Toehold stakes fail to deter rivals in multi-round auctions
New computational modeling suggests that buying a preliminary stake in a target company does not frighten off competing bidders.
Acquiring a toehold stake before launching a takeover bid is traditionally viewed as a dual-purpose strategy: it lowers the cost of the final acquisition and deters rivals from entering the fray. This research challenges the deterrence theory by modeling takeovers as multi-round auctions with escalating offers rather than the single-exchange events assumed in classical models. The findings show that while the arithmetic benefit of owning shares remains, the ability of a toehold to scare off competitors disappears once a second round of bidding is possible.
This breakdown in deterrence explains why toehold stakes are rarer in practice than corporate finance theory predicts. The model demonstrates that aggressive preemptive bidding occurs even without a toehold, meaning the behavior stems from the public, turn-based nature of the auction rather than the ownership of the stake. The presumed relationship where a larger toehold leads to more deterrence only holds in contests that end after a single round.
For firms designing acquisition strategies, this suggests that the capital deployed to secure a preliminary stake may not provide the strategic moat previously assumed. If rivals are willing to engage in a multi-round process, the toehold does not function as a psychological or economic barrier to entry. The cost and price impact of accumulating these shares may outweigh the benefits if the primary goal is to avoid a bidding war.
Beyond the strategy of takeovers, the work highlights a critical instability in the software used to calculate these economic outcomes. The researchers found that game solvers can return two different, equally converged figures for the value of a preemptive bid depending on the starting point of the calculation. This instability suggests that quantitative models used to price takeover premiums or evaluate bid aggression may be producing confident but inconsistent results.
This inconsistency poses a risk for any entity relying on computational game theory to determine the optimal bid price or the likelihood of a rival's exit. The reliance on solvers that can converge on different equilibrium points means that the perceived "correct" bid may be an artifact of the software's starting parameters rather than a reflection of market reality.
Market participants should view the "deterrence value" of a toehold as a fragile assumption that collapses under the reality of iterative bidding. The focus for corporate control shifts from the size of the initial stake to the structural rules of the auction process itself.