DETERMINANTS OF THE BLOCK PREMIUM AND OF PRIVATE BENEFITS OF CONTROL

Enrique Schroth and Rui Albuquerque
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Enrique Schroth: University of Lausanne

No 655, 2008 Meeting Papers from Society for Economic Dynamics

Abstract: We study the determinants of private benefits of control using data on negotiated block transactions. We estimate structurally the block pricing model in Burkart, Gromb, and Panunzi (JF, 2000), acknowledging the significant presence of both block premia and block discounts in our sample. The evidence supports the BGP model, where the block is traded either at a premium or a discount depending on how competitive the block seller can be in opposing a potential tender offer for the target's stock. We find that private benefits represent 3% to 4% of the target firm's stock market value. Our estimation approach allows us to measure the efficiency with which private benefits are extracted: we find that on average, each $1 of private benefits costs shareholders $2 of equity value. Private benefits increase with the target's cash holdings and decrease with its short term debt. Moreover, the elasticities of private benefits to cash holdings and short term debt are consistently almost equal to each other (in absolute value), providing strong support for Jensen's free cash flow hypothesis. Further, the effect of cash on private benefits is stronger if the target's cash is higher than the acquirer's cash. Private benefits decrease with the target's size and increase with its past performance and proportion of intangible assets. Acquirer's overpay an average of 7% of the target's stock price relative to the BGP benchmark. We use our structural estimation to conduct a counterfactual policy evaluation of the Mandatory Bid Rule. Our results suggest that the Mandatory Bid Rule fails to add value to shareholders because it fails to prevent welfare decreasing transactions and deters welfare increasing transactions by forcing inefficient tender offers.

Date: 2008
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Working Paper: Determinants of the Block Premium and of Private Benefits of Control (2008)
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