This paper provides the first theoretical explanation and the first empirical analysis of contingent value rights (CVRs), which have been used as a means of payment in acquisitions, exchange offers, debt restructurings, Chapter 11 reorganizations, and lawsuit settlements. A CVR is a put option committing to pay additional cash or securities to CVR holders, contingent on the issuer's share price falling below a prespecified reference level. In this paper, we develop a model to show that CVRs can help a higher-intrinsic-value firm to reveal its firm type when the firm faces an asymmetric information problem. Our model predicts that i) when CVRs are offered along with cash or stock, the announcement period abnormal stock return is greater than that in stock offers, ii) firms facing more severe asymmetric information problems are more likely to offer CVRs to signal their firm type, and iii) firms that are relatively more cash-constrained are more likely to offer CVRs rather than cash. We test all three predictions using a sample of mergers and acquisitions. Our empirical results are consistent with the predictions of the model.
* Chatterjee, [email protected] and Yan, [email protected], Schools of Business, Fordham University, 113 W 60th St, New York, NY 10023. The earlier version of this paper was circulated under the title “Contingent Value Rights: Theory and Empirical Evidence.” For helpful comments or discussions, we thank Hendrik Bessembinder (the editor), Tim Burch, Thomas Chemmanur, Michael Fishman, Murali Jagannathan, Yuri Khoroshilov, Srinivasan Krishnamurthy, Jinliang Li, Robert Mooradian, Lemma Senbet, Spencer Martin, Kristian Rydqvist, and Rajdeep Singh, as well as participants at the 2003 European Finance Association meetings, the 2003 Financial Management Association meetings, the 2004 Western Finance Association meetings, and seminars at SUNY Binghamton and Northeastern University. We also thank Pierre Hillion (the referee) for helpful suggestions. We alone are responsible for any errors or omissions.