Optimal toeholds in takeover contests

We offer an explanation for why raiders do not acquire the maximum possible toehold prior to announcing a takeover bid. By endogenously modeling the target firm's value following an unsuccessful takeover we demonstrate that a raider may optimally acquire a small toehold even if the acquisition does not drive up the pre-tender target price. This occurs because although a larger toehold increases profits if the takeover Succeeds it also conveys a higher level of managerial entrenchment and hence a tower firm value if the takeover fails. We derive new predictions regarding the optimal toehold and target value following a failed takeover. We also examine the impact of a rival bidder and dilution. (c) 2005 Elsevier B.V. All rights reserved.