Linear Probability Models of Takeovers I

Abstract

In this chapter I shall develop and test various formulations of the first of two basic models of takeovers employing two variables discussed in the previous chapter. This first model investigated is based on the anticipated inverse relationship between the valuation ratio and the probability that a firm will be taken over. The valuation ratio and the financial variables are included in separate models since it was expected that the effect of the latter would be felt through the valuation ratio. I shall investigate a number of relationships based on various possible formulations of the valuation ratio and size, a variable not expected to be correlated with the valuation ratio. Finally, each of the 67 industries will be treated separately since it is expected that it is the indicators of the firm’s performance relative to comparable firms in the same industry which single it out as a takeover candidate. In this way, the specification of the model is improved such that the variations attributable solely to the industry class will be removed thereby giving the variables a greater chance to capture the posited dependence of the probability of takeover on each.