm completes an acquisition. For a target firm that is not acquired, the final offer is defined as the highest offer it received, and for an unsuccessful bidding firm, the final offer is defined as the highest offer it makes. If the fee is a function of offer terms, the estimated contract fee is calculated using the terms of the final offer.’ Contract Fees and Offer Value: In section 2 of panel A, the average target-firm contract fee for an acquisition increases from $0.37 million for offers under $50 million to an average of $10.44 million for offers over $1 billion. For the same range of offer values, the average bidding-firm contract fee increases from $0.21 million to $6.70 million (panel B, section 2). These fee increases, however, are not proportional. Average fees decrease from 1.65% to 0.34% of offer value for target firms and from 0.84% to 0.24% for bidding firms. Total fees average 1.29% of the value of the offer, but the average ranges from 3.20% for the smallest offers to 0.60% for the largest (panel C, section 2). These contract-fee patterns are repeated for the notransaction fees shown in the first sections of the panels. Fee Variation:
The 114 total fees for an acquisition (panel C, section 2) have a mean of $7.96 million, with a range of $0.28 million to $64.22 million and a standard deviation of $9.17 million. Since the median of $4.79 million is substantially less than the mean, the distribution is also positively skewed. For total fees as a percentage of offer value, the standard deviation of 0.82% is large in relation to the mean of 1.29% and the percentages range from 0.14% to 5.17%. Substantial cross-sectional variation persists for each category of offer value, for both target and bidding firms and for both no-transaction and acquisition fees. For example, no-transaction fees for target firms at the lowest offer values (panel A, section 1) range from $0.02 million to $0.5 million and fee percentages range from 0.31% to 1.58%. Target-firm acquisition fees for the highest offers (panel A, section 2) range from $2.5 miIlion to $46.2 million (0.07% to 0.65%). The pattern is similar for bidding firms and for total fees. The large variation in contract fees even after offer value is adjusted for suggests that individual contracts are written for different offers and is inconsistent with the use of a single pricing formula in setting banker fees (for example, the Lehman formulaX3 *If the offer consists of more than one step, the value of each step is included in the value of the final offer. If the offer involves both cash and securities, the values of the components are summed to calculate final-offer value. 3The Lehman formula is a fee schedule attributed originally to Lehman Brothers and frequently said to be the basis for pricing by other firms in the industry. Various definitions of the formula appear in print. All are descending step functions of the value of the transaction. One example is: 5% of the first million dollars of transaction value, 4% of the second million, 3% of the third million, 2% of the fourth million, and 1% of the value above $4 million.
R.M. McLaughlin, Inuestment-banking contracts in tender offers
221
Fees and Ofer
Outcome: Since a large proportion of the typical fee is contingent on the outcome of the offer, the expected value of the fee is significantly less than the fee for a completed acquisition. Average total contract fees are $7.96 million for an acquisition, but only $1.56 million for no transaction (table 3, panel C). For target firms the corresponding values are $4.21 million and $0.79 million (panel A) and for bidding firms $2.70 million and $0.45 million (panel B). This substantial difference in compensation for completed transactions persists at every level of transaction value for both target and bidding firms. For 18 target firms and 5 bidding firms the entire fee is contingent on acquisition, and in the typical contract over 80% of the investment banker’s compensation is contingent in some way on completion of the transaction.
Average fees are higher for Comparison of Target- and Bidding-Firm Fees: target firms than for bidding firms in nearly every value category (panels A and B), whether or not a transaction takes place. The Wilcoxon signed-rank test for differences is significant at the 0.001 level and regression analysis indicates that, for completed offers of the same value, target-firm fees are 30% higher than bidding-firm fees, suggesting that it is more costly to represent a target firm. Target-firm bankers may have to expend more time or effort than bidding-firm bankers or they may have to expend additional resources, such as ‘using up’ proprietary lists of potential bidders. Also, the target firm often has less control over offer timing than the bidding firm and may have to pay extra for this ‘urgency’. In addition, an acquisition represents the final opportunity for the target firm’s banker to receive delayed compensation for prior service. This argument, however, assumes a continuing relationship between target firm and banker, and such commitments appear to be diminishing [see Hayes et al. (1983) and Eccles and Crane (1988)l. 4. Contract forms and contract distribution Contract fees fall into three basic categories: fixed fees, shares-based fees, and value-based fees. Fixed fees are independent of offer outcome and, as shown in table 4, are used infrequently (in 9.7% of target-firm contracts and 5.7% of bidding-firm contracts). Shares-based and value-based fees, in contrast, are contingent on offer outcome. Shares-based fees are contingent only on the number of shares purchased and are the usual bidding-firm contract (79.7% of the bidding-firm sample). Value-based fees are contingent on both the number of shares acquired and the price paid and are typically used by target firms (72.6% of the target-firm sample). Fixed-Fee Contracts:
These contracts are most often used for atypical situations. In 7 of the 12 target-firm contracts that specify a fixed fee, the
of investment-banker
tender-offer
Table 4 fee contracts for 125 target firms and 192 bidding firms. Target-firm bidding-firm data are from 1978 through 1985.
data are from 1980 through
1985;
type
153 79.7%
112 58.3% 0.53% 79.1% $1,118
41 21.4% 0.56% 81.2% $916
11 5.7%
0.68% 0.0% $91
0.54% 79.7% $1,064
0.55% 85.3% $1,174
0.55% 85.3% $1,174
-
0.30% 0.0% $856
22 17.6%
Subtotals
22 17.6%
Step function of shares purchased
fees
0.0%
0
Linear function of shares purchased
Shares-based
12 9.6%
Independent of offer outcome
Fixed fees
0.69% 86.3% $1,156
28 14.6%
0.83% 83.3% $1,126
69 55.2%
Total-value Function of total offer value
fees
0.69% 86.3% $1,156
-
28 14.6%
0.88% 79.4% $1,100
91 72.8%
Subtotals
0 0.0%
1.05% 67.2% $987
22 17.6%
Incremental-value Function of increase in offer value -___
Value-based
0.57% 75.7% $1,021
192 100%
0.77% 72.6% $1,092
125 100%
Row totals
“The contract acquisition fee as a percentage of offer value. Both fee and offer value are estimated from the terms of the final offer. bThe percentage of the fee for acquisition that is contingent on offer outcome. Acquisition fee is estimated from the terms of the final offer.
Target firms Number of contracts Percent of sample Averages : percentage feea % of fee contingentb offer value ($ millions) Bidding firms Number of contracts Percent of sample Averages : percentage feea % of fee contingentb offer value ($ millions)
Description
Contract
For each contract type the table shows: the number of contracts and percentage of the sample; the average of the fees for an acquisition as a percentage of the value of the offer; and the average offer value. Offer value is estimated using the terms of the tinal offer. The tinal offer for a target firm is the successful offer or, if the target firm is not acquired, the highest offer. The final offer for a bidding firm is its successful offer or, if the bidding firm is not successful, the highest offer it makes. If the offer consists of more than one step, the value of each step is included in the offer value. If the offer involves both cash and securities, the two components are summed to estimate offer value. Fees are estimated from the terms of the contracts between bankers and client firms. If the contract fee is a function of offer terms, it is estimated using the terms of the final offer. Averages are equally-weighted.
Distribution
R.M. McLaughlin, Inuestment-banking contracts in tender offers
223
investment banker’s role appears to be limited to providing an opinion letter assessing the value of the offer to target-firm shareholders. Bidding firms use fixed fees for low-valued offers in which they control the target’s equity. The average offer value is only $91 million. In 6 of the 11 offers shown in table 4, the bidding firm had previously acquired more than 20% of the target’s equity. In the remaining cases, the target endorsed the offer and the offer resulted in an acquisition. Shares-Based Fee Contracts: Approximately 25% of shares-based fees are linear functions of the number of shares purchased, as in the 1984 Goldman Sachs contract with Mobil Corp. for its bid for Superior Oil Co. The terms of $1 million to be credited against $0.02 per share acquired resulted in an estimated contract fee of approximately $2.55 million when the offer succeeded. More often, contracts in this category are step functions of the number of shares purchased. For example, in the 1980 Canadian Pacific Enterprises bid for Hobart Corp, first Boston’s fee from Canadian Pacific was to be $0.25 million if Canadian Pacific acquired less than 51% of Hobart’s shares, $0.75 million if the percentage was between 51% and SO%, $1.75 million if it was between 80% and 90%, and $2.25 million if Canadian Pacific acquired over 90% of Hobart’s shares. Since the offer was defeated by a higher bid from Dart & Kraft Inc., the estimated contract fee to First Boston was the $0.25 million minimum. In all of the step-function contracts, the first fee increase occurs at or above the percentage at which the bidding firm acquires voting control of the target. In the simplest variation, a contingent payment is made if, and only if, a merger takes place. In practice, most of the shares-based contracts in the sample reduce to this simple form, because in nearly all of the offers, the bidding firm purchases either all of the target-firm shares or none. Contract terms (percentages in linear fees and the number of steps, step points, and step percentages in step-function fees) differ even for offers of similar value. No standard pricing formula is apparent. Most investment bankers use different pricing formulas for different clients. An exception is Morgan Stanley, which usually sets fees according to a sliding scale of offer value. The only common contract provision is that the banker receives the largest contingent fee only if a transaction is completed. Value-Based Fee Contracts: Total-value fees and incremental-value fees are contingent on offer value, and for both the contingent fee is paid only for a completed acquisition. The total-value fees are usually linear functions of value. For example, in a 1985 hostile bid by Nortek, Kidder Peabody’s contract with the target, Transway International, specified a fee of $0.35
224
R.M. McLaughlin, Investment-banking contracts in tender offers
million plus 1% of the value of a completed transaction. Ridder’s contract fee totaled $3.51 million when Transway was acquired through a friendly offer valued at $316 million. Occasionally, a total-value fee is a step function of value, as in the 1981 Dean Witter Reynolds contract with Bunker Ramo. When Bunker Ramo was acquired, the contingent fee of 1% of the first $100 million of total value and 0.5% of any amount over $100 million resulted in a contract fee of approximately $2.1 million. In incremental-value-fee contracts, an additional fee is paid only if an offer above a specified amount (usually the initial bid) results in a transaction. For example, in 1982 Giddings and Lewis was the target of a hostile offer. It contracted to pay its banker, Goldman Sachs, $0.30 million plus 6% of the value of a transaction above the initial bid of $25 per share. When an offer of $30 per share was completed, Goldman Sachs’s contract fee was $3.28 million. In some incremental-value-fee contracts, the percentage is an increasing step function of the final price. For example, in First Boston’s 1980 contract with Pullman Inc. the fee was 1.5% of the value between $28 and $40 per share, 2% of the value between $40 and $45 per share, and 3% of the value over $45 per share. Target-Firm Contract Provisions in Hostile Offers: Contract incentives in hostile offers usually are not focused on maintaining the target’s independence. In 29 of the 62 resisted offers, the target-firm banker’s fee is actually higher if the original, hostile offer is completed than if the target remains independent. For example, in the 1981 Kidder Peabody contract with Cenco following a hostile offer by National Medical Enterprises, the contingent fee of 0.75% of offer value was payable for any completed acquisition, including the initial hostile offer. When a subsequent friendly offer was successful, the contract fee for Kidder was $1.26 million. In 31 of the 62 offers, even though success of the original, resisted bid results in payment of the smallest fee, the banker’s fee is still maximized if some transaction is completed. The banker’s fee is maximized if no transaction takes place in only 2 of the 62 resisted offers. In Turner Broadcasting’s 1985 hostile offer for CBS Inc., the only contingent fee in the contract between CBS and Morgan Stanley is for the failure of the Turner offer. In Phillips Petroleum’s resistance of a 1985 offer from Icahn Group, its fee contracts with Morgan Stanley and First Boston specify two contingent payments: one to be paid if the Icahn offer failed, the other to be paid if a proposed Phillips recapitalization plan were completed. Such fees may be used so infrequently because target management wants to avoid creating conflicts with shareholder value maximization. Target firms that resist are relatively more likely than those that don’t to use incremental-value fees and many contracts provide additional fees for successful defensive tactics, for example, failure of the hostile bid, a success-
225
R.M. McLaughlin, Investment-banking contracts in tender offers
ful recapitalization, or completion of an approved offer.4 These additional fees are used in various combinations and depend in different ways on target approval of a completed offer. For example, the terms of the 1980 contract between Pullman, Inc. and First Boston specified a fee of $0.30 million plus the larger of: i) $0.20 million if the original bidder acquired no shares or ii) an incremental-value fee for any acquisition completed at a price above the initial bid. First Boston’s fee would have been minimized if the initial, hostile offer had been completed. The incremental-value fee, however, was to be paid for any acquisition even if the completed transaction was resisted (the contract fee was $5.5 million when Pullman was acquired at a substantially increased bid). In contrast, in the 1981 Lehman Brothers contract with Garfinckel, Brooks Brothers, Miller & Rhoads, the total-value fee was to be paid only for a transaction approved by Garfinckel’s board of directors. The contingent fees for a completed acquisition were 1% of offer value if the board approved the transaction but only $0.25 million if the board rejected it. When a higher, board-endorsed bid succeeded, Lehman’s contract fee was $2.32 million. Contract Terms: Many contracts specify payments for transactions that substitute for completion of the original offer. Target-firm contracts often include fees for asset sales that occur before, or instead of, an acquisition. These sales may alter the form or content of a friendly transaction or defend against a hostile offer. Also, fees are paid if the target successfully completes a share repurchase. Bidding-firm contracts often include fees to be paid if the bidding firm acquires target-firm assets directly, and some bidding-firm contracts in 1985 also provide for fees if the bidding firm sells shares back to the target. Contracts frequently specify that payments under one provision are to be credited against payments due under other provisions. For example, in both target- and bidding-firm contracts the minimum fee is often credited against any contingent fee. For target firms, fees for asset sales are usually credited against any fee for a subsequent acquisition. In some contracts, payment of fees under more than one provision is prohibited, and occasionally a maximum is set for all compensation. Maximum limits on fees are binding for very few offers in the sample, however. Some firms hire more than one investment banker, as did Hasbro Ind. Inc. in its 1984 friendly offer for Milton Bradley. Hasbro had a fee contract of $0.20 million plus 0.5% of transaction value with Bear Stearns and a contract of 0.5% of transaction value with Finance. Many contracts extend beyond the tender offer. For example, target-firm contracts often state that the fee will Additional
4A chi-square test for differences significant at the 0.001 level.
in contract
use between
the hostile
and nonhostile
groups
is
226
R.M. McLaughlin, Investment-banking contracts in tender offers
paid for any acquisition target- and bidding-firm ing merger as if they customarily indemnify arising from the offer.
within a specified period, such as one year, and both contracts typically treat shares acquired in an ensuwere acquired in the tender offer. Finally, firms their investment bankers against any legal liability
5. Contract incentives
With over 80% of the typical investment banker’s fee contingent on the offer outcome, the contracts create powerful incentives that influence how bankers provide services to their client firms. The bankers’ services fall into three categories: (i> prior search - locating potential bidders or targets, (ii) effort - working to complete offers, seeking higher bids, defending against hostile offers, and negotiating, (iii> ofSer evaluation - advising on bidding strategy, on the offer price, and on the accept/reject decision, and evaluating the potential for competitive bids. Consistent with client-firm interests, most contracts support prior search and some types of banker effort. In three areas, however, contract incentives can create conflicts with the interests of either firm management or shareholders: 1) nearly all contracts may lead bankers to recommend bargaining positions that are less than ideal for shareholders, 2) bidding-firm contracts provide no incentives for the investment banker to minimize the price paid, and 3) target-firm contracts in hostile offers frequently contain incentives for the target firm’s banker to complete a hostile transaction. 5.1. Contract features supporting client-firm interests Prior Search: Investment bankers often ‘pitch deals’ to prospective clients in return for being retained if the firm decides to pursue the offer. All three contract forms support this prior search, since they are all transaction-specific. For bidding firms, fee contracts are always written for a specific target firm. Although target fees usually cover transactions with any bidder, the contracts are always written in connection with a specific offer. Thus by awarding the contract the firm rewards a banker for locating a potential target or bidder. Effort : Typical contracts provide effort incentives consistent with basic firm objectives. Bidding firms typically use shares-based fees, motivating their bankers to complete the transaction. Total-value fees induce target-firm bankers not only to complete the initial offer but also to seek out higher bids. Incremental-value fees lead target-firm bankers to secure an increase in the
R.M. McLaughlin, Investment-banking contracts in tender offers
227
bid as a condition of completing any transaction. Only fixed fees provide no effort incentives, and they are used infrequently. The sharp increase in fees for an acquisition results in payoffs to the banker that are discontinuous in firm value at the outcome of the offer. Such contracts may encourage better banker effort. Bankers bear the entire cost of their efforts but receive only a fraction of the marginal benefit, so nonlinear fees may be required for best-effort incentives. Determining whether the contracts actually provide best-effort incentives, however, would require both detailed knowledge of the factors influencing each offer and richer models of optimal behavior. Ogler Evaluation : Once the fee is determined, and if advice is given with zero marginal cost, fixed fees are consistent with best evaluation by the banker. Since these fees contain no incentives, they create no conflicts of interest. 5.2. Contract features potentially in conflict with client-firm interests Effort: Contingent contracts do not always provide compatible effort incentives. For example, in only two hostile offers in the sample do bankers for target firms have incentives to maintain the target’s independence. In many hostile offers the banker’s fee is higher if a rejected bid succeeds than if no transaction takes place. Thus, the target firm’s investment banker frequently has a substantial incentive to complete an offer that the firm’s management continues to resist. If resistance is not simply a bargaining tactic, these contracts are clearly in conflict with management interests. If target management is acting for shareholders, the contract incentives conflict with their interests as well. If there are agency issues between shareholders and managers, such incentives may be consistent with the interests of target-firm shareholders even if they are incompatible with management’s stated objectives. The contract provisions do not always favor shareholders’ interests over those of managers, however. The two hostile-offer contracts with contingent fees only if the target stays independent would clearly favor an entrenched management acting for itself at the expense of shareholders. In the typical biddingfirm shares-based fee contract, the banker has an incentive to complete the transaction but no incentive to minimize the price paid. This may be in the interests of a management team seeking to maximize firm size, but does not support the shareholders’ interest in acquiring the target at the lowest possible price. The effect is heightened for bidding firms using total-value fees. These create direct incentives for the banker to increase the price paid. Q@r Evaluation: Models of bargaining in tender offers are not sufficiently well developed to determine the optima1 bargaining strategy for a firm in a
228
R.M. McLaughlin, Inues~menf-banking contracts in tender offers
given offer. For this reason it is impossible to judge whether a contract provides appropriate rewards to bankers in a specific case. Since contingent contracts misalign the payoffs to banker and client firms, however, they create the potential for conflicts of interest in the banker’s evaluation of the offer, with different contingent contracts misaligning payoffs in contrasting ways. For example, a critical part of evaluating an offer for a target firm is determining the ideal amount of resistance. Even if a target wants to be acquired, it may use resistance as a bargaining tactic. Since optimal resistance is so difficult to determine, the target could give in too easily by accepting too low an offer, or hold out too long, thus losing the best offer available. Instead of aligning banker and shareholder interests, target fee contracts bias bankers either to accept an offer too soon (total-value fees) or to hold out too long (incremental-value fees). In the Kidder Peabody total-value contract with Transway International described in section 4, Kidder was to be paid $0.35 million plus 1% of acquisition value. The $0.35 million represented only 0.19% of Transway’s estimated stand-alone value.5 Since Kidder was to receiver 1% of firm value for an acquisition but only 0.19% of firm value otherwise, failure to complete a transaction is proportionally five times worse for Kidder than for Transway’s shareholders. The potential conflicts from this misalignment are illustrated by a simple numerical example shown in table 5, panel A that assumes: the total-value fee is $0.4 million for no transaction or 1% of offer value for an acquisition; the stand-alone value of the firm is $200 million; the initial offer is $220 million; if the initial offer is accepted, the offer is completed with probability 1.0; and if the offer is rejected, a $250 million offer is completed with probability 0.7 and no transaction takes place with probability 0.3. With these assumptions, shareholder expected value is maximized if the initial offer is rejected ($235 million to $220 million), but expected value for the investment banker is higher if the offer is accepted ($2.20 million to $1.87 million). This misalignment is common to all total-value fee contracts in the sample. The no-transaction fee is always a much lower percentage of the target’s stand-alone value than the acquisition fee is of the firm’s acquisition value. The total-value fee may lead the banker to recommend that the target firm accept too low an offer, in an effort to ensure a completed transaction. At an extreme, the banker might prefer an acquisition at a price substantially below the pre-offer value of the target firm to failure to complete a transaction. The effect is heightened with a shares-based contract. Since the banker receives no direct benefit from a price increase, the contract provides no incentive to ‘The stand-alone value is estimated of the tender offer.
by the market
value one month
before
the announcement
229
R.M. McLaughlin, Inuestment-banking contracts in tender offers Table 5
Illustrations of the potential conflicts of interest between investment banker and target firm that may result from misalignment of the fees paid to bankers and the payoffs to common shareholders. Figures are in millions of dollars. Expected
value ($ millions)
if the offer is: Rejected
Accepted Panel A: Conflict with a total-oalue fee
The example assumes: a total-value fee of $0.4 million for no transaction or 1% of offer value for an acquisition; the stand-alone value of the firm is $200 million; the initial-offer value is $220 million; if the initial offer is accepted, the offer is completed with probability 1.0; and if the offer is rejected, a $250 million offer is completed with probability 0.7 and no transaction takes place with probability 0.3. Expected value to the target firm
$220
Expected value to the investment banker = $2.20
(0.01X220) = $1.87
(0.7X250) + (0.3X200) = $235 (0.7)(0.01X250)
+ (0.3X0.4)
Panel B: Conflict with an incremental-value fee The example assumes: the incremental-value fee is $0.5 million for no transaction or 6% of offer value above $250 million for an acquisition; the stand-alone value of the firm is $220 million and the initial-offer value is $250 million; if the initial offer is accepted, the offer is completed with probability 1.0; and if the initial offer is rejected, a $300 million offer is completed with probability 0.2 and no transaction takes place with probability 0.8. Expected value to the target firm
$250
Expected value to the investment banker
$0.5
(0.2X300) + (0.8X220) = $236 (0.2XO.O6X30~-25C0
+ (0.8X0.5)
risk a reduction in the probability of a transaction by advising the target-firm to hold out for a higher price. Incremental-value fee contracts create a contrasting problem. For example, in the 1982 offer for Giddings and Lewis described in section 4, Goldman Sachs’s fee increased from the minimum of $0.3 million to $3.28 million when the bid increased from $25 to $30. A 25% increase in value for Giddings’ shareholders meant a fee increase of over l,OOO% for Goldman Sachs. Because a contingent fee is paid only for a transaction at an increased price, the banker may recommend that the target firm hold out too long, rejecting good offers in an attempt to secure a higher bid. This potential conflict is illustrated by the example in panel B of table 5, which assumes: the incremental-value fee is $0.5 million for no transaction or 6% of offer value above $250 million for an acquisition; the stand-alone value of the firm is $220 million and the initial-offer value is $250 million; if the initial offer is
230
R.M. McLaughlin, Investment-banking contracts in tender offers
accepted, the offer is completed with probability 1.0; and if the initial offer is rejected, a $300 million offer is completed with probability 0.2 and no transaction takes place with probability 0.8. Shareholder expected value is highest if the offer is accepted ($250 million to $236 million), but the investment banker’s expected value is maximized if the offer is rejected ($1.0 million to $0.5 million). For bidding-firms, shares-based fees may lead bankers to urge the firm to increase its bid no matter how high the current offer, since a higher offer may increase the probability that the transaction will be completed. The banker has no incentive to maximize the expected value of the surplus to the bidding firm, only the probability of acquisition. These incentives may also pressure bidding-firm bankers to base an analysis of target-firm value on assumptions that support an offer above a competing bid. Since there are few independent checks to use in evaluating such advice and since mistakes take so long to manifest themselves, these contract incentives potentially accentuate the problem of the winner’s curse. 5.3. Alternative contracts
Alternative contract forms could eliminate many of the potential conflicts of interest between banker and client. For example, a total-value contract paying the same percentage of firm value for no transaction and for an acquisition aligns payoffs to bankers and shareholders. Such a fee effectively gives the banker an equity position in the firm and eliminates potential conflicts of interest in offer evaluation. Making the fee linear in firm value might, however, entail a trade-off of effort incentives for evaluation incentives. The incentives for target-firm bankers to complete resisted offers could be eliminated by limiting payment of contingent fees to board-approved acquisitions. With this provision, the banker has no incentive to work against the interests of the target-firm board and has substantial incentives to arrange and/or complete an acquisition of which the target-firm management approves. This provision is found in some, but not all, target-firm contracts in hostile offers. The board-approval provision is beneficial even if managers’ fear of shareholder lawsuits under the business judgment rule is influencing contract terms.6 For example, target-firm management may not want to appear to reject all offers out of hand; by requiring board approval it signals its intent to evaluate future offers. Also, the risk of contract manipulation against bankers is minimal. Since fees represent such a small percentage of offer value, it is unlikely that the target firm’s board would alter its public position on an offer simply to reduce the banker’s fees. 6For a discussion
of the business
judgment
rule, see Gilson
(1986, ch. 14).
R.M. McLaughlin, Investment-banking contracts in tender offers
231
For bidding firms, an alternative contract incorporating pricing incentives is a fee that is contingent on acquisition and is also a decreasing function of offer price, that is, a ‘reverse’ total-value fee. Such a fee motivates the banker to manage the offer so as to maximize the surplus to the bidding firm and more closely aligns the interests of banker and bidding-firm shareholders. Although disclosing the terms of such a contract would reveal important information about the bidding firm’s reservation price, that is not a restriction on the use of the contract. The SEC does not require disclosure of specific contract terms in Schedule 14d filings and in some offers bidding firms have disclosed only that the fee is ‘based on offer value’. Several arguments may explain why these alternative contract forms are not often used. First, investment bankers may be more easily controlled by other means, for example, through reputation. Second, contractual incentive problems may simply reflect unresolved conflicts of interest between shareholders and management. In that case, the observed contracts do not suggest that either shareholders or management consistently have the upper hand. A third possibility is that observed contracts are designed primarily to control effort and that client firms do not really use investment bankers’ offer evaluations. However, market knowledge - the ability to ‘price the deal’ - is generally understood to be an area of banker expertise, and at least anecdotal evidence exists that client firms rely on their bankers’ advice.7 For example, Robert Campeau, CEO of Campeau Corp., attributed the decision to increase his bid for Federated Department Stores by $500 million at least in part to the advice of his investment bankers.’ 6. Summary and conclusions Investment-banker fees calculated from fee contracts for a sample of tender offers are much smaller than is commonly believed. Fees for target-firm bankers average $4.2 million (0.77% of acquisition value) and the average for bidding-firm bankers is $2.7 million (0.56% of acquisition value). Total fees average $7.96 million (1.29% of acquisition value). The disparity between the fees reported in the business press and the sample averages is primarily due to three factors: financing and underwriting fees are excluded from calculation of the sample advisory fees, fees increase with the value of the offer, and fees vary widely for offers of similar value. Because the press typically includes financing fees in its totals and concentrates on unusually large offers with extreme fees, the reported fees far exceed the sample averages. Although this study shows that investment-banker advisory fees are typically ‘For bankers’
perceptions
of their abilities,
‘Wall Street Journal, 9 Jan., Federated, see Kaplan (1989).
1990,
p.
see Eccles and Crane
1. For
a discussion
(1988).
of Campeau’s
acquisition
of
232
RX
McLaughlin, ~nvesfme~f-banking contracts in tender offers
substantially lower than the levels implied in press reports, it does not analyze whether the fees are excessive or whether they result from substantial market power or from competitive pricing. The fees are substantially contingent on offer outcome, giving investment bankers substantial incentives to complete a transaction. Further, provisions in target-firm contracts motivate bankers to seek a high price. The contracts create potential conflicts of interest, however, between banker and client. These fees are used despite the existence of alternative contracts that would eliminate or substantially reduce the potential conflicts, suggesting either that our understanding of the contracting process between firm and investment banker in tender offers is incomplete or that the contracts can be improved. References Baron, David P., 1979, The incentive problem and the design of investment banking contracts, Journal of Banking and Finance 3,-157-175. Baron. David P.. 1982. A model of the demand for investment banking advising and distribution services for new issues, Journal of Finance 37, 955-976. Baron, David P. and Bengt Holmstrom, 1980, The investment banking contract for new issues under asymmetric information: Delegation and the incentive problem, Journal of Finance 35, 1115-1138. Beatty, Randolph P. and Jay R. Ritter, 1985, Investment banking, reputation, and the underpricing of initial public offerings, Journal of Financial Economics 15, 213-232. Eccles, Robert G. and Dwight B. Crane, 1988, Doing deals: Investment banks at work (Harvard Business School Press, Boson, MA). Gilson, Ronald J., 1986, The law and finance of corporate acquisitions (Foundation Press, Mineola, NY). Hayes, Samuel L., A. Michael Spence, and David Van Praag Marks, 1983, Competition in the investment banking industry (Harvard University Press, Cambridge, MA). Hertzberg, Daniel, 1985, Advice in the Revlon brawl wasn’t cheap - Fees in takeover fight will establish record, Wall Street Journal, 8 Nov., 6. Kaplan, Steven R., 1989, Campeau’s acquisition of Federated: Value destroyed or value added?, Journal of Financial Economics 25, 191-212. Mandelker, Gershon and Artur Raviv, 1977, Investment banking: An economic analysis of optimal underwriting contracts, Journal of Finance 32, 683-694. Petre, Peter, 1986, Merger fees that bend the mind, Fortune 113, 18-30. Ritter, Jay R., 1985, The choice between firm commitment and best effort contracts, Working uaoer (University of Pennsylvania, Philadelphia, PA). Smith; Clifford W., 1977, Alternative methods for raising capital: Rights versus underwritten offerings. Journal of Financial Economics 5, 273-307. Smith, Clifford W., 1986, Investment banking and the capital acquisition process, Journal of Financial Economics 15, 3-29. Thackray, John, 1986, The great trade robbery, Management Today, March, 80-84, 114.
of Financial
Economics
28 (1990) 209-232.
Investment-banking in tender offers
North-Holland
contracts
An empirical analysis Robyn M. McLaughlin* Boston College, Chestnut Hill, MA 02167, USA Received
July 1988, final version
received
October
1990
Empirical analysis reveals that investment-banker advisory fees in tender offers average 1.29% of the value of a completed transaction, far below the levels often alluded to in the business press. Most fees are contingent on offer outcome, with target-firm fees typically contingent on transaction value and bidding-firm fees on the number of shares purchased. Although these contingent contracts motivate investment bankers to satisfy some client objectives, many also create conflicts of interest between banker and firm. These incentive problems are apparent in offer evaluation, in hostile offers, and in the price paid by bidding firms.
1. Introduction
The role of investment bankers in corporate control contests is controversial, both because of the compensation they allegedly receive and because of potential conflicts of interest between the bankers and their client firms. This paper addresses these concerns by examining the size of banker fees in tender offers and the contract terms governing them. There are three primary results. First, measured properly, banker advisory fees are substantially smaller than what the business press reports. Second, most fee contracts are substantially contingent on offer outcome. Third, the contracts *I thank Paul Asquith, Larry Benveniste, Thomas Downs, Robert Merton, John Parsons, John G. Preston, Elizabeth Strock, Robert Taggart, Hassan Tehranian, Nickolaos Travlos, Jerry Viscione, and William Wilhelm for helpful discussions. I have benefited from the extensive comments of an anonymous referee and editors Michael Jensen and Richard Ruback. Hollyce States provided valuable editorial assistance. Any remaining errors are my own.
0304-405X/90/$03.50
0 1990-Elsevier
Science
Publishers
B.V. (North-Holland)
210
R.M. McLaughlin, Investment-banking contracts in tender offers
create potential for conflicts of interest between bankers and client firms, particularly in offer evaluation, hostile offers, and the price paid by bidding firms. The paper’s major findings are summarized in table 1. Press coverage creates a distorted impression of investment-banking fees by concentrating on sensational offers and fees, often including compensation for financing and other related services. Total investment-banker fees excluding financing fees, however, actually average only $7.96 million, or 1.29% of the offer’s value for completed transactions, in tender offers between 1980 and 1985. For offers valued over $1 billion, the average total fee is $17.73 million and the percentage of offer value drops to 0.60%. For transactions of comparable value, tender-offer fees are roughly half the size of investment bankers’ fees for underwriting. Most fees in the sample are contingent on the outcome of the offer. In the average contract, over 80% of the fee is paid only if an acquisition is completed. Typically, the fee for the target firm’s banker is a function of offer value and the fee for the bidding firm’s banker is a function of the number of shares purchased. Both types of contract create the potential for conflicts of interest because the payoffs to bankers and shareholders are misaligned. The paper is organized as follows. The sample is described in section 2. In section 3, the size of investment bankers’ fees is examined. The sample contracts are described in section 4. Contract incentives and alternative contract forms are discussed in section 5, and a summary and conclusions are presented in section 6. 2. Data 2.1. The sample The sample comprises fee contracts between investment bankers and client firms for 195 tender offers between 1978 and 1985. The contracts are obtained from the Securities and Exchange Commission (SEC) Schedule 14d filings required in tender offers. The original list of tender offers, compiled from the January 1978 to December 1985 issues of the SEC News Digest, was reduced to samples for target and bidding firms satisfying the following selection criteria: (1) The target firm is listed on the New York Stock Exchange. (2) The offer does not involve a> a firm’s bid for its own shares, b) a bidding group that includes members of the target firm’s current management, or c) firms bidding for each other’s shares. (3) For the bidding-firm sample, the offer is initiated between January 1978 and December 1985. (4) For the target-firm sample, the offer is initiated between January 1980 and December 1985.
R.M. McLaughlin, Investment-banking contracts in tender offers
211
Table 1 Summary of major findings on investment-banker advisory fees in tender offers for a sample of 132 target firms from January 1980 to December 1985 and 195 bidding firms from January 1978 to December 1985. Fees are calculated from the terms of the contract between the banker and the client firm and do not include financing, underwriting, legal or accounting fees, or out-of-pocket expenses. Averages are equally-weighted. If the fee is a function of the terms of the offer, it is calculated using the terms of the final offer. The final offer for a target firm is the successful offer or, if the target firm is not acquired, the highest offer. The final offer for a bidding firm is the successful offer or, if the bidding firm is not successful, the highest offer it makes. If the offer consists of more than one step, the value of each step is included in the final offer’s value. If the offer involves both cash and securities, the two components are summed to calculate final-offer value. The total fee is the sum of the contracted investment-banker fees for the target firm and all bidding firms. The averages are for offers for which contract information is available for the target firm and all bidding firms.
Average contract fees for a completed acquisition Contract form
Potential incentive problems
132 Target firms
195 Bidding firms
116 Total fees
4.21 million 0.77% of acquisition value
2.70 million 0.57% of acquisition value
$7.96 million 1.29% of acquisition value
80% of fee contingent on transaction value
80% of fee contingent on completing the transaction
NA
Conflicts of interest in offer evaluation
Conflicts of interest in offer evaluation
Incentive to complete a transaction in hostile offers
No incentive to minimize price paid
NA
The second restriction eliminates 23 observations that either do not represent arms-length transactions (for example, self-tenders and leveraged buyouts) or in which the roles of target and bidding firm are ambiguous. The third and fourth restrictions result from changes in SEC filing requirements. Schedule 14dl filings were mandatory for bidding firms throughout the sample period, whereas Schedule 14d9 filings were first required of target firms in December 1979. 170 observations in the target-firm sample and 237 observations in the bidding-firm sample meet the criteria. There are fewer targets than bidders because of the shorter sampling period and because of competitive bidding. When a firm is the object of multiple bids, a single contract covers all offers for the target and is listed only once in the target-firm sample. Contracts for each of the competing bidders, however, are included in the bidding-firm sample. Since the SEC does not specifically require disclosure of banker and fee-contract information, some observations are incomplete, resulting in final
212
R.M. McLaughlin, Investment-banking contracts in tender offers
samples of 134 target contracts and 195 bidding contracts. Dates of public announcement, changes in offer terms, and offer outcomes are obtained from the Wall Street Journal and the Wall Street Journal Index. Proxy statements for firms involved in completed tender offers are searched to compare the fees actually paid with those calculated from the terms of the contracts listed in the Schedule 14d filings. 2.2. Contract-fee calculation
The fees reported in this paper are calculated from the terms of the contracts between investment bankers and their client firms. For this reason, the fees are estimates and do not necessarily equal actual compensation. Available data suggest, however, that the estimates closely approximate the fees actually paid. For many tender offers that result in a merger, actual investment-banker compensation can be determined from merger proxy statements. For the 56 target firms with available data, the fees actually paid are within 20% of the estimated contract fees, and 51 of the 56 are within 10%. For 32 of 33 bidding firms, the actual fees are within 5% of the estimated contract fees. The differences are evenly divided between positive and negative values and the average difference is zero. The fees I analyze are for tender-offer management and advisory services only. They do not include fees for financing, underwriting, asset divestitures after the offer, or legal or accounting services. Reimbursements for out-ofpocket expenses are also excluded. Financing and underwriting fees are excluded because they compensate bankers at least in part for bearing financial risk in providing investment capital, a service that is not unique to tender offers. Financing fees are not a significant issue for this sample because explicit, simultaneous contracting with the banker for both advisory and financing services occurs for only eight of the bidding firms. Financing fees have become more important since 1985, however, because of the increased use of junk bonds and bridge loans provided by investment bankers. 3. Distribution
of investment-banker
fees
Investment-banker fees reported in the business press are sensationally large. For example, an article in Fortune [Petre (198611 highlights several offers with total fees over $15 million, and the press reported fees of over $100 million for Pantry Pride’s 1985 acquisition of Revlon, Inc. [see, for example, Hertzberg (198511. The average of $7.96 million for total advisory fees in table 1 is in sharp contrast to these amounts. As shown in table 2, for transactions of similar value, these fees are roughly one-half the size of the underwriting compensation reported by Smith (1977). This comparison with underwriting fees allows only limited inferences. Since the banker’s services
213
R.M. McLaughlin, Investment-banking contracts in tender offers
Table 2 Comparison of investment-banker
underwriting fees and tender-offer contract fees.
Transaction value ($ millions)
Smith: Fees in underwritten equity offers (% of offer vaIueIa
Tender offers: Total target- and bidding-firm contract fees for a completed acquisition t% of offer vaIuejb
Ratio: tender-offer fees to fees for underwriting
0 to 50 50 to 100 100 to 500
5.29% 3.97 3.81
3.15% 1.92 1.51
0.55 0.48 0.40
“These data are summarized from table 1 in Smith (1977, p. 277). bThese data are summarized from table 3, panel C, section 2.
are so different for the two activities, it is not possible to determine what the relative fee levels should be. Underwriting is the only other investment-banking activity with sufficient compensation data available, however, to provide a crude comparison with tender-offer fees. Press reports often include banker compensation for financing, underwriting, and asset divestiture. For example, in the Revlon offer, financing fees and fees for the sale of assets after the offer totaled $78 million of the more than $100 million reported. Even after adjustment for financing fees, however, reported advisory fees are typically several times greater than the $7.96 million average in table 1. Three features of investment-banker tender-offer fees explain the remaining differences: (i) Fees increase with the value of the offer, although not proportionally. (ii> Fees vary widely for offers of comparable value. (iii) Fees are substantially higher for completed transactions. Since press coverage concentrates on the highest-valued, completed acquisitions with the highest fees, the fees reported in the press are substantially above the norm. Investment-banker advisory fees are summarized in table 3, with target-firm fees in panel A, bidding-firm fees in panel B, and total fees in panel C. The contract fee to be paid if the tender offer fails is included in the first section of each panel, and the fee if the offer is completed in the second section.’ In each section, average fees are presented by category of final-offer value. The ‘For example, Technicolor, Inc. is the target in a tender offer with a value of $99 million. Technicolor’s investment banker, Goldman Sachs, is to receive $100,000 if no transaction takes place and $625,000 if an acquisition is completed. The $100,000 contract fee is included (in panel A, section 1) in the average no-transaction fee for offers valued between $50 million and $100 million. The $625,000 fee is included (in panel A, section 2) in the average acquisition fee for offers valued between $50 million and $100 million.
investment-banker
advisory contract
Table 3 fees for 134 target firms and 195 bidding
firms in tender
offers from 1978 to 1985.
Min
0.31% 0.00 0.04 0.00 0.00 0.00 0.00
0.47% 0.17 0.14 0.14 0.10 0.08 0.26
0.71% 0.23 0.14 0.09 0.06 0.03 0.09
0.91% 0.23 0.17 0.11 0.10 0.05
0.18
All offers
of offer value
0.00
0 to 50 50 to 100 100 to 250 250 to 500 500 to 1000 over 1000
1.83 Fees as a percentage
$0.02 0.00 0.09 0.00 0.00 0.00
0.25
$0.14 0.13 0.21 0.61 0.74 3.25
0.79
0 to 50 50 to 100 100 to 250 250 to 500 500 to 1000 over 1000
banker
Dollar value of fees ($ millions)
to be paid to the investment
Std. dev.
All offers
fees - Fees contracted
Median
Percentiles
1 .oo
0.10
0.02
0.29
1.58% 0.39 0.21 0.19 0.16 0.06
$0.30 0.25 0.30 0.75 1.00 2.00
0.47% 0.04 0.07 0.00 0.02 0.01
Max
1.58
1.58% 0.56 0.69 0.56 0.40 0.31
14.20
134
9 24 24 24 19 34
134
24 19 34
2.50 3.00 14.20
0.50 1.13
9 24 24
N
$0.50
shares or assets are purchased
80th
$0.08 0.03 0.10 0.00 0.10 0.13
if no target-firm
20th
contract fees, January 1980 to December 198.5
$0.18 0.15 0.25 0.30 0.40 1.00
1: No-transaction
Mean
target-firm investment-banker
$0.20 0.17 0.27 0.47 0.66 2.07
Section
Final-offer value” ($ millions)
Panel A: Estimated
Fees are expressed in dollars and as a percentage of final-offer value.* Fees are estimated from the terms of the contract between the banker and the client firm. If the fee is a function of offer terms, it is estimated using the terms of the final offer. The contract fee does not include financing, underwriting, legal or accounting fees, or out-of-pocket expenses. The sample is partitioned by target firm, bidding firm, and total fees and, within each category, by offer outcome. Averages are equally-weighted.
Estimated
P : 3
; a P f: 2. 3 B
2 Ft : 00 * =: ,31 2 E % 3 2 F z g s’
$
4.21
1.65% 1.15 0.89 0.86 0.47 0.34
0.77
0 to 50 50 to 100 100 to 250 250 to 500 500 to 1000 over 1000
All offers
$0.37 0.84 1.55 3.15 3.10 10.44
0.63
1.54% 1.00 0.97 0.86 0.49 0.33
2.50
$0.33 0.75 1.65 2.97 2.59 7.04
fees - Fees contracted
All offers
0 to 50 50 to 100 100 to 250 250 to 500 500 to 1000 over 1000
Section 2: Acquisition
banker
0.59
1.26% 0.63 0.34 0.38 0.27 0.14
Fees as a percentage
6.01
$0.30 0.53 0.73 1.48 2.09 8.81
0.04
0.31% 0.19 0.08 0.09 0.04 0.07
of offer value
0.02
$0.02 0.15 0.11 0.45 0.25 2.50
Dollar value of fees ($ millions)
to be paid to the investment
2.42% 1.51 1.18 1.11 0.69 0.49 1.12
0.32
6.14
$0.67 1.13 2.13 4.30 5.58 14.51
0.57% 0.62 0.69 0.57 0.17 0.21
0.73
$0.06 0.48 9.23 2.25 1.24 4.28
if the target firm is acquired
4.47
4.47% 2.99 1.55 1.67 0.95 0.65
46.22
$0.77 2.60 3.05 6.94 7.50 46.22
by the final offer
8
132
23 24 24 18 35
i 9
3
E
E
All offers
0.14
0.49% 0.27 0.15 0.09 0.07 0.04
50 100 250 500 1000 1000
0 to 50 to 100 to 250 to 500 to over
$0.10 0.19 0.24 0.32 0.48 1.02
0.45
50 100 250 500 1000 1000
All offers
0 to 50 to 100 to 250 to 500 to over
Mean
Median
Std. dev. Min 20th
80th
MaX
0.61
0.25
0.00
$0.05 0.00 0.00 0.00 0.00 0.15
0.28% 0.26 0.10 0.05 0.05 0.05 0.18
0.42% 0.21 0.14 0.08 0.05 0.02 0.09
0.0
0.19% 0.00 0.00 0.00 0.00 0.01
Fees as a percentage of offer value
$0.04 0.19 0.17 0.21 0.47 0.99
$0.10 0.15 0.20 0.25 0.33 0.70
Dollar value of fees ($ millions)
0.04
0.22% 0.10 0.07 0.05 0.04 0.01
0.15
$0.08 0.09 0.11 0.15 0.25 0.50
1.01% 1.29 0.57 0.21 0.24 0.27 1.29
0.20
4.50
0.50 0.32% 0.41 0.20 0.12 0.08 0.05
$0.20 1.00 0.85 1.00 2.00 4.50
$0.12 0.25 0.32 0.50 0.58 1.00
Section 1: No-transaction fees - Fees contracted to be paid to the investment banker if no target-firm shares or assets are purchased
Final-offer valuea ($ millions)
Percentiles
Panel B: Estimated bidding firm investment banker contract fees, January 1978 to December 1985
194
11 31 42 37 30 43
194
31 42 37 30 43
11
N
“h
$
2
k
0.84% 0.83 0.68 0.59 0.46 0.24
0.57
0 to 50 so to 100 100 to 250 250 to 500 500 to 1000 over 1000
All offers
$0.21 0.62 1.10 2.04 2.96 6.70
2.70
50 100 250 500 1000 1000
All offers
0 to 50 to 100 to 250 to 500 to over
0.52
0.86% 0.79 0.67 0.54 0.43 0.21
1.70
$0.20 0.58 1.00 2.00 2.82 5.00 0.08
$0.08 0.10 0.08 0.25 0.95 1.00
0.33
0.31% 0.28 0.32 0.26 0.20 0.14 0.02
0.42% 0.18 0.07 0.05 0.13 0.02
Fees as a percentage of offer value
3.15
$0.14 0.27 0.54 0.94 1.54 4.28
Dollar value of fees ($ millions)
0.27
0.57% 0.62 0.41 0.32 0.31 0.13
0.70
$0.10 0.41 0.73 1.25 1.92 3.55
0.81
0.99% 1.05 0.90 0.79 0.59 0.37
4.00
$0.37 0.90 1.51 2.66 3.67 10.00
1.74
1.58% 1.51 1.74 1.28 1.07 0.54
20.00
$0.51 1.27 2.50 4.85 9.40 20.00
Section 2: Acquisition fees - Fees contracted to be paid to the investment banker if the target firm is acquired by the final offer
R $
44 195
& S
h g !$ P ; s.
9 $
44 195 11 31 42 37 30
E P ““s 9 p c 3 11 31 42 37 30
20th 80th
MaX
_N
E 8E
All offers
0.30 0.21
1.25% 0.56 0.29 0.17 0.23 0.08
1.63% 0.49 0.35 0.20 0.19 0.11
0 to 50 to loo to 250 to 500 to over
so 100 250 500 1000 1000
0.68
$0.33 0.39 0.50 0.55 1.28 2.50
1.56
$0.38 0.37 0.55 0.84 1.31 3.55 0.00
$0.23 0.00 0.20 0.00 0.00 0.15
0.38
0.71% 0.25 0.20 0.16 0.12 0.11 0.00
0.94% 0.00 0.08 0.00 0.00 0.01
Fees as a percentage of offer value
2.36
$0.13 0.20 0.29 0.75 0.98 3.58
0.07
0.98% 0.21 0.17 0.06 0.08 0.05
0.30
$0.28 0.18 0.29 0.18 0.49 0.93
0.44
2.45% 0.67 0.47 0.33 0.27 0.14
2.11
$0.56 0.55 0.73 1.55 2.08 6.55
2.49
2.49% 0.80 0.90 0.62 0.47 0.59
14.78
$0.60 0.65 1.48 2.75 3.50 14.78
g f
21 14 22 18 32
; g q 4 3
14 21 22 18 32 112
5
$ 2 $
112
C$
8
5
c
P
so 100 250 500 1000 1000
All offers
0 to so to 100 to 250 to 500 to over
Min
3’
Median
Percentiles
Dollar value of fees ($ millions)
Mean
Std. dev.
Section 1: No-transaction fees - Fees contracted to be paid to the investment banker if no target-firm shares or assets are purchased
Final-offer value” ($ millions)
Panel C: Estimated total investment-banker contract fees, January 1980 to December 1985
The total fee is the sum of the contracted investment-banker fees for the target firm and all bidding firms. The averages are for offers for which contract information is available for the target firm and all bidding firms.
3.20% 2.02 1.61 1.42 0.93 0.60
1.29
0 to 50 50 to 100 100 to 250 250 to 500 500 to 1000 over 1000
All offers
banker
9.17
4.79
1.16% 0.72 0.60 0.55 0.31 0.25 0.82
2.54% 2.13 1.68 1.40 0.95 0.56 1.10
Fees as a percentage
$0.36 0.53 1.06 2.20 2.46 11.48
0.14
2.49% 0.64 0.40 0.30 0.48 0.14
of offer value
0.28
$0.28 0.50 0.75 1.45 3.25 7.10
Dollar value of fees ($ millions)
to be paid to the investment
$0.85 1.42 2.89 4.97 5.83 14.42
fees - Fees contracted
0.57
2.49% 1.41 1.05 0.96 0.59 0.42
2.11
$0.37 0.93 1.65 3.22 3.58 8.46
if the target
5.17% 3.08 2.83 2.72 1.53 1.37 5.17
1.91
64.22
11.50
4.80% 2.81 2.10 1.83 1.23 0.76
$1.22 2.33 4.44 10.29 11.52 64.22
by the final offer
$1.19 2.11 3.46 6.60 7.87 24.30
firm is acquired
114
5 14 21 22 18 34
114
5 14 21 22 18 34
aIf a firm completes a transaction, the final offer is the successful offer. If a target firm is not acquired, the final offer is the highest offer made for it. If a bidding firm does not acquire the target, its final offer is the highest offer it makes. If an offer consists of more than one step, the values of each step is included in the value of the final offer. If the offer involves both cash and securities, the two components are summed to calculate final-offer value.
7.96
$0.83 1.47 2.68 5.24 5.99 17.73
All offers
0 to 50 50 to 100 100 to 250 250 to 500 500 to 1000 over 1000
Section 2: Acquisition
220
R.M. McLaughlin, Investment-banking contracts in tender offers
final offer is the successful offer if a firm completes an acquisition. For a target firm that is not acquired, the final offer is defined as the highest offer it received, and for an unsuccessful bidding firm, the final offer is defined as the highest offer it makes. If the fee is a function of offer terms, the estimated contract fee is calculated using the terms of the final offer.’ Contract Fees and Offer Value: In section 2 of panel A, the average target-firm contract fee for an acquisition increases from $0.37 million for offers under $50 million to an average of $10.44 million for offers over $1 billion. For the same range of offer values, the average bidding-firm contract fee increases from $0.21 million to $6.70 million (panel B, section 2). These fee increases, however, are not proportional. Average fees decrease from 1.65% to 0.34% of offer value for target firms and from 0.84% to 0.24% for bidding firms. Total fees average 1.29% of the value of the offer, but the average ranges from 3.20% for the smallest offers to 0.60% for the largest (panel C, section 2). These contract-fee patterns are repeated for the notransaction fees shown in the first sections of the panels. Fee Variation:
The 114 total fees for an acquisition (panel C, section 2) have a mean of $7.96 million, with a range of $0.28 million to $64.22 million and a standard deviation of $9.17 million. Since the median of $4.79 million is substantially less than the mean, the distribution is also positively skewed. For total fees as a percentage of offer value, the standard deviation of 0.82% is large in relation to the mean of 1.29% and the percentages range from 0.14% to 5.17%. Substantial cross-sectional variation persists for each category of offer value, for both target and bidding firms and for both no-transaction and acquisition fees. For example, no-transaction fees for target firms at the lowest offer values (panel A, section 1) range from $0.02 million to $0.5 million and fee percentages range from 0.31% to 1.58%. Target-firm acquisition fees for the highest offers (panel A, section 2) range from $2.5 miIlion to $46.2 million (0.07% to 0.65%). The pattern is similar for bidding firms and for total fees. The large variation in contract fees even after offer value is adjusted for suggests that individual contracts are written for different offers and is inconsistent with the use of a single pricing formula in setting banker fees (for example, the Lehman formulaX3 *If the offer consists of more than one step, the value of each step is included in the value of the final offer. If the offer involves both cash and securities, the values of the components are summed to calculate final-offer value. 3The Lehman formula is a fee schedule attributed originally to Lehman Brothers and frequently said to be the basis for pricing by other firms in the industry. Various definitions of the formula appear in print. All are descending step functions of the value of the transaction. One example is: 5% of the first million dollars of transaction value, 4% of the second million, 3% of the third million, 2% of the fourth million, and 1% of the value above $4 million.
R.M. McLaughlin, Inuestment-banking contracts in tender offers
221
Fees and Ofer
Outcome: Since a large proportion of the typical fee is contingent on the outcome of the offer, the expected value of the fee is significantly less than the fee for a completed acquisition. Average total contract fees are $7.96 million for an acquisition, but only $1.56 million for no transaction (table 3, panel C). For target firms the corresponding values are $4.21 million and $0.79 million (panel A) and for bidding firms $2.70 million and $0.45 million (panel B). This substantial difference in compensation for completed transactions persists at every level of transaction value for both target and bidding firms. For 18 target firms and 5 bidding firms the entire fee is contingent on acquisition, and in the typical contract over 80% of the investment banker’s compensation is contingent in some way on completion of the transaction.
Average fees are higher for Comparison of Target- and Bidding-Firm Fees: target firms than for bidding firms in nearly every value category (panels A and B), whether or not a transaction takes place. The Wilcoxon signed-rank test for differences is significant at the 0.001 level and regression analysis indicates that, for completed offers of the same value, target-firm fees are 30% higher than bidding-firm fees, suggesting that it is more costly to represent a target firm. Target-firm bankers may have to expend more time or effort than bidding-firm bankers or they may have to expend additional resources, such as ‘using up’ proprietary lists of potential bidders. Also, the target firm often has less control over offer timing than the bidding firm and may have to pay extra for this ‘urgency’. In addition, an acquisition represents the final opportunity for the target firm’s banker to receive delayed compensation for prior service. This argument, however, assumes a continuing relationship between target firm and banker, and such commitments appear to be diminishing [see Hayes et al. (1983) and Eccles and Crane (1988)l. 4. Contract forms and contract distribution Contract fees fall into three basic categories: fixed fees, shares-based fees, and value-based fees. Fixed fees are independent of offer outcome and, as shown in table 4, are used infrequently (in 9.7% of target-firm contracts and 5.7% of bidding-firm contracts). Shares-based and value-based fees, in contrast, are contingent on offer outcome. Shares-based fees are contingent only on the number of shares purchased and are the usual bidding-firm contract (79.7% of the bidding-firm sample). Value-based fees are contingent on both the number of shares acquired and the price paid and are typically used by target firms (72.6% of the target-firm sample). Fixed-Fee Contracts:
These contracts are most often used for atypical situations. In 7 of the 12 target-firm contracts that specify a fixed fee, the
of investment-banker
tender-offer
Table 4 fee contracts for 125 target firms and 192 bidding firms. Target-firm bidding-firm data are from 1978 through 1985.
data are from 1980 through
1985;
type
153 79.7%
112 58.3% 0.53% 79.1% $1,118
41 21.4% 0.56% 81.2% $916
11 5.7%
0.68% 0.0% $91
0.54% 79.7% $1,064
0.55% 85.3% $1,174
0.55% 85.3% $1,174
-
0.30% 0.0% $856
22 17.6%
Subtotals
22 17.6%
Step function of shares purchased
fees
0.0%
0
Linear function of shares purchased
Shares-based
12 9.6%
Independent of offer outcome
Fixed fees
0.69% 86.3% $1,156
28 14.6%
0.83% 83.3% $1,126
69 55.2%
Total-value Function of total offer value
fees
0.69% 86.3% $1,156
-
28 14.6%
0.88% 79.4% $1,100
91 72.8%
Subtotals
0 0.0%
1.05% 67.2% $987
22 17.6%
Incremental-value Function of increase in offer value -___
Value-based
0.57% 75.7% $1,021
192 100%
0.77% 72.6% $1,092
125 100%
Row totals
“The contract acquisition fee as a percentage of offer value. Both fee and offer value are estimated from the terms of the final offer. bThe percentage of the fee for acquisition that is contingent on offer outcome. Acquisition fee is estimated from the terms of the final offer.
Target firms Number of contracts Percent of sample Averages : percentage feea % of fee contingentb offer value ($ millions) Bidding firms Number of contracts Percent of sample Averages : percentage feea % of fee contingentb offer value ($ millions)
Description
Contract
For each contract type the table shows: the number of contracts and percentage of the sample; the average of the fees for an acquisition as a percentage of the value of the offer; and the average offer value. Offer value is estimated using the terms of the tinal offer. The tinal offer for a target firm is the successful offer or, if the target firm is not acquired, the highest offer. The final offer for a bidding firm is its successful offer or, if the bidding firm is not successful, the highest offer it makes. If the offer consists of more than one step, the value of each step is included in the offer value. If the offer involves both cash and securities, the two components are summed to estimate offer value. Fees are estimated from the terms of the contracts between bankers and client firms. If the contract fee is a function of offer terms, it is estimated using the terms of the final offer. Averages are equally-weighted.
Distribution
R.M. McLaughlin, Inuestment-banking contracts in tender offers
223
investment banker’s role appears to be limited to providing an opinion letter assessing the value of the offer to target-firm shareholders. Bidding firms use fixed fees for low-valued offers in which they control the target’s equity. The average offer value is only $91 million. In 6 of the 11 offers shown in table 4, the bidding firm had previously acquired more than 20% of the target’s equity. In the remaining cases, the target endorsed the offer and the offer resulted in an acquisition. Shares-Based Fee Contracts: Approximately 25% of shares-based fees are linear functions of the number of shares purchased, as in the 1984 Goldman Sachs contract with Mobil Corp. for its bid for Superior Oil Co. The terms of $1 million to be credited against $0.02 per share acquired resulted in an estimated contract fee of approximately $2.55 million when the offer succeeded. More often, contracts in this category are step functions of the number of shares purchased. For example, in the 1980 Canadian Pacific Enterprises bid for Hobart Corp, first Boston’s fee from Canadian Pacific was to be $0.25 million if Canadian Pacific acquired less than 51% of Hobart’s shares, $0.75 million if the percentage was between 51% and SO%, $1.75 million if it was between 80% and 90%, and $2.25 million if Canadian Pacific acquired over 90% of Hobart’s shares. Since the offer was defeated by a higher bid from Dart & Kraft Inc., the estimated contract fee to First Boston was the $0.25 million minimum. In all of the step-function contracts, the first fee increase occurs at or above the percentage at which the bidding firm acquires voting control of the target. In the simplest variation, a contingent payment is made if, and only if, a merger takes place. In practice, most of the shares-based contracts in the sample reduce to this simple form, because in nearly all of the offers, the bidding firm purchases either all of the target-firm shares or none. Contract terms (percentages in linear fees and the number of steps, step points, and step percentages in step-function fees) differ even for offers of similar value. No standard pricing formula is apparent. Most investment bankers use different pricing formulas for different clients. An exception is Morgan Stanley, which usually sets fees according to a sliding scale of offer value. The only common contract provision is that the banker receives the largest contingent fee only if a transaction is completed. Value-Based Fee Contracts: Total-value fees and incremental-value fees are contingent on offer value, and for both the contingent fee is paid only for a completed acquisition. The total-value fees are usually linear functions of value. For example, in a 1985 hostile bid by Nortek, Kidder Peabody’s contract with the target, Transway International, specified a fee of $0.35
224
R.M. McLaughlin, Investment-banking contracts in tender offers
million plus 1% of the value of a completed transaction. Ridder’s contract fee totaled $3.51 million when Transway was acquired through a friendly offer valued at $316 million. Occasionally, a total-value fee is a step function of value, as in the 1981 Dean Witter Reynolds contract with Bunker Ramo. When Bunker Ramo was acquired, the contingent fee of 1% of the first $100 million of total value and 0.5% of any amount over $100 million resulted in a contract fee of approximately $2.1 million. In incremental-value-fee contracts, an additional fee is paid only if an offer above a specified amount (usually the initial bid) results in a transaction. For example, in 1982 Giddings and Lewis was the target of a hostile offer. It contracted to pay its banker, Goldman Sachs, $0.30 million plus 6% of the value of a transaction above the initial bid of $25 per share. When an offer of $30 per share was completed, Goldman Sachs’s contract fee was $3.28 million. In some incremental-value-fee contracts, the percentage is an increasing step function of the final price. For example, in First Boston’s 1980 contract with Pullman Inc. the fee was 1.5% of the value between $28 and $40 per share, 2% of the value between $40 and $45 per share, and 3% of the value over $45 per share. Target-Firm Contract Provisions in Hostile Offers: Contract incentives in hostile offers usually are not focused on maintaining the target’s independence. In 29 of the 62 resisted offers, the target-firm banker’s fee is actually higher if the original, hostile offer is completed than if the target remains independent. For example, in the 1981 Kidder Peabody contract with Cenco following a hostile offer by National Medical Enterprises, the contingent fee of 0.75% of offer value was payable for any completed acquisition, including the initial hostile offer. When a subsequent friendly offer was successful, the contract fee for Kidder was $1.26 million. In 31 of the 62 offers, even though success of the original, resisted bid results in payment of the smallest fee, the banker’s fee is still maximized if some transaction is completed. The banker’s fee is maximized if no transaction takes place in only 2 of the 62 resisted offers. In Turner Broadcasting’s 1985 hostile offer for CBS Inc., the only contingent fee in the contract between CBS and Morgan Stanley is for the failure of the Turner offer. In Phillips Petroleum’s resistance of a 1985 offer from Icahn Group, its fee contracts with Morgan Stanley and First Boston specify two contingent payments: one to be paid if the Icahn offer failed, the other to be paid if a proposed Phillips recapitalization plan were completed. Such fees may be used so infrequently because target management wants to avoid creating conflicts with shareholder value maximization. Target firms that resist are relatively more likely than those that don’t to use incremental-value fees and many contracts provide additional fees for successful defensive tactics, for example, failure of the hostile bid, a success-
225
R.M. McLaughlin, Investment-banking contracts in tender offers
ful recapitalization, or completion of an approved offer.4 These additional fees are used in various combinations and depend in different ways on target approval of a completed offer. For example, the terms of the 1980 contract between Pullman, Inc. and First Boston specified a fee of $0.30 million plus the larger of: i) $0.20 million if the original bidder acquired no shares or ii) an incremental-value fee for any acquisition completed at a price above the initial bid. First Boston’s fee would have been minimized if the initial, hostile offer had been completed. The incremental-value fee, however, was to be paid for any acquisition even if the completed transaction was resisted (the contract fee was $5.5 million when Pullman was acquired at a substantially increased bid). In contrast, in the 1981 Lehman Brothers contract with Garfinckel, Brooks Brothers, Miller & Rhoads, the total-value fee was to be paid only for a transaction approved by Garfinckel’s board of directors. The contingent fees for a completed acquisition were 1% of offer value if the board approved the transaction but only $0.25 million if the board rejected it. When a higher, board-endorsed bid succeeded, Lehman’s contract fee was $2.32 million. Contract Terms: Many contracts specify payments for transactions that substitute for completion of the original offer. Target-firm contracts often include fees for asset sales that occur before, or instead of, an acquisition. These sales may alter the form or content of a friendly transaction or defend against a hostile offer. Also, fees are paid if the target successfully completes a share repurchase. Bidding-firm contracts often include fees to be paid if the bidding firm acquires target-firm assets directly, and some bidding-firm contracts in 1985 also provide for fees if the bidding firm sells shares back to the target. Contracts frequently specify that payments under one provision are to be credited against payments due under other provisions. For example, in both target- and bidding-firm contracts the minimum fee is often credited against any contingent fee. For target firms, fees for asset sales are usually credited against any fee for a subsequent acquisition. In some contracts, payment of fees under more than one provision is prohibited, and occasionally a maximum is set for all compensation. Maximum limits on fees are binding for very few offers in the sample, however. Some firms hire more than one investment banker, as did Hasbro Ind. Inc. in its 1984 friendly offer for Milton Bradley. Hasbro had a fee contract of $0.20 million plus 0.5% of transaction value with Bear Stearns and a contract of 0.5% of transaction value with Finance. Many contracts extend beyond the tender offer. For example, target-firm contracts often state that the fee will Additional
4A chi-square test for differences significant at the 0.001 level.
in contract
use between
the hostile
and nonhostile
groups
is
226
R.M. McLaughlin, Investment-banking contracts in tender offers
paid for any acquisition target- and bidding-firm ing merger as if they customarily indemnify arising from the offer.
within a specified period, such as one year, and both contracts typically treat shares acquired in an ensuwere acquired in the tender offer. Finally, firms their investment bankers against any legal liability
5. Contract incentives
With over 80% of the typical investment banker’s fee contingent on the offer outcome, the contracts create powerful incentives that influence how bankers provide services to their client firms. The bankers’ services fall into three categories: (i> prior search - locating potential bidders or targets, (ii) effort - working to complete offers, seeking higher bids, defending against hostile offers, and negotiating, (iii> ofSer evaluation - advising on bidding strategy, on the offer price, and on the accept/reject decision, and evaluating the potential for competitive bids. Consistent with client-firm interests, most contracts support prior search and some types of banker effort. In three areas, however, contract incentives can create conflicts with the interests of either firm management or shareholders: 1) nearly all contracts may lead bankers to recommend bargaining positions that are less than ideal for shareholders, 2) bidding-firm contracts provide no incentives for the investment banker to minimize the price paid, and 3) target-firm contracts in hostile offers frequently contain incentives for the target firm’s banker to complete a hostile transaction. 5.1. Contract features supporting client-firm interests Prior Search: Investment bankers often ‘pitch deals’ to prospective clients in return for being retained if the firm decides to pursue the offer. All three contract forms support this prior search, since they are all transaction-specific. For bidding firms, fee contracts are always written for a specific target firm. Although target fees usually cover transactions with any bidder, the contracts are always written in connection with a specific offer. Thus by awarding the contract the firm rewards a banker for locating a potential target or bidder. Effort : Typical contracts provide effort incentives consistent with basic firm objectives. Bidding firms typically use shares-based fees, motivating their bankers to complete the transaction. Total-value fees induce target-firm bankers not only to complete the initial offer but also to seek out higher bids. Incremental-value fees lead target-firm bankers to secure an increase in the
R.M. McLaughlin, Investment-banking contracts in tender offers
227
bid as a condition of completing any transaction. Only fixed fees provide no effort incentives, and they are used infrequently. The sharp increase in fees for an acquisition results in payoffs to the banker that are discontinuous in firm value at the outcome of the offer. Such contracts may encourage better banker effort. Bankers bear the entire cost of their efforts but receive only a fraction of the marginal benefit, so nonlinear fees may be required for best-effort incentives. Determining whether the contracts actually provide best-effort incentives, however, would require both detailed knowledge of the factors influencing each offer and richer models of optimal behavior. Ogler Evaluation : Once the fee is determined, and if advice is given with zero marginal cost, fixed fees are consistent with best evaluation by the banker. Since these fees contain no incentives, they create no conflicts of interest. 5.2. Contract features potentially in conflict with client-firm interests Effort: Contingent contracts do not always provide compatible effort incentives. For example, in only two hostile offers in the sample do bankers for target firms have incentives to maintain the target’s independence. In many hostile offers the banker’s fee is higher if a rejected bid succeeds than if no transaction takes place. Thus, the target firm’s investment banker frequently has a substantial incentive to complete an offer that the firm’s management continues to resist. If resistance is not simply a bargaining tactic, these contracts are clearly in conflict with management interests. If target management is acting for shareholders, the contract incentives conflict with their interests as well. If there are agency issues between shareholders and managers, such incentives may be consistent with the interests of target-firm shareholders even if they are incompatible with management’s stated objectives. The contract provisions do not always favor shareholders’ interests over those of managers, however. The two hostile-offer contracts with contingent fees only if the target stays independent would clearly favor an entrenched management acting for itself at the expense of shareholders. In the typical biddingfirm shares-based fee contract, the banker has an incentive to complete the transaction but no incentive to minimize the price paid. This may be in the interests of a management team seeking to maximize firm size, but does not support the shareholders’ interest in acquiring the target at the lowest possible price. The effect is heightened for bidding firms using total-value fees. These create direct incentives for the banker to increase the price paid. Q@r Evaluation: Models of bargaining in tender offers are not sufficiently well developed to determine the optima1 bargaining strategy for a firm in a
228
R.M. McLaughlin, Inues~menf-banking contracts in tender offers
given offer. For this reason it is impossible to judge whether a contract provides appropriate rewards to bankers in a specific case. Since contingent contracts misalign the payoffs to banker and client firms, however, they create the potential for conflicts of interest in the banker’s evaluation of the offer, with different contingent contracts misaligning payoffs in contrasting ways. For example, a critical part of evaluating an offer for a target firm is determining the ideal amount of resistance. Even if a target wants to be acquired, it may use resistance as a bargaining tactic. Since optimal resistance is so difficult to determine, the target could give in too easily by accepting too low an offer, or hold out too long, thus losing the best offer available. Instead of aligning banker and shareholder interests, target fee contracts bias bankers either to accept an offer too soon (total-value fees) or to hold out too long (incremental-value fees). In the Kidder Peabody total-value contract with Transway International described in section 4, Kidder was to be paid $0.35 million plus 1% of acquisition value. The $0.35 million represented only 0.19% of Transway’s estimated stand-alone value.5 Since Kidder was to receiver 1% of firm value for an acquisition but only 0.19% of firm value otherwise, failure to complete a transaction is proportionally five times worse for Kidder than for Transway’s shareholders. The potential conflicts from this misalignment are illustrated by a simple numerical example shown in table 5, panel A that assumes: the total-value fee is $0.4 million for no transaction or 1% of offer value for an acquisition; the stand-alone value of the firm is $200 million; the initial offer is $220 million; if the initial offer is accepted, the offer is completed with probability 1.0; and if the offer is rejected, a $250 million offer is completed with probability 0.7 and no transaction takes place with probability 0.3. With these assumptions, shareholder expected value is maximized if the initial offer is rejected ($235 million to $220 million), but expected value for the investment banker is higher if the offer is accepted ($2.20 million to $1.87 million). This misalignment is common to all total-value fee contracts in the sample. The no-transaction fee is always a much lower percentage of the target’s stand-alone value than the acquisition fee is of the firm’s acquisition value. The total-value fee may lead the banker to recommend that the target firm accept too low an offer, in an effort to ensure a completed transaction. At an extreme, the banker might prefer an acquisition at a price substantially below the pre-offer value of the target firm to failure to complete a transaction. The effect is heightened with a shares-based contract. Since the banker receives no direct benefit from a price increase, the contract provides no incentive to ‘The stand-alone value is estimated of the tender offer.
by the market
value one month
before
the announcement
229
R.M. McLaughlin, Inuestment-banking contracts in tender offers Table 5
Illustrations of the potential conflicts of interest between investment banker and target firm that may result from misalignment of the fees paid to bankers and the payoffs to common shareholders. Figures are in millions of dollars. Expected
value ($ millions)
if the offer is: Rejected
Accepted Panel A: Conflict with a total-oalue fee
The example assumes: a total-value fee of $0.4 million for no transaction or 1% of offer value for an acquisition; the stand-alone value of the firm is $200 million; the initial-offer value is $220 million; if the initial offer is accepted, the offer is completed with probability 1.0; and if the offer is rejected, a $250 million offer is completed with probability 0.7 and no transaction takes place with probability 0.3. Expected value to the target firm
$220
Expected value to the investment banker = $2.20
(0.01X220) = $1.87
(0.7X250) + (0.3X200) = $235 (0.7)(0.01X250)
+ (0.3X0.4)
Panel B: Conflict with an incremental-value fee The example assumes: the incremental-value fee is $0.5 million for no transaction or 6% of offer value above $250 million for an acquisition; the stand-alone value of the firm is $220 million and the initial-offer value is $250 million; if the initial offer is accepted, the offer is completed with probability 1.0; and if the initial offer is rejected, a $300 million offer is completed with probability 0.2 and no transaction takes place with probability 0.8. Expected value to the target firm
$250
Expected value to the investment banker
$0.5
(0.2X300) + (0.8X220) = $236 (0.2XO.O6X30~-25C0
+ (0.8X0.5)
risk a reduction in the probability of a transaction by advising the target-firm to hold out for a higher price. Incremental-value fee contracts create a contrasting problem. For example, in the 1982 offer for Giddings and Lewis described in section 4, Goldman Sachs’s fee increased from the minimum of $0.3 million to $3.28 million when the bid increased from $25 to $30. A 25% increase in value for Giddings’ shareholders meant a fee increase of over l,OOO% for Goldman Sachs. Because a contingent fee is paid only for a transaction at an increased price, the banker may recommend that the target firm hold out too long, rejecting good offers in an attempt to secure a higher bid. This potential conflict is illustrated by the example in panel B of table 5, which assumes: the incremental-value fee is $0.5 million for no transaction or 6% of offer value above $250 million for an acquisition; the stand-alone value of the firm is $220 million and the initial-offer value is $250 million; if the initial offer is
230
R.M. McLaughlin, Investment-banking contracts in tender offers
accepted, the offer is completed with probability 1.0; and if the initial offer is rejected, a $300 million offer is completed with probability 0.2 and no transaction takes place with probability 0.8. Shareholder expected value is highest if the offer is accepted ($250 million to $236 million), but the investment banker’s expected value is maximized if the offer is rejected ($1.0 million to $0.5 million). For bidding-firms, shares-based fees may lead bankers to urge the firm to increase its bid no matter how high the current offer, since a higher offer may increase the probability that the transaction will be completed. The banker has no incentive to maximize the expected value of the surplus to the bidding firm, only the probability of acquisition. These incentives may also pressure bidding-firm bankers to base an analysis of target-firm value on assumptions that support an offer above a competing bid. Since there are few independent checks to use in evaluating such advice and since mistakes take so long to manifest themselves, these contract incentives potentially accentuate the problem of the winner’s curse. 5.3. Alternative contracts
Alternative contract forms could eliminate many of the potential conflicts of interest between banker and client. For example, a total-value contract paying the same percentage of firm value for no transaction and for an acquisition aligns payoffs to bankers and shareholders. Such a fee effectively gives the banker an equity position in the firm and eliminates potential conflicts of interest in offer evaluation. Making the fee linear in firm value might, however, entail a trade-off of effort incentives for evaluation incentives. The incentives for target-firm bankers to complete resisted offers could be eliminated by limiting payment of contingent fees to board-approved acquisitions. With this provision, the banker has no incentive to work against the interests of the target-firm board and has substantial incentives to arrange and/or complete an acquisition of which the target-firm management approves. This provision is found in some, but not all, target-firm contracts in hostile offers. The board-approval provision is beneficial even if managers’ fear of shareholder lawsuits under the business judgment rule is influencing contract terms.6 For example, target-firm management may not want to appear to reject all offers out of hand; by requiring board approval it signals its intent to evaluate future offers. Also, the risk of contract manipulation against bankers is minimal. Since fees represent such a small percentage of offer value, it is unlikely that the target firm’s board would alter its public position on an offer simply to reduce the banker’s fees. 6For a discussion
of the business
judgment
rule, see Gilson
(1986, ch. 14).
R.M. McLaughlin, Investment-banking contracts in tender offers
231
For bidding firms, an alternative contract incorporating pricing incentives is a fee that is contingent on acquisition and is also a decreasing function of offer price, that is, a ‘reverse’ total-value fee. Such a fee motivates the banker to manage the offer so as to maximize the surplus to the bidding firm and more closely aligns the interests of banker and bidding-firm shareholders. Although disclosing the terms of such a contract would reveal important information about the bidding firm’s reservation price, that is not a restriction on the use of the contract. The SEC does not require disclosure of specific contract terms in Schedule 14d filings and in some offers bidding firms have disclosed only that the fee is ‘based on offer value’. Several arguments may explain why these alternative contract forms are not often used. First, investment bankers may be more easily controlled by other means, for example, through reputation. Second, contractual incentive problems may simply reflect unresolved conflicts of interest between shareholders and management. In that case, the observed contracts do not suggest that either shareholders or management consistently have the upper hand. A third possibility is that observed contracts are designed primarily to control effort and that client firms do not really use investment bankers’ offer evaluations. However, market knowledge - the ability to ‘price the deal’ - is generally understood to be an area of banker expertise, and at least anecdotal evidence exists that client firms rely on their bankers’ advice.7 For example, Robert Campeau, CEO of Campeau Corp., attributed the decision to increase his bid for Federated Department Stores by $500 million at least in part to the advice of his investment bankers.’ 6. Summary and conclusions Investment-banker fees calculated from fee contracts for a sample of tender offers are much smaller than is commonly believed. Fees for target-firm bankers average $4.2 million (0.77% of acquisition value) and the average for bidding-firm bankers is $2.7 million (0.56% of acquisition value). Total fees average $7.96 million (1.29% of acquisition value). The disparity between the fees reported in the business press and the sample averages is primarily due to three factors: financing and underwriting fees are excluded from calculation of the sample advisory fees, fees increase with the value of the offer, and fees vary widely for offers of similar value. Because the press typically includes financing fees in its totals and concentrates on unusually large offers with extreme fees, the reported fees far exceed the sample averages. Although this study shows that investment-banker advisory fees are typically ‘For bankers’
perceptions
of their abilities,
‘Wall Street Journal, 9 Jan., Federated, see Kaplan (1989).
1990,
p.
see Eccles and Crane
1. For
a discussion
(1988).
of Campeau’s
acquisition
of
232
RX
McLaughlin, ~nvesfme~f-banking contracts in tender offers
substantially lower than the levels implied in press reports, it does not analyze whether the fees are excessive or whether they result from substantial market power or from competitive pricing. The fees are substantially contingent on offer outcome, giving investment bankers substantial incentives to complete a transaction. Further, provisions in target-firm contracts motivate bankers to seek a high price. The contracts create potential conflicts of interest, however, between banker and client. These fees are used despite the existence of alternative contracts that would eliminate or substantially reduce the potential conflicts, suggesting either that our understanding of the contracting process between firm and investment banker in tender offers is incomplete or that the contracts can be improved. References Baron, David P., 1979, The incentive problem and the design of investment banking contracts, Journal of Banking and Finance 3,-157-175. Baron. David P.. 1982. A model of the demand for investment banking advising and distribution services for new issues, Journal of Finance 37, 955-976. Baron, David P. and Bengt Holmstrom, 1980, The investment banking contract for new issues under asymmetric information: Delegation and the incentive problem, Journal of Finance 35, 1115-1138. Beatty, Randolph P. and Jay R. Ritter, 1985, Investment banking, reputation, and the underpricing of initial public offerings, Journal of Financial Economics 15, 213-232. Eccles, Robert G. and Dwight B. Crane, 1988, Doing deals: Investment banks at work (Harvard Business School Press, Boson, MA). Gilson, Ronald J., 1986, The law and finance of corporate acquisitions (Foundation Press, Mineola, NY). Hayes, Samuel L., A. Michael Spence, and David Van Praag Marks, 1983, Competition in the investment banking industry (Harvard University Press, Cambridge, MA). Hertzberg, Daniel, 1985, Advice in the Revlon brawl wasn’t cheap - Fees in takeover fight will establish record, Wall Street Journal, 8 Nov., 6. Kaplan, Steven R., 1989, Campeau’s acquisition of Federated: Value destroyed or value added?, Journal of Financial Economics 25, 191-212. Mandelker, Gershon and Artur Raviv, 1977, Investment banking: An economic analysis of optimal underwriting contracts, Journal of Finance 32, 683-694. Petre, Peter, 1986, Merger fees that bend the mind, Fortune 113, 18-30. Ritter, Jay R., 1985, The choice between firm commitment and best effort contracts, Working uaoer (University of Pennsylvania, Philadelphia, PA). Smith; Clifford W., 1977, Alternative methods for raising capital: Rights versus underwritten offerings. Journal of Financial Economics 5, 273-307. Smith, Clifford W., 1986, Investment banking and the capital acquisition process, Journal of Financial Economics 15, 3-29. Thackray, John, 1986, The great trade robbery, Management Today, March, 80-84, 114.