How Toeholds Become Footholds

We document empirical evidence that bidders tailor their takeover strategy when facing entrenched target managers. Key elements of takeover strategies comprise the toehold investment and the initial bid premium. Intervening variables are the principal outsider and contest parameters. Several relationships are identified. First, initial bid premiums for targets characterized by entrenchment are comparatively low because bidders can not compensate entrenched managers for lost private benefits without overpaying. Second, toeholds alone have no explanatory power in explaining bidders' takeover strategy. Instead, for targets with entrenched managers toeholds are optimized with respect to the principal outsider rather than the target management block in order to create a foothold that effectively threatens entrenchment. Thus, bidders with toeholds effectively bypass entrenched target managers. Third, our measure of free rider cost savings is increasing in toehold/principal outsider and decreasing in entrenchment, implying an optimal toehold strategy (in tandem with a low bid premium) that recognizes the pivotal role of the principal outsider