The Effect of Corporate Takeover on the Function of Internal Incentive Plan in Target Firms

Abstract

We examine the impact of takeover bids on the function of internal incentive plan with a sample of takeover targets that successfully avoid the takeover attempts. Before the bids, unsuccessful takeover targets perform poorly in the stock market. Their CEOs are paid less, get less job security, and could benefit less from the completion of the takeovers, relative to the counterparts in completed takeover targets documented by Hartzell, Ofek, and Yermack (2004. Review of Financial Studies 17, 37-61). Following the unsuccessful bids, target firms fire undoing managements, construct severance contracts and grant a substantial restricted stocks and options to the CEOs. Their pay-performance sensitivity becomes stronger following the bids, and stock performance is also much better than before. Our study provides support to the theoretical argument that the threat of corporate takeover has a positive effect on the function of internal control mechanism in incentive alignment.