Termination Fees in Mergers and Acquisitions: Protecting Investors or Managers?

Abstract

Unknown less than 15 years ago, termination fees (otherwise called kill fees) are now a commonplace component of merger and takeover agreements. Such fees typically require target firms to pay a monetary consideration to bidders if a merger or takeover agreement is broken. However, institutional investors and shareholder groups have expressed strong reservations about the magnitude of such termination fees in recent large transactions. We argue that the magnitude of termination fees reflects either potential agency problems or economic efficiency considerations. Focusing on a sample of mergers and acquisitions involving Canadian targets that allows us a richer ownership structure environment and an ability to obtain exact information on merger costs and termination fees, we evaluate the determinants of the magnitude of termination fees. First, we show that the Thomson Financial Securities Data's SDC PlatinumTM Worldwide Mergers & Acquisitions Database underestimates the true extent of termination fees. Second, results are consistent with termination fees being an efficient mechanism. Termination fees are found to be higher in transactions where the bidder incurs extensive merger costs, the deal includes a cash component and operating synergies are expected. We also find that deal premium and termination fees act as complements. Third, we do not find strong support for termination fees being a sign of agency problems. Relative termination fees are not related to changes in the CEO's golden parachute the year before the deal or to CEO retention in the acquiring firm. We do find that relative termination fees are greater with lower levels of CEO shareholdings but decrease as CEO ownership increases. Further, mechanisms related to greater monitoring do appear to reduce the level of relative termination fees. Relative termination fees are lower when the target has greater outside directors or higher leverage. Fees are also lower when we have very large family or financial block holdings. However, termination fees may simply act as complements to binding agreements from large shareholders to vote in favour of the deal or tender their shares.