Tender Offers and Leverage

We examine the role of leverage in tender offers for widely held firms. Leverage allows raiders to appropriate part of the value gains arising from takeovers, hence reducing the takeover premium and mitigating the free-rider problem. Leveraged takeovers may thus be profitable even if target shareholders are dispersed. Bankruptcy costs, incentive problems on the part of the raider, and defensive leveraged recapitalizations and asset sales by the target management all limit the raider's ability to borrow, thus shifting takeover gains to target shareholders and reducing the takeover likelihood. While bankruptcy costs are a social cost, the takeover premium is merely a wealth transfer to target shareholders. As the raider does not maximize social welfare, he uses too much debt compared to the social optimum.