Meta June 2, 2020

How a stock bid of $98 can beat one of $102? -- Game Theory (Day 59)

Calvin Pak @titans

Watched lecture 6 today. Check out the topics covered in this lecture, aren't these fascinating???

Applying what you've learned, you see how a stock bid of $98 can beat one of $102; how insisting you lose a competition can be a winning strategy; and why being blackmailed can be in your best interest...

How a stock bid of $98 can beat one of $102

In 1988, in a takeover bid for the Federated Stores (which owns Bloomingdale's) which priced at $100, Macy offered to buy at $102 contingent on Macy's getting > 50% of the shares. Campeau made a two-tier bid, at $105 and $90, for half of the company respectively. If Campeau gets 50% or fewer shares, he pays $105 per share; at 100% of shares, the price is $97.50; anything in between, he pays $97.50 to $105.

So who should you sell your shares to? Macy's or Campeau? Let's look at the different possibilities:

  1. If Campeau gets less than 50% of the shares: you have 3 choices: sell to Campeau (at $105), sell to Macy's (at $102), or not sell at all (at $100).

  2. If Campeau gets more than 50%, Macy's bid is taken away for not meeting the contingency, your choices are: sell to Campeau at somewhere between $97.50 to $105, or not sell and might end up being forced to sell at $90.

Obviously, in both scenarios, the best choice is to sell to Campeau.

Of course, the two-tier offer could be unfair. Even though Campeau did win the bid, he won it with a modified offer.

Why would the four major tobacco companies agree to the advertisement ban?

Tobacco companies have huge lobbying power during their hay days. Why would they agree to the federal government TV ban back in the days?

While TV ads may attract new smokers, the most important reason is to take smokers away from competitions. Assume there are only two tobacco companies A and B, if A advertises and B doesn't, A could own up to 80% of the market share, and vice versa. If both A and B advertise, they are roughly owning the same market share, but end up with less revenue as TV ads are costly.

So the best-case scenario is actually if both A and B decide not to advertise. But in the free economy, if A does not advertise then B will advertise gain the majority of the market share. So the equilibrium is when both A and B buy ads.

So the government ban is actually a win-win-win situation for all parties. With the ban, now both A and B will make more revenues.

Strategies can be quantified

In this course, I learned how to quantify strategies and analyze them with a payout tree. The outcome may sound counter-intuitive sometimes, but it is mathematically sound. While humans are not always rational--hence the rise of the behavioral science--the game theory is actually a great baseline for making strategic decisions in most cases.

Check out the entire 24 lectures if you are interested:

  1. 1

    Wah that was fascinating, especially the tobacco example :)

    1. 2

      Yes, isn't it counter-intuitive but true! ;-)

      1. 2

        Nice to get a chance to learn that :)