When Is the Right Time to ‘Go Shop?’

By Ian Thomas October 14, 2013

When retailer Rue21 in May announced plans to sell itself to private equity firm Apax Partners for approximately $1.1 billion, the company said a special committee of its board would seek potential rival bidders during a 40-day so-called go-shop period.

During that time, the committee and its financial advisor, Perella Weinberg Partners, contacted 60 potential acquirers who they thought might be interested in an alternative transaction.

Just six of those 60 expressed enough interest to even pursue a deal, and none submitted an alternative acquisition proposal.

Go-shop provisions, which became popular during the buyout boom a decade ago, allow sellers to seek a better deal for about 30 to 50 days after reaching an agreement with another party. If the board secures a superior offer, it may terminate the original agreement and pay a lower termination fee for backing out.

While the option to shop may provide the board with a few advantages, a new study suggests that go-shop clauses are not likely to produce much better post-agreement offers, and can even reduce any acquisition premium from the initial agreement.

The study, conducted by Columbia Business School professors Charles Calomiris and Donna M. Hitscherich, along with Adonis Antoniades of the European Central Bank, analyzed more than 300 announced transactions between 2004 and 2011.

Taking into account deal size and the volatility of a company’s stock, the authors found that premiums offered to a target that has a go-shop clause are generally between 24% and 62% lower than in deals that aren't shopped.

“Any non-cash consideration that makes directors feel better is a good thing,” says Hitscherich. “But the fact of the matter is, it comes with a cost, and these types of options aren’t free.”

One of the main arguments for go-shop clauses is the reduction of litigation risk, she says. However, the study found no higher market price reaction to merger announcements that included go-shop clauses, or any other identifiable effect.

In fact, Hitscherich and Calomiris say, the impetus often comes out of a conflict of interest from the hired legal teams, who may be pushing go-shops on clients who don’t really need them.

Incorporating the clause in a merger agreement can make it easier to win court cases that may arise from the deal, helping lawyers look good and attract future clients, they say.

“It may be very hard for prospective clients to observe the size of the foregone acquisition premium that results from go-shop clauses,” Calomiris says. “And, much easier to observe the superior litigation outcomes produced by go-shops.”

Adding these sorts of “rituals” clouds the true goal for boards in a taxing situation, says Gary Lutin, chairman of the Shareholder Forum, an investor advocacy group.

“Directors should be encouraged to make decisions based on their business judgment about what actually works, rather than follow rituals designed for the sole purpose of defending litigation claims,” says Lutin. “Directors generally have no incentives to do anything other than find the best deal, so it’s really counterproductive to impose one-size-fits-all rules that limit their ability to do a good job.”

Similar situations were seen this year in deals at Dell, BMC Software and Smithfield Foods, all of which had go-shop clauses and failed to find a higher bid. But there are situations where having a go-shop clause could be beneficial, Hitscherich says.

In some cases, the price of including a go-shop clause could be less than costs arising from fiduciary duty suits, the authors say. One such instance would be where the company has a less concentrated ownership group and there is a higher likelihood of a deal's being challenged with conflict-of-interest claims.

A company that negotiated quietly with only a few parties or had multiple top executives involved in the buyout would also benefit from a go-shop clause, indicating that they checked the market for other offers, Hitscherich says.

Directors should ultimately take into consideration that the threat of litigation in connection with proposed mergers can never be entirely eliminated, regardless of any clause or language used, writes Christine Azar, a partner at Labaton Sucharow.

“The special committee must be ready to negotiate, and not merely act as a figurehead for the interested parties,” she says.