The Impact of Go‐Shop Provisions in Merger Agreements

• Date: 01 March 2017
• Author: Sridhar Gogineni,John Puthenpurackal
• DOI: http://doi.org/10.1111/fima.12146
• Published date: 01 March 2017

The Impact of Go-Shop Provisions

in Merger Agreements

Sridhar Gogineni and John Puthenpurackal∗

We examine whether go-shop provisions in merger agreements are used to benefit target share-

holders or for agency/entrenchment reasons. We find that go-shop provisions are more likely in

deals involving the negotiation selling method, financial buyers and all cash financing, and in

targets with less valuation uncertainty. We confirm that go-shops have a positive association

with the initial offer premium. Results suggest that deals with go-shop provisions are more likely

to have a competing bid and an upward revision of the initial offer premium. Collectively, our

results indicate that go-shops are effectivecontractual devices used to further target shareholder

interests.

The board of directors and management of target firms have a fiduciary duty to obtain the

highest possible price for their shareholders during corporate takeovers. Target firms typically

employ either an auction or negotiation selling method (Boone and Mulherin, 2007a). In auc-

tion deals, the prepublic takeover process involves contacting several potential bidders, signing

confidentiality/standstill agreements, and accepting private bids (Boone and Mulherin, 2007b).

In negotiation deals, however, the target engages with only one bidder in the prepublic takeover

process.1Using either selling method, the target board negotiates with the bidder(s) and if an

acceptable price is obtained from a bidder, a definitive merger agreement is signed and a public

announcement is made. Typically, after the public announcement of a merger agreement, target

boards do not actively solicit new bids, although unsolicited superior bids can still be considered.

In this paper, westudy the impact of go-shop provisions in merger agreements that signif icantly

alter the selling process of target firms. In deals with a go-shop provision, the target firm is allowed

to actively solicit other bids during a “go-shop” period of typically 30 to 45 days starting on the

day of the public announcement of a merger agreement with a particular bidder. Most deals with

go-shop clauses also include target termination fee clauses. If a successful bidder emerges during

the go-shop period, the go-shop clause allows for a reduced targetter mination fee, typically50%

to 60% of the termination fee, which lowersthe cost of ter minating the initial deal. Differenttypes

of merger clauses have been studied in the prior literature (Bates and Lemmon, 2003; Officer,

Weare grateful to Raghavendra Rau (Editor) and an anonymous refereefor helpful comments and suggestions. Wewould

like to thank Suman Banerjee, Louis Ederington, Chitru Fernando, Ben Gilbert, Bill Megginson, Sanjay Ramchander,

AlexandreSkiba, and seminar or conference participants at Colorado State University,the University of Wyoming, Oregon

State University,and the Oklahoma Research Conference for helpful comments and suggestions. Sridhar Gogineni would

like to thank the University of Wyomingfor financial assistance. John Puthenpurackal acknowledges financial assistance

through a summer researchgrant from the Lee Business School at UNLV.

∗Sridhar Gogineni is an Assistant Professor in the Department of Economics & Finance at the College of Business at

the University of Wyoming,Laramie, Wyoming. John Puthenpurackal is a Professorin the Department of Finance at Lee

Business School at the University of Nevada – Las Vegas in Las Vegas, NV.

1Although auctions appear to be a more transparent demonstration of fiduciary duty, properly structured negotiation deals

have been shown to produce similar target returns (Hansen, 2001; Povel and Singh, 2006; Boone and Mulherin, 2007a).

Consistent with this, Aktas, de Bodt, and Roll (2010) find evidence that even in the absence of explicit competition, latent

competition in negotiation deals results in higher bid premiums.

Financial Management •Spring 2017 •pages 275 – 315

276 Financial Management rSpring 2017

2003; Boone and Mulherin, 2007b; Jeon and Ligon, 2011; Denis and Macias, 2013). However,

partly due to their relatively recent introduction, there has been virtually no study of go-shop

provisions with only a few business law articles examining their potential impact (Sauter, 2008;

Subramanium, 2008).2

Using a large sample of merger agreements from 2003 to 2012, we undertake a detailed

analysis of go-shop provisions to determine whether these provisions are motivated by agency

reasons or to benefit target shareholders. The agency-problem-based explanation argues that

target management secures deals with favored bidders and use go-shop provisions as window

dressing to cosmetically demonstrate fiduciary duty to shareholders. Since most deals with go-

shop provisions also havetarget termination fee clauses, new bidders face a termination fee, albeit

a reduced one, and are disadvantaged relative to the initial bidder. This could curb the bidding

interest of potentially higher value bidders to the detriment of target shareholders. Therefore, the

use of go-shop provisions motivated by agency problems implies lower bidder competition and

lower premiums to target shareholders in deals with these provisions.

The shareholder interest explanation argues that targets use go-shop provisions to improve

incentives for bidding while protecting shareholder interests. Potential bidders are more likely to

participate in the bidding process and bid aggressively if they are compensated for negotiation

costs and information externalities and perceive a timely end to the takeoverprocess. This can be

achieved through offeringbidders a f avoredposition in the takeover process and compensation for

a deal breakup. Thus, go-shop provisionscould improve incentives for bidding, while still allowing

superior bids to be solicited after the initial merger agreement. Inclusion of go-shop provisions to

further shareholder interests implies that these provisions enhance bidder competition and result

in higher premiums to target shareholders.

To determine empirical support for either explanation, we examine: 1) which firm and deal

characteristics are correlated with the use of go-shop provisions, 2) how go-shop provisions

are associated with the initial and final premiums, 3) whether go-shop provisions impact the

probability of eliciting competing bids, and 4) whether go-shop provisions affect the likelihood

and magnitude of upward revisions to the initial offer premium.

Go-shops are more likely to be ex-ante in deals involving the negotiation selling method. A

negotiation deal, while signaling a commitment to the initial bidder with no bidder competition

prior to the initial merger agreement, lacks a robust market check of a target firm’s value. In

these cases, target boards may fulfill their fiduciary duty by signing a merger agreement and

testing the transaction with a postsigning market check. Such deals likely benefit more from the

features of go-shops that make it less costly to solicit superior bids after the initial agreement

is signed. Consistent with this view, we find that go-shop provisions are more likely in deals

involving the negotiation selling method. We also find that target firms associated with lower

agency related problems are more likely to incorporate go-shop provisions inmerger ag reements.

This is inconsistent with an agency explanation and consistent with a target shareholder interest

explanation.

Next, we examine the effect of go-shop provisions on initial offer premiums. Initial offer

premiums and contract provisions, such as a go-shop, are likelyto be jointly determined during the

negotiations betweenthe bidder and the target.3After taking into account the endogenous nature of

2Go-shops have also been coveredin the business press. For example, an article in The New YorkTimes on February 28,

2011 by Andrew Sorkin titled “Go Shop Can Be a FigLeaf for a Deal to Hide Behind” suggests that some go-shops are

merely “window dressing” intended to subvert a true auction and enrich management.

3In the presence of a go-shop provision, the strategy of the initial bidder could be: 1) incorporate the likelihood of a

competing bid due to the go-shop provision and providea lower initial bid to maintain a margin of safety to subsequently

Gogineni & Puthenpurackal rThe Impact of Go-Shop Provisions 277

go-shop provisions and initial premiums, wef ind that initial premiums are higher in deals with go-

shop provisions as compared to deals without go-shop provisionsproviding support to shareholder

interest as motivation to use these provisions. Further, the market reacts more favorably to the

inclusion of go-shop provisions in merger agreements. Cumulative abnormal returns (CARs)

around the merger announcement date are higher for go-shop deals when compared to no go-

shop deals.

Consistent with the shareholder interest explanation, we find that deals with go-shop provisions

are more likely to attract competing bids (henceforth referred to as deal jumping) after the

initial merger agreement. Results suggest that the inclusion of go-shop provisions increases the

probability of attracting a competing bid by approximately 73.3%.4This higher incidence of

competing bids in go-shop deals translates into economically meaningful revisions to initial offer

premiums. The results suggest that the initial offer price is revised upward in 19.3% of deals

with go-shop provisions compared to 6.37% of deals without go-shop provisionsand, on average,

the magnitude of offer price increase is 4.06% and 1.06% in deals with and without go-shop

provisions, respectively. These price revisions ultimately result in target shareholders in go-shop

deals receiving final premiums that are no lower than those received by targetshareholders in no

go-shop deals. The above benefits of go-shops appear to occur primarily in deals employing the

negotiation selling method.

Our results are robust to using subsamples that ex-ante are more prone to agency problems.

That is a subset of deals in the top tercile of termination fees as a percent of the transaction

value (High Agency1) following Jeon and Ligon (2011) and a subset of deals with below median

institutional ownership and below median net of market returns (High Agency2) following Bates

and Lemmon (2003). The results are also robust to using matched samples based on industry,

selling method, size, and book-to-market ratio. Overall, go-shops appear to be used in merger

agreements to balance the need to improve the incentivesfor bidding and not discourage potential

superior bids furthering target shareholder interests, on average.

The rest of the paper is organized as follows. We discuss theoretical motivations, reviewrelated

literature regarding termination fee provisions, and develop our hypotheses in Section I. Sample

selection and variables used are discussed in Section II. We present our empirical findings in

Section III and test the robustness of our main results in Section IV. We provide our conclusions

in Section V.

I. Theory, Prior Research, and Hypotheses

A. Theory and Prior Research

As discussed in Boone and Mulherin (2007b), there are two primary theories of the role

of contractual provisions in corporate takeovers. The agency problem or entrenchment theory

suggests that a provision could be used to favor the interests of management at the expense of

target shareholders. For example, a target termination provision can be used to secure deals with

match a competing bid or 2) provide a higher initial bid to deter any competing bid that could result from the go-shop

provision.

4Probability estimates are based on the coefficient estimate on the Goshop binary variable in Model 1 of Panel B,Table VII

(log odds ratio of 1.013). On a similar note, univariate results suggest that nearly13.5% of deals with go-shop provisions

attract a competing bid compared to 3.54% of deals without go-shop provisions. Loweroccur rence of competing bids in

deals without go-shop provisions is consistent with the findings of Moeller, Schlingemann, and Stulz (2007) who note

that only 4.19% of deals from 1980 to 2002 involvedcompetition by rival bidders.