How toeholds become footholds

We document empirical evidence that bidders tailor their takeover strategy when facing entrenched target managers. Key elements of a takeover strategy comprise the toehold purchase and the initial bid premium. We find that toeholds are acquired in cognizance of the principal outsider and target management block. Bidders’ free rider cost savings are measured by the product of the toehold and the initial bid premium. Several relationships are identified. Initial bid premiums for targets characterized by entrenchment are comparatively low and result in low free rider benefits to bidders. To avoid overpayment, bidders do not compensate entrenched managers for lost private benefits. Instead, in entrenchment scenarios toeholds are optimized with respect to the principal outsider as well as the target management block in order to create a foothold that neutralizes entrenchment. At the median toeholds match the spread between the principal outsider and the target management block in entrenchment scenarios, are about double the spread for shareholder-aligned targets and much smaller for owner-managed targets. Takeovers of owner-managed targets rely more on a higher offer price.