Abstract
Due to a variety of liquidity constraints, CEOs of U.S. corporations hold highly undiversified portfolios of stock and options of their own firms. This results in an illiquidity discount, measured by the difference between the market value and the executive value of their holdings. We argue that acquisitions offer an effective mechanism for target CEOs to remove many liquidity constraints and reduce or eliminate the illiquidity discount. Following Shleifer and Vishny (2003), we further argue that for overvalued acquirer firms the acquisitions enable acquirer CEOs to improve the long-term value of their illiquid wealth. Using a sample of 250 acquisitions during 1993-2001, we document several incentive effects of illiquid stock and option holdings. Target CEOs who face higher illiquidity discount accept lower acquisition premium and are more likely to leave after the acquisition completes. They also put up lower resistance and speed up the acquisition. Similarly, acquirer CEOs who face higher illiquidity discount pay higher acquisition premium, speed up the acquisition, pursue relatively undervalued targets, and make multiple and diversifying acquisitions using stock payment.
Published Version
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