Philips open offer -- Prisoner's Dilemma?

B Venkatesh

ROYAL Philips has made an open offer to buy the 17.1 per cent stake from the minority shareholders in Philips India at Rs 105 per share. This case resembles the classic game theory problem called the Prisoner's Dilemma. How?

To state in financial economics jargon, prisoner's dilemma is a co-operative non-zero-sum game. In this game, two thieves are arrested by the police, and are kept in separate rooms. If one confesses, he goes scot-free, while the other serves a one-year jail sentence. If both confess, they get six months. But if both are silent, they are set free.

The dominant strategy is, therefore, to remain silent. However, since one thief suspects the other of confessing, he may also want to confess. If they both do, they will get six months as sentence. Thus, while it is in their own interest to remain silent, they may want to confess, because they suspect the other of doing so.

How does this relate to the open offer by Royal Philips? That the company is paying a hefty premium to the market price could well mean that the shares are of good value at that price. The existing shareholders may, therefore, want to hold the shares to reap any further gains in the stock price.

But a shareholder could also lose by not tendering to the offer! How? If at least 7 per cent of the other shareholders were to tender to the offer, the shares will be delisted from the stock exchanges. And that means that those that do not tender cannot sell the shares in the market thereafter!

So, if a shareholder does not tender, she may gain more. But, she may also lose if others tender to the offer and she does not. What if she tenders to the offer? She may not gain as much as she would if all the shareholders do not tender to the offer.

In short, even if the shareholder may gain from holding, she may want to tender to the offer fearing that the other shareholders will.