The sources of value destruction in acquisitions by entrenched managers

Abstract

Prior work has established that entrenched managers make value-decreasing acquisitions. In this study, we ask how exactly they destroy that value. Overall, we find that value destruction by entrenched managers comes from a combination of factors. First, they disproportionately avoid private targets, which have been shown to be generally associated with value creation. Second, when they do buy private targets or public targets with blockholders, they tend not to use all-equity offers, which has the effect of avoiding the transfer of a valuable blockholder to the bidder. We further test whether entrenched managers simply overpay for good targets or actually choose targets with lower synergies. We find that while they overpay, they also choose low-synergy targets in the first place, as shown by combined announcement returns and post-merger operating performance. JEL classification: G34; G32Keywords: Corporate governance; Mergers; Entrenchment; Blockholders; Overpayment Electronic copy available at: http://ssrn.com/abstract=1562247 Electronic copy available at: http://ssrn.com/abstract=1562247 The Sources of Value Destruction in Acquisitions by Entrenched Managers AbstractPrior work has established that entrenched managers make value-decreasing acquisitions. In this study, we ask how exactly they destroy that value. Overall, we find that value destruction by entrenched managers comes from a combination of factors. First, they disproportionately avoid private targets, which have been shown to be generally associated with value creation. Second, when they do buy private targets or public targets with blockholders, they tend not to use all-equity offers, which has the effect of avoiding the transfer of a valuable blockholder to the bidder. We further test whether entrenched managers simply overpay for good targets or actually choose targets with lower synergies. We find that while they overpay, they also choose low-synergy targets in the first place, as shown by combined announcement returns and post-merger operating performance.JEL classification: G34; G32

Takeover law to protect shareholders: Increasing efficiency or merely redistributing gains?

“…Recently, the effect of investor protection laws on mergers and acquisitions has been examined (Danbolt and Maciver, 2012;Martynova and Renneboog, 2008b;Bris and Cabolis, 2008;Rossi and Volpin, 2004). Other literature has examined wealth effects in mergers and acquisitions across countries and over time as well as in relation to the acquirer's and target's attributes such as corporate governance (Harford et al, 2012;Bhagat et al, 2005). To verify the contribution of this paper, we test whether existing investor protection indices are able to capture a similar degree of variation in premiums and announcement returns as the takeover law index we construct.…”

Firm size, sovereign governance, and value creation: Evidence from the acquirer size effect

“…We expect that larger firms in weak governance countries will do takeovers that are more likely to increase long-run operating performance. A value-creating takeover should both be associated with a more positive market reaction and should increase operating performance (Li, Forthcoming;Healy et al, 1992;Powell and Stark, 2005;Harford et al, 2012). We expect that large firms in weak governance countries will be more likely to experience operating improvements than their counterparts in strong governance countries.…”

“…. We restrict the sample to takeovers that are for at least USD 1m, are completed, and for which the acquirer owns less than 50% of the target before the takeover and holds 100% of the target after (consistent with Masulis et al, 2007;Harford et al, 2012). Table A1 in Appendix 1 contains a detailed description of the variables and their calculation.…”

“…Using the natural log of the firm's market capitalization does not alter our findings. We also include a number of control variables that are standard to the literature (see, e.g., Harford, Humphery-Jenner and Powell, 2012;Humphery-Jenner and Powell, 2011;Moeller et al, 2004;Moeller and Schlingemann, 2005;Moeller et al, 2005;Masulis et al, 2007;and Travlos, 1987). Specifically, we include relative size of the target, Tobin's q, return on assets, capital expenditures, free cash flow, leverage, and indicator variables for diversifying deals, all cash, all stock, target organizational status (i.e., public, private or subsidiary), competed deals, and friendly deals.…”

“…The dependent variable is measured as the transaction value scaled by the target's market value one week or four weeks before the takeover. This is a relatively standard way to compute takeover premiums (Humphery-Jenner and Powell, 2011;Harford et al, 2012;Alexandridis et al, 2013).…”