Ex-ante (incentive) effects of
takeovers. Positives
In theory: raise managerial discipline, incentives
to exert effort and treat shareholders well
In practice:


Free-rider problem among small shareholders hinder
takeovers  decreases incentive effect
Takeover defenses impede takeovers  decrease
incentive effect
Empirical evidence:

Performance is not a determinant of a takeover. Size
seems to matter (targets are usually smaller than
non-targets) (Comment and Schwert (1995), Franks
and Mayer (1996)). Hence, no discipline effect
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Ex-ante (incentive) effects of
takeovers. Negatives
Short-termism (boosting current profits at the
detriment of long-term interests) (Stein (1988))
Reduction of firm-specific investments by
management and workers (Shleifer and
Summers (1988))
Managerial entrenchment (Shleifer and Vishny
(1989))
Takeover defenses
Concentration of control (more relevant for
countries with weak shareholder protection –
see later)
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Takeover defenses
Poison pills (e.g. rights to current shareholders
to buy new stock at a discount)
Golden parachutes
Staggered boards (only a fraction of board can
be reelected each year)
White knights (“friendly” acquirers who are
invited to overbid the raider)
Question: are takeover defenses (and any
resistance in general) beneficial or harmful for
the target shareholders?
3
Reasons why management may
resist a takeover
Management believes they can generate
greater long-term value than the acquirer’s
bid price
Management does not want to lose their
job/control over company
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Empirical evidence on the effect of
takeover defenses on shareholder value
Two hypotheses:


Management entrenchment hypothesis
Shareholder interest hypothesis
Managerial entrenchment hypothesis: takeover defenses
(anti-takeover devices) are installed with the purpose to
“entrench” management  reduce disciplinary force of
takeovers
Shareholder interest hypothesis: takeover defenses
prevent value-decreasing takeovers, improve the target’s
bargaining position in takeover negotiations, discourage
inefficient short-termism and encourage firm-specific
investment
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Empirical evidence on takeover
defenses
In favor of “shareholder interest”:

Firms that have defensive mechanisms
receive higher premiums in takeovers
(Comment and Schwert (1995), Varaiya
(1987), Heron and Lie (2007))
This can be interpreted as higher bargaining power
of firms with anti-takeover arrangements


On average, improvement in post-adoption
performance (e.g. Field and Karpoff (2006))
Evidence on reduction of short-termism (more
R&D investment) is mixed
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Empirical evidence on takeover
defenses
In favor of “managerial entrenchment”:

Generally negative stock price reaction to adoption of
anti-takeover devices (Ryngaert (JFE 1988),
Malatesta and Walking (JFE 1988), DeAngelo and
Rice (JFE 1983))
Effect is quite small, usually < 1%
Caution: adoption of a defense is endogenous


Presence of anti-takeover provisions has negative
impact of firm value (Gompers, Ishii and Metrick (QJE
2003))
Why? Because some potentially value-increasing
takeovers are deterred
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Empirical evidence on antitakeover statutes
Mostly negative effect on stock returns
(e.g. Karpoff and Malatesta (1989))
Negative effect on TFP (Betrand and
Mullainathan (2003))
Less investment and less disinvestment,
i.e. managers become more passive
(Betrand and Mullainathan (2003))
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Overall:
Evidence on takeover defenses is
inconclusive
Evidence on anti-takeover laws is also
mixed, but overall suggests that
shareholders are likely to lose from them
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So, are hostile takeovers an effective
corporate governance mechanism?
Maybe not so much…
Ex-post problems:


Free-rider problem impedes efficient takeovers
Agency problem inside the acquirer: takeovers may be done for empirebuilding purposes
Recall: no or negative long-run stock returns, no improvement in operating
performance
Firms with more excess cash are more likely to make bad acquisitions
(Harford (JF 1999), Lang et al (JFE 91))

Takeover gains: creation of value or redistribution from stakeholders
(e.g. workers)?
Ex-ante problems:




Same free-rider problem reduces managerial discipline
Takeover defenses too
Managerial short-termism under a takeover threat
Reduced incentives to do firm-specific investment under a takeover
threat
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