Smart Buyers

Mike Burkart, Samuel Lee

Series number :

Serial Number:

326/2012

Date posted :

January 01 2012

Last revised :

January 29 2012

SSRN

Keywords

Bilateral trade •
asymmetric information •
royalties •
cash-equity offers •
debtequityswaps •
contingent value rights •
commissions •
lemons problem

We study transactions in which sellers fears being underpaid because their outside option is better known to the buyer. We rationalize various observed contracts as solutions to such smart buyer problems. Key to these solutions is granting the seller upside participation. In contrast, the lemons problem calls for granting the buyer downside protection.

But, in either case, the seller (buyer) receives a convex (concave) claim. Thus, contracts usually associated with the lemons problem, such as debt or cash-equity offers, can be equally well manifestations of the smart buyer problem, although the two information asymmetries have opposite cross-sectional implications.

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