How Does Private Firm Innovation Affect Anti-Takeover Provisions in Corporate Charters? Evidence from Firms Going Public

Abstract

We make use of data on anti-takeover provisions (ATPs) and top characteristics hand-collected from IPO prospectuses to analyze the effect of the pre-IPO innovativeness and the top quality of private firms on the number and strength of ATPs in their corporate charters (formed at IPO). We test two opposing hypotheses: the value hypothesis, which predicts that more innovative private firms and those with higher top quality will include a larger number of (and stronger) ATPs in their corporate charters; and the management hypothesis, which makes the opposite prediction. Our empirical findings are as follows. First, firms with greater pre-IPO innovativeness (as measured by the number of patents and citations per patent) and higher top quality are each associated with a larger number of and stronger ATPs; the joint effect of pre-IPO innovativeness and top quality on the number and strength of ATPs is also positive. Second, the IPO market rewards firms with a combination of greater pre-IPO innovation productivity and stronger ATPs with higher IPO and immediate post-IPO secondary market valuations. Third, we use an instrumental variable analysis by exploiting the quasi-random assignment of patent applications to examiners with different grant rates to show that the above results are causal. Finally, firms with stronger ATPs at IPO have significantly greater post-IPO innovation productivity, measured by the quantity and quality of innovation. Overall, our findings support the long-term value creation hypothesis and reject the entrenchment hypothesis.