working papers

Security Design for Private Acquisitions

With Mark Jansen and Thomas Noe

Informal Abstract: Theoretical paper showing that if there is information asymmetry (the seller knows more) and disagreement as to how well the buyer will run the company, then asking the seller to provide a loan to the buyer is a great idea. Much better than asking the seller to keep a stake in the company, and even when the buyer is not financially constrained. This ‘seller financing’ is indeed common in acquisition of private assets.

Formal Abstract: We consider the security design problem of an acquirer with value-add capacity for a target firm. The target firm has a single owner with private information about the suitability of his firm for the value-add plan. The parties disagree about the magnitude of the acquirer’s value-add. The acquirer’s offer consists of a mix of cash and securities. Although the acquirer can choose any monotone limited liability security, we show that, under general conditions, the only security she employs is non-recourse debt provided by the seller. The cash-debt mix depends on the degree of both information asymmetry and disagreement.