How a firm’s advertising activity can generate takeover interest and strengthen its bargaining power

In the summer of 2009, US technology company Data Domain, Inc. was the subject of a bidding war between two rival companies. The winning bidder offered a final 87% premium to the share price in order to seize control, and Data Domain’s shareholders profited handsomely from the deal. There are many reasons why two companies might fiercely compete to acquire a company but it is interesting to note that in the fiscal year prior to receiving offers, Data Domain roughly tripled its advertising spend. Could this have been a factor in the attractiveness of the Data Domain deal to its suitors?

The authors of the paper Target Firm Advertising and Firm Value (who include Professor Anh Tran of Bayes Business School) explore the phenomenon of firms that are either interested in or concerned about a takeover, increasing their advertising activity prior to an offer. They propose and test two contrasting hypotheses that may explain it.

The first hypothesis is referred to as information transmission. This is adapted from an earlier theory that, through advertising, firms inform potential bidders as well as customers that they are a high-quality business.

The second hypothesis is investor attention. This posits that a firm’s management increases advertising to take advantage of behavioural biases and attract the attention of potential bidders.

Both hypotheses share the assumption that the increased spend on advertising is an effort by the firms to promote their products, attract potential acquirers and investors, and to bolster their bargaining position in the event of a takeover offer. The implication for both is that the higher advertising spend means lower search costs for potential bidders, meaning the firm is more likely to be a bid target, may see higher takeover premiums, and a larger share of merger gains than might otherwise have been expected.

To test these implications, the researchers analysed a sample of 7,827 M&A bids for publicly traded US firms announced during 1986-2016. Empirical analysis indicated that:

• Increased advertising is associated with a higher probability of becoming a takeover target.
• In general, targets who advertise prior to a takeover attempt see higher takeover premiums for their shareholders.
• Increasing advertising spend by a single standard deviation is associated with a one percentage point higher takeover premium.
• More advertising results in more attention, as measured through Google searches, and greater search volume intensity results in an increase in premium.
• Targets that advertise have an increased chance of attracting more than one bidder, with a higher probability therefore that initial bids will be raised as rivals compete to win.
• Increased advertising does strengthen the target’s bargaining power, with bidders having to offer more as a result.

The results also show that the increase in target shareholder wealth tends to be paid out of the acquirer’s share of takeover gains. Thus, the evidence suggests that increased advertising not only heightens customer awareness, but also investor recognition and manager negotiation positions.

Finally, through the use of withdrawn deals, the authors establish the causal effect of advertising on target premiums and find that the information transmission hypothesis is the more likely explanation for the effects seen. The results show that even if the acquisition fails, targets that advertise prior to receiving a bid experience a permanent upward revaluation of about 1%. Such revaluation would not occur if the positive association between a target’s pre-takeover advertising and the merger premium paid to that firm stemmed from investors’ behavioural biases.

The accepted version of the paper Target Firm Advertising and Firm Value is available for download at City Research Online.