Preemptive bidding in takeover auctions with externality

•The paper analyzes preemptive jump bidding in takeover auctions with externality.•Jump bidding reduces social surplus in the presence of positive externality but not without it.•The size of the externality reduces the size of the jump bid but not the preemption rate.

This paper analyzes the preemptive jump bidding equilibrium in takeover auctions when the acquisition of the target firm by one of the bidders may affect the profit of the other bidder. It shows that such externality has no effect on the preemption rate but affects the size of the jump bid required to preempt competition. Namely, the required jump bid is lower in the presence of positive externality and it is higher when the externality is negative. Preemptive bidding does not affect the expected profit of the second bidder, increases the expected profit of the first bidder and leads to lower expected profit of the seller. The effect of the jump bidding on the seller's profit and the social surplus negatively depends on the externality.