Time Warner, Inc., Is Playing Games with Stockholders (Case Study)
’s above-market offer for Ti Paramount me, Inc. consistent with the notion that the prevailing market price for common stock is an accurate reflection of the discounted net present value of future cash flows? Was manage ment’s
rejection of ’s
above-market offer for Ti Paramount me, Inc.
consistent with the value-maximization concept?
that a Ti me Warner shareholder could
buy additional shares at a market price of $90 or participate in the company’s
rights offering. Construct the payoff the matrix that corresponds to a $90 per share purchase decision versus a decision
to participate in the rights offering with subsequent 100%, 80%, and 60% participation
by all Ti me Warner shareholders.
C. Describe the secure ga
me theory strategy for Ti me
Warner shareholders. Was there a
D. Explain why the price of Ti
me Warner common stock fell following the announce ment of the company’s controversial rights
offering. Is such an offering in the
best interests of shareholders?
CASE STUDY SOLUTION
A. These are, of course, controversial questions designed to spur debate on the issues of capital market efficiency and the convergence or divergence between shareholder and managerial interests.
’s 1989 above-market offer for Ti Paramount me, Inc. is consistent with the notion that the prevailing market price for common stock is an accurate reflection of the discounted net present value of future cash flows to the extent that such a merger promised significant synergistic
benefits. As a separate entity, the
stock market estimated the discounted net present value of Ti me, Inc. at $125 per share. It is possible that advantages from combining
Ti Paramount me might have led to such a dramatic
improve ment in cash flows that a
$200 versus $125 market price per share could be justified. However, subsequent events may call this
interpretation into question. and Warner have
many similarities, and Ti Paramount me Warner’s
failure to generate such synergies makes the magnitude of such benefits
questionable. Still, one might argue
that Paramount manage ment
headed by Marvin Davis might have better managed the combined company than the
Ti me Warner manage ment team headed by Stephen Ross. On the other hand, if the 1989 offer of $200
per share was above the fair value of Ti me,
Inc., then perhaps hubris on the part of Paramount
manage ment is to bla me. In light
of Ti me Warner’s subsequent
performance, the fact that such an attractive Paramount
offer was turned down by Ti me manage ment suggests that they neglected to fully consider
B. The payoff matrix that corresponds to a $90 per share purchase decision versus a decision to participate in the rights offering in light of 100%, 80%, and 60% participation by all Ti
me Warner shareholders is:
Share Purchase Cost Payoff Matrix
States of Nature
Note that investors wish to minimize the cost of additional share purchases. Therefore, a payoff is realized in terms of a lower share purchase price.
C. A secure strategy, so
called the maximin strategy, guarantees the best possible outco me given the worst possible scenario. In this case, the worst possible scenario for
current shareholders would occur if they chose to participate and all other
shareholders also decided to participate in the rights offering. In that case, everybody would pay $105 per
share. To avoid that outco me, the secure strategy for current shareholders is
not to participate in the rights offering, and to instead buy additional shares
in the marketplace for $90. Because the
best possible outco me cannot be
assured without knowledge of the actions of other participating shareholders,
there is no dominant strategy in this case.
D. The price of Ti
me Warner common stock fell subsequent to the
announce ment of the company’s
controversial rights offering for a number of reasons. The uncertain nature of the contingent rights
offering increases the risk of Ti me
Warner stock and, absent any offsetting increase in cash flows, thereby reduces
the risk-adjusted net present value of future cash flows. Thus, the contingent nature of the rights
offering has the predictable effect of reducing the market price of Ti me Warner stock.
The simple fact that the company wanted to sell additional common stock
at a market price of $105 per share also seems to suggest that manage ment views this price as “high,” and indicates so me lack of confidence in the company’s future
prospects. And finally, the cohesive
nature of the offering might drive down the price of the company’s stock
because it suggests an adversarial rather than cooperative relationship between
manage ment and stockholders.
Interestingly, in light of the furor caused by its contingent rights offering, Ti
Warner decided to withdraw the offer a few weeks after it had been
announced. In its place, the company
decided to offer current shareholders the right to purchase up to 34.45 million
new shares at a fixed price of $80 per share.
The company’s invest ment
bankers also took a haircut on commissions, reducing their take to a total of
3% of the amount raised and agreed to purchase for their own account any unsold
shares. Obviously, the initial
contingent rights offering was a bad idea.
Both large and small investors heralded the company’s change in the
offering as a victory for shareholders.