Due Diligence - Brett Green

Finance

Speaker : Brett Green

Buil. T - Room T104

Due diligence is common practice prior to the execution of large transactions. Yet, it has been largely overlooked in the literature. We study a model of the due diligence process and analyze its effect on prices, the division of surplus, and efficiency. Our baseline model is a common value setting with competitive buyers who make price offers to a seller. There is (symmetric) uncertainty about whether the gains from trade are positive. If the seller accepts one of the offers, the winning buyer has the right to gather information and choose when (if ever) to execute the transaction. Within this setting, we demonstrate that (i) a higher price is not necessarily better for the seller, (ii) even perfectly competitive buyers earn positive profits, and (iii) the winning buyer conducts too much due diligence relative to the social optimum. These findings motivate an investigation as to whether commonly observed features such as break-up fees, debt financing, and deadlines can improve efficiency. We also consider extensions to allow for asymmetric information, private values, and renegotiation.