Prior to the announcement of a tender offer, the bidding firm is legally allowed to acquire shares in the open market, subject to some limitations. These pre-announcement purchases are known as toeholds. This paper presents a simple model that describes the bidder's optimal toehold acquisition strategy, within an environment that closely parallels the present legal institutions. The model shows that toeholds and bids interact in a complex manner even without the presence of asymmetric information. By examining a simple environment the paper provides a useful alternative hypothesis for tests of other, presumably more complex, models. One of the main implications of our model is that if no competing bidders are expected, no toeholds should be purchased. The paper also demonstrates that the correct specification of an empirical model can be critical. For example, under some parameter values toehold purchases may exhibit a negative cross-sectional correlation with the pre-announcement run up in the stock price. This occurs even though prices are strictly increasing the size of the toehold. Several implications concerning various aspects of merger legislation are considered. For example, we demonstrate that a rule similar to a “fair price” provision has the desirable property that a second bidder arrives and wins if and only if he places a higher value on the target than the initial bidder.

This paper investigates the design of privatization mechanisms in emerging market economies characterized by political constraints that limit the set of viable privatization options. Our objective is to explain the striking diversity of mechanisms observed in practice and the frequent use of an apparently sub-optimal privatization mechanism: private negotiations. We develop a simple model in which privatization is to be carried out by a government agent, who plays favorites among bidders but is potentially disciplined by losing his private benefits of staying in office. If the political environment is such that the privatization agent himself aims at raising the fair value for the company, then privatization auctions and private negotiations are equally successful in raising public revenues. If, however, political considerations distort the agent’s incentives, it may be that a seemingly transparent auction will raise less revenue, than opaque private negotiations. We also show that information disclosure laws may have negative welfare implications: they may help the privatization agent to collude with some of the bidders to the disadvantage of non-colluding bidders.