Control Premium (Stock) - Explained
What is a Control Premium?
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Table of ContentsWhat is a Control Premium?How does a Control Premium Work? Academic Research on Control Premium
What is a Control Premium?
A control premium refers to an amount a buyer is willing to pay to acquire a majority or controlling the share of a publicly-traded company. This amount is often over and above the current market price, buyers an investors pay this amount to acquire a majority share in a company. A control premium is often higher than the current market price of a public company. When an acquirer is willing to pay an excessive amount for the controlling shares of a company which is kore than the price the company is currently trading in the market, a control premium is paid.
How does a Control Premium Work?
The purchase of minority shares of a public company is often done at the price established by market participants. However, when a buyer or an acquiree wants to acquire the majority (controlling) shares of a publicly-traded company, a premium must be offered, this is an amount more than the current market price of the companys shares. A control premium, when offered by an acquiree is done through a tender offer that is given to the publicly traded company. The tender offer included the amount of the majority shares of the company the acquirer wants and the price offered for the purchase. Generally, the amount an acquirer offers to pay for the majority shares of a company must match the intrinsic value of the target company. Actual premiums paid by acquirers differ, the premium is specific to the company whose shares are to be purchased and the type of synergy the acquirer hopes to build with the company.
Academic Research on Control Premium
- The control premium: A preference for payoff autonomy, Owens, D., Grossman, Z., & Fackler, R. (2014). American Economic Journal: Microeconomics, 6(4), 138-61. We document individuals' willingness to pay to control their own payoff. Experiment participants choose whether to bet on themselves or on a partner answering a quiz question correctly. Given participants' beliefs, which we elicit separately, expected-money maximizers would bet on themselves in 56.4 percent of the decisions. However, participants actually bet on themselves in 64.9 percent of their opportunities, reflecting an aggregate control premium. The average participant is willing to sacrifice 8 percent to 15 percent of expected asset-earnings to retain control. Thus, agents may incur costs to avoid delegating and studies inferring beliefs from choices may overestimate their results on overconfidence.
- Private benefits of control: An international comparison, Dyck, A., & Zingales, L. (2004). The Journal of Finance, 59(2), 537-600. We estimate private benefits of control in 39 countries using 393 controlling blocks sales. On average the value of control is 14 percent, but in some countries can be as low as -4 percent, in others as high a +65 percent. As predicted by theory, higher private benefits of control are associated with less developed capital markets, more concentrated ownership, and more privately negotiated privatizations. We also analyze what institutions are most important in curbing private benefits. We find evidence for both legal and extra-legal mechanisms. In a multivariate analysis, however, media pressure and tax enforcement seem to be the dominating factors.
- The Sale-of-Control Premium: The Definition, Bayne, D. C. (1968). Minn. L. Rev, 53, 485.
- Mergers and the market for corporate control, Manne, H. G. (1965). Journal of Political economy, 73(2), 110-120.
- The Sale-of-Control Premium: The Disposition, Bayne, D. C. (1969). Cal. L. Rev., 57, 615.
- Premium control in an insurance system, an approach using linear control theory, Martin-Lf, A. (1983). Scandinavian Actuarial Journal, 1983(1), 1-27. The problem of finding good premium control methods in an insurance business is considered. A mathematical model of the cash flows and the reserves is discussed, and a linear control law with feed back for the premium is proposed. The behaviour of the system is analysed using the methods of control theory. It is shown that stability is maintained only if the feed back is not too strong and that undesirable oscillations can easily be produced caused by delays in the system. The problem of determining the control so that a desired solidity is obtained is considered, and it is shown how a quantitative measure of the necessary solidity can naturally be introduced.
- Out-of-the-money CEOs: Private control premium and option exercises, Fos, V., & Jiang, W. (2015). The Review of Financial Studies, 29(6), 1549-1585. When a proxy contest is looming, the rate at which CEOs exercise options to sell (hold) the resulting shares slows down by 80% (accelerates by 60%), consistent with their desire to maintain or strengthen voting rights when facing challenges. Such deviations are closely aligned with features unique to proxy contests, such as the record dates and nomination status, and are more pronounced when the private benefits are higher or when the voting rights are more crucial. The distortions suggest that incumbents value their stocks higher than the market price when voting rights are valuable for defending control.
- Corporate control transactions, Easterbrook, F. H., & Fischel, D. R. (1981). Yale Lj, 91, 698.
- Agency problems and synergistic effects in Romania: The determinants of the control premium, Dragota, V., Lipara, C., & Ciobanu, R. (2013). Finance a Uver, 63(2), 197. Estimation of the control premium remains one of the main concerns in the financial literature: different approaches take into consideration synergistic effects, agency problems, and the bargaining power of different agents. We estimated the level of the control premium and its determinants for Romanian listed companies in the period 20002011. The median of the control premium was 25%. Using a linear regression model, we found that the determinants of the control premium for Romanian listed companies are similar to those revealed for other countries. The control premium was directly related to the liquidity of the shares of the acquired company before the transaction, to the percentage share purchased in the transaction, and to the ownership concentration of the acquired company. Also, its level was higher if the buyer was a corporation, and also if the acquirer, or the majority shareholder before the transaction, was Romanian. The control premium was inversely related to the size of the acquired company, to the bargaining power of the buyer, and to the fact that the acquirer was already a shareholder of the target company. The control premium increases if the target company has a majority shareholder, or at least shareholders owning more than 33% of the equity capital, before the transaction, but decreases if the ownership is dispersed. Moreover, we find that the sector of the target company has an influence on the control premium. Thus, if the firm was active in services or in the machinery and equipment industry, the control premium was higher, while if it was active in agriculture, construction, the food industry, or the chemicals industry it was lower.
- Managerial control of voting rights: Financing policies and the market for corporate control, Stulz, R. (1988). Journal of financial Economics, 20, 25-54. This paper analyzes how managerial control of voting rights affects firm value and financing policies. It shows that an increase in the fraction of voting rights controlled by management decreases the probability of a successful tender offer and increases the premium offered if a tender offer is made. Depending on whether managerial control of voting rights is small or large, shareholders' wealth increases or falls when management strengthens its control of voting rights. Management can change the fraction of the votes it controls through capital structure changes, corporate charter amendments, and the acquisition of shareholder clienteles.
- Control premium in the presence of rules imposing mandatory tender offers: can it be measured?, Massari, M., Monge, V., & Zanetti, L. (2004). In this paper we modify the approach pioneered by Barclay and Holderness (1989) and recently reproposed by Dyck and Zingales (2004) in order to measure the value of control in countries, like Italy, where transfer of control is regulated by law. Our estimates range from 12% to 14%, depending on the number of shares acquirers expect to buy on the market in force of the obligation to launch a tender offer. Our results confirm some theoretical predictions, namely a positive relation between the magnitude of the premiums and the degree of stock-pyramiding. In general terms, the magnitude of private benefit of control observed from our analysis is smaller then in previous studies. Our results suggest further research, aimed at testing similar methodologies in other countries in which transactions that convey control are driven by legal requirements, and at assessing if a relation actually exists between the appeal and the credibility of the acquirers, on one hand, and the observed magnitude of control premia, on the other.
- The law and economics of self-dealing, Djankov, S., La Porta, R., Lopez-de-Silanes, F., & Shleifer, A. (2008). Journal of financial economics, 88(3), 430-465. We present a new measure of legal protection of minority shareholders against expropriation by corporate insiders: the anti-self-dealing index. Assembled with the help of Lex Mundi law firms, the index is calculated for 72 countries based on legal rules prevailing in 2003, and focuses on private enforcement mechanisms, such as disclosure, approval, and litigation, that govern a specific self-dealing transaction. This theoretically grounded index predicts a variety of stock market outcomes, and generally works better than the previously introduced index of anti-director rights.