This paper considers the choice of tender offer financing in the presence of atomistic shareholders. If the tender offer is financed with debt, the raider can extract at least part of the gains from future value improvements as the additional leverage introduced into the merged firm reduces the posttakeover share value and therefore the incentives for target shareholders to hold on to their shares. In contrast, if the tender offer is financed with equity, any gains from future value improvements must be passed to the target shareholders. The paper further considers the optimal choice of capital structure by the target management in response to a concrete takeover threat. It is shown that an increase in leverage raises the bid premium but reduces the probability that the takeover succeeds as it limits the raider's ability to borrow against the target's existing assets.
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