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Takeover Premia and Leverage: Theory, Empirical Observations and Recommendations

Abstract The greater a target company’s leverage, the less cash or shares an acquirer needs to control the target enterprise. Given the benefits of acquiring a target, the equity takeover premium is spread over relatively more assets in a more highly leveraged target, thus reducing the premium paid relative to the entire enterprise. This suggests that more levered targets may receive greater equity premia, expressed as a percent of the unaffected share price, other things equal. To test this, we examine takeover transactions that occurred during the 2003–2013 time period. We find that higher equity takeover premia are related to higher pre-deal leverage levels, consistent with theory. Our results are robust with respect to size, industry, profitability, year of transaction, synergy potential, and type of acquirer (strategic, horizontal or financial). Our empirical analyses support the Appraisal Foundation Working Group’s recommendation for best practices, namely, to adjust takeover premia for leverage.