We investigate how loan covenants associated with potential target firms affect takeover deals. We propose two possible channels. Under a discipline channel, the target firm becomes an attractive candidate for takeovers and merger deals are facilitated. Under a constraint channel, covenants hinder merger activity. We find support for the latter channel. Takeover likelihood is lower, deal failures are more common, the likelihood of price renegotiation is higher, and acquisition premium is lower when the target is bound by covenants. Covenant tightness exacerbates this effect.

Cash- and stock-financed takeover bids induce strikingly different target revaluations. We exploit detailed data on unsuccessful takeover bids between 1980 and 2008, and we show that targets of cash offers are revalued on average by +15% after deal failure, whereas stock targets return to their pre-announcement levels. The differences in revaluation do not revert over longer horizons. We find no evidence that future takeover activities or operational changes explain these differences. While the targets of failed cash and stock offers are both more likely to be acquired over the following eight years than matched control firms, no differences exist between cash and stock targets, either in the timing or in the value of future offers. Similarly, we cannot detect differential operational policies following the failed bid. Our results are most consistent with cash bids revealing prior undervaluation of the target. We reconcile our findings with the opposite conclusion in earlier literature (Bradley, Desai, and Kim, 1983) by identifying a look-ahead bias built into their sample construction.

During takeover battles, a tender offer provides a call option right to the target’s shareholders: it guarantees the offered price but maintains the chance of a higher offer. We present an options-based approach to estimate the probability and expected value of higher competing takeover bids using target stock price data. Analysing Canadian takeover battles in the period 1997 to 2007 we find that during the 5 trading days prior to the occurrence of an increased takeover bid, the estimated probability of a higher bid exceeds 80% on average and the expected value of a potential competing bid almost matches the realized value.

Takeover bids provide an option right to the target's shareholders; they guarantee the offered price but maintain the chance of higher offers. Using Option Pricing Theory (OPT) we estimate the probability and expected value of higher bids from target stock prices.