A Theory of Takeovers and Disinvestment

We present a real-options model of takeovers and disinvestment in declining industries. As product demand declines, a first-best closure level is reached, where overall value is maximized by shutting down the firm and releasing its capital to investors. Absent takeovers, managers of unlevered firms always abandon the firm's business too late, but debt and golden parachutes can mitigate this inefficiency. We analyze the effects of takeovers of under-leveraged firms. Takeovers by raiders enforce first-best closure. Hostile takeovers by other firms occur either at the first-best closure point or too early. We also consider management buyouts and mergers of equals and show that in both cases closure happens inefficiently late