Determinants of Premiums on Self-Tender Offers

Article excerpt

We investigate why firms pay a premium when making a tender offer to repurchase shares, and if the size of the premium is related to the elasticity of the supply curve for the firm's stock. We find that premiums on self-tender offers are related to characteristics of tendering firms, and to variables that are proxies both for the capital gains and for the information content of the announcement. Our results indicate that stockprice inelasticity, caused by taxes, is an important determinant of offer premiums for fixed-price self-tender offers. We also find that the information conveyed by the offer, measured by the post-expiration appreciation of the firm's stock, is contained in the tender offer premium, and that offer premiums are inversely related to firm size and to pre-offer stock performance. In addition, we present evidence that share repurchase tender offers may frequently be oversubscribed by design.

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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. …