Institutional Investors' Impact on the Terms and Outcome of Freeze-out Tender Offers

Institutional Investors' Impact on the Terms and Outcome of Freeze-out Tender Offers

Beni Lauterbach, Yevgeny Mugerman

December 07 2018

Freezeout tender offers are offers by the controlling shareholders to purchase all publically traded shares. These going-private offers are suspect. Given controlling shareholders’ superior inside information, such offers might sometimes involve attempts of controlling shareholders to buy public shares at a price that is below fair-value.

The only public investor that can potentially block the controlling shareholders’ tunneling attempts is the institutional investor. The academic literature generally accepts that institutional investors are more professional and more informed. Institutional investors also engage in some monitoring activities, and tend to suffer less than the public at large from behavioral biases.

We examine the effect of institutional investors on freezeout offer success likelihood and on accepted offers’ terms. Freezeout offers are large terminal deals that should awake even sleeping giants such as institutional investors. To further challenge institutional investors we conduct our study in an economy, Israel, where the law provides very little protection for small investors against misconceived freezeout offers. In such a setting, institutional investors’ reaction should be bolder and easier to observe. Another attractive feature of our data is that in about 35% of our sample, institutional investors do not have any holdings in the firm. This sharpens our tests by facilitating a novel analysis of the fundamental effect of mere presence of institutional investors.

Our sample comprises 201 freezeout tender offers in Israel during 2000-2016 of which 87 (about 43%) were rejected. This extraordinary high rejection rate illustrates the tough decision facing public investors in our sample. It is clear that institutional investors can make a difference in such an environment.

In general, our evidence supports the contention that institutional investors defend the small public investors. Freeze-out offers are rejected more frequently when institutional investors hold the firm. Further, in accepted offers, the offer premium is higher when institutional investors hold the firm and where there appear to be pre-negotiations between controlling and public shareholders. Interestingly, in both these findings, the effect is due to the mere presence of institutional investors. The exact level of institutional holdings and the concentration of their holdings have insignificant coefficients and negligible economic effects. It appears that the presence of even one institutional investor is a “rule breaker” or a step function. The presence of an institutional investor constraints controlling shareholders and forces them to be more considerate of the public or else offer might fail. This is our most novel and significant finding and conclusion.

 Another interesting finding is that public investors do not lose by rejecting freeze-out offers. On average, the cumulative net of market stock returns of firms with rejected offers (from offer announcement to half a year after offer rejection) exceeds the offer premium. We find though that when institutional investors are present and there are pre-negotiations between controlling and public shareholders, offer rejection hurts public shareholders (as offer premium exceeds on average the comparable net of market stock return). We conjecture that sometimes institutional investors reject fair freezeout offers just because they want to demonstrate their power to controlling shareholders. Such a strategic behavior may serve well the long-term interests of institutional and general public investor community. The possibility of strategic behavior by institutional investors should be further examined in future research.

Authors

Real name: 
Yevgeny Mugerman