A decision- theoretic model for M&A sale processes

A Work Project, presented as part of the requirements for the Award of a Masters Double Degree in Economics and International Business from the NOVA – School of Business and Economics and Insper Instituto de Ensino e Pesquisa

PRANDO, Thiago Gonzaga de Camargo Ferreira Prando. A decision-theoretic model for M&A sale processes. Dissertation (Mastership) – NOVA School of Business and Economics and Insper Instituto de Ensino e Pesquisa, São Paulo, 2016. When potential buyers receive invitations from target companies to engage in competitive M&A sale processes they face a challenging decision. Considering significant due diligence investments, target value uncertainty and unclear competitive environment, should they accept such invites? The main purpose of this study is to formulate a decision rule for prospective acquirers to enter takeover contests according to these relevant factors. In addition, this dissertation explores the formation of optimal bids in the decisive stage of controlled sales (sealed-bid auctions) with uncertain presence of one competitor. A decision-theoretic model is designed where a potential buyer (Player A) is invited to participate in an M&A sale process. Its due diligence investments are modeled as the purchase of real options and the optimal bid value is calculated according to its expected payoff maximization. The participant has incomplete information regarding the existence of rivals and their strength and takes decisions that seek robustness with respect to misspecifications. Due diligence investments decision rules are established according to Player A’s capabilities to create value through the acquisition, its beliefs regarding the potential rivalry, and required spending to analyze the target. Optimal bidding strategies ultimately depend on our participant’s beliefs concerning the potential competition. Our findings show that an uncertain strong second bidder might prevent Player A to place a higher offer. This is an exciting result that prompts re-thinking on competition’s threat. Sellers and their financial advisors should take these results into account when tailoring efficient sale processes, especially managing a proper perceived competitive environment.