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Publication Title

Washington University Law Quarterly

Abstract

Financing of hostile takeovers has emerged as a central issue in the ongoing debate concerning corporate takeovers. Concomitant with the increase in the dollar value of takeovers during the past few years has been a significant increase in the percentage of tender offer financing accounted for by bank borrowing and the issuance of high yield debt, (that is, debt securities which are rated below Standard and Poor's BBB-or Moody's Baa3), hereafter referred to as junk bonds, have accounted for an increasingly greater percentage of takeover financing. This Article examines these concerns about debt financing of corporate takeovers from an "efficient markets" perspective. The efficient-market hypothesis has important implications for public policy toward corporate takeovers. Because a takeover involves the payment of premiums to target shareholders, prospective bidders must perceive a way to raise the target firm's value, that is, the discounted cash flow of the target firm. We argue that junk-bond financing facilitates takeovers which in turn promote economic efficiency. Critics of leveraged takeovers, in our view, exaggerate the risks associated with these transactions, and in some instances, misunderstand the nature of corporate debt. After illustrating the structure of a leveraged takeover with an analysis of Mesa Petroleum's unsuccessful bid for Unocal, this Article seeks to correct the misperceptions about corporate debt with a discussion of the economics of corporate leverage. Finally, we use the Mesa-Unocal case to evaluate the claims made by critics of leveraged takeovers.

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