Sold below value? Why some targets accept very low and even negative takeover premiums.

Although many studies acknowledge negative premiums, there exists no theoretical or dedicated empirical analysis of the phenomenon. In our sample of 1,937 US mergers (1995 to 2011), 8.4 percent of all targets received offers with negative premiums where the initial bid undercuts the pre-announcement market price. We theoretically show that target overvaluation, market liquidity and ‘hidden earnouts’, where target shareholders participate in the bidder’s share of joint synergies, can explain negative premiums. The theory for negative premiums also generalizes to very low premiums (VLPs), which include positive premiums. Empirical tests provide substantial support for explanations pertaining to overvaluation and hidden earnouts. As discriminating hypotheses we predict and confirm that target shareholders' market reaction to negative premiums with hidden earnouts (with overvaluation) is positive (negative). Relative size and method of payment play an important role. When a big target is paid with stock, a combination of hidden earnouts and VLPs can be the only way for the bidder to prevent loss of control. Our explanations for VLPs predict lower values for most premiums below the median and thus apply to a significant proportion of the takeover market.