Share Repurchase and Takeover Deterrence

Abstract

This article examines the use of share repurchase as a takeover deterrent. The main result is that in the presence of an upward-sloping supply curve for shares, the takeover cost to the acquirer can be greater if the target firm distributes cash through share repurchase than if it chooses either to pay a cash dividend or to do nothing. Because shareholders willing to tender in the repurchase are systematically those with the lowest valuations, the repurchase skews the distribution of remaining shareholders toward a more expensive pool. Examining the equilibrium behavior of all players in a stylized takeover game, conditions exist under which repurchase deters takeover. The example of capital gains taxation is then considered, when investors with different basis values impute different reservation values to their holding. Repurchase is more effective as a deterrent when it alters the marginal shareholder, when shareholder heterogeneity is large, and when the private benefit of control from takeover isn't too large.