A couple of months ago I got a phone call from a friend who had put her house
on the market. She had a few offers, including one which was all-cash. Should
she go with it, she asked, even if it wasn’t the highest of the lot? Of course
not, I said. It’s no business of hers where the money comes from: she should
just accept the highest offer. Yes, there might be a small chance that the finaning
doesn’t go through, but that in no way makes up for the tens of thousands of
dollars she’d be losing out on by taking the lower offer.
All the same, realtors and home sellers seem to love all-cash offers. And in
that respect they’re startlingly similar to corporate boards. Often, when one
company offers to acquire another, boards will discount any offer made in stock
rather than cash. Indeed, in some instances, a company will agree to a lower
sale price just in order to get cash rather than the equivalent amount in stock
and/or debt.
What’s going on here? Part of the issue is that the sale price, in terms of
stock, is agreed before the stock is actually handed over – so if the
acquirer’s stock tumbles between the deal being signed and the stock transfer
taking place, then the shareholders of the target company end up getting less
money. On the other hand, such an eventuality can easily be dealt with: it’s
simplicity itself to hedge that kind of exposure to an individual stock price.
What’s more, if you’re getting a fixed number of shares, there’s a good chance
that they’ll go up in value before you receive them, rather than going down.
No, the real problem is not the value of the shares upon receipt. It’s the
long-term performance of those shares after they’ve been acquired.
For even people who prefer cash, it
turns out, are still more likely than not to hold onto shares if that’s
what they’re given:
Research by Associate Professor Malcolm Baker, Professor Joshua Coval, and
Harvard University professor Jeremy C. Stein shows that 80 percent of individual
investors and 30 percent of institutional investors appear to be more inertial
than logical. They take the default option, passively accepting the shares
offered as consideration in stock mergers and acquisitions…
"Investor irrationality is something that people tend to focus on when
they think about investing in capital markets," [Baker] continues, "but
there are also implications for corporate finance." For example, when
investors hold onto stock they’ve received in an acquisition—taking
the path of least resistance—it keeps those shares off the open market
and makes the price relatively higher than it would have been otherwise.
This explains a lot. It explains, for one thing, why companies don’t just sell
stock in a secondary offering and then use the cash to buy the company they
want to acquire. That would depress their share price. Offering stock rather
than cash, on the other hand, doesn’t hurt the share price nearly as much, because
most of the recipients of the stock won’t sell it.
And it also explains why boards are suspicious of all-stock offers. They know
their own weakness: that they’re likely to hold on to the stock rather than
sell it. But it doesn’t explain the attraction of all-cash offers for houses.
Finally it’s worth remembering all the entrepeneurs who turned down all-stock
offers from Google for their companies. If they’d taken the Google stock, rather
than holding out for more money, they’d be much better off right now than they
are.