Cash Offers vs Stock Offers

A couple of months ago I got a phone call from a friend who had put her house on the market. She had a few offers, including one which was all-cash. Should she go with it, she asked, even if it wasn't the highest of the lot? Of course not, I said. It's no business of hers where the money comes from: she should just accept the highest offer. Yes, there might be a small chance that the finaning doesn't go through, but that in no way makes up for the tens of thousands of dollars she'd be losing out on by taking the lower offer.

All the same, realtors and home sellers seem to love all-cash offers. And in that respect they're startlingly similar to corporate boards. Often, when one company offers to acquire another, boards will discount any offer made in stock rather than cash. Indeed, in some instances, a company will agree to a lower sale price just in order to get cash rather than the equivalent amount in stock and/or debt.

What's going on here? Part of the issue is that the sale price, in terms of stock, is agreed before the stock is actually handed over – so if the acquirer's stock tumbles between the deal being signed and the stock transfer taking place, then the shareholders of the target company end up getting less money. On the other hand, such an eventuality can easily be dealt with: it's simplicity itself to hedge that kind of exposure to an individual stock price. What's more, if you're getting a fixed number of shares, there's a good chance that they'll go up in value before you receive them, rather than going down.

No, the real problem is not the value of the shares upon receipt. It's the long-term performance of those shares after they've been acquired. For even people who prefer cash, it turns out, are still more likely than not to hold onto shares if that's what they're given:

Research by Associate Professor Malcolm Baker, Professor Joshua Coval, and Harvard University professor Jeremy C. Stein shows that 80 percent of individual investors and 30 percent of institutional investors appear to be more inertial than logical. They take the default option, passively accepting the shares offered as consideration in stock mergers and acquisitions...
"Investor irrationality is something that people tend to focus on when they think about investing in capital markets," [Baker] continues, "but there are also implications for corporate finance." For example, when investors hold onto stock they've received in an acquisition—taking the path of least resistance—it keeps those shares off the open market and makes the price relatively higher than it would have been otherwise.

This explains a lot. It explains, for one thing, why companies don't just sell stock in a secondary offering and then use the cash to buy the company they want to acquire. That would depress their share price. Offering stock rather than cash, on the other hand, doesn't hurt the share price nearly as much, because most of the recipients of the stock won't sell it.

And it also explains why boards are suspicious of all-stock offers. They know their own weakness: that they're likely to hold on to the stock rather than sell it. But it doesn't explain the attraction of all-cash offers for houses.

Finally it's worth remembering all the entrepeneurs who turned down all-stock offers from Google for their companies. If they'd taken the Google stock, rather than holding out for more money, they'd be much better off right now than they are.