1. 1 Initial Offer Precision and M&A Outcomes Matti Keloharju Aalto University and Harvard Business School with Petri Hukkanen, Aalto University

2. 2 Story

3. Motivation Consider two alternative list prices for a house: $1000,000 vs. $1020,000 Setting a round list price may elicit smaller counteroffers and lead to an ultimately lower deal price Why? List price serves as an anchor Precision is a signal of confidence in valuation People are hardwired to communicate with round numbers, unless they have reason to be precise Recipients interpret precise numbers in the same way

4. Research idea Apply recent social psychological research to the financial market: Precise opening price leads to less price adjustment Janiszewski and Yu (2008), Thomas, Simon, and Kadiyali (2010), Mason et al. (2013), Zhang (2013), Lotchelder, Stuppi, and Tröschel (2014) M&A is an ideal application: Economic significance: lots of deals, big transactions The behavior of each party and deal outcome are clearly documented in public databases Observing stock market response gives external validation for the precise-bid strategy

5. Research questions 1. Are bids precise? 2. Do imprecise (i.e. round) initial bid prices affect: A. Price revision from initial offer price to final price? Round prices signal willingness to revise offer B. Likelihood that the initial bidder will win the deal? Potential competing bidders may view round bids as less informed, which may attract competition Round bids may be a signal of low acquirer competence C. Announcement reaction for the initial bidder? 1) Target more likely to accept offer 2) At cheaper price 3) Cash bids tend to elicit a positive price reaction 3. Do senior investment bankers say they prefer precise bids?

6. Caveat Data environment does not allow randomization of treatments Cannot be sure that our results do not suffer from some endogeneity biases But: It is nearly costless to make a precise bid (relatively to making a round bid) Minimize the effect of omitted variables by controlling for all the usual suspects All deal and firm characteristics we use as controls are known at the time of the first bid

7. Data Cash offers made on publicly listed US-based targets in 1985-2012 Exclude repurchases, recapitalizations, restructuring, and joint ventures Exclude offers with bid price lower than $5 per share Focus on cash bids because: Initial bids are observable only for cash bids Do not need approval from bidder shareholders, which means they are more likely to be bidder driven Data from SDC, CRSP and Compustat

8. 8 Research question 1: Are bids precise?

9. Are bids precise? Distribution of decimals

10. Are bids precise? Distribution of last digit, conditional on price per share being divisible by one dollar

11. Are bids precise? No! About one half of all bids divisible by one dollar About 5/6 of all bids divisible by quarter If precise offers give an edge to the initial bidder, few bidders are taking advantage of this edge Using precise bids to bluff about the precision of the valuation signal must be rare

12. 12 Research question 2: What are the effects of precise bids?

13. Bid precision and likelihood to win the deal N=1769

14. Bid precision and price adjustment N=260

15. Bid precision and acquirer announcement reaction N=308

16. Regression setup Explain various M&A outcomes with non-overlapping initial bid precision dummies and standard controls Omitted bid precision category: precision greater than one quarter Controls: Tender offer, hostile offer, inverse price, horizontal offer, premium, public acquirer, toehold, ln(transaction value), volatility (relative offer price change specification only), relative size (market reaction specification only)

17. Bid precision and price adjustment N=260

18. Interpreting price adjustment coefficients Coefficient for $5 precision variable: 10.1% Coefficient for $1 precision variable: 7.6% Median transaction value: $254 million Unconditional probability for price change: 18.2% For the median company, making a bid at $5 level is associated with 10.1% x 18.2% x $254 million = $4.7 million higher expected purchase price than making it at precision greater than one quarter For the median company, making a bid at $1 level is associated with 7.6% x 18.2% x $254 million = $3.5 million higher expected purchase price than making it at precision greater than one quarter

19. Alternative outcomes Is precision also significantly related with: Likelihood of competing offers? Dummy for whether the price changes? Time to close the deal? Target stock market reaction? No! No evidence that favorable outcomes would be outweighed by unfavorable outcomes. If anything, evidence from these alternative outcomes support the evidence from the main outcomes.

20. 20 Research question 3: Do investment bankers say they prefer precise bids?

21. Do investment bankers prefer precise bids? Evidence from semi-structured interviews Approached 10 senior bankers or ex-bankers Interviewees have on average 14 years of M&A experience 6 bankers work or have worked in a bulge-bracket bank The interview lasted on average 23 minutes

22. Interviewees’ bid precision preferences N = 10

23. Why didn’t investment bankers say they prefer precise bids? Because they hadn’t thought about the issue! Round bids constitute the cognitively least costly option: Market practice Only one banker had a strong preference for precise bids He was the only respondent to have the same story in his mind as us

24. 24 Conclusion

25. Implications for bidding Virtually costless to change bid precision from round to precise If all firms did so, the information content of precision would go to zero However, as long as this does not happen, and targets do not fully internalize bidders’ bluff, bidders can expect to benefit from making precise bids

26. Conclusion Most bidders express the initial offer price per share at round terms This practice is associated with the following unfavorable outcomes for the acquirer: Higher purchase price for shares Lower probability to complete the deal Lower announcement reaction Many experienced investment bankers seem to be unaware of the merits of precise bids

27. 27 Additional slides

28. Why do bidders tend to make round bids? A behavioral explanation and supporting literature People tend to communicate with round rather than precise numbers Baird et. al 1970), Dehaene and Mehler (1992), Jansen and Pollman (2001) Precise expressions are more likely to be used when communicators have more confidence in what they say Channel (1994), Yaniv and Foster (1995), Goldsmith, Koriat, and Weinberg- Eliezer (2002), Welsh, Navarro, and Begg (2011) These tacit norms also apply to negotiations involving sophisticated parties and high stakes Mason (2013), Kobak et al. (2012), Klimek et al. (2012)

29. Why do targets interpret precise bids differently? A behavioral explanation and supporting literature A recipient generally assumes that the given information is as informative as required, but no more than that Grice (1975) Recipients consider precise offers more informed and are more likely to rely on what they convey Zhang and Schwartz (2013), Schley and Peters (2013), Jerez-Fernandez, Angelo, and Oppenheimer (2013)

30. Descriptive statistics Outcome variables

31. Descriptive statistics Control variables

32. Bid precision and likelihood to win the deal N=1769

33. Bid precision and likelihood to win the deal Control variables

34. Bid precision and and price adjustment Control variables

35. Bid precision and acquirer announcement reaction N=308

36. Bid precision and acquirer announcement reaction Control variables

37. Do investment bankers prefer precise bids? Assessing bankers’ preference for precision The interviewees were asked to assume advising the acquirer in a pure-cash offer for a public target They were then asked whether they would advise their client to make an initial offer at the price of $15.00 (round bid) vs. $15.20 (precise bid) If necessary, a third offer price option of $14.80 (precise bid) was introduced The bankers’ preference for precise bids was assessed on a five-point scale

38. Many bankers have not thought of bid precision Only 1 of the bankers exhibited a strong preference for precise bids. He had the same story as us in his mind. The 2 bankers with a weak preference for precise bids could not properly explain the reason for their preference without being helped. 7 bankers either preferred round offers or did not prefer either type. 3 bankers had discussed bid precision with their colleagues. 0 bankers were aware of the academic literature on the effect of bid precision on negotiation outcomes.