Do Termination Provisions Truncate the Takeover Bidding Process?

Audra L. Boone School of Business Administration

College of William & Mary Williamsburg, VA 23187

(757) 221-2954 audra.boone@business.wm.edu

J. Harold Mulherin Department of Economics

Claremont McKenna College Claremont, CA 91711

(909) 607-3141 harold.mulherin@claremontmckenna.edu

January 2005

JEL Codes: G34; K22; D44 Keywords: Takeover auctions; termination fees; stock option agreements; shareholder voting agreements

We thank Tim Burch, Bob Comment, Erik Lie, Thomas Moeller, Janet Smith, and seminar participants at Clemson University, Drexel University, the University of Iowa, and the 2004 meeting of the Financial Management Association in New Orleans for comments on prior drafts.

Do Termination Provisions Truncate the Takeover Bidding Process?

Abstract

We provide new evidence of the role of termination provisions such as

termination fees and stock option agreements in the takeover bidding process. Our

contribution is a new database on the takeover process taken from SEC documents. Using

this data, we find that termination provisions are positively related to takeover

competition and show that prior findings of an inverse relation between termination

provisions and takeover competition stem from an artificially narrow depiction of the

takeover bidding process. We also find that termination provisions are widely used

throughout 1990s and show that prior findings of time series changes in the incidence and

choice of termination provisions result from the incomplete data in sources other than

SEC takeover documents. We also find that shareholder voting agreements can substitute

for termination fees and stock option agreements and, therefore, should not be viewed by

the courts as de facto evidence of the absence of takeover competition. As a whole, our

evidence is consistent with models such as Povel and Singh (2004) in which termination

provisions do not truncate takeover bidding but instead culminate the takeover bidding

process.

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Do Termination Provisions Truncate the Takeover Bidding Process?

As emphasized by Ronald Coase (1992), there is much to be learned from the

organizational and contractual devices that are used to guide the incentives of transacting

parties. Indeed, a growing body of research under the heading of “law and finance” seeks

to understand the interaction between the legal system and the organizational features that

evolve across firms and markets (La Porta, et al. (1998)). As noted by Macey and O’Hara

(2000, p.113), the maintained hypothesis of the law and finance research is that “the

behavior of markets is a complex process that is crucially dependent on legal rules and

structures.”

An important application of law and finance research is the role played by the

termination provisions devised by targets and bidders as part of the corporate takeover

process. These provisions include termination fees that promise a specific amount of

money to the bidder and stock option agreements that grant the bidder the option to

purchase a certain fraction of the target’s common stock in the event the target is

acquired by another party. As surveyed by Roosevelt (2000), a central question in legal

and financial research is the impact of termination provisions on takeover competition: do

the provisions inhibit takeover competition and entrench target self-serving managers or

do the provisions instead promote competition by mitigating information costs and

facilitating takeover auctions? As modeled by Povel and Singh (2004), a more general

question is the role of termination provisions within the entire bidding process.

The depth and breadth of the importance of the answers to such queries has been

heightened by a recent debate in the Delaware courts on related contractual devices used

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in corporate takeovers. In the 2003 Omnicare decision, a divided court voided a

shareholder voting agreement in which two insiders owning 65 percent of a target firm

committed to vote their shares in favor of a particular bidder. The majority of the court

felt that the agreement disenfranchised minority shareholders. By contrast, the dissenting

jurists argued that contractual provisions “cannot be reviewed in a vacuum” and that the

“court should review the entire bidding process.” (See Omnicare, Inc. v. NCS Healthcare,

Inc., 818 A.2d 914, 2003 Delaware.)

To address the debate highlighted by the split judicial decision, we provide new

evidence on the role of termination provisions in the takeover bidding process. We

specifically analyze the effect of the provisions on takeover competition and more

generally consider the factors determining the structure of termination provisions and the

interaction of the provisions with other facets of takeover agreements. Our research

sequentially addresses the following four related questions:

How do termination provisions affect takeover competition?

How have termination provisions evolved over time?

What affects the choice of termination fees and stock option agreements?

How do termination provisions interact with shareholder voting agreements?

The extant empirical research on termination provisions (see Appendix A), provides

incomplete and inaccurate answers to these four questions. A primary conclusion of the

prior research is that termination provisions are associated with reduced takeover

competition. If accurate, this result would cast a dim view on termination provisions in

the eye of the courts. However, we show that this result is due to an artificially narrow

3

definition of takeover competition that fails to consider the active bidding process that

occurs prior to the public announcement of takeover agreements.

We also provide new evidence on the evolution of the incidence and choice of

termination provisions over time. Prior research by Coates and Subramanian (2000)

argues that there has been a growing incidence of termination provisions over time and

that decisions in Delaware courts have influenced the overall incidence of such

provisions as well as the choice between termination fees and stock option agreements.

We show that the prior results on the incidence and choice of termination provisions over

time are inaccurate and are related to the use of data from the Securities Data Corporation

(SDC). Using a more comprehensive database taken directly from filings at the U.S.

Securities and Exchange Commission (SEC), we find little evidence that the incidence of

termination provisions has increased over time or that judicial decisions have influenced

the type of termination provision chosen over time.

We also provide novel results on the choice between termination fees and stock

option agreements. Because much of the prior research on termination provisions has

separately focused on either termination fees (Bates and Lemmon (2003), Officer (2003))

or stock option agreements (Burch (2001)), there is little or no direct analysis of this

query. We find that an important factor affecting the choice between types of termination

provisions is whether the method of payment involves stock.

We also provide the first systematic analysis of the interaction of termination

provisions with shareholder voting agreements. The absence of prior research on voting

agreements is due in part to the fact that the 2003 Omnicare decision came after much of

the prior empirical research on termination provisions was published. Moreover, data on

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shareholder voting agreements are not readily available on sources such as SDC. Our

analysis of data from SEC filings fills this empirical void by studying the shareholder

voting agreements and other ownership arrangements that are found in the takeover

process.

The paper proceeds as follows. Section 1 describes our data set on takeovers and

termination provisions. Section 2 studies the relation between termination provisions and

takeover competition. Section 3 reports evidence of the incidence and structure of

termination provisions over time. Section 4 analyzes the choice between termination fees

and stock option agreements. Section 5 considers the interaction between termination

provisions and related contractual devices such as shareholder voting agreements. Section

6 reports multiple regression analysis that synthesizes the findings in the paper. Section 7

summarizes the paper and notes the implications of our results.

1. The Data Set

1.1 The Sample of Firms Our sample comprises 400 takeovers that were announced during the 1989 to

1999 period, roughly the same time period employed in the prior research on termination

provisions that is surveyed in Appendix A. The sample is taken mostly from the 381

completed and unsuccessful takeovers studied by Mulherin and Boone (2000). That study

began with all of the firms listed on the Value Line Investment Survey at the beginning of

1990 and tracked those firms that were the object of a takeover attempt during the 1990s.

The current sample adds 47 takeovers that were resolved in 2000 but loses 28 takeovers

from the original sample due to missing data.

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The sample of 400 takeover attempts includes 377 completed acquisitions and 23

withdrawn deals. The sample has 103 tender offers and 297 mergers. Cash was used

exclusively in 147 of the sample takeovers and some or all stock was used in the other

253 takeovers. Sixty of the takeovers began with an unsolicited offer by the bidder or a

third party.

1.2 The Data on Termination Provisions

Our analysis focuses on termination provisions granted by the target to the

bidding firm in a takeover. To determine the incidence of termination provisions, we use

the filings of the U.S. Securities and Exchange Commission (SEC). We have found this

source to be more comprehensive than the information provided by the Securities Data

Corp. (SDC), the common source used in prior research. For each takeover in our sample,

we reviewed the filings from the EDGAR system of the SEC (for takeovers in 1993 and

later) and LexisNexis and Laser Disclosure (for takeovers in 1993 and earlier).

Information on termination provisions was garnered from the 14A and S-4 filings (for

mergers) and 14D filings (for tender offers).

Table 1 reports the incidence of the termination provisions in the sample. As

reported at the bottom of the table, 246 of the sample takeovers (62 percent) have a

termination fee only, 48 (12 percent) have a stock option agreement only, and 69 (17

percent) have both a termination fee and a stock option agreement. In total, 91 percent of

the sample takeovers have a termination fee, a stock option agreement, or both. This is a

higher rate of incidence that that reported in prior research (see Appendix A), which we

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attribute to our use of the SEC filings as a data source rather than the SDC data used in

other studies.

As also reported in Table 1, the high rate of usage of termination provisions is

similar throughout the sample period. In 1989, the first year of the sample, 91 percent of

the takeovers have a termination provision, while in 1999, the last year in the sample, 98

percent of the takeovers have a termination provision. The smallest percentage of

takeovers with a termination provision is 74 percent in 1991 and the largest percentage is

98 percent in 1999.

Table 2 reports summary statistics on deal size and the use of termination

provisions. Panel A reports the mean and median deal size (in $ billion) for the full

sample, where deal size is proxied by the equity value of the target firm 21 days after the

announcement of the takeover. The mean (median) deal size is $3.23 billion ($0.92

billion). These values are relatively large, reflecting the fact that the sample comes from

firms listed on the Value Line Investment Survey. By comparison, in samples taken from

SDC, Bates and Lemmon (2003, Table 2) report a mean (median) deal value of $873

million ($136 million) and Officer (2003, Table 5) reports a mean (median) target equity

value on event day -1 of $711 million ($124 million).

Panel B of Table 2 categorizes deal size by the incidence of termination

provisions. The 246 takeovers with a termination fee only are below average in size. By

contrast, the takeovers with a stock option agreement only or with both a termination fee

and a stock option agreement are above average in size. The 37 takeovers with neither a

termination fee nor a stock option agreement are below average in size.

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Table 3 provides information on the magnitude of the termination provisions used

in the sample takeovers. In Panel A, the magnitude of the termination fee is measured by

dividing the dollar amount of the fee by deal size, as proxied by the equity value of the

target firm 21 days after the announcement of the takeover. The mean (median)

magnitude of the termination fees in the sample is 3.55 percent (3.21 percent). By

comparison, Bates and Lemmon (2003, Table 1) report a mean value of 3.3 percent and

Officer (2003, Table 2) reports a mean value of 3.8 percent. Hence, the magnitude of the

termination fees in our sample is comparable to that reported in prior research.

Panel B of Table 3 reports the magnitude of the stock options agreements in the

sample takeovers, where magnitude is the fraction of the target’s common stock that is

optioned to the bidder. The mean (median) value is 20.19 percent (19.9 percent), which is

comparable to prior research such as Burch (2001). The centering of stock option

agreements at slightly less than 20 percent is related to the rules of the NYSE and other

stock exchanges that preclude an increase in shares outstanding by 20 percent or more

without a shareholder vote (Ayres, 1990, footnote 3).

2. Termination Provisions and Takeover Competition

2.1 Theory

A central question in the debate on termination provisions is the effect that the

provisions have on takeover competition. One view is the entrenchment hypothesis which

argues that target management uses termination provisions to favor a selected bidder.

Management would gain in this scenario by facilitating job security (Kahan and Klausner

(1996)). Target shareholders, however, would lose due to less active bidding for the firm

8

(Bulow and Klemperer (1996), Schwartz (1986)). The entrenchment hypothesis predicts

that termination provisions are negatively related to takeover competition.

An alternative theory is the information/commitment hypothesis that argues that

termination provisions are used to compensate for information costs and to provide a

commitment mechanism in the takeover bidding process. As noted by several authors

(e.g., Grossman and Hart (1980), Berkovitch and Khanna (1990), Berkovitch, Bradley,

and Khanna (1989)), the time between the public announcement of a takeover and the

completion of the deal allows other possible bidders the opportunity to free-ride on the

information generated by the original bidding and negotiation. Such potential free-riding

might dampen the incentives of bidders to participate in the pre-announcement takeover

process and thereby lessen the returns to target shareholders. By providing compensation

in the event that the target is acquired by another bidder, termination provisions are a

contractual means to induce participation in the takeover process.

A complementary role of termination provisions stems from their commitment

effects. A well-known result from auction theory is that commitment is important to

maximize seller revenues (McAfee and McMillan (1987)). In the takeover setting, if

bidders do not envision an end to the bidding process, they will not bid as aggressively

(Klemperer (1998)). Termination provisions in merger agreements are one mechanism

for the target firm to commit to the end of the bidding process (Macey (1990), Thomas

and Hansen (1992), Fraidin and Hanson (1994), Povel and Singh (2004)). In contrast to

the entrenchment hypothesis, therefore, the information/commitment hypothesis predicts

that termination provisions promote takeover competition.

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2.2 Prior Empirical Research

Prior empirical research, surveyed in Appendix A, concludes that termination

provisions are associated with reduced takeover competition. In each of the prior papers,

termination provisions are found to be inversely related to public takeover auctions.

The interpretation of the empirical evidence varies somewhat across the authors

of the prior studies. Coates and Subramanian (2000, p. 389) infer support for the

entrenchment hypothesis by concluding that termination provisions protect deals from

high-valued bidders and thereby impair allocational efficiency. Burch (2001, p.139)

concurs that stock option agreements discourage competition for the target but argues that

the options improve the bargaining power of target management and enhance target

shareholder returns. For termination fees, Bates and Lemmon (2003, p.471) state that the

provisions truncate a natural bidding process. But because they find that termination fees

are not inversely related to target returns, they reject the entrenchment hypothesis. Officer

(2003, p.454) argues that any apparent competitive deterrence of termination fees is

related to other deal characteristics.

Although noting some of the information issues associated with corporate

takeovers, the existing empirical analysis provides little or no direct testing of the

information/commitment theory. One reason for this lack of analysis is the conclusion

that termination provisions are negatively related to takeover auctions. Burch (2001,

p.108), for example, expresses doubt about the relevance of theories such as Berkovitch

and Khanna (1990) and Berkovitch, Bradley, and Khanna (1989) because of his finding

that stock option agreements deter subsequent takeover competition.

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2.3 A New Measure of Takeover Competition

The finding that termination provisions are inversely related to takeover

competition appears to be at odds with the information/commitment hypothesis.

However, we show that this finding stems from the narrow definition of takeover

competition that has been used in the prior research. Rather than focus solely on public

takeover auctions as the proxy for takeover competition, we use SEC documents to

measure the private, pre-announcement bidding for the target firms in our sample.

Authors such as Bates and Lemmon (2003, footnote 2) have acknowledged that analysis

of the non-public bidding process could shed light on information/commitment theories

such as Berkovitch and Khanna (1990), but they refrained from doing such analysis due

to the absence of readily observable data. Our novel analysis of the private takeover

process allows us to more fully capture the competitiveness of takeover bidding.

Figure 1 illustrates the private takeover process that we study. Models relevant to

this process include French and McCormick (1984), Hansen (2001), Povel and Singh

(2004), and Ye (2004). The process usually begins with the private initiation of a possible

sale by the target firm and its investment bank, although it may be initiated by an

unsolicited bidder. The target decides how many firms to contact; it may contact a single

bidder or instead solicit inquiries from multiple bidders. The target then asks the selected

bidder or bidders to sign confidentiality/standstill agreements. These agreements facilitate

the sharing of non-public information but have a quid pro quo that the potential bidders

must agree not to make an unsolicited bid for the target. (See Kidd (2003) and

Subramanian (2003) for further discussion of confidentiality/standstill agreements.) Once

potential bidders have received non-public information, private bidding for the target is

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conducted. In our sample, the total time of this private bidding process averages six to

seven months.

The ultimate outcome is a takeover agreement that is usually publicly announced

within a day or two of signing. Once announced, the average deal in our sample takes

roughly six months to complete due to requirements of approval from regulatory agencies

and, in the case of a share deal, target shareholders. During the time between public

announcement and deal completion, other bidders may make an offer for the target.

To capture the takeover process in Figure 1, we reviewed the SEC takeover

documents for each of the target firms in our sample. From our review of the SEC

documents, we categorized each sample takeover as either an auction or a negotiation.

Takeovers classified as auctions were those where the target firm and its investment bank

contacted multiple potential buyers and also had multiple potential buyers attain access to

non-public information by signing confidentiality/standstill agreements. By contrast, in

takeovers categorized as negotiations, the target contacted only a single bidder and signed

a confidentiality/standstill agreement only with that bidder.

The variety of the private takeover process is described in the four cases reported

in Appendix B. The Boatmen’s Bancshares and Nalco Chemical cases are auctions. The

ENSERCH Corp and Pioneer Hi Bred International cases are negotiations. The text in

Appendix B is taken directly from the SEC EDGAR filings and exemplifies the detail on

the takeover process that is available in the SEC documents.

Table 4 provides a summary of the private and public takeover process for the

sample firms. Panel A reports the data for the full sample of 400 firms. In a representative

takeover, the target firm and its investment bank contacted and/or were contacted by nine

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potential bidders. Roughly four potential bidders received non-public information by

signing confidentiality/standstill agreements. On average, 1.29 firms made private written

offers and 1.13 firms made a publicly announced bid for the target. As a whole, the data

in Panel A indicate that the takeover process during the 1990s was much more

competitive than can be garnered by focusing solely on the number of publicly

announced bidders.

Panel B of Table 4 stratifies the data on the private and public sales process into

the two sales procedure categories, auction and negotiation. The auction category has 202

observations, or slightly more than half of the sample. In a representative auction, 21

potential buyers are contacted and roughly 7 sign confidentiality/standstill agreements.

On average, 1.57 firms make private written offers and 1.24 firms make a publicly

announced bid for the target.

In the 198 negotiations, the target firm focuses on a single bidder. The average

number of firms contacted is slightly greater than one due to some cases where the target

firm did not respond to an unsolicited inquiry or where preliminary talks with a potential

bidder did not materialize (see, for example, the ENSERCH case in Appendix B). In the

takeovers classified as negotiated, the number of confidentiality/standstill agreements and

the number of private bids is always equal to one. The average number of public bidders

is slightly greater than one because of a few public, unsolicited bids for the targets in

negotiated deals.

2.4 Termination Provisions and Takeover Competition

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We use our classification of auctions and negotiations to provide new evidence on

the relation between termination provisions and takeover competition. Table 5 reports

information on the incidence of termination provisions in the two takeover procedures.

As shown in Panel A, auctions are more likely to have a termination provision than are

negotiations; indeed, virtually every auction in the sample has a termination provision.

The logit regression in Panel B confirms that auctions are significantly more likely to

have a termination provision than are negotiations.

In contrast to prior research, these results indicate that termination provisions are

positively associated with takeover competition. By using a more complete measure of

the takeover process, we find support for the information/commitment hypothesis and

reject the entrenchment hypothesis.

Table 6 provides related results on the magnitude of the termination provisions

across the two takeover procedures. Panel A shows that, for the subset of deals with a

termination fee, the average magnitude of the fee is slightly larger for auctions, although

the regression analysis in Panel C indicates that there is no significant difference across

the two takeover procedures. Panel B reports that the average magnitude of the stock

option agreements is larger for auctions, and the regression analysis indicates that the

difference in magnitude is statistically significant (p-level=0.091). Overall, the results in

Table 6 complement the results on the incidence of termination provisions and indicate

that the magnitude of the provisions is not impeding takeover competition.

3. The Incidence of Termination Provisions over Time

3.1 Prior Research

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Prior research, relying on data from SDC, has reported a growing incidence of

termination provisions over time. For example, Coates and Subramanian (2000, p.315)

report that 40 percent of the takeovers in their sample had a termination provision in 1988

compared with 80 percent in 1998. Bates and Lemmon (2003, page 472) report that the

use of termination fees in their sample increased from 2 percent in 1989 to 60 percent in

1998. Officer (2003, Table 1) reports a similar increasing trend of termination fees in his

sample period of 1988 to 2000.

Coates and Subramanian (2000) conjecture that these trends in the incidence and

choice of termination provisions have been affected by judicial decisions in Delaware

courts. They argue that the ruling in Paramount Communications v. QVC Network in

December 1993 (637 A.2d 34) that voided the use of a stock option agreement induced a

reduced use of stock option agreements and a greater use of termination fees. They

further argue that the decision in Brazen v. Bell Atlantic in March 1997 (695 A.2d 43)

that sanctioned a $550 million termination fee led to a greater incidence of termination

provisions in general.

In support of their conjectures, Coates and Subramanian (2000) report that there

were significant changes in the incidence of termination provisions after the Paramount

and Brazen decisions. In their regression analysis, a dummy variable for takeovers in

1994 and later, to capture the Paramount decision, is negatively related to the use of stock

option agreements and positively related to the use of termination fees. A dummy

variable for takeovers in 1997 and later, to capture the Brazen decision, is positively

related to the use of both stock option agreements and termination fees. Bates and

Lemmon (2003, Table 5) also report positive effects of the Paramount and Brazen

15

decisions on the use of termination provisions in their sample. Similarly, Officer (2003,

Table 1) reports that the use of termination fees roughly doubles at the break points of the

two legal decisions.

These results of the effect of legal decisions, if correct, have important

implications. Indeed, drawing on the results from Coates and Subramanian (2000), recent

commentators (e.g., Knight (2004)) have argued that the recent Omnicare decision, which

voided the use of a shareholder voting agreement, will lead to an increased use of

termination fees.

3.2 New Evidence

We question the prior evidence of the effect the Paramount and Brazen decisions

on the incidence of termination provisions. The prior results appear, instead, to be due to

incomplete reporting of termination provisions on the SDC database, especially in the

late 1980s and early 1990s.

Evidence of the incompleteness of the SDC data is provided in Table 7. Panel A

compares the incidence of termination provisions that we determined from SEC filings

with the data reported on SDC for our sample of 400 takeovers. For the full sample, the

SEC filings indicate that 91 percent of the sample takeovers had a termination provision.

By contrast, the SDC data report termination provisions for only 66 percent of the

takeovers, a difference of 25 percent.

The difference between the SEC filings and the SDC data is especially noticeable

in the early years of the sample. In 1989 and 1990, the difference is 50 percent or more.

The difference is nearly as large in 1993, the year before the Paramount decision.

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Similarly, in 1996, the year before the Brazen decision, there is also a large difference of

44 percent. In 1997 and later, the difference between the SEC filings and the SDC data is

not as large. In results not reported in the table, we find that a regression of the difference

between the SEC and SDC data on a simple linear time trend results in a negative and

significant coefficient.

We ran regression analysis to see if the incomplete data on SDC could affect the

analysis of the effects of the judicial decisions on the incidence of termination provisions.

In Panel B of Table 7, the first regression uses SEC filings as the source of the

termination provision data. Using this comprehensive data, the regression analysis finds

no significant effect of either the Paramount or Brazen decision on the incidence of

termination provisions. By contrast, the second regression that uses SDC data to classify

termination provisions finds significant changes in the incidence of termination

provisions at the breakpoints of the two legal decisions. Hence, the prior findings in

Coates and Subramanian (2000), Bates and Lemmon (2003), and Officer (2003) may

stem from the incompleteness of the data reporting in SDC rather than reflect an actual

effect of the judicial decisions. We return to this question again in our multiple regression

analysis in Section 6.

Although we do not find the effect of the judicial decisions reported in prior

research, we do find evidence of changes in the design of the provisions over time. In

particular, we find a growing use of option caps in the termination provisions in our

sample, where an option cap is defined as a dollar limit on the gain that a bidder can

attain by exercising a stock option agreement. For example, in the takeover of Boatmen’s

Bancshares by NationsBank in 1996 (see Appendix B), the bidder was granted an option

17

to obtain 19.9 percent of the target’s common stock. However, the agreement limited the

profit that the bidder could make from the option to $250 million.

Panel A of Table 8 reports the time series incidence of option caps. The first cap

in the sample occurs in 1994, the year after the Paramount legal decision. There is a

steady increase in option caps over time, and by the final year of the sample, 91 percent

of the takeovers having a stock option agreement also have an option cap.

Panel B of Table 8 reports data on the magnitude of the option caps in the sample,

where magnitude is defined as the dollar amount of the cap divided by the equity value of

the target 21 days after merger announcement. For the full sample of 52 caps, the mean

(median) is 3.91 percent (3.85 percent). The average magnitude of the cap is similar for

the two takeover procedures. Auctions have a mean (median) cap of 4.00 percent (3.30

percent) while negotiations have a mean (median) cap of 3.86 percent (3.92 percent).

Hence, the growing use of option caps has made the relative magnitude of stock option

agreements converge to that for termination fees. Overall, the evidence indicates that the

design, although not the incidence, of termination provisions has changed somewhat over

time.

4. The Choice of Termination Provision: Fee versus Option

4.1 Conceptual Issues

Another unexplored question about termination provisions is the determinant of

the specific type of termination provision chosen in a particular takeover. What affects

the choice of a termination fee versus a stock option agreement? Because much of the

prior research on termination provisions has separately focused on either termination fees

18

(Bates and Lemmon (2003), Officer (2003)) or stock option agreements (Burch (2001)),

there is little or no direct analysis of this query.

As discussed previously in Section 2, there are two distinct hypotheses on the use

of termination provisions, the entrenchment hypothesis and the information/commitment

hypothesis. The entrenchment hypothesis provides little or no guidance as to the choice

between provisions, arguing generally that some sort of provision would be granted to a

favored bidder. By contrast, the information/commitment hypothesis suggests that the

choice of provisions will be related to the factors affecting deal completion once a

takeover is announced.

To conceptualize the factors affecting the choice between fees and options, it is

useful to note the similarities and differences of the two types of termination provisions.

Termination fees and stock option agreements have the common feature that they award

money to the initial bidder if the target is ultimately acquired by another party. The

monetary amount in the termination fee is the specific figure contracted in the takeover

agreement. The value of the stock option is a function of the exercise price in the

agreement, the market price of the target if the object of another takeover bid, and any

cap on the option value that might be prescribed in the agreement.

As noted by Wasserstein (2000, p.675), however, a distinguishing feature of a

stock option vis-à-vis a termination fee is that the stock option agreement also conveys

possible voting rights to the initial bidder. For example, in the 19.9 percent stock option

granted by Fred Meyer (the target) to Kroger (the bidder) described in a November 9,

1998, S-4 filing by Kroger, Fred Meyer contracted to prepare and file a shelf registration

19

statement for the shares in the option and Kroger contracted to be present at all

stockholder meetings for the purpose of determining quorum.

In terms of the information/commitment hypothesis, this distinctive feature of

stock option agreements is relevant in stock deals that require a target shareholder vote.

The potential for the bidder to vote a faction of the shares of the targets better ensures a

favorable completion of the deal. This reduction in uncertainty is quite important in stock

deals, which we find in our sample to have a lengthier period between takeover

announcement and resolution than cash deals: 219 calendar days for stock deals as

compared to 118 calendar days for cash deals. Hence, one would expect stock deals to be

more likely to employ a stock option agreement than cash deals.

4.2 Empirical Analysis

Table 9 reports the relation between the chosen type of termination provision and

the method of payment in the takeover. As reported in Panel A, 60 percent of the

takeovers with termination fees have some or all stock as the method of payment, while

85 percent of the takeovers with a stock option agreement have some or all stock as the

method of payment. Hence, takeovers with a stock option agreement are more likely to

have stock as the method of payment.

The simple logit regressions in Panel B report similar results. The choice of a

termination fee is inversely related to having some or all stock as the method of payment.

The choice of a stock option agreement is positively related to having some or all stock as

a method of payment. Hence, the decision of the type of termination provision chosen in

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a given takeover is related to the method of payment in the transaction. This result is

consistent with the information/commitment hypothesis.

5. Shareholder Voting Agreements and other Ownership Variables

5.1 Policy Issues

In addition to termination fees and stock option agreements, another contractual

device found in some takeover contracts is a shareholder voting agreement. In this

agreement, blockholders (e.g., insiders, founding family members) in the target firm

pledge to vote to approve the merger or to tender their shares in the tender offer.

A 2003 decision in the Supreme Court of Delaware, Omnicare v. NCS

Healthcare, recently ruled on a shareholder voting agreement in which two blockholders

in the target firm, NCS Healthcare, pledged to vote 65 percent of the shares in favor of

merger with Genesis Health Ventures. The court voided the voting agreement, ultimately

allowing Omnicare to buy NCS. The court concluded that the voting agreement was

coercive and precluded the possibility of a superior transaction. (For background, see

Knight (2004), as well as “Merger Business Faces New Order with Court Ruling on

‘Lockups’,” Wall Street Journal, April 7, 2003.)

The recent court decision raises several unexplored questions. How common are

shareholder voting agreements? What is the magnitude of the representative agreement?

How do they interact with termination fees and stock option agreements?

Although prior research on termination provisions has studied bidder toeholds,

there is little or no empirical research on shareholder voting agreements. This may be in

part due to the fact that the 2003 Omnicare decision came after much of the prior research

21

on termination provisions was published. Moreover, data on shareholder voting

agreements are not readily available on data sources such as SDC. Our analysis fills this

empirical void by studying the shareholder voting agreements and other ownership

variables for the takeovers in our sample.

5.2 Incidence of Shareholder Voting Agreements and other Ownership Variables

To determine the incidence and magnitude of shareholder voting agreements in

our sample, we searched the SEC documents for each of our takeovers. The data on the

incidence and magnitude of shareholder voting agreements, ownership affiliation and

bidder toeholds are reported in Table 10. Shareholder voting agreements are found in 68

takeovers, or 17 percent of the sample. The average fraction of shares in the agreements

is 41 percent of the target’s common stock. Voting agreements in takeovers with a

termination provision average 40 percent while agreements in takeovers without a

termination provision average 52 percent.

To complement the analysis of shareholder voting agreements, we also tabulated

data on two other ownership variables. We determined whether the target had a long-term

ownership affiliation with bidder via a parent-subsidiary or other corporate relation. We

also tabulated cases where the bidder attained a toehold stake in the target in the period

immediately preceding the takeover attempt. Our separate categorization of long-term

ownership affiliations and bidder toeholds differs from prior research such as Burch

(2001), Bates and Lemmon (2003), and Officer (2003) which tends to lump all ownership

stakes by the bidder reported by SDC into a single toehold category. We draw this

22

distinction to more accurately reflect the theoretical work (e.g., Bebchuk (1982)) which

models a toehold as a stake strategically obtained prior to commencing a bid.

In 28 takeovers, 7 percent of the sample, the bidder has a long-term ownership

affiliation with the target. For these 28 cases, the average fraction of shares in the

affiliation is 54 percent. Ownership affiliations in takeovers with a termination provision

average 40 percent while those without a termination provision average 60 percent.

There are also 28 takeovers in which the bidder obtains a toehold. The average

toehold is 7 percent, while the median is 5 percent, the fraction of shares that activates

Williams Act filing requirements. The average toehold for takeovers with a termination

fee is 7 percent and the average toehold for takeovers without a termination provision is 3

percent.

In sum, the data in Table 10 indicate that shareholder voting agreements are often

found in takeover contracts. They are more prevalent than ownership affiliations or

bidder toeholds. The magnitude of the voting agreements is comparable to ownership

affiliations and much larger than bidder toeholds.

5.3 Interaction with Termination Provisions

We next consider how shareholder voting agreements and the other ownership

variables interact with termination provisions. We first consider the 37 takeovers in our

sample that do not grant a termination fee or a stock option to the bidder. While only 9

percent of the sample, scrutiny of this set of firms sheds light on the role of termination

provisions.

23

Table 11 reports some characteristics of the 37 takeovers that do not grant a

termination provision to the bidder. In 8 cases, the takeover had a shareholder voting

agreement that averaged 52 percent of the target’s shares outstanding. In 20 cases, the

bidder had an ownership affiliation that averaged 60 percent of the target’s shares

outstanding. One takeover had both a shareholder voting agreement and an ownership

affiliation, indicating that in 27 of the 37 takeovers without a termination provision (73

percent), the bidder had a sizable direct or pledged stake in the target firm. Hence, in a

large majority of the small fraction of takeovers without a termination provision, the

target has an alternative contractual mechanism with which to make a commitment to the

bidder. Indeed, in only 10 takeovers, or 2.5 percent of the sample, is the deal “naked” in

the sense that the takeover agreement does not have a termination provision and/or a

shareholder voting agreement or other large ownership block.

There is no time series pattern in the naked deals. Three of the 101 deals (2.9

percent) in the 1989 to 1993 period have neither a termination provision nor a voting

agreement. By comparison, 3 of the 128 deals (2.3 percent) in the 1994 to 1996 period

and 4 of the 171 deals (2.3 percent) in the 1997 to 1998 period are without some sort of

deal protection.

To more generally consider the interaction of shareholder voting agreements and

the other ownership variables with termination provisions, we regress the incidence of

termination provisions on the magnitude of the ownership variables. Table 12 reports the

results. In the first regression, the incidence of termination provisions is negatively

related to the magnitude of shareholder voting agreements, although the coefficient is not

statistically significant (p-level=0.135). In the second regression, the magnitude of

24

ownership affiliation is negatively and significantly related to the likelihood of a

termination provision. In the third regression, the coefficient for the bidder toehold

variable is positive but not statistically significant.

The final column in Table 12 reports a regression of the incidence of termination

provisions on all three ownership variables. Both shareholder voting agreements and

ownership affiliation are negatively and significantly related to the use of a termination

provision. The bidder toehold variable flips signs but remains statistically insignificant.

The results provide new, important evidence on the interaction of termination

provisions with other aspects of takeover contracts. Consistent with inferences from

Tables 10 and 11, shareholder voting agreements and ownership affiliation provide a

substitute contractual mechanism for termination provisions.

The results are highly pertinent to the recent Omnicare decision in the Delaware

Supreme Court. The court in that decision voided a shareholder voting agreement of 65

percent, arguing that the agreement entailing more than a majority of shares outstanding

was coercive to minority shareholders. Our results indicate that such a voting agreement

is not unprecedented. Indeed, shareholder voting agreements and ownership affiliations

often exceed a majority of shares outstanding. Our results support the dissenting jurists in

the Omnicare decision who argued that contractual provisions “cannot be reviewed in a

vacuum” and that the “court should review the entire bidding process.” (See Omnicare,

Inc. v. NCS Healthcare, Inc., 818 A.2d 914, 2003 Delaware.)

6. A Synthesis of the Analysis

25

The previous analysis has separately considered various aspects of the role of

termination provisions in the takeover bidding process. In this section, we synthesize the

analysis in multiple regression analysis. The analysis is reported in Table 13.

We report four logit regressions that capture the overall use of termination

provisions, the specific use of termination fees and stock options agreements, and the

choice between termination fees and stock option agreements. The first three regressions

use all 400 observations in the sample. The first regression is a logit specification where

the dependent variable equals one in the 363 deals where a takeover has a termination

fee, an option agreement or both. In the second regression, the dependent variable equals

one in the 315 takeovers with a termination fee and in the third regression the dependent

variable equals one in the 117 takeovers with a stock option agreement. The fourth

regression uses the 363 observations with a termination fee, an option agreement or both.

The dependent variable equals one for the takeovers with a stock option agreement (with

or without a termination fee) and equals zero in the takeovers with a termination fee only.

The independent variables are those previously studied on takeover competition,

the timing of termination provisions, the method of payment, and ownership

characteristics. To model takeover competition, Auction is a dummy variable equal to 1 if

the takeover procedure was an auction. To proxy for the effect of judicial decisions,

Paramount is a dummy variable equal to 1 if the announcement of the takeover occurred

in 1994 or later and Brazen is a dummy variable equal to 1 if the takeover announcement

occurred in 1997 or later. To measure method of payment, Stock is a dummy variable

equal to 1 if the payment terms entail some or all stock. To denote voting agreements and

other sizable ownership, we use Affiliated/Agreement, which is the fraction of the

26

target’s common stock either held by a long-term affiliated bidder or committed by a

blockholder in a voting agreement in favor of the takeover. Toehold is the fraction shares

held by the bidder as part of a toehold strategy.

As control variables, we also add two variables used in prior empirical research.

The first control variable, Deal Size, is the equity value of the target firm 21 days after

the takeover announcement. We find that deal size is not significantly related to the use

of termination fees but is positively related to the use of stock option agreements. The

second control variable, Bank, is a dummy variable equal to one if the target firm is in the

banking industry. Coates and Subramanian (2000, p.325) state that banks tend to use

stock option agreements rather than termination fees because of regulatory capital rules.

Consistent with this statement, we find that the bank dummy is negatively related to the

use of termination fees and positively related to the use of stock option agreements.

6.1 Termination Provisions and Takeover Competition

Our univariate analysis in Section 2 found that a termination provision was more

likely to be used when the takeover procedure was an auction. This result holds for our

multiple regression analysis. In the first regression in Table 13, the coefficient on the

auction dummy is positive and significant. Hence, termination provisions are positively

associated with takeover competition. These results support the information/commitment

hypothesis and are not consistent with the entrenchment hypothesis.

We also stratified the analysis by the type of termination provision. The

regression for termination fees finds a positive and significant relation between the use of

fees and takeover competition. In the stock option agreement regression, the coefficient

27

on the auction variable is positive but not statistically significant. Hence, neither of the

specific types of termination provisions is associated with reduced takeover competition.

The final regression in Table 13 provides one means of analyzing the choice

between termination fees and stock option agreements. The dependent variable equals

one for the takeovers with a stock option agreement (with or without a termination fee)

and equals zero in the takeovers with a termination fee only. In this regression, the

coefficient on the auction dummy is negative and significant. Hence, deals with a stock

option agreement (with or without a termination fee) are more likely to be done via

negotiation. This result is probably tied to the endogenous choices made by target firms

in the takeover process as modeled by Povel and Singh (2004).

6.2 The Incidence of Termination Provisions over Time

The Paramount and Brazen dummy variables in Table 13 proxy for the

intertemporal effects of judicial decisions on termination provisions. Prior research by

Coates and Subramanian (2000) and others has concluded that these legal decisions

affected both the incidence and choice of termination provisions over time. Our analysis

in Section 3 suggested that the prior results may have stemmed from the use of data from

SDC rather than the SEC filings that we use in our analysis.

In the first multiple regression in Table 13, the coefficient on the Paramount

dummy is positive and significant, while the coefficient on the Brazen dummy is positive

but not statistically significant. The positive effects of the Paramount dummy stem from

the use of termination provisions. In the second regression on termination fees, the

28

Paramount coefficient is positive and significant, while in the third regression on stock

option agreements, the coefficient is negative but not significant.

These results on the timing of termination provisions are not consistent with the

prior findings reported by Coates and Subramanian (2000). While the positive coefficient

on the Paramount dummy resembles their analysis, the overall results do not concur with

their story that the Paramount decision shifted targets from stock option agreements to

termination fees. In the third and fourth regressions on the use of stock option agreements

and the choice between fees and options, the coefficient on the Paramount dummy is not

statistically significant.

Moreover, unlike the results in Coates and Subramanian (2000), we find no effect

of the Brazen decision on the incidence or structure of termination provisions. As

reported in Table 13, none of the coefficients of the Brazen dummy in any of the four

regressions is statistically significant.

The main difference between our analysis and the prior research is that our

sampling of termination provisions comes directly from SEC takeover documents rather

than relying on data from SDC. The results in Table 13 question the conclusions from the

prior research as to the growing incidence of termination provisions over time as well as

the effect of judicial decisions on the incidence and choice of the provisions. More

generally, our results raise flags about the reliance on sources other than the actual

takeover documents provided by the SEC.

6.3 The Choice of Termination Provision: Fee versus Option

29

Although we do not find the effect of judicial decisions on the choice of

provisions reported in prior research, we do find that the method of payment is an

important factor in the choice between termination fees and stock option agreements. As

reported in the second regression in Table 13, the use of termination fees is not

significantly related to the use of stock. By contrast, in the third regression, the use of a

stock option agreement is positively and significantly related to stock as the method of

payment. Similarly, the fourth regression indicates that the choice of a stock option rather

than a termination fee is positively and significantly related to stock deals.

The results in Table 13 for the stock variable are consistent with the analysis in

Section 4. Overall, the positive relation between the choice of stock option agreements

and the use of stock as a method of payment is consistent with the

information/commitment hypothesis.

6.4 Shareholder Voting Agreements and other Ownership Variables

Table 13 also provides analysis on the interaction between termination provisions

and other contractual features of the takeover process. The variable Affiliated/Agreement

is the fraction of the target’s common stock either held by a long-term affiliated bidder or

committed by a blockholder in an agreement in favor of the takeover. Toehold is the

fraction shares held by the bidder as part of a toehold strategy.

As reported in the first regression in Table 13, the coefficient on

Affiliated/Agreement is negative and statistically significant. This result indicates that

shareholder voting agreements and other long-term ownership stakes provide substitutes

for termination provisions. As reported in the second and third regression, these results

30

hold for the specific cases of both termination fees and stock option agreements. These

results, combined with the analysis in Section 5, indicate that shareholder voting

agreements are often used in takeover agreements and serve a similar function as that of

termination provisions.

The results in Table 13 indicate that toeholds are not related to the use of either

termination fees or stock option agreements. This result contrasts with the findings in

prior research such as Burch (2001), Bates and Lemmon (2003), and Officer (2003). The

difference in results stems from the fact that the prior research tends to lump all

ownership stakes by the bidder reported by SDC into a single toehold category. We feel

that our distinction between long-term blockholdings and toeholds obtained proximate to

a takeover more accurately reflects takeover strategy. Our results indicate that the

likelihood that a takeover agreement contains a termination provision is not affected by

whether a bidder obtains a small stake in a target firm prior to commencing the takeover

attempt. In essence, a toehold is not a substitute for a termination provision. Among other

things, while a toehold can possibly compensate a bidder for investing in information

about the target (Bebchuk (1982)), a toehold does not provide any commitment that the

target will sell to that bidder.

6.5 A Summary of the Analysis

The results in Table 13 can be summarized in four key points. First, termination

provisions are positively associated with takeover competition. Second, the choice

between a termination fee and a stock option agreement is tied to deal size and method of

payment: large stock deals are more likely to employ a stock option agreement. Third,

31

there is little evidence that judicial decisions influenced either the intertemporal incidence

of termination provisions or the choice between termination fees and stock option

agreements. Fourth, shareholder voting agreements and other long-term ownership

arrangements serve as a substitute for termination provisions while toeholds obtained

proximate to a takeover do not.

7. Conclusion

The contribution of our research can be pinpointed by returning to the depiction

of the takeover process in Figure 1. Prior research has focused on the public aspects of

this process. In doing so, the prior research has incorrectly concluded that termination

provisions are negatively associated with takeover competition. Our research, by more

accurately capturing both the private and public takeover process, indicates that

termination provisions enhance rather than impede takeover competition.

Our results have important policy implications. Consistent with the framework of

research in the area of law and finance (Macey and O’Hara (2000)), takeover law in

Delaware and other jurisdictions is all about process (Varallo and Raju (2000)). A central

issue in the policy debate has been the concern that termination provisions obstruct the

process by foreclosing takeover auctions (Ayres (1990)). In relation to this concern,

Bainbridge (1990, pp.327-328) suggests a requirement that boards of directors shop the

company prior to implementing a termination provision. Similarly, Kahan and Klausner

(1996, footnote 47) state, “We would not object if targets made an ex ante commitment to

grant a lockup to the party that offers the highest bid in a properly structured auction.”

Our analysis of the private takeover process indicates that targets actually do shop the

32

company before implementing termination provisions and that termination provisions

often culminate an auction. Such findings allay the legal concerns that termination

provisions foreclose takeover competition.

In our detailed treatment of the takeover process, we have also uncovered new

evidence on the use of other contractual devices such as shareholder voting agreements

that are also used by targets and bidders. We find that such agreements act as substitutes

for termination provisions. Our analysis of shareholder voting agreements is quite timely.

A recent decision in the Delaware courts ruled against the use of a shareholding voting

agreement in which a group of majority shareholders committed their shares to a

particular bidder (see, “Merger Business Faces New Order with Court Ruling on

‘Lockups’,” Wall Street Journal, April 7, 2003). Our analysis indicates that such

agreements are often used in corporate takeovers as a means of committing to a deal and

should not be viewed by the courts as de facto anti-competitive.

Our research also has implications for broader debates in corporate law. Analysis

by legal scholars such as Easterbrook and Fischel (1982) and Bebchuk (1982) has

contested the pros and cons of corporate takeover auctions and has proposed policies

ranging from an outright ban on to a mandatory prescription of takeover auctions. The

setting of this debate was on the public takeover auctions of an earlier era. Our evidence

on the private takeover process indicates that auctions are an endogenous aspect of the

current takeover environment. Such evidence supports the position of Macey (1990) that

there should not be any particular sales procedure imposed by the courts.

Our research is also informative to different theoretical models of the takeover

process. Bulow and Klemperer (1996) predict that takeover auctions generate greater

33

returns than one-on-one negotiation and argue against the use of termination provisions.

By contrast, Povel and Singh (2004) point out the commitment aspects of termination

provisions and argue that the provisions can enhance the wealth of target shareholders.

Since we find that the use of termination provisions is directly related to takeover

competition, our evidence is more in line with the arguments of Povel and Singh (2004).

Future work can further test the distinguishing predictions of the models by analyzing the

wealth effects of takeover auctions vis-à-vis negotiations.

Our detailed analysis of the takeover process also has more general implications

for research methodology. Our evidence from SEC documents suggests inaccuracies in

the findings of prior research that relied on data from SDC. In particular, we document a

widespread use of termination provisions from the late 1980s through the 1990s and do

not find the time series changes in the incidence and choice of termination provisions

reported in prior research. Our results raise flags about the reliance on sources other than

the actual takeover documents from the SEC.

As a whole, our evidence is consistent with the theory that termination provisions

mitigate information problems inherent in the takeovers of publicly traded corporations

and enable the target firm to commit to an end of the bidding process. Termination

provisions do not truncate bidding but instead culminate the bidding process.

34

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Appendix A. Prior Empirical Analysis of Termination Provisions This appendix reviews the empirical analysis of termination provisions. _________________________________________________________________________________________________________________________________ Association of Provision with: Time % with Average Public Deal Target Conclusion on Effect Authors Period # Obs Provision Size Auction Completion Return of Termination Provision 1. Analysis of Stock Option Agreements Coates and ‘88-‘99 3,163 23% 19.9% - + > 0 Protect deals from hi value bidders (p.389) Subramanian (2000) Burch (2001) ‘88-‘95 2,067 8% 20% - + ≥ 0 Discourage competition for target (p.139) Used by target managers to enhance their bargaining position (p.139) _________________________________________________________________________________________________________________________________ 2. Analysis of Termination Fees Coates and ‘88-‘99 3,163 48% 3% - + 0 Reduce allocational efficiency (p.389) Subramanian (2000) Officer (2003) ‘88-‘00 2,511 42% 3.8% - + ≥ 0 Deterrence effect related to other deal characteristics (p.454) Bates and ‘89-‘98 3,037 37% 3.3% - + ≥ 0 Truncate a natural bidding process (p.471) Lemmon (2003) Improve bargaining position of target managers (p.502) _________________________________________________________________________________________________________________________________

38

Appendix B. Examples of the Private Takeover Process This appendix details the private takeover process for four sample firms: Boatmen’s Bancshares (auction), Nalco Chemical (auction), ENSERCH (negotiation), and Pioneer Hi Bred International (negotiation, no termination provision). ________________________________________________________________________ Boatmen’s Bancshares (1996) S-4 Filing by Nationsbank Corp, November 15, 1996 Classification: Auction During the period from late June through early August 1996, members of Boatmen's senior management met with senior executives of four bank holding companies (including NationsBank) with which there had been previous informal discussions and which were believed to be the most likely to be interested in, and also financially and otherwise capable of, engaging in a business combination with Boatmen's. At its regular meeting on August 13, 1996, the Boatmen's Board authorized and directed Boatmen's senior management, with the assistance of its financial and legal advisors, to explore more formally the interest expressed by four bank holding companies. On August 13 and 14, 1996, Boatmen's, through its financial advisers, contacted the four companies (including NationsBank), and each executed a confidentiality agreement. Each company was then provided with certain confidential information with respect to Boatmen's, and was invited to review additional confidential information and to meet with certain members of Boatmen's senior management. The four companies reviewed materials and engaged in discussions with Boatmen's senior management between August 15 and August 25, 1996… In the course of these discussions, one of the four bank holding companies determined not to proceed further, stating that its decision was due to circumstances particular to it, and not related to Boatmen's. Each of the three remaining companies provided to Boatmen's confidential information regarding it and its operations similar in nature and scope to the information provided by Boatmen's. Also during the week of August 19, 1996, Mr. Craig met with the chief executive officer of each of the three remaining bank holding companies, principally to discuss non-financial aspects of a possible business combination. Among the topics discussed at each of the meetings were the strategic focus of a combined company going forward, the nature and extent of the continued presence by the combined company in St. Louis, the possible effects of the combination on Boatmen's employees and the technologies which the other party could provide in order to offer enhanced products and services to Boatmen's customers. Mr. Craig reported the content of these discussions as well as the status of the due diligence process then being conducted at a meeting of the Executive Committee of the Boatmen's Board on August 23, 1996. The three companies then participating in the process, including NationsBank, were invited to submit on August 26, 1996 proposals for a business combination with

39

Boatmen's… Each of the three bank holding companies submitted a proposal as requested by Boatmen's. In their final forms, each of the three proposals contemplated a stock-for-stock merger in which holders of Boatmen's Common Stock would receive in the merger shares of the counterparty's common stock at a specified exchange ratio. Each company … required that Boatmen's and such company enter into a stock option agreement substantially similar to the Boatmen's Stock Option Agreement or a termination fee agreement … On August 27, 1996, representatives of each of the three bank holding companies met separately with Boatmen's and its advisors to address questions raised by Boatmen's about their companies and their respective proposals. Each company also was invited to clarify and improve its proposal in terms of price or any other factor. In light of the prices reflected in the proposals from the other bank holding companies, among other factors, Boatmen's management advised NationsBank that it would recommend a revised NationsBank proposal for approval by the Boatmen's Board and would execute promptly a definitive merger agreement and stock option agreement if NationsBank agreed to increase its proposed exchange ratio of 0.643 to the Exchange Ratio, and NationsBank submitted such a revised proposal. At a meeting of the Boatmen's Board held on August 28, 1996, Mr. Craig and other members of the Boatmen's management team described the events which had transpired since the meeting of the Boatmen's Board on August 13 and presented the terms of the three proposals submitted. Mr. Craig discussed the relative advantages and disadvantages of a potential merger with NationsBank (including the proposed exchange ratio of 0.6525 of a share of NationsBank Common Stock for each share of Boatmen's Common Stock), as well as those of the other merger transactions which had been proposed… Members of Boatmen's senior management and Boatmen's legal advisors also made presentations to the Boatmen's Board, in which certain specific terms of the NationsBank proposal and the proposed form of agreement, as discussed, and the Boatmen's Stock Option Agreement were discussed. No action was taken by the Boatmen's Board at this meeting. Following the meeting, representatives of Boatmen's and NationsBank negotiated and finalized the terms of the Agreement and the Boatmen's Stock Option Agreement. A special meeting of the NationsBank Board was held on the morning of August 29, 1996 to consider a proposal to acquire Boatmen's. Mr. McColl and other members of the NationsBank senior management team presented the proposal… Members of the NationsBank senior management team then discussed additional benefits of the acquisition and the specific terms of the form of Agreement and Boatmen's Stock Option Agreement… In conclusion, Mr. McColl discussed the procedures remaining after receipt of Board approvals and the execution of a definitive Agreement, including the submission of regulatory applications, the preparation and filing of a registration statement and joint proxy statement-prospectus, the holding of shareholder meetings by each company before year-end, and a targeted closing of the transaction in January 1997. After due consideration of the foregoing matters … the NationsBank Board unanimously (with five directors absent) approved the Agreement…

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On the afternoon of August 29, 1996, the Boatmen's Board met again to consider the NationsBank proposal… The Boatmen's Board then unanimously approved the Agreement and the Boatmen's Stock Option Agreement and the transactions contemplated thereby as being in the best interests of Boatmen's, its shareholders and other constituencies, and the Agreement and the Boatmen's Stock Option Agreement were executed by Boatmen's and NationsBank. As an inducement to NationsBank to enter into the Agreement, Boatmen's (as issuer) and NationsBank (as grantee) entered into the Stock Option Agreement, dated August 29, 1996 (the "Boatmen's Stock Option Agreement"), pursuant to which Boatmen's granted NationsBank an irrevocable option (the "Boatmen's Option") to purchase from Boatmen's up to 31,218,660 shares of Boatmen's Common Stock (subject to adjustment in certain circumstances, but in no event to exceed 19.9% of the shares of Boatmen's Common Stock outstanding upon exercise thereof), at a price of $43.375 per share… the total profit that NationsBank may derive from the Boatmen’s option cannot exceed $250 million. ________________________________________________________________________ Nalco Chemical (1999) DEFM14A Filing, November 24, 1999 Classification: Auction We undertook an exploration of our strategic alternatives beginning in the first quarter of 1999. During meetings from March 23 to April 5, 1999, Goldman presented our management with a description of strategic alternatives and a list of various entities that it considered to be potentially suitable strategic partners. On April 5, 1999, representatives of Goldman and Nalco met to consider further the list of potential strategic partners in greater detail. At this meeting, we and Goldman identified a select group of companies that we considered suitable candidates for initial contact. On April 9, 1999, a Goldman representative contacted Mr. Christian Maurin, the Chairman of Degremont, a wholly owned subsidiary of Suez Lyonnaise, and advised him that we were in the process of considering various strategic options that could ultimately include a role for Degremont. As a result, representatives of us and Degremont participated in a meeting the following week. Degremont entered into a confidentiality agreement, dated as of April 13, 1999, with us and was subsequently provided with background information relating to us and our operations. Between the dates of April 6 and April 26, 1999, we directly and through Goldman contacted six other entities that were considered as potentially suitable strategic partners... As a result of this initial contact, five of the six entities approached by us and Goldman expressed a desire to consider further a possible transaction with us. Two of these five entities entered into confidentiality agreements with us, which agreements included standstill provisions, and were permitted an opportunity to review background information relating to us and our affiliates. Discussions with these entities did not produce any firm proposals to acquire Nalco.

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On April 21, 1999, senior representatives of each of Degremont, Suez Lyonnaise and Nalco met in Chicago, Illinois. The meeting was attended by, among others, Mr. Edward J. Mooney, our Chairman and Chief Executive Officer, and Goldman representatives. We and Goldman representatives answered questions raised by the representatives of Suez Lyonnaise, Degremont and J.P. Morgan, Suez Lyonnaise's and Degremont's financial advisor. On April 27, 1999, Mr. Maurin sent a letter to Mr. Mooney advising us of Degremont's interest in acquiring the company in a cash transaction. At its regularly scheduled meeting of April 28, 1999, our Board of Directors was advised of (i) Degremont's interest in acquiring Nalco and (ii) developments relating to the various other entities with whom confidentiality agreements had been signed. On May 2, 1999, Goldman sent a letter to Degremont requesting that Degremont indicate an approximate purchase price at which it would be willing to acquire Nalco. On May 10, 1999, Degremont provided us with a preliminary non-binding proposal in which it (i) reiterated its interest in acquiring Nalco and (ii) indicated a potential purchase price in the range of $43.00-$49.00 per share of Common Stock. We were advised that this preliminary proposal was subject to Degremont's due diligence review of Nalco. During the evening of May 10, a representative of Goldman advised Mr. Maurin and Mr. Remy that there would be no further discussions if the proposed purchase price remained in that range ($43.00-$49.00). On May 12, 1999, Mr. Maurin and Mr. Mooney, in a telephone conversation, agreed to meet to discuss a possible transaction between the parties. On May 17 and May 18, 1999, senior representatives of Degremont, Suez Lyonnaise, and Nalco participated in meetings in Paris. At these meetings, the participants discussed various issues relating to a possible transaction among the parties, including potential synergies between the companies. On May 25, 1999, Degremont sent a further non-binding proposal relating to a potential cash acquisition of Nalco at a purchase price of $52.00 per share of Common Stock. This offer represented a premium of 53% over our then-current market price and a premium of 66% over our three-month weighted average market price. Shortly thereafter, Mr. Mooney and Mr. Maurin had a telephone conversation during which Mr. Mooney advised Mr. Maurin that our Board of Directors would be meeting on June 5, 1999 to consider, among other things, Degremont's non-binding proposal to acquire Nalco and the status of discussions with other entities. Following our Board of Directors' meeting, Mr. Mooney had a telephone conversation with Mr. Maurin on June 7, 1999 during which he advised Mr. Maurin that, although our Board of Directors appreciated Degremont's most recent offer and considered it to be a serious proposal, the purchase price remained insufficient. On June 9, 1999, Mr. Maurin and Mr. Mooney had a further telephone conversation during which they reached an agreement, subject to the favorable negotiation of a definitive merger agreement, whereby Degremont indicated it would acquire Nalco for a

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purchase price of $54.00 per share of Common Stock, provided it was given certain assurances relating to exclusivity in negotiations with us. From June 11, 1999, legal, financial and accounting representatives of Suez Lyonnaise continued the due diligence review of Nalco until a definite merger agreement was reached. Beginning on June 16, 1999 through June 18, 1999, representatives of Suez Lyonnaise, Degremont and Nalco met in New York City to discuss and negotiate the proposed acquisition of Nalco. On June 24, 1999, following a significant increase in the trading volume and price of our Common Stock, we issued a press release announcing that we were engaged in discussions regarding a possible business combination. Later that same day, members of the senior management of Suez Lyonnaise, Degremont and Nalco met in New York City to discuss further ongoing issues raised during the due diligence review. During these discussions, Suez Lyonnaise indicated that it wished to renegotiate the purchase price. Later that afternoon, our Board of Directors was advised of this development and about issues raised by Suez Lyonnaise with respect to the proposed merger agreement. On June 25, 1999, the parties continued to negotiate the proposed purchase price and other terms of the proposed merger agreement relating to the conditions to the Offer, termination rights and payment of fees and expenses. Agreement was reached, subject to final negotiation of the definitive agreement that Suez Lyonnaise would agree to acquire Nalco for a purchase price of $53.00 per share of Common Stock and $1,060.00 per share of ESOP Preferred Stock. The legal representatives of Suez Lyonnaise and Nalco continued to negotiate the terms of the proposed merger agreement throughout June 26 and June 27, 1999. At a meeting held on June 27, 1999, our Board of Directors approved Suez Lyonnaise's offer to acquire Nalco for a purchase price of $53.00 per share of Common Stock and $1,060.00 per share of ESOP Preferred Stock, the Merger and the Merger Agreement. Later that same evening, the Merger Agreement was executed… Note: the termination fee was $125 million. ________________________________________________________________________ ENSERCH Corp (1996) 424B3 Filing by TUC Holding Co (Texas Utilities), September 27, 1996 Classification: Negotiation In February 1995 ENSERCH retained the services of Morgan Stanley to conduct a financial advisory review of ENSERCH's shareholder relations program and to suggest procedures that would enable ENSERCH to evaluate unsolicited business combination

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proposals … On August 15, 1995, Morgan Stanley presented the results of its analysis to ENSERCH senior management. On November 29, 1995, Mr. Erle Nye, President and Chief Executive of TUC, informally approached Mr. David W. Biegler, Chairman, President and Chief Executive Officer of ENSERCH… Mr. Nye indicated that TUC would be interested in discussing the possibility of a business combination… At the regular ENSERCH Board Meeting on February 13, 1996, Mr. Biegler reported his conversation with Mr. Nye, as well as the possibility that other companies might have an interest in ENSERCH… The ENSERCH Board voted to engage Morgan Stanley to undertake a further strategic review. On February 15, 1996, Mr. Biegler telephoned Mr. Nye to inform him of the decision of the ENSERCH Board to commence a process which could lead to consideration of possible business combinations and that Morgan Stanley would be engaged as ENSERCH's financial advisor for this purpose. Mr. Nye indicated that TUC remained interested in considering making a proposal and would begin to finalize its evaluation. On February 27, 1996, ENSERCH senior management met with Morgan Stanley to discuss undertaking a strategic review. On or about March 1, TUC formally retained Barr Devlin as financial advisor with respect to the possible transaction. On March 12, 1996, the ENSERCH Special Committee met again with Morgan Stanley, Mr. Biegler and other senior officers of ENSERCH... While not ruling out any alternatives, the ENSERCH Special Committee was of the view that a business combination could be the most attractive strategy for ENSERCH, but only if the combined businesses would complement each other sufficiently to enhance shareholder value over the long term and if the transaction would have good prospects of surmounting any regulatory hurdles and achieving broad public support. The ENSERCH Special Committee also was of the view that a negotiated transaction with a selected partner would be the most likely transaction to be successfully consummated. On the basis of the compatibility of corporate cultures, overlapping service areas and the likelihood of a favorable public response and regulatory acceptance, the ENSERCH Special Committee expressed its belief that TUC was the partner most likely to satisfy these considerations… Accordingly, the ENSERCH Special Committee authorized Morgan Stanley to initiate discussions with Barr Devlin to determine the extent of TUC's interest in pursuing the possibility of a business combination. On March 20, 1996, ENSERCH and TUC executed a confidentiality agreement in which TUC undertook to keep confidential all information provided by ENSERCH in connection with TUC's review of a possible transaction. TUC also agreed not to make any offer regarding a possible business combination or to participate in any proxy solicitation involving ENSERCH without the prior written consent of the ENSERCH board. At ENSERCH's regular Board Meeting on March 26, 1996, Mr. Biegler and the ENSERCH Special Committee reported to the ENSERCH Board on the status of the

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activities of the ENSERCH Special Committee and Morgan Stanley. At this same meeting, the ENSERCH Board addressed the issue of its Shareholders Rights Plan due to expire in May. Representatives of Skadden, Arps, Slate, Meagher & Flom discussed with the ENSERCH Board the replacement of the Shareholders Rights Plan with a proposed plan to take effect upon the expiration of the existing rights plan. After discussion, the replacement rights plan was unanimously approved by the ENSERCH Board. Following the ENSERCH Board meeting, in a discussion with one of the directors, Mr. Biegler learned that another company had a possible interest in a business combination with ENSERCH. The chairman of the other company subsequently telephoned to request a meeting with Mr. Biegler, which was scheduled for April 9, 1996. At a meeting on March 27, 1996, Mr. Biegler advised Mr. Nye of the possible interest by the other company. Mr. Nye reported that he had heard rumors of the other company's interest in ENSERCH and stated that TUC would not look favorably upon a bidding contest. Mr. Nye expressed willingness to devote additional resources to consideration of a possible business combination with ENSERCH. On April 8, 1996, Mr. Biegler and Mr. Nye met to review the status of discussions. Mr. Nye indicated that TUC was considering aggregate valuations of ENSERCH in the range of $1.6 billion to $1.7 billion… On April 9, 1996, Mr. Biegler met with the chairman of the other company... The other chairman indicated interest in discussing a negotiated business combination with ENSERCH, but presented no offer. Mr. Biegler indicated he was not in a position to provide any information and could make no commitments, but he would respond in due course. Mr. Biegler reported this meeting to the ENSERCH Special Committee and the ENSERCH Board. On April 11, 1996, the ENSERCH Special Committee met again to review the status of negotiations. Mr. Biegler described the progress of the negotiations and stated his view that a valuation of approximately $1.65 billion to $1.7 billion warranted continued discussion. On April 11, 1996, Mr. Biegler and Mr. Nye and their respective counsel met to discuss the break-up fee and stock option, the limits on the collar on the conversion ratio and the application of TUC's representations and warranties at the closing date. On April 12, 1996, the ENSERCH Board and senior ENSERCH management again met to continue to review the progress of the negotiations… The principal issues discussed consisted of the conversion ratio, the break-up fees and stock option, the limits on the collar on the conversion ratio, TUC credit support for ENSERCH public debt, the circumstances under which the parties could terminate the Plan of Merger... While the meeting was in progress, the ENSERCH Board received a formal proposal from TUC…

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The proposed conversion ratio for the merger was based on equity value of $7.17 per share of ENSERCH Common Stock. The ENSERCH Board and senior ENSERCH management met on April 13, 1996, to consider the TUC proposal… It was generally agreed by the ENSERCH Board that the TUC proposal was not acceptable but was of sufficient interest to merit continued negotiations… The ENSERCH Board then discussed the outstanding issues that needed to be resolved before a transaction with TUC could go forward. These issues consisted of the conversion ratio, the limits on the collar on the conversion ratio, the break-up fees and the size of the stock option... The ENSERCH Board directed Mr. Biegler to discuss with Mr. Nye possible modifications of the parties' positions on these matters. The meeting recessed in order to permit Mr. Biegler to meet with Mr. Nye. Mr. Biegler returned and reported to the ENSERCH Board that Mr. Nye had agreed on behalf of TUC to modify the proposal to accommodate certain concerns the ENSERCH Board had raised. The conversion ratio was increased to $8.00 per share and the collar was broadened to 10% from 7 1/2%, the break-up fee was reduced, the duration of any unilateral extension of the closing date by TUC was reduced … After these discussions… the ENSERCH Board again reviewed and discussed the proposal and then voted unanimously to approve the merger proposal. Mr. Nye was invited to meet with the ENSERCH Board, which he then did. Following the meeting on April 13, 1996 the relevant agreements for the Mergers were executed... On April 15, 1996, the proposed Mergers were publicly announced. Pursuant to the Stock Option Agreement dated as of April 13, 1996, by and between ENSERCH and TUC (the "Stock Option Agreement"), ENSERCH has granted TUC the right (the "Option"), to purchase, under certain circumstances relating to a Business Combination (as hereinafter defined) proposal by a third party, up to 3,363,570 authorized but unissued shares of ENSERCH Common Stock, subject to adjustment (which represents 4.9% of the shares of ENSERCH Common Stock outstanding on March 31, 1996), at $16.375 per share. The Plan of Merger may be terminated under certain circumstances listed below. Where indicated, termination will result in the payment by one party to the other, as liquidated damages, of either or both (i) out-of-pocket expenses and fees incurred by the other in connection with the Mergers and the transactions contemplated by the Plan of Merger in an amount of up to $15 million ("Out-of-Pocket Expenses") and (ii) a termination fee equal to $42.5 million less Out-of-Pocket Expenses (the "Termination Fee"). ________________________________________________________________________ Pioneer Hi Bred International (1999) PREM14A Filing, July 2, 1999 Classification: Negotiation, no termination fee or stock option agreement

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As part of our 1997 partnership, DuPont bought an equity interest in Pioneer consisting of 164,445.86 shares of voting preferred stock for $1.71 billion… After completion of our self-tender, DuPont held approximately 20 percent of Pioneer's equity and voting power… Under the terms of the investment agreement, DuPont has the right to nominate two directors to the Pioneer board. Charles O. Holliday, Jr., Chairman and Chief Executive Officer of DuPont and William F. Kirk, a Senior Vice President of DuPont, are DuPont's representatives on our current 14-member board. Our board also includes two members of Pioneer senior management, Charles S. Johnson, President and Chief Executive Officer of Pioneer and Jerry Chicione, the Chief Operating Officer of Pioneer. On … January 7, 1999, Mr. Holliday called Mr. Johnson and expressed DuPont's interest in pursuing discussions to determine the feasibility of a business combination in which DuPont would acquire the remaining 80 percent of Pioneer not owned by DuPont… On January 22, 1999, Pioneer discussed the possible transaction with Lazard Freres, its outside financial advisors, and Fried, Frank, Harris, Shriver & Jacobson, its outside legal advisors. On January 24, 1999, Mr. Holliday and Mr. Johnson met… Mr. Holliday discussed that, in terms of price, he was considering a range of $30 to $35 per share, but that he had not yet fully reviewed these pricing levels with DuPont's senior management or its board or with its financial advisors. Mr. Johnson responded that he also had not obtained the views of his management, Pioneer's board or Lazard but that his impression was that pricing had to be at least in the $40 to $45 per share range, payable all in the form of DuPont common stock. On January 26 and January 27, 1999, Mr. Johnson called the Pioneer outside board members to update them on the talks with DuPont. Between January 25 and February 24, 1999, members of senior management of Pioneer and DuPont and their financial advisors met on various occasions to discuss valuation and structure. Before the Pioneer board meeting scheduled for March 2, 1999, DuPont delivered a term sheet and DuPont's legal advisors, Skadden, Arps, Slate, Meagher & Flom LLP delivered a draft merger agreement detailing other aspects of DuPont's proposal, including: that Pioneer agree not to solicit other third party bids; that Pioneer not be able to terminate the merger agreement to accept third party proposals; that Pioneer pay an unspecified termination fee if Pioneer were unable to consummate the merger in certain circumstances generally involving third party bids; On March 1 and March 2, 1999, the Pioneer board met in New York… Management, Lazard and Fried Frank gave presentations to the board. Management gave a status update regarding the talks with DuPont and management's insistence that the price be at least $40 per share in a tax-free reorganization. Lazard reviewed valuation models and other relevant matters and commented, on a preliminary basis and subject to the final terms of the merger agreement, that $40 could be viewed as fair to Pioneer's shareholders, other than DuPont, from a financial point of view… Fried Frank also

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discussed the implications of the "deal protection" or "lock-up" arrangements requested by DuPont. After discussion, the board directed management to go forward with their talks with DuPont to seek an all stock transaction for at least $40 per share in a one-step merger, with the exchange ratio fixed at signing of the merger agreement. The board indicated that, although it was willing not to solicit alternative bids, the merger agreement must not unduly burden Pioneer from accepting a higher bid from a third party, if one were to emerge after announcement of the transaction with DuPont. Accordingly, the board believed the merger agreement should permit Pioneer to terminate the agreement if a superior proposal emerged without Pioneer being obligated to pay any break-up fees… On March 2, 1999, Messrs. Johnson and Chicoine met with Messrs. Holliday and Kirk to deliver the proposal consistent with the board's directions. On March 5, 1999, there was a telephone call between Messrs. Holliday and Johnson… As part of its proposal, DuPont also wanted to prohibit Pioneer from soliciting offers to acquire Pioneer from other third parties … DuPont was willing to consider allowing Pioneer to have the right to terminate the merger agreement to accept an unsolicited superior proposal during the pendency of DuPont's tender offer, and tentatively agreed that in light of DuPont's 20 percent ownership position in Pioneer that it would not insist that Pioneer pay any break-up fees if Pioneer exercised this termination right or otherwise. During the following few days, both parties attempted to negotiate the terms of the transaction other than price which had been tentatively set at $40 per share payable 45 percent in cash and 55 percent in stock, with the exchange ratio to be determined shortly before closing. Some of the main issues at this point were: whether the Pioneer board would have the ability to negotiate with and provide confidential information to third parties who made unsolicited indications of interest in acquiring Pioneer; whether Pioneer would be required to disclose the identity of any third party who made an alternative proposal and the terms thereof and whether Pioneer would agree to other deal protection features requested by DuPont; whether, and for how long after the public announcement of the merger, the Pioneer board would have the ability to terminate the merger agreement if Pioneer received a superior offer that the Pioneer board believed it had a fiduciary duty to accept… In a Dow Jones newswire released in the morning on Friday, March 12, 1999, Dow Jones claimed that a Pioneer spokesman dismissed the speculation that Pioneer was discussing a bid from DuPont by saying Pioneer was sticking to its long-held position of remaining independent. A few hours later Pioneer issued a press release which announced that it was in discussions with DuPont regarding a possible business combination. By March 13, 1999, the parties came to agreement on all of the open issues as follows:

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the Pioneer board would have the ability to negotiate with third parties with respect to an unsolicited proposal, inquiry or indication of interest relating to a superior proposal if the board decided that it was its fiduciary duty to do so, so long as Pioneer notified DuPont that it was having substantive negotiations with a third party. However, Pioneer would not be obligated under the merger agreement to identify the party or the terms of the discussions… On March 14, 1999, Pioneer had a telephonic board meeting among all members, other than the two DuPont directors and two other outside directors who were unable to attend the meeting, to review the merger agreement and the proposed transaction with DuPont. Management reviewed the status of discussions, the economic terms of the merger and the arrangements regarding management. Lazard then delivered its oral opinion to the board of directors that, as of March 14, 1999 the consideration to be received by Pioneer shareholders, other than DuPont and its affiliates, was fair from a financial point of view. Lazard's opinion was set forth in writing in a letter dated as of March 14, 1999. Fried Frank then reviewed the board's fiduciary obligations and the terms of the merger agreement. Fried Frank reviewed several special factors applicable to the proposed merger with DuPont… At the conclusion of these presentations the management members of the board, Messrs. Johnson and Chicoine, left the meeting to permit the outside directors to discuss the transaction independently and ask questions of Lazard and Fried Frank. The outside board members present then unanimously approved the merger agreement. Messrs. Johnson and Chicoine then returned to the meeting and unanimously approved the merger agreement. The two outside board members unable to attend the board meeting approved the merger agreement later that evening. ________________________________________________________________________

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Table 1. Termination Provisions by Year This table reports the incidence of termination provisions (termination fees and stock option agreements) granted to the bidder by the target by year for the sample of 400 takeovers. Year indicates the year the takeover was announced. Termination Fee Only refers to takeovers with a termination fee but no stock option agreement. Option Only refers to takeovers with a stock option agreement but no termination fee. Both refers to takeovers with both a termination fee and a stock option agreement. None refers to a takeover with neither a termination fee nor a stock option agreement. Percent with Provision refers to the fraction of takeovers in a given year with a termination fee, a stock option agreement or both. Data on termination provisions are taken from SEC documents.

Year Termination Fee Only

Option Only Both None

Percent with

Provision1989 9 2 0 1 92% 1990 20 2 5 7 79% 1991 5 7 2 5 74% 1992 12 5 2 2 90% 1993 10 2 2 1 93% 1994 17 3 4 6 80% 1995 33 12 10 4 93% 1996 31 2 4 2 95% 1997 44 5 9 6 91% 1998 31 7 21 2 97% 1999 34 1 10 1 98%

Full Sample 246 48 69 37 91%

Percent of Sample 62% 12% 17% 9%

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Table 2. Summary Statistics on Deal Size

This table reports summary statistics on takeover deal size as proxied by the equity value (in billions of dollars) of the target 21 days after the takeover announcement. Panel A reports the data for the full sample. Panel B reports the data by the incidence of termination provisions. Fee Only refers to takeovers with a termination fee but no stock option agreement. Option Only refers to takeovers with a stock option agreement but no termination fee. Both Fee and Option refers to takeovers with both a termination fee and a stock option agreement. None refers to takeovers with neither a termination fee nor a stock option agreement. Data on termination provisions are taken from SEC documents. # Obs Mean ($ bil) Median ($ bil)

Panel A: The Full Sample

All Firms 400 3.23 0.92

Panel B. The Sample Categorized by Incidence of Termination Provisions

Fee Only 246 2.17 0.57

Option Only 48 5.86 2.21

Both Fee and Option 69 6.01 2.09

None 37 1.73 0.99

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Table 3. Magnitude of Termination Provisions This table reports the magnitude of the termination provisions granted to the bidder by the target firm. Panel A reports data on mean and median percentage termination fees where the denominator is the equity value of the target firm 21 days after the takeover announcement. Panel B reports the mean and median stock option agreements where the data reflect the fraction of the target’s common stock in the stock option agreement. Data on termination fees and stock option agreements are taken from SEC documents.

# Obs Mean Median

Panel A: Termination Fees

315 3.55% 3.21%

Panel B: Stock Option Agreements

117 20.19% 19.90%

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Table 4. Summary of the Private and Public Takeover Process This table summarizes the takeover process for the sample of 400 target firms. Panel A characterizes the entire sample. Contact indicates the average number of potential bidders with which the target firm and its investment bank were in contact. Confidential indicates the average number of potential bidders that signed a confidentiality/standstill agreement. Private Bidders indicates the average number of bidders that submitted a private written offer. Public Bidders indicates the average number of bidders that announced a formal bid for the target in the financial media. Panel B reports the data by takeover procedure. Auction refers to takeovers in which multiple potential bidders were contacted and signed confidentiality agreements. Negotiation refers to a process focusing on one bidder.

# Obs Contact Confidential Private Bidders

Public Bidders

Panel A. The Full Sample

Full Sample 400 9.49 3.75 1.29 1.13

Panel B. The Sample Categorized by the Takeover Procedure

Auction 202 20.67 6.83 1.57 1.24

Negotiation 198 1.02 1.00 1.00 1.02

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Table 5. Incidence of Termination Provisions by Takeover Procedure This table reports the incidence of termination provisions granted to the bidder by the target for the auction and negotiation sub-samples. Panel A reports the incidence by takeover procedure. Termination Fee Only refers to takeovers with a termination fee but no stock option agreement. Option Only refers to takeovers with a stock option agreement but no termination fee. Both refers to takeovers with both a termination fee and a stock option agreement. None refers to a takeover with neither a termination fee nor a stock option agreement. Percent with Provision refers to the fraction of takeovers with a termination fee, a stock option agreement or both. Data on termination provisions are taken from SEC documents. Panel B reports a logit regression where the dependent variable equals one when a takeover has a termination provision and the independent variable equals one when the takeover procedure is an auction. The reported statistics for each variable are coefficient (p-value in parentheses). The p-value for the individual coefficients is based on the Wald Chi-square test. The model p-value is based on the Wald Chi-square test for global significance of the explanatory variables.

Panel A. Incidence by Takeover Procedure

Termination Fee Only Option Only Both None Percent with

Provision

Auction 151 20 25 6 97%

Negotiation 95 28 44 31 84%

Panel B. Regression Analysis

Variable Coefficient (p-value)

Intercept 1.68 (0.000)

Auction 1.80 (0.000)

R-square 0.084

Model p-value 0.000

# Obs 400

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Table 6. Magnitude of Termination Provisions by Takeover Procedure This table reports the magnitude of the termination provisions granted to the bidder by the target firm for the auction and negotiation sub-samples. Panel A reports data on mean and median percentage termination fees where the denominator is the equity value of the target firm 21 days after the takeover announcement. Panel B reports the mean and median stock option agreements where the data reflect the fraction of the target’s common stock in the stock option agreement. Data on termination fees and stock option agreements are taken from SEC documents. Panel C reports regression analysis where the dependent variable in the two regressions is (1) the magnitude of the termination fee and (2) the magnitude of the stock option and the independent variable equals one when the takeover procedure is an auction. The regressions use the takeovers having the given termination provision. The reported statistics for each variable are coefficient (p-value in parentheses). The p-value for the individual coefficients is based on a t-test. The model p-value is based on an F-test.

# Obs Mean Median

Panel A: Termination Fees

Auction 176 3.71% 3.32% Negotiation 139 3.34% 3.10%

Panel B: Stock Option Agreements

Auction 45 21.51% 19.90% Negotiation 72 19.36% 19.90%

Panel C. Regression Analysis Fee and Option Amount

Coefficient (p-value)

Variable Termination Fee (%) Stock Option (%)

Intercept 0.033 (0.000)

0.194 (0.000)

Auction 0.004 (0.294)

0.022 (0.091)

Adjusted R-square 0.0003 0.0161

Model p-value 0.294 0.091

# Obs 315 117

55

Table 7. Comparing with SDC Data This table reports comparisons of the data on termination provisions taken from SEC documents with the termination provision data reported on SDC for the same takeovers. Panel A reports the incidence of termination provisions by year, where Year is the year the takeover was announced and Percent with Provision refers to the fraction of takeovers in a given year with a termination fee, a stock option agreement, or both. Difference is the difference between the SEC and SDC data by year. Panel B reports logit regressions where the dependent variable equals one if the takeover had a termination provision. The two independent variables are dummy variables capturing Delaware court decisions. Paramount is a dummy variable equal to 1 if the announcement of the takeover occurred in 1994 or later. Brazen is a dummy variable equal to 1 if the takeover announcement occurred in 1997 or later. Regression 1 uses SEC data as the source of the termination provisions while regression 2 uses SDC data. The reported statistics for each variable are coefficient (p-value in parentheses). The p-value for the individual coefficients is based on the Wald Chi-square test. The model p-value is based on the Wald Chi-square test for global significance of the explanatory variables. Panel A. Termination Provisions by Year

Percent with Provision

Year SEC Data SDC Data Difference

1989 92% 33% 59% 1990 79% 29% 50% 1991 74% 58% 16% 1992 90% 62% 28% 1993 93% 53% 40% 1994 80% 60% 20% 1995 93% 61% 32% 1996 95% 51% 44% 1997 91% 80% 11% 1998 97% 87% 10% 1999 98% 83% 15%

Full Sample 91% 66% 25%

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Table 7. Continued

Panel B. Regression Analysis of Incidence of Termination Provision

Variable Coefficient (p-value)

SEC Data SDC Data

Intercept 1.67 (0.000)

-0.18 (0.371)

Paramount 0.60 (0.142)

0.49 (0.066)

Brazen 0.62 (0.174)

1.27 (0.000)

R-square 0.02 0.11

Model p-value 0.019 0.000

# Obs 400 400

57

Table 8. Use of Option Caps This table reports the annual incidence and the average magnitude of caps on the stock option agreements granted to bidders by targets. An option cap places a dollar limit on the gain that the bidder could attain by invoking the option. Panel A reports the incidence of caps by year. Number of Caps reports the number of stock option agreements to the bidder that have an option cap. Percent of Sample reports the fraction of takeovers with an option cap in a given year. Percent of Options w/Caps reports the fraction of takeovers having a stock option to the bidder that have a cap on the option. Panel B reports the mean and median of the magnitude of the option caps, where magnitude is the dollar value of the cap divided by the equity value of the target firm 21 days after the takeover announcement. The data are presented for all takeovers having option caps as well as for the auction and negotiation sub-samples. Data on option caps are taken from SEC documents. Panel A. Option Caps by Year

Year Number of Option Caps Percent of Sample Percent of Options

w/ Caps

1989 0 0 0%

1990 0 0 0%

1991 0 0 0%

1992 0 0 0%

1993 0 0 0%

1994 1 3% 14%

1995 8 14% 36%

1996 5 13% 83%

1997 6 9% 43%

1998 22 36% 79%

1999 10 22% 91%

All Caps 52 13% 44%

Panel B. Magnitude of Option Caps

Number of Caps Mean Median All With Caps 52 3.91% 3.85% Auction 20 4.00% 3.30% Negotiation 32 3.86% 3.92%

58

Table 9. Choice of Termination Provision This table reports the relation between the use of termination fees and stock option agreements and the method of payment in the takeover. Panel A reports the fraction of takeovers where the method of payment is some or all stock by termination provision type. Termination Fee refers to takeovers with a termination fee. Stock Option refers to takeovers with a stock option agreement. Data on termination fees and stock option agreements are taken from SEC documents. Panel B reports logit regressions where the dependent variable in the two regressions equals 1 when (1) the target grants a termination fee to the bidder and (2) the target grants a stock option agreement to the bidder. The independent variable Some Stock equals one when the payment method involves some or all stock. The reported statistics for each variable are coefficient (p-value in parentheses).The p-value for the individual coefficients is based on the Wald Chi-square test. The model p-value is based on the Wald Chi-square test for global significance of the explanatory variables.

# Obs # With Some Stock % With Some Stock

Panel A: Choice of Termination Provision and Method Payment

Termination Fee 315 189 60%

Stock Option 117 99 85%

Panel B. Regression Analysis of Incidence of Termination Provisions

Coefficient (p-value)

Variable Termination Fee Stock Option

Intercept 1.792 (0.000)

-1.969 (0.000)

Some Stock -0.708 (0.010)

1.528 (0.000)

R-square 0.017 0.074

Model p-value 0.008 0.000

# Obs 400 400

59

Table 10. Shareholder Voting Agreements and other Ownership Variables This table reports information on shareholder voting agreements, ownership affiliations, and toeholds for the sample takeovers. Shareholder Voting Agreement refers to the takeovers where a blockholder(s) commits to vote in favor of the merger or tender shares in a tender offer, with the mean and median fraction of shares in the voting agreements reported. Ownership Affiliation refers to the takeovers where the bidder had a long-term ownership interest in the target, with the mean and median fraction of shares held by the bidder prior to the commencement of the takeover reported. Toehold refers to takeovers where the bidder obtains an ownership stake just prior to the takeover announcement. Information to construct the table was taken from SEC documents.

Shareholder Voting Agreements and other Ownership Variables

# Obs Mean Median

Shareholder Voting Agreements 68 41% 40%

With termination provision 60 40% 39%

Without termination provision 8 52% 55%

Ownership Affiliation 28 54% 58%

With termination provision 8 40% 33%

Without termination provision 20 60% 63%

Toehold 28 7% 5%

With termination provision 24 7% 5%

Without termination provision 4 3% 1%

60

Table 11. Takeovers with no Termination Provision This table provides data on the 37 sample takeovers with neither a termination fee nor a stock option agreement granted to the bidder by the target. Shareholder Voting Agreement refers to the takeovers having no termination provision but where a blockholder(s) commits to vote in favor of the merger or tender shares in a tender offer, with the average fraction of shares in the voting agreement reported in the right hand column. Ownership Affiliation refers to the takeovers having no termination provision but where the bidder had a long-term ownership interest in the target, with the average fraction of shares held by the bidder prior to the commencement of the takeover reported in the right hand column. No Share Relation refers to cases where no ownership affiliation or shareholder voting agreement existed between the target and the bidder and the takeover did not have a termination provision. Information to construct the table was taken from SEC documents. ________________________________________________________________________ Number of Average Fraction Other Deal Characteristics Observations of Shares ________________________________________________________________________ Shareholder Voting Agreement 8 52% Ownership Affiliation 20 60% No share relation 10 n.a. Total 37 ________________________________________________________________________ Note: the total number of observations equals 37 because one takeover had both a shareholder voting agreement and an ownership affiliation.

61

Table 12. Termination Provisions, Shareholder Voting Agreements and other Ownership Variables This table reports logit regressions where the dependent variable equals one if the takeover had a termination fee, a stock option agreement, or both. The independent variables are the magnitude of voting agreements, ownership affiliations and toeholds. Voting Agreement refers to the fraction of shares a blockholder(s) commits to vote in favor of the takeover. Ownership Affiliation refers to the fraction of shares held by bidders with a long-term ownership interest in the target. Toehold refers to the fraction of shares the bidder obtains just prior to the takeover announcement. The reported statistics for each variable are coefficient (p-value in parentheses). The p-value for the individual coefficients is based on the Wald Chi-square test. The model p-value is based on the Wald Chi-square test for global significance of the explanatory variables. Information on termination provisions, voting agreements, ownership affiliation and toeholds was taken from SEC documents.

Regression Analysis of Incidence of Termination Provisions

Coefficient (p-value)

Variable (1) (2) (3) (4)

Intercept 2.39 (0.000)

2.95 (0.000)

2.27 (0.000)

3.24 (0.000)

Voting Agreement -1.20 (0.135) -- -- -2.35

(0.008)

Ownership Affiliation -- -7.39 (0.000) -- -7.72

(0.000)

Toehold -- -- 3.82 (0.692)

-2.43 (0.756)

Adjusted R-square 0.008 0.31 0.0008 0.33

Model p-value 0.159 0.000 0.655 0.000

# Obs 400 400 400 400

62

Table 13. Multiple Regression Analysis of the Incidence of Termination Provisions This table reports logit regression analysis of termination provisions granted to the bidder by the target firm. The first three regressions have 400 observations and the fourth regression has 363 observations. In regression 1, the dependent variable is equal to one for the 363 takeover agreements where any termination provision is granted. In regression 2, the dependent variable is equal to 1 in the 315 takeover agreements granting the bidder a termination fee. In regression 3, the dependent variable is equal to 1 in the 117 takeover agreements granting the bidder a stock option agreement. In regression 4, the dependent variable equals 1 in the 117 takeover agreements granting the bidder a stock option agreement (with or without a termination fee) and zero in the 246 takeover agreements granting the bidder only a termination fee. Auction is a dummy variable equal to 1 if the takeover procedure was an auction. Paramount is a dummy variable equal to 1 if the announcement of the takeover occurred in 1994 or later. Brazen is a dummy variable equal to 1 if the takeover announcement occurred in 1997 or later. Stock is a dummy variable equal to 1 if the payment terms entail some or all stock. Affiliated/Agreement is the fraction of the target’s common stock either held by a long-term affiliated bidder or committed by a blockholder in an agreement in favor of the takeover. Toehold is the fraction shares held by the bidder as part of a toehold strategy. Deal Size is the equity value of the target firm 21 days after the takeover announcement. Bank is a dummy variable equal to one if the target firm is in the banking industry. The 1st regression does not have a bank dummy because all deals where a bank is a target employ a fee, option or both. The reported statistics for each variable are coefficient (p-value in parentheses). The p-value for the individual coefficients is based on the Wald Chi-square test. The model p-value is based on the Wald Chi-square test for global significance of the explanatory variables.

Coefficient (p-value)

Variable All Provisions Termination Fee Stock Option Fee versus Option

Intercept 2.358 (0.239)

2.276 (0.171)

-4.256 (0.001)

-4.283 (0.001)

Auction 2.303 (0.000)

1.371 (0.000)

0.389 (0.178)

-4.283 (0.054)

Paramount 0.934 (0.087)

1.083 (0.012)

-0.251 (0.515)

-0.429 (0.280)

Brazen 0.130 (0.815)

0.569 (0.197)

0.182 (0.572)

0.179 (0.583)

Stock 1.169 (0.013)

0.394 (0.316)

0.794 (0.015)

0.669 (0.046)

Affiliated/Agreement -5.226 (0.000)

-4.394 (0.000)

-1.796 (0.023)

-0.699 (0.402)

Toehold -8.576 (0.360)

-0.097 (0.993)

-17.050 (0.274)

-16.653 (0.281)

Deal Size -0.081 (0.580)

-0.095 (0.435)

0.210 (0.025)

0.237 (0.013)

Bank -- -4.865 (0.000)

4.456 (0.000)

4.423 (0.000)

R-square 0.37 0.44 0.30 0.28 Model p-value 0.000 0.000 0.000 0.000 # Obs 400 400 400 363

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Figure 1. Timeline of the Takeover Process

The Private Takeover Process The Public Takeover Process Private Takeover Takeover Initiation Announcement Completion | | | | | | Confidentiality Bidding/ Takeover Agreement Public Bidding/ Regulatory Shareholder Standstill Negotiation Voting Agreements Negotiation Approval Voting Agreements Termination Provisions