Determinants of premiums on self-tender offers.
In perfect capital markets, all securities of equal risk are perfect substitutes, so the number of shares traded for a particular security has no effect on its value. A change in the price of a security due solely to buying or selling pressure creates a profitable arbitrage opportunity, which cannot exist in a frictionless trading environment because arbitrageurs will instantly exploit it. In actuality, however, capital markets are not perfect, and studies of events that result in an imbalance between the supply of and demand for a particular firm's shares suggest that stock prices may be less than infinitely elastic. Investors may have private valuations of the stock that differ from the market consensus, resulting in an upward-sloping supply curve for a firm's shares.
Taxes are an example of a market imperfection that can cause investors to have different reservation prices. The effects of capital gains taxes on investor behavior have been a concern in the finance literature since the early 1960s. (1) Stulz (1988), Brown (1988), Brown and Ryngaert (1992), and Bagwell (1991, 1992) discuss the effect of capital gains taxes on investors' reservation prices in responding to various types of tender offers, and conclude that taxes are likely to be a major cause of heterogeneous reservation prices. (2) Shareholders with unrealized capital gains require a premium to tender their shares because tendering causes the tax to come due.
Studying fixed-price tender offers may be informative because these offers are typically much larger than open market transactions. Our data show that the mean (median) share repurchase tender offer is for 24.7% (17.3%) of the firm's shares. Self-tender offers generally include a sizable premium over the pre-announcement price of the firm's shares. Presumably at least part of this premium is based on the bidder's assessment of the elasticity of the supply curve for the shares. (3) A portion of the premium may also be unrelated to stock price elasticity, if the bidding firm anticipates that the announcement per se will convey new information to the market, thereby changing investors' assessments of the stock's value. (4)
This study examines the determinants of offer premiums for a sample of fixed-price tender offers from 1970 through 1999. We investigate the extent to which the offer premiums for these tender offers are explained by both tax-related and non-tax variables. Specifically, we ask the question "What factors do managers consider in setting the offer price for a share repurchase tender offer?" We find that offer premiums are influenced by the pre-offer share price, the marginal investor's estimated cost basis in the stock, the pre-offer performance of the stock, firm size, and the information content of the offer (i.e., the shares' post-offer appreciation). Specifically, we find that a variable combining the cost basis and tax rate is negatively related to the offer premium. This finding supports the notion that the investor's exposure to capital gains taxes is an important determinant of tender premiums. In addition, we find that smaller firms offer higher premiums, that firms with positive pre-offer stock performance offer smaller premiums, and that post-offer appreciation is positively related to the premium offered.
We also investigate the possibility that the objectives of self-tender offer vary among firms. Sixty-five percent of the offers in our sample are oversubscribed, and on many occasion they are hugely oversubscribed, whereas the other 35% are undersubscribed. We investigate two possible explanations for the frequent occurrence of oversubscription. First, we consider the possibility that oversubscribed offers are due to random variation in tender rates and/or errors in setting the offer price. Alternatively, we consider the possibility that offer prices are selected to cause the offer to be oversubscribed. Based on a logit analysis of over- versus under-subscription, we conclude that some tender offers may be oversubscribed by design.
The following section describes the population of share repurchase tender offers from 1970 through 1999. Section II explains the methodology of the study, Section III reports the findings, Section IV examines the oversubscription issue, and Section V summarizes our conclusions.
I. Fixed-Price Self-Tender Offers
Share repurchases are thought to be made by managers with private information that their firm's shares are undervalued (Dann, 1981). Three methods commonly used by firms to repurchase shares are fixed-price tender offers, Dutch auction tender offers, and open market repurchases. (5) This study examines whether fixed price self-tender offer premiums are related to stock price elasticity. That is, we assume that the managers of repurchasing firms, and the investment bankers who advise them, are informed about both the value of the stock and the elasticity of the supply curve for the firm's stock, and that they utilize this information to set the prices for tender offers (thereby determining offer premiums).
We study fixed-price self-tender offers announced between 1970 and 1999. The data for tender offers from 1970 through 1984 are from Hertzel and Jain (1991) and, for offers from 1978 through 1991, from Nohel and Tarhan (1998). (6) We supplement these data with additional announcements of self-tender offers found using the Lexis Nexis and the Securities Data Corporation (SDC) databases. We require that information about the firm be available in the Center for Research in Security Prices (CRSP) database. We eliminate tender offers when the date of the public announcement cannot be confirmed, when the offer is motivated by a merger or by a takeover threat, or when the information about the terms of the offer is insufficient for our purposes. In addition, tender offers that appear to have negative offer premiums and those pertaining to ADRs, Shares of Beneficial Interest, and Units are deleted, which eliminates five observations. The resulting sample includes 399 fixed-price tender offers to repurchase shares.
Table I shows summary information about the firms in our sample. Panel A contains data for the entire sample. The mean market capitalization of firms repurchasing their shares is roughly the same as the mean capitalization of all CRSP firms. The marked difference between the mean and median market values of repurchasing firms indicates that, although the sample includes some very large firms, most of the firms repurchasing shares are smaller. Panel B shows these data for five-year sub-periods. From 1995-1999 the average repurchasing firm is much smaller than the average firm, but from 1975-1995 the average repurchasing firm is much larger than the average firm. The number of fixed-price self-tender offers averages about 16 offers per year from 1970 to 1989, but, on average, only eight offers per year occur in the 1990s. This pattern may be due to higher stock prices in the 1990s and, possibly, to the increased use of both Dutch auction tender offers and open market share repurchases in more recent years. (7)
Table II provides summary information about the 399 self-tender offers. The first column of numbers shows data for the entire sample. The average (median) offer seeks to purchase $89 ($11) million of common stock, which is 24.7 (17.3)% of the shares outstanding at the time of the offer. The mean (median) offer premium, measured as the percentage by which the offer price exceeds the stock price ten days before the announcement of the offer, is 24.7 (20.6)%. The announcement of the offer results in an average (median) market-adjusted return of 13.3 (10.7) % during the three trading days around the day of the announcement (i.e., from days -1 to + 1). The cumulative mean market-adjusted returns for the forty trading days around the date of the announcement of the tender offer are shown in Figure 1. The market-adjusted return is computed by taking the return on each stock minus the return on the CRSP equal weighted index for each day. Although very small positive returns begin to occur on Day minus 5, it is evident that most of the price reaction is concentrated in the three days surrounding the announcement. The pattern of returns shown in Figure 1 is remarkably similar to that reported by Dann (1981) for 143 share repurchases via fixed-price tender offers that took place from 1962 through 1976.
[FIGURE 1 OMITTED]
The last three columns in Table II show data for three sub-periods during which different tax rates on capital gains are in effect. Tax Regime I is from 1970 to 1978, when the average tax rate was 34.80/0. (8) Tax Regime II includes 1978 to 1981 and 1987 to 1997, periods when the tax rate on capital gains was 28%, and Tax Regime III covers from 1981 to 1986 and from 1997 to 1999, when the tax rate was 200/0. (9) Although the average percentage of shares sought in the self-tender offers is larger in Tax Regimes II and III, tender offer premiums are lower, which is consistent with taxes on capital gains influencing the premiums offered in self-tender offers. Table II also reveals a number of differences between self-tender offers during Tax Regime I and the other two (later) time periods. Both the dollar size of the share repurchases and the percentage of the outstanding shares sought are larger during the later periods, and the reaction of the stock price to the announcement of the offers is much smaller.
This section presents a simple theoretical model of the tendering decision and describes the linear regression that we use to investigate the determinants of tender offer premiums.
A. Theoretical Model
Investors will only tender their shares if the after-tax proceeds from doing so exceed the value of the alternative to tendering (i.e., simply continuing to hold their shares). (10) The ex ante financial consequence of not tendering one's shares is to continue to own shares with a value equal to the firm's expected stock price after the offer expires. Accordingly, the [k.sup.th] investor will tender her shares at the offer price ([P.sub.Offer]) when:
(1) [P.sub.Offer] - ([P.sub.Offer] - [C.sub.k])([tau]) > E([P.sub.Post-offer])
where [C.sub.k] is the investor's cost basis in the shares and t is the tax rate, so that ([P.sub.Offer] - [C.sub.k])([tau]) is the amount of tax that will have to be paid, and E([P.sub.Post-offer]) is the expected value of the shares after the repurchase offer expires. (11) Equivalently, the investor will tender when:
(2) [P.sub.Offer](1 - [tau]) + [C.sub.k]([tau]) > E([P.sub.Post-offer])
(3) [P.sub.Offer] > E([P.sub.Post-offer]) - [C.sub.k]([tau])/(1-[tau])
B. Empirical Model
We use a linear regression model to investigate the effect of firm characteristics, the size of the offer, and various tax-related variables, on offer premiums for fixed-price self-tender offers. We estimate following regression equation:
[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII.]
where the alphas are regression coefficients. The expected sign of each coefficient is shown in parentheses.
The dependent variable, [Premium.sub.it], is the offer premium (in dollars) for a particular tender offer i at time t. We measure the offer premium in dollars because the firm's managers express the offer price (and, equivalently, the offer premium) in dollars rather than, for example, as a percentage of the market price. Premium, is defined as the amount by which the offer price exceeds the pre-offer price of the firm's shares, where the pre-offer price is measured as the closing stock price ten trading days before the tender offer is announced.
The first independent variable is the pre-offer price of firm i's shares ten days before the tender offer is announced, [Price.sub.it]. Using the price ten days before the announcement eliminates any effect of anticipatory pre-announcement trading from the firm's pre-offer share price (see Figure 1). The pre-offer share price is included in the regression, in part, to control for the effect of scale, because the offer premium is measured in dollars. Ceteris paribus, we might expect to observe larger dollar premiums in tender offers for higher priced stocks and vice versa. For example, if a typical percentage premium for a tender offer is 20%, the premium would be $20 on a $100 share of stock, but only $4 on a $20 share of stock. The coefficient on [Price.sub.it] can be thought of as the average percentage offer premium for the offer in our sample before considering the effect of the other independent variables.
The second independent variable is the percentage of the shares outstanding being sought in the tender offer, Sought,, which is included in the announcement of the offer. We hypothesize that the premiums observed for tender offers are positively related to the proportion of shares being sought. That is, if the supply curve for the firm's shares is inelastic, then acquiring relatively more of the outstanding shares requires paying a higher price to attract shares that would not otherwise be tendered. Therefore, this variable will be significant if there are important non-tax sources of share price inelasticity. (12) In addition, [Sought.sub.it] will be significant if offers for larger proportions of the firm's shares convey more information about the anticipated post-offer value of the shares, in effect shifting the supply curve for the shares.
The third independent variable in Equation (4) is the average ddaily volume of trading in the firm's shares as a percentage of the shares outstanding ([TradeVol.sub.it]) from forty trading days before the announcement to ten days before the announcement. This variable indicates the normal day-to-day liquidity of the firm's stock in the marketplace. We expect offer premiums will be inversely related to liquidity. In addition, tender offer premiums may also be lower for stocks that trade more often because investors' cost bases will be closer to the stocks' current market values. Thus, there are two reasons to expect a negative coefficient on [TradeVol.sub.it].
The next independent variable is the cost basis of the shares times the ratio of the tax rate on capital gains to one minus the tax rate on capital gains, or [CostBasis.sub.it][([TaxRate.sub.t])/(1-[TaxRate.sub.t])]. This variable corresponds to the term [C.sup.k]([tau])/(1-[tau]) in our model of an investor's decision to tender or not to tender (Equation 3). [CostBasis.sub.it] is an estimate of the original cost of the marginal share that must be tendered by investors in order for the number of shares tendered to equal the number of shares sought. We estimate [CostBasis.sub.it] from closing stock prices and daily trading volumes preceding the tender offer. (13) Our estimate of the marginal shareholder's cost basis is the closing price of the stock on the day when the cumulative historical trading volume equals the number of shares sought in the tender offer. Since [CostBasis.sub.it] is determined, in part, by the number of shares sought, it captures the effect of [Sought.sub.it] on the tendering investors' tax status. This procedure implicitly assumes that the firm's shareholders at the time of the tender offer all purchased their shares during the period immediately preceding the offer, and that the shareholders with the highest cost bases are the ones who will tender their shares. Clearly, both assumptions are simplifications, so our estimate of the cost basis is only an approximation of the relevant investors' cost bases. However, it may provide a better measure of the cross sectional variation in investors' cost bases than simpler measures that assume that all of the firm's shareholders have exactly the same cost basis (e.g., the average stock price during some arbitrary period preceding the announcement). (14) [TaxRate.sub.t] is the maximum tax rate on capital gains in effect at the time of the tender offer.
The fifth independent variable in the regression is the percentage of the shares of firm i owned by institutional investors at the time the tender offer is announced, [InstOwn.sub.it]. This variable may be related to the tax-status of the firm's shareholders because some institutional investors, such as foundations and university endowments, are tax exempt. Others are tax-advantaged compared to individual investors; i.e., they pay a lower rate on income from capital gains and/or are able to defer the payment of taxes on capital gains (e.g., pension funds). In addition, many investment companies have been shown to be more concerned with pre-tax returns than with after-tax returns, even though capital gains realized by open-end mutual funds are taxable to their individual investors. (15) We, therefore, hypothesize that tender offer premiums may be inversely related to institutional ownership, because many institutional investment managers have little or no tax disincentive to tendering their shares and thereby realizing a capital gain. (16) Data regarding institutional ownership are from the Standard and Poors Stock Guide.
The next variable, [FirmSize.sub.it], controls for any relation between the size of the firm and tender offer premiums. Vermaelen (1981) observes that larger announcement returns are associated with smaller firms for tender offers from 1962-1977, suggesting that share repurchases by smaller firms may offer larger premiums and thereby convey more information about the firm's future prospects. In later studies, Lakonishok and Vermaelen (1990) and Comment and Jarrell (1991) also report an inverse relation between firm size and offer premiums for self-tender offers. Based on these studies, we hypothesize that the coefficient on this firm size will be negative. We measure [FirmSize.sub.it] as the logarithm of the market value of the firm's equity at the time of the offer.
We also examine the effect of firm's pre-offer stock market performance on the level of the offer premium. Pre-offer performance, [Perform.sub.it], is measured as the price of the firm's stock thirty trading days before the tender offer divided by the price of the firm's stock 500 trading days before the offer. Both Lakonishok and Vermaelen (1990) and Comment and Jarrell (1991) report an inverse relation between pre-offer stock performance and offer premiums, so we anticipate a negative sign on this variable.
Finally, the expected post-offer share price is relevant to the investor's decision whether or not to tender her shares (see Equation 3) and, therefore, to the manager's decision regarding the price of the tender offer. We include the post-offer price appreciation of the firm's shares ([PostApprec.sub.it]) divided by one minus the capital gains tax rate, [TaxRate.sub.t], as an independent variable to determine if the anticipated re-valuation of the shares is built into the tender offer premium. Actual post-offer price appreciation serves as a proxy for expected appreciation. [PostApprec.sub.it] is measured as the share price ten days after the expiration of the offer minus the pre-offer share price. Ceteris paribus, we expect the coefficient on this variable to be positive, for two reasons. First, the offer premium informs the market about the extent of undervaluation perceived by firm management. Second, as shown in Equation (3), investors tender their shares when doing so is more profitable than continuing to hold them, so the offer premium should be positively related to the post-offer share price.
Including post offer price as an independent variable in Equation (4) raises a question about the direction of causality. Studies by Vermaelen (1981) and Comment and Jarrell (1990) report an association between offer premiums and announcement period returns, and infer that the former are a determinant of the latter. Offer premiums affect announcement period returns because they create an opportunity for arbitrage while the offer remains in effect. That is, so-called risk arbitrageurs will purchase shares in the open market and then tender them to the repurchasing firm if the difference between the market price and the offer price is large enough for this trading to be profitable. (17) Such arbitrage transactions causes offer premiums to affect announcement returns, but such transactions have no effect on post-offer returns. Our interpretation is that the manager's private information is one determinant of the premium that he decides to offer, and that post-offer price appreciation reflects the information content of the tender offer. We report our results with and without the post offer price variable, however, in view of this question regarding the direction of causality.
We estimate the parameters of Equation (4) for 243 fixed-price self-tender offers that took place from 1970 through 1999. The number of observations in the regression analysis is smaller than the total of 399 self-tender offers identified during the period, because the data needed to compute the cost basis variable and/or information regarding institutional ownership are not available for 84 firms. In addition, we eliminate offers with no expiration date reported and offers where the shares no longer trade following the expiration of the offer (generally leveraged buyouts). The final sample is 243 tender offers.
A. Summary Statistics
Summary statistics regarding the offers used in the regression analysis are shown in Table III. The mean (and median) size of the tender offers in the regression sample is much larger than in our initial population of 399 tender offers (See Table II). Apparently the additional data requirements eliminate primarily smaller firms. The regression sample is otherwise representative of the larger sample in terms of the percentage of the firm's share being sought in the offer, offer premiums, and announcement returns.
The mean and median offer premiums are $4.27 and $2.75, compared to a mean and median pre-offer share price of $23.91 and $15.38, respectively. The firm's mean and median daily trading volumes are trivial compared to the proportion of shares being sought in the tender offers. The mean and median values of the variable representing [C.sub.k]([tau])/(1-[tau]), the product of the estimated cost basis and the capital gains tax rate divided by one minus the tax rate, are $10.96 and $7.36. The mean institutional ownership of the firms in our sample is 21% of the outstanding shares, whereas the median institutional holding is about 13%. Although institutions hold a large proportion of the shares of some of the firms in our sample, the relatively small median holding indicates smaller institutional holdings in most of the firms. The mean (median) size of the regression firms is $689 ($89) million, compared to the mean (median) size of $554 ($58) million for the 399 repurchasing firms shown in Table I. The mean and median pre-offer performance of the firms' stock is positive, as is the post-offer price appreciation in their stock. The mean (median) post-offer appreciation is about 16 (15)% of the mean (median) pre-offer share prices. Apparently, firms that use fixed-price tender offers to repurchase their shares subsequently perform well, at least in the short run, a finding consistent with the notion that share repurchases convey positive information to the market about the firm's prospects. (18)
B. Regression Results
Table IV shows the results of two regression analyses. The first column of numbers shows the regression results without the post-offer appreciation variable, and the second column shows the results with this independent variable included. The coefficients on the pre-offer share price (largely a scalar variable), the investors' cost basis, the pre-offer return on the firm's shares, firm size, and the post-offer appreciation in the firm's shares (a measure of the private information conveyed by the offer), have the expected sign and are significant at the .05 level or higher. After accounting for the effects of tax liabilities and information content on investors' reservation prices, we do not find support for the idea that offer premiums are set by managers who believe that the supply curve for their firm's shares is fundamentally inelastic and upward-sloping. The adjusted [R.sub.2]'s of the regressions without and with the post-offer appreciation variable are 79% and 88%, respectively.
The significant negative coefficient on the investor's estimated cost times the tax rate divided by one minus the tax rate supports the hypothesis that tender offer premiums are affected by investors' capital gains tax liabilities. The negative coefficient on firm size in Model 1 indicates that, ceteris paribus, smaller firms offer higher premiums when they repurchase shares. Firm size also has a negative coefficient in Model 2, but it is not significant (t = -1.37). Smaller firms may be more likely to be undervalued than larger firms due to both information asymmetries and a lack of information and/or a following by analysts and investors (see Merton, 1987). Differences in the amount of information available about large and small firms may explain the higher offer premiums found for small firms. Atiase (1985) documents that market participants have more information about larger firms. Dann (1981) and Vermaelen (1981) suggest that self-tender offers are a signaling phenomenon, and smaller firms may have more to signal about undervaluation than do larger firms.
We also find a negative coefficient on the firm's pre-offer stock market performance, a finding that indicates that firms whose stock has been doing well offer smaller premiums and vice versa. This result may be related to the firm's motivation for a share repurchase. Prosperous firms may repurchase shares to distribute free cash flow to their shareholders. This motive may affect their choice of a tender price and result in lower offer premiums. There is evidence that firms use share repurchases as a substitute for cash dividends, especially for temporary free cash flows. (19) Conversely, it is possible that managers of firms that have not been doing well perceive that their firms are undervalued, and that this perception motivates them to repurchase shares. This hypothesis is consistent with Dann's (1981) depiction of share repurchases as a signaling phenomenon.
Contrary to expectations, institutional ownership has a positive effect on offer premiums, although the coefficient is not significant at the .10 level. We hypothesized the opposite effect because institutions are tax advantaged and, therefore, have less of a disincentive to tendering their shares. Although it is generally thought that institutional investors favor share repurchases, (20) the only evidence that institutions sell their shares into self-tender offers is the positive association between institutional holdings and tendering rates reported by Brown and Ryngaert (1991). We investigate this issue further by examining institutional holdings for the three months before and after the month the tender offer is announced. (21) Table V shows both percentage institutional holdings and the number of institutions holding shares. The mean and median percentage institutional holding is roughly constant from Month -3 to Month -1 and both increase markedly following the month of the repurchase announcement. The mean and median numbers of institutions owning shares in the repurchasing firms increase following the self-tender offer. (22) The positive relation between offer premiums and institutional holdings in the regression is less surprising in view of the results in Table V, where we find no evidence that institutions sell their shares in response to self-tender offers. Institutions may prefer that firms use free cash flow to repurchase shares, compared to the alternatives, but they are not necessarily inclined to tender their own shares in such offers.
The coefficient on the proportion of shares being sought in the offer is positive, but it is not statistically significant. Therefore, after separately considering the effects of tax liabilities and information content on investors' reservation prices, we find no support for the idea that non-tax sources of price inelasticity are important. Comment and Jarrell (1991) also find no significant relation between offer premiums and the percentage of shares sought in self-tender offers. Finally, the coefficient on daily trading volume is not significant. Historical trading volume may not be a relevant measure of liquidity for tender offers that, on average, seek to acquire almost 25% of the firm's outstanding shares.
In summary, the basic regression Model (1) indicates that offer premiums are determined by investors' cost bases, a finding that supports the hypothesis that tax liabilities affect investors' reservation prices and, therefore, stock price inelasticity. We also find a significant negative relation between offer premiums and firm size in Model 1. One interpretation of this finding is that information asymmetry is lower for larger firms; so, for these firms, undervaluation may less frequently be a motive for repurchases. Market participants generally have more information about larger firms. We report an inverse relation between offer premiums and the performance of the firm's stock during the two years preceding the tender offer. We conjecture that this result may also be related to lower information content. Firms that have been doing well may repurchase shares to distribute temporarily excess free cash flow to their shareholders, rather than to signal undervaluation.
When we add a proxy for the amount of private information conveyed by the offer premium--the post-offer appreciation in the firm's shares--as an independent variable, we find that it is positively and significantly related to the offer premium. The increase in the value of the firm following share repurchases likely results from nonpublic information conveyed to the market by the announcement of the terms of the tender offer. Managers already possess this nonpublic information, which affects the price at which they offer to repurchase shares. That is, managers anticipate the post-offer value of the shares when setting the offer price, and investors learn about post-offer value of the shares from the size of the offer premium. We report this extension of the analysis separately as Model 2, because the direction of causality between offer premiums and post-offer appreciation is an unresolved issue. Our interpretation of the relation between offer premiums and post-offer prices is that both offer premiums and post-offer share values include the previously nonpublic information conveyed to the market by the announcement of the self-tender offer.
The bottom line regarding the findings presented as Models 1 and 2 in Table IV is that the addition of the stock's post-offer appreciation as an independent variable does not materially affect the results of the regression analysis. That is, all of the significant explanatory variables continue to have the same sign and, except for firm size, to be significant in both models. Model 2 simply increases the explanatory power of the analysis by including another relevant piece of information.
IV. Oversubscribed Tender Offers
The preceding analysis implicitly assumes that the firm's objective in setting the tender offer price is to solicit tenders equal to the announced number of shares sought. Fixed-price share repurchase tender offers are generally oversubscribed, however. (23) Table VI contains information about the shareholders' responses to the self-tender offers in our sample. Sixty-five percent of the offers are oversubscribed. The mean and median number of shares sought is 3.02 million and 1.00 million shares, respectively, for all of the offers, whereas the mean and median number of shares actually tendered in response to the offers is 6.43 million and 1.36 million. The average offer is oversubscribed by 72%--that is, the number of shares tendered is 172% of the number of shares sought--and the median offer is 29% oversubscribed. It seems doubtful that a cross-sectional variation of this magnitude is due solely to managers being unable to accurately predict the supply curve of the firm's shareholders. In particular, a heavily oversubscribed offer means that the premium offered for the shares was unnecessarily large. If the firms' objective is simply to acquire the number of shares sought, we would expect them to miss on the low side more often than they do, and to miss on the high side by a narrower margin. That is, the firm incurs a direct cost when offers are oversubscribed because the offer premium is unnecessarily high, whereas there is no explicit cost when an offer is undersubscribed.
Two possible explanations for offers being oversubscribed come to mind. If the offer price is designed, on average, to solicit the number of shares being sought, oversubscribed offers are due to random variation in tendering rates and/or to errors in price-setting. Alternatively, for some offers, the offer price may be intentionally chosen to cause the offer to be oversubscribed. For example, a heavily oversubscribed offer in which the firm repurchases only the number of shares originally sought, results in a pro rata distribution among shareholders that greatly resembles a dividend except that it is more favorably taxed than a cash dividend. Table VI indicates that oversubscribed self-tender offers are generally heavily oversubscribed, a finding consistent with the "dividend substitution" scenario. The percentage oversubscription data show that the mean and median shares tendered in these offers are 231% and 180% of the number of shares sought. These offers are oversubscribed by such a wide margin that a pro rata purchase of shares tendered may have been the objective in setting the offer price.
Table VI also shows data for offers that are undersubscribed. In a typical undersubscribed offer, the firm receives tenders of approximately 70% of the number of shares sought, so the margin by which offers are undersubscribed is very different from the magnitude by which they are oversubscribed. The firm is obligated to purchase all of the shares tendered. (24) It appears that undersubscribed offers may be due to either mispricing by managers, where they underestimate the size of the offer premium required to solicit tenders of the number of shares sought, or to investors having different private valuations of the shares than managers. A third possibility is that managers intentionally underprice some tender offers because they are seeking to repurchase undervalued shares at a "bargain" price. In this case, however, they might be more likely to use an open market repurchase than a fixed-price tender offer.
Table VII shows descriptive statistics for the 243 firms in our sample categorized according to whether or not the tender offer is oversubscribed. The average percentage of shares sought is significantly lower for oversubscribed offers. The mean (median) offer premium is higher for oversubscribed offers, and the differences are significant at 1 (5)% level. On average, firms with oversubscribed offers are smaller than those with undersubscribed offers. In addition, the average post-offer appreciation is higher for oversubscribed offers, but the median post-offer appreciation is lower. Most of the other variables do not differ significantly between over- and under-subscribed offers, and those variables that do differ are not related in any obvious way to the offer's reception by the firm's shareholders.
We examine the reception of self-tender offers by estimating a logistic model where the dependent variable is whether or not the offer is oversubscribed. We estimate the following model:
(5) [Oversubscribed.sub.it] = [PHI] [[[beta].sub.0] + [[beta].sub.1] [Premium.sub.it] + [[beta].sub.2] [Price.sub.it] + [[beta].sub.3] [Sought.sub.it] + [[beta].sub.4] [TradeVol.sub.it] + [[beta].sub.5] [CostBasis.sub.it] ([TaxRate.sub.t]/ 1-[TaxRate.sub.t]) + [[beta].sub.6] [InstOwn.sub.it] + [[beta].sub.7] [FirmSize.sub.it] + [[beta].sub.8] [Perform.sub.it] + [[beta].sub.9] ([PostApprec.sub.it]/1 - [TaxRate.sub.t])]
where the dependent variable, [Oversubscribed.sub.it], has a value of 1 if the offer is oversubscribed and 0 otherwise, O is the logistic cumulative density function, and the independent variables are as defined earlier. As in the regression analysis, we estimate the marginal effects of the variables in Equation (5) both without and with [PostApprec.sub.it]. The results of these logistic models are shown as Models 1 and 2, respectively, in Table VIII.
If some offers are intentionally designed to be oversubscribed, offer premiums will be empirically related to the incidence of oversubscription and vice versa. The marginal effect of the offer premium variable in Model 1 is positive and significant, a finding that indicates that the size of the offer premium is one factor that causes an offer to be oversubscribed. This result is consistent with the hypothesis that some tender offers are designed to be oversubscribed. Several other variables in Model 1 also have a significant marginal effect on the probability that an offer is oversubscribed. Oversubscription is negatively related to both the pre-offer share price (.05 level) and the percentage of outstanding shares being sought (.01 level), and positively related to the size of the firm (.10 level). It is particularly noteworthy that smaller firms' offers are less likely to be oversubscribed, even though the regressions in Table IV (and in Table VIII below) show that they exhibit higher offer premiums. This finding is further evidence in support of the idea--already discussed in connection with Table IV--that smaller firms are more likely to be undervalued.
In Model 2, we find that post-offer price appreciation is negatively related to the probability that the offer is oversubscribed. This variable is a proxy for the amount of positive information conveyed by the announcement of the tender offer. Positive information, conveyed to the market by the terms of the offer, makes shareholders more reluctant to tender their shares, even at prices that include a premium over the pre-offer share price. The coefficient on premium is larger in Model 2 than in Model 1, but with an offsetting sign on post-offer appreciation. That is, offers that result in a large revaluation of the shares are likely to be undersubscribed despite having a high offer premium. There is no reason to believe that this under-subscription is an intended effect of the self-tender offer (e.g., post-offer appreciation may simply be due to the arrival of positive information during the offer period). The signs and marginal effects of the other significant variables in the logistic regression model are essentially unchanged when we add post-offer appreciation.
Both logistic models raise the possibility that some of the self-tender offers in our sample were designed to be oversubscribed. This observation gives rise to two questions. First, how does the presence of such offers affect the determinants of offer premiums? We address this issue by adding an indicator variable for oversubscribed offers to the regression model shown as Equation (4). The indicator variable for oversubscription equals 1 if an offer is oversubscribed and 0 otherwise. The results of this analysis are shown in Table IX. The intercepts of the Model 1 and Model 2 regressions remain positive and significant, although they are slightly lower than the intercepts reported in Table IV. The coefficient on the oversubscription variable is also positive, and it is significant at the .01 level for both models. The coefficients on this variable (1.63 and 1.60, respectively) may be thought of as the extra premium (in dollars) that managers add to cause offers to be oversubscribed. These numbers are quite large. Recall from Table III that the mean and median offer premiums for these firms are $4.27 and $2.75. There is otherwise little change in the regression results reported for the two tender offer models (i.e., Tables IV and IX). That is, all of the variables that are significant at the .05 level or higher in Table IV have the same sign and are also significant in Table IX, the coefficients are of the same magnitude, and in each case adjusted R-squared for the Model 2 regression is slightly higher.
We investigate the determinants of offer premiums in self-tender offers. Capital gains taxes can cause investors to have heterogeneous reservation prices for a firm's shares, and our results support the hypothesis that taxes are related to price inelasticity. Offer premiums are negatively related to a tax variable, and are lower when the investor's tax liability is lower and vice versa. Smaller firms offer higher premiums in share repurchases, an observation that suggests that there may be greater information asymmetry for small firms than for large firms. Offer premiums are negatively related to a firm's pre-offer share price performance. We conjecture that firms that have been doing well repurchase shares to distribute free cash flow (i.e., as a substitute for cash dividends), whereas other firms may repurchase shares to signal that their shares are undervalued. Because we find no evidence that offer premiums are related to the proportion of the firm's shares being sought in the tender offer, we conclude that share prices are not inelastic in the absence of the effect of taxes on investors' reservation prices.
The private information conveyed by an offer will partially determine the offer premium when an investor's alternative to tendering her shares is to continue to own shares valued at the post-offer share price. We use the post-offer appreciation in the firm's shares as a measure of the value of the information signaled by the offer, and find it to be positively related to the offer premium. Presumably managers consider the anticipated ppost-offer value of the share when setting the offer price and, thereby, convey this information to investors.
Sixty-five percent of the tender offers we study are oversubscribed. Moreover, the typical oversubscribed offer is oversubscribed by a wide margin--the mean number of shares tendered in these offers is 231% of the shares sought--leading us to believe that these offers are designed to be oversubscribed. We investigate this issue using a logistic model, where the dependent variable is whether or not an offer is oversubscribed. If oversubscription is due to random variation in shareholder tendering rates, then the marginal effect of offer premiums on the likelihood that an offer is oversubscribed will not be statistically significant.
We find that the marginal effect of the offer premium variable is positive and significant at the .01 level. Although this relation could be due to the influence of premiums on tendering rates, minor pricing errors are an unlikely explanation for offers being so hugely oversubscribed. The probability that an offer is oversubscribed is also negatively related to both the pre-offer share price and the proportion of shares sought. When we include a measure of the amount of information conveyed by the offer--the post-offer price appreciation--in the analysis, we find that the marginal effect of this variable on the probability that an offer is oversubscribed is negative and significant. Investors are less likely to tender their shares when offers convey important positive information about the firm's prospects.
Finally, we examine the effect of a variable indicating oversubscription on our analysis of the determinants of offer premiums, and find that the only important difference is a higher offer premium for oversubscribed offers. The magnitude of the extra premium for these offers--about $1.60--is quite large compared to the mean and median offer premiums we observe. A heavily oversubscribed share repurchase that results in a pro rata purchase of the shares tendered and a cash dividend differ primarily in the tax treatment of the distribution of cash to the firm's shareholders. Many self-tender offers may essentially be tax advantaged cash dividend payments in disguise.
Table I. Sample of Fixed-price Self-Tender Offers Market capitalization for repurchasing firms is the share price on the day of the announcement times the number of shares outstanding. Market capitalization for all firms is an average of the annual mean capitalization of firms in the CRSP value-weighted index during each sub-period, as reported by CRSP. Mean Market Capitalization of Time No. of Self- Repurchasing Period Tender Offers Firms ($ millions) Panel A. Total Sample 1970-1999 399 $554.43 Panel B. Data for 5-years Sub-Periods 1970 to 1974 72 $162.68 1975 to 1979 85 $756.86 1980 to 1984 81 $716.11 1984 to 1989 82 $537.87 1990 to 1994 33 $513.92 1995 to 1999 46 $567.43 Median Market Capitalization of Mean Market Time Repurchasing Capitalization of Period Firms All Firms ($ millions ($ millions) Panel A. Total Sample 1970-1999 $57.51 $495.16 Panel B. Data for 5-years Sub-Periods 1970 to 1974 $30.24 $200.37 1975 to 1979 $43.59 $183.58 1980 to 1984 $110.92 $277.3 1984 to 1989 $89.09 $369.72 1990 to 1994 $42.96 $597.63 1995 to 1999 $91.82 $1315.46 Table II. Characteristics of Share Repurchases (1970-1999) The dollar amount sought is the tender offer price times the number of shares sought. The percentage sought is the number of shares sought divided by shares outstanding. The offer premium is the percentage by which the tender offer price exceeds the share price 10 days before the offer. The announcement return is the market-adjusted return on the stock from days -1 to +1, where day 0 is the day the share repurchase is announced. Tax Regime I is 1970-1978, Tax Regime II is 1978-1981 and 1987-1997, and Tax Regime III is 1981-1986 and 1997-1999. Numbers in parentheses are standard deviations. 1970 to Tax Regime Characteristic Statistic 1999 I Dollar Amount Sought Mean $88.57 $25.82 (millions) ([sigma]) (255.32) (104.88) Median $10.85 $5.60 Percentage Sought Mean 24.65% 16.52% ([sigma]) (22.83) (11.80) Median 17.32% 13.11% Offer Premium Mean 24.69% 26.82% ([sigma]) (22.39) (18.33) Median 20.55% 23.46% Announcement Return Mean 13.31% 17.36% ([sigma]) (12.44) (13.00) Median 10.73% 15.41% Capital Gains Tax Rate Mean 27.87% 34.83% No. of Repurchases -- 399 125 Tax Regime Tax Regime Characteristic II III Dollar Amount Sought $106.24 $132.82 (millions) (342.88) (222.42) $14.40 $42.00 Percentage Sought 28.62% 27.97% (24.54) (27.03) 19.96% 17.57% Offer Premium 24.64% 22.41% (21.73) (26.93) 21.21% 17.65% Announcement Return 12.10% 10.60% (12.48) (10.59) 10.22% 8.80% Capital Gains Tax Rate 28.00% 20.00% No. of Repurchases 161 113 Table III. Descriptive Statistics for the Sample of 243 Firms Used in Regression Analysis Variable Mean ([sigma]) Median Dollar Amount Sought $134.53 $21.45 ($ millions) (339.7) Shares Sought (%) 21.16% 16.32% (16.9 Offer Premium (%) 24.61% 20.00% (23.1) Announcement Return (%) 11.86% 9.87% (10.8) Offer Premium ($) $4.27 $2.75 (7.6) Pre-Offer Share Price ($) $23.91 $15.38 (42.9) Trading Volume (%) 0.26% 0.13% (0.5) Cost Basis x 10.96 7.36 [(Tax Rate/(1-Tax Rate)] $ (18.99) Institutional Ownership (%) 21.18% 13.25% (21.0) Firm Size ($ millions) $688.93 $88.68 (2,771) Pre-Offer Return (%) 19.2% 8.6% (59.0) Post-Offer Appreciation/ 3.88 2.26 (1-Tax Rate) (10.23) Table IV. Regression Results for 243 Self-Tender Offers (1970-1999) Independent Variable Predicted Sign Model 1 Intercept 7.95 ** (2.47) Pre-Offer Price ($) + 0.222 *** (19.07) Shares Sought (%) + 1.56 (1.03) Trading Volume (%) - -91.93 (-1.64) Cost Basis x - -0.160 *** [Tax Rate/(1-Tax Rate)] ($) (-6.40) Institutional Ownership (%) - 1.86 (1.23) Firm Size (ln) - -0.353 * (-1.94) Pre-Offer Return - -1.00 ** (-2.53) Post-Offer Appreciation x + n.a. [1/(1-Tax Rate)] ($) Adjusted R-Squared 0.793 F-Value 133.52 *** No. of Observations 243 Independent Variable Model 2 Intercept 4.77 ** (1.98) Pre-Offer Price ($) 0.166 *** (17.34) Shares Sought (%) 1.029 (0.91) Trading Volume (%) 26.22 (0.61) Cost Basis x -0.150 *** [Tax Rate/(1-Tax Rate)] ($) (-8.02) Institutional Ownership (%) 1.16 (1.03) Firm Size (ln) -0.186 (-1.37) Pre-Offer Return -0.935 *** (-3.16) Post-Offer Appreciation x 0.306 *** [1/(1-Tax Rate)] ($) (13.73) Adjusted R-Squared 0.885 F-Value 233.62 *** No. of Observations 243 Note: The dependent variable in the regression is the tender offer premium measured in dollars. The numbers in parentheses are t-values. *** Significant at the .01 level. ** Significant at the .05 level. * Significant at the .10 level. Table V. Institutional Holding Before and After Self-tender Offers Information about institutional holdings is from the Standard and Poors Stock Guide. Data are available for 144 of the 243 firms in the regression sample. Month -3 Month -2 Month -1 Institutional Holdings: Mean 21.7% 21.5% 21.6% ([sigma]) (20.4) (20.1) (20.2) Median 14.9% 15.0% 15.3% No. of Institutions: Mean 68.6 70.4 71.2 ([sigma]) (129.3) (134.3) (135.1) Median 23.5 24.5 23.5 Month +1 Month +2 Month +3 Institutional Holdings: Mean 25.5% 25.4% 26.4% ([sigma]) (25.5) (24.9) (25.3) Median 16.4% 16.3% 18.6% No. of Institutions: Mean 78.0 72.7 72.8 ([sigma]) (159.0) (147.3) (147.2) Median 25.5 25.0 24.5 Table VI. Investors' Responses to Self-Tender Offers Oversubscribed All Offers (N = 243) Offers (N = 157) Mean Median Mean Median Shares Sought (millions) 3.23 1.00 3.74 1.00 (7.04) (8.32) Shares Tendered (millions) 6.62 1.36 9.59 2.34 (18.96) (23.13) Oversubscription (%) 72% 29% 131% 80% (183) (206) Undersubscribed Offers (N = 86) Mean Median Shares Sought (millions) 2.28 1.25 (3.56) Shares Tendered (millions) 1.31 0.59 (1.75) Oversubscription (%) -33% -30% (26) Note: The numbers in parentheses are standard deviations. Table VII. Descriptive Statistics for Undersubscribed versus Oversubscribed Firms Oversubscribed Dollars Sought (millions) Mean $146.95 Median $20.00 Shares Sought (%) Mean 18.75% Median 15.58% Offer Premium (%) Mean 26.36% Median 21.74% Announcement Return (%) Mean 11.19% Median 9.21% Offer Premium ($) Mean $5.01 Median $2.88 Pre-Offer Share Price ($) Mean $25.24 Median $16.00 Trading Volume (%) Mean 0.25% Median 0.14% Cost Basis x Mean 10.98 (Tax Rate/(1-Tax Rate)) Median 7.48 Institutional Ownership Mean 22.24% Median 14.57% Firm Size ($ millions) Mean $675.82 Median $91.89 Pre-Offer Return (%) Mean 1.204 Median 1.087 Post-Offer Appreciation x Mean 4.04 (1/(1-Tax Rate)) Median 1.74 Observations 157 Undersubscribed p-value Dollars Sought (millions) $70.18 0.1863 $17.50 0.5856 Shares Sought (%) 25.55% 0.0581 17.35% 0.3950 Offer Premium (%) 21.43% 0.0333 17.40% 0.1190 Announcement Return (%) 13.07% 0.3124 10.33% 0.1323 Offer Premium ($) $2.92 0.0032 $2.00 0.0223 Pre-Offer Share Price ($) $21.47 0.3507 $12.94 0.3060 Trading Volume (%) 0.27% 0.0180 0.10% 0.0362 Cost Basis x 10.93 0.6455 (Tax Rate/(1-Tax Rate)) 6.89 0.6255 Institutional Ownership 19.24% 0.2474 12.53% 0.6255 Firm Size ($ millions) $712.84 0.0221 $55.78 0.3060 Pre-Offer Return (%) 1.172 0.4660 1.086 0.8256 Post-Offer Appreciation x 3.58 0.0218 (1/(1-Tax Rate)) 2.88 0.0135 Observations 86 Note: The p-values are for the Kruskal-Wallis (median) test for differences in means (median) between undersubscribed and oversubscribed self-tender offers. Table VIII. Logistic Regression Results for Self-Tender Offers Independent Variable Model 1 Model 2 Intercept -0.7182 -0.7218 (0.150) (0.159) Premium ($) 0.0572 *** 0.0784 *** (0.000) (0.000) Pre-Offer Price ($) -0.0087 ** -0.0095 ** (0.020) (0.015) Shares Sought (%) -0.6662 *** -0.6553 ** (0.006) (0.010) Trading Volume (%) 8.6177 4.6698 (0.338) (0.648) Cost Basis x Tax Rate ($) -0.0001 0.0015 (0.989) (0.851) Institutional Ownership (%) -0.0816 -0.0757 (0.722) (0.748) Firm Size (ln) 0.0510 * 0.0501 * (0.070) (0.077) Pre-Offer Return 0.0259 0.0353 (0.658) (0.553) Post-Offer Share Appreciation n.a. -0.0227 ** (0.009) Pseudo R-squared 0.1015 0.1242 No. of Observations 243 243 Note: The dependent variable takes a value of 1 if the offer was oversubscribed and 0 otherwise. *** Significant at the .01 level. ** Significant at the .05 level. * Significant at the .10 level. Table IX. Regression Results with Oversubscription Indicator Variable Independent Variable Predicted Sign Model 1 Intercept 7.72 ** (2.45) Oversubscription (Dummy) + 1.63 *** (3.48) Pre-Offer Price ($) + 0.219 *** (19.24) Shares Sought (%) + 2.45 (1.63) Trading Volume - -95.58 * (-1.74) Cost Basis x - -0.152 *** [Tax Rate/(1-Tax Rate)] ($) (-6.19) Institutional Ownership (%) - 1.93 (1.31) Firm Size (ln) - -0.411 ** (-2.52) Pre-Offer Return + -0.976 ** (-2.52) Post-Offer Appreciation x n.a. [1/(1-Tax Rate)] ($) Adjusted R-Squared 0.803 F-Value 123.88 *** No. of Observation 243 Independent Variable Model 2 Intercept 4.55 * (1.97) Oversubscription (Dummy) 1.60 *** (4.68) Pre-Offer Price ($) 0.164 *** (17.79) Shares Sought (%) 1.90 * (1.73) Trading Volume 22.40 (0.55) Cost Basis x -0.142 *** [Tax Rate/(1-Tax Rate)] ($) (-7.88) Institutional Ownership (%) 1.23 (1.14) Firm Size (ln) -0.243 * (-1.86) Pre-Offer Return -0.910 *** (-3.21) Post-Offer Appreciation x 0.305 *** [1/(1-Tax Rate)] ($) (14.30) Adjusted R-Squared 0.894 F-Value 221.08 No. of Observation 243 Note: The dependent variable in the regression is the tender offer premium measured in dollars. The numbers in parentheses are t-values. *** Significant at the .01 level. ** Significant at the .05 level. * Significant at the .10 level.
We are grateful to the anonymous referee for suggestions that greatly improved the article.
(1) Holt and Shelton (1961) and Sprinkel and West (1962). Constantinides and Scholes (1980), Constantanides (1983), and Dyl (1979) demonstrate the optimality of postponing taxable gains as a general rule.
(2) In a related study of investors' reservation prices, Klein (2001) demonstrates that price inelasticities due to capital gains taxes explain the reversals in stock returns reported by DeBondt and Thaler (1985).
(3) Hodrick (1999) presents evidence that stock price elasticity affects corporate financial decisions.
(4) Dann (1981) and Vermaelen (1981).
(5) Tender offers commit the firm to purchase a certain number of shares, whereas announcements of open market repurchases can be viewed more as an option to repurchase (Ikenberry and Vermaelen, 1996).
(6) We are grateful to Mike Hertzel and Tom Nohel for providing these data.
(7) Comment and Jarrell (1991) report that by 1989 there were more Dutch auction self-tender offers than fixed-price self-tender offers.
(8) During this period, the maximum capital gains tax rate varied from a low of 30.2% (1/10/70-12/31/70) to a high of 35.0% (1/1/72-10/30/78). During 1971 the maximum rate was 32.5%.
(9) Tax rates were verified using Hoerner (1992), the Research Institute of America database, and other sources.
(10) We ignore the investors' third alternative, which is to sell their shares in the open market prior to the expiration of the tender offer. This action has the same tax consequences as tendering the shares.
(11) This simple model of the investor's decision implicitly assumes that she will be able defer taxes indefinitely. Otherwise, the left side of Equation (1) would be the present value of the expected after-tax proceeds from selling the stock in the future.
(12) Equation (4) contains no direct proxies for non-tax share price inelasticity. If managers are less likely to purchase large amounts of stock when they anticipate that a large premium will be required, the coefficient on [Sought.sub.it] will be biased towards zero.
(13) For each firm, historical daily trading volume and closing stock price are recorded until the cumulative historical daily trading volume equals the number of shares outstanding. These data are then arranged in descending order by stock price.
(14) For example, Brown and Ryngaert (1992) use the share price 250 trading days before a tender offer as an estimate of shareholders' cost bases.
(15) See Barclay, Pearson, and Weisbach (1998).
(16) Although institutional investors are frequently assumed to be tax advantaged, we are aware of no evidence regarding their proclivity to tender shares in response to repurchase offers.
(17) Lakonishok and Vermaelen (1990) report sizeable abnormal returns from this trading strategy.
(18) Other studies report similar findings; e.g., Dann (1981) and Vermaelen (1981). In addition, Lakonishok and Vermaelen (1990) report profits from buying shares when a self-tender offer is announced, tendering the shares, and subsequently selling in the open market any shares not taken in the offer.
(19) See Guay and Harford (2000) and Jagannathan et al. (2000).
(20) See Bartov et al. (1998).
(21) Data for the three months preceding and following the month of the announcement are available for 144 of the 243 firms in the regression sample.
(22) Other studies also report that institutions purchase shares in firms that engage in stock repurchases (Grinstein and Michaely, 2002).
(23) We are grateful to the referee for pointing out this issue and suggesting that we explore it further.
(24) This is true for the firms in our sample, which includes only offers that were completed. Some tender offers specify that the offer is canceled if the number of shares tendered is less than the number sought.
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Anne M. Anderson is an Assistant Professor of Finance at Lehigh University. Edward A. Dyl is a Professor of Finance at the University of Arizona.
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|Author:||Anderson, Anne M.; Dyl, Edward A.|
|Date:||Mar 22, 2004|
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