Antitakeover Statutes and Internal Corporate Governance

Abstract

AbstractManuscript TypeEmpiricalResearch Question/IssueThis paper examines the relation between internal corporate governance and the market for corporate control by analyzing how firms' internal governance mechanisms are related to states' antitakeover statutes (ATS). Specifically, we test two competing hypotheses concerning the effect of ATS on internal governance: the substitution hypothesis and the complementarity hypothesis.Research Findings/InsightsWe provide evidence that is consistent with the complementarity hypothesis that exposure to a possible takeover increases rather than decreases the need for better internal governance mechanisms. Specifically, firms that are exposed to takeover threats (i.e., firms in states without ATS or firms that opt out of states' ATS) have stronger internal governance mechanisms (i.e., adopt a greater number of governance standards) than do firms that are not exposed to takeover threats (i.e., firms in states with ATS). In a similar vein, firms adopt more internal governance standards when states abolish existing ATS.Theoretical/Academic ImplicationsAlthough prior research suggests that exposure to takeover threats reduces managerial entrenchment through its disciplinary effect, our study provides evidence that exposure to a possible takeover could exacerbate the managerial myopia problem and that firms mitigate this problem through internal governance mechanisms. The results of the present study suggest that certain governance mechanisms (e.g., state‐level ATS) are more effective in addressing the agency problem in the presence of other complementary governance mechanisms (e.g., firm‐level governance standards), contributing to the growing literature that calls attention to the importance of viewing various governance mechanisms from a bundle perspective. In addition, our study contributes to the literature with a new identification strategy. Our identification strategy makes use of the fact that firms would not be subject to the same shock from the abolition of ATS if they had already opted out, which enables us to analyze the relation between ATS and internal governance mechanisms more accurately. This identification strategy may benefit future studies that consider state‐level changes in ATS to be exogenous shocks.Practitioner/Policy ImplicationsOur study provides empirical evidence concerning the complex ramifications of states' antitakeover statutes for corporate governance that policymakers and market regulators should consider in their decision‐making. The complementarity, particularly between state‐level laws and firm‐level board functions, may deserve better attention from policymakers, regulators, and corporate managers.