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deal was agreed to relatively quickly. However, in some circumstances a quick deal may not be the best. AT&T's $48 billion acquisition of TCI is an example of a friendly deal where the buyer did not do its homework and the seller did a good job of accommodating the buyer's (AT&T's) desire to do a quick deal at a higher price. Speed may help ward off unwanted bidders, but it may work against a close scrutiny of the transaction.

      Sometimes friendly negotiations may break down, leading to the termination of the bid or a hostile takeover. An example of a negotiated deal that failed and led to a hostile bid was the tender offer by Moore Corporation for Wallace Computer Services, Inc. Here negotiations between two archrivals in the business forms and printing business proceeded for five months before they were called off, leading to a $1.3 billion hostile bid. In 2003 Moore reached agreement to acquire Wallace and form Moore Wallace. One year later Moore Wallace merged with RR Donnelley.

      In other instances a bid is opposed by the target right away and the transaction quickly becomes a hostile one. One classic example of a very hostile bid was the 2004 takeover battle between Oracle and PeopleSoft. This takeover contest was unusual due to its protracted length. The battle went on for approximately a year before PeopleSoft finally capitulated and accepted a higher Oracle bid.

      Most merger agreements include a material adverse change clause. This clause may allow either party to withdraw from the deal if a major change in circumstances arises that would alter the value of the deal. This occurred in late 2005 when Johnson & Johnson (J&J) stated that it wanted to terminate its $25.4 billion purchase of Guidant Corporation after Guidant's problems with recalls of heart devices it marketed became more pronounced. J&J, which still felt the criticism that it had paid too much for its largest prior acquisition, Alza (acquired in 2001 for $12.3 billion), did not want to overpay for a company that might have unpredictable liabilities that would erode its value over time. J&J and Guidant exchanged legal threats but eventually seemed to agree on a lower value of $21.5 billion. J&J's strategy of using the material adverse change clause to get a better price backfired, as it opened the door for Boston Scientific to make an alternative offer and eventually outbid J&J for Guidant with a $27 billion final.

Auctions versus Private Negotiations

      Many believe that auctions may result in higher takeover premiums. Boone and Mulherin analyzed the takeover process related to 377 completed and 23 withdrawn acquisitions that occurred in the 1990s.6 Regarding the auctions in their sample, they found that on average 21 bidders were contacted and 7 eventually signed confidentiality and standstill agreements. In contrast, the private negotiated deals featured the seller dealing with a single bidder.

      Boone and Mulherin found that more than half of deals involved auctions; the belief in the beneficial effects of auctions raised the question of why all deals are not made through auctions. One explanation may be agency costs. Boone and Mulherin analyzed this issue using an event study methodology, which compared the wealth effects to targets of auctions and negotiated transactions. Somewhat surprisingly they failed to find support for the agency theory. Their results failed to show much difference in the shareholder wealth effects of auctions compared to private negotiated transactions. This result has important policy implications as there has been some vocal pressure to require mandated auctions. The Boone and Mulherin results imply that this pressure may be misplaced.

Confidentiality Agreements

      When two companies engage in negotiations the buyer often wants access to nonpublic information from the target, which may serve as the basis for an offer acceptable to the target. A typical agreement requires that the buyer, the recipient of the confidential information, not use the information for any purposes other than the friendly deal at issue. This excludes any other uses, including making a hostile bid. While these agreements are negotiable, their terms often are fairly standard.

      Confidentiality agreements, sometimes also referred to as non-disclosure agreements (NDAs), usually cover not just information about the operations of the target, including intellectual property like trade secrets, but also information about the deal itself. The latter is important in instances where the target does not want the world to know it is secretly shopping itself. In addition, these agreements often include a standstill agreement, which limits actions the bidder can take, such as purchases of the target's shares. Standstill agreements often cover a period such as a year or more. We discuss them further in Chapter 5. However, it is useful to merely point out now that these agreements usually set a stock purchase ceiling below 5 %, as purchases beyond that level may require a Schedule 13D disclosure (discussed in Chapter 3), which may serve to put the company in play.

      In a recent Delaware Chancery Court decision, Chancellor Strine underscored that a confidentiality agreement does not automatically assume a standard agreement.7 However, he also stated that the NDA may limit the ability of one party to use information covered by the NDA to take actions not allowed under the agreement, including a hostile bid.

Initial Agreement

      When the parties have reached the stage where there are clear terms upon which the buyer is prepared to make an offer that it thinks the seller may accept, the buyer prepares a term sheet. This is a document that the buyer usually controls but that the seller may have input into. It may not be binding, but it is prepared so that the major terms of the deal are set forth in writing, thus reducing uncertainty as to the main aspects of the deal. The sale process involves investing significant time and monetary expenses, and the term sheet helps reduce the likelihood that parties will incur such expenses and be surprised that there was not prior agreement on what each thought were the major terms of the deal. At this point in the process, a great deal of due diligence work has to be done before a final agreement is reached. When the seller is conducting an auction for the firm, it may prepare a term sheet that can be circulated to potential buyers so they know what is needed to close the deal.

      While the contents will vary, the typical term sheet identifies the buyer and seller, the purchase price and the factors that may cause that price to vary prior to closing (such as changes in the target's financial performance). It will also indicate the consideration the buyer will use (i.e., cash or stock) as well as who pays what expenses. While there are many other elements that can be added based on the unique circumstances of the deal, the term sheet should also include the major representations and warranties the parties are making.

      The term sheet may be followed by a more detailed letter of intent (LOI). This letter delineates more of the detailed terms of the agreement. It may or may not be binding on the parties. LOIs vary in their detail. Some specify the purchase price, while others may only define a range or formula. It may also define various closing conditions, such as providing for the acquirer to have access to various records of the target. Other conditions, such as employment agreements for key employees, may also be noted. However, many merger partners enter into a merger agreement right away. So a LOI is something less than that, and it may reflect one of the parties not necessarily being prepared to enter into a formal merger agreement, For example, a private equity firm might sign a LOI when it does not yet have firm deal financing. This could alert investors, such as arbitragers, that the deal may possibly never be completed.

Disclosure of Merger Negotiations

      Before 1988, it was not clear what obligations U.S. companies involved in merger negotiations had to disclose their activities. However, in 1988, in the landmark Basic v. Levinson decision, the U.S. Supreme Court made it clear that a denial that negotiations are taking place, when the opposite is the case, is improper.8 Companies may not deceive the market by disseminating inaccurate or deceptive information, even when the discussions are preliminary and do not show much promise of coming to fruition. The Court's decision reversed earlier positions that had treated proposals or negotiations as being immaterial. The Basic v. Levinson decision does not go so far as to require companies to disclose all plans or internal proposals involving acquisitions. Negotiations between two potential merger partners, however, may not be denied. The exact timing of the disclosure is still not clear. Given the requirement to disclose, a company's hand may be forced by the pressure of market speculation. It is often difficult to confidentially

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