Empirical evidence shows that termination fees (“lockups”) in merger agreements of public companies discourage competition for the target company but do not necessarily harm target shareholders. This Article presents a signaling theory consistent with this evidence and considers the theory’s normative implications. The chief argument is that the presence of a lockup in an agreement signals the acquirer’s high valuation of the target, and this discourages other potential acquirers from competing. By increasing the deal price in exchange for the inclusion of a lockup in the agreement and thereby restricting competition, a target company and a high-valuing acquirer are able to divide between them the surplus that results from avoiding the transaction costs of a bidding contest. Building on that analysis, this Article shows that although lockups increase target shareholder wealth, they may nevertheless be socially undesirable.
