Antitakeover Statutes Research Articles

The Effect of State Antitakeover Laws on Corporate Tax Avoidance

We examine the implications of enhanced managerial control afforded by state anti-takeover laws for tax avoidance and find the strength of anti-takeover statutes in a state is negatively related to tax avoidance of firms incorporated in that state. In testing underlying mechanisms, we find that the empirical results support the price discount concern hypothesis (i.e., managers refrain from tax avoidance activities to prevent potential stock price discounts induced by heightened investor perception of tax-related rent extraction in firms with severe agency problems). By contrast, the results are inconsistent with the quiet life hypothesis (i.e., managers entrenched by state anti-takeover protection enjoy the quiet life by under-investing in tax planning opportunities). Our findings are generally consistent with the takeover market phenomenon that one of managers' concerns lies in their inability to re-contract away the adverse consequences of perceived agency problems arising from state anti-takeover protection.

Regulatory Competition and the Market for Corporate Law

This article develops an empirical model of firms’ choice of corporate laws under inertia. Delaware dominates the incorporation market, though recently Nevada, a state whose laws are highly protective of managers, has acquired a sizable market share. Using a database of firm incorporation decisions from 1995 to 2013, we show that most firms dislike protectionist laws, such as anti-takeover statutes and liability protections for officers, and that Nevada’s rise is due to the preferences of small firms. Consistent with the bonding hypothesis, our estimates indicate that despite inertia, Delaware would lose significant market share and revenues if it adopted protectionist laws. (JEL G34, G38, K21, K22, L25, L51)

Antitakeover Statutes and Internal Corporate Governance

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.

Regulatory Competition and the Market for Corporate Law

This article develops an empirical model of firms’ choice of corporate laws under inertia. Delaware dominates the incorporation market, though recently Nevada, a state whose laws are highly protective of managers, has acquired a sizable market share. Using a novel database of incorporation decisions from 1995-2013, we show that most firms dislike protectionist laws, such as anti-takeover statutes and liability protections for officers, and that Nevada’s rise is due to the preferences of small firms. Consistent with the bonding hypothesis, our estimates indicate that despite inertia, Delaware would lose significant market share and revenues if it adopted protectionist laws.

Antitakeover Statutes and Internal Corporate Governance

Antitakeover Statutes and Internal Corporate Governance

"Is Good Governance Always Good? Innovation, Governance, and Performance Feedback"

Is good governance good for innovation? Innovation requires tolerance for failure, but reduced accountability is also prone to moral hazard, creating a tension in the effects of reducing managerial entrenchment on innovation. Leveraging insights from the Behavioral Theory of the Firm, specifically the non-linear increase in managerial benefits from improving performance around performance targets, we theorize that managerial preference for risk-taking and moral hazard is contingent on the risk of underperformance. As a result, reducing managerial entrenchment has detrimental effects in firms that face the risk of underperformance and suffer from increased risk aversion but has beneficial effects in overperforming firms exposed to the increased risk of moral hazard. We find empirical support based on staggered adoptions of anti-takeover statutes and block institutional ownership and suggest the consequences of governance choice to be dynamic, having different effects even within a single firm over time dep...

The Law and Finance of Anti-Takeover Statutes

Lawyers and financial economists have fundamentally different views of anti-takeover statutes. While corporate lawyers and academics generally dismiss these statutes as irrelevant, economists study them empirically and conclude that they – and hence the threat of a takeover – affect firm and managerial behavior. This article seeks to examine the divide between the law and the finance approach to anti-takeover statutes. We first explain why these statutes, as used by financial economists, are not a proper metric of the potential takeover threat facing a firm. This poses the question of why finance studies of these statutes find results. We therefore examine in greater detail three finance studies and show that their results are due to omitted variables or improper specifications. When corrected for these problems, the association between anti-takeover statutes and the hypothesized effect disappeared. We then supplement this specific critique with a more general critique that identifies three flaws – coding errors, failure to account for managerial share ownership, and selection bias – that pervade the finance studies on anti-takeover statutes and bias their results. Broadly, our paper calls into question most of the understanding of the effect of takeover threat, which is based to a large extent on finance studies of anti-takeover statutes.

Citizens United, Independent Expenditures, and Agency Costs: Reexamining the Political Economy of State Antitakeover Statutes

We test the agency theory of corporate political activity by examining the association between the legality of independent expenditures and antitakeover lawmaking in the US states. Exploiting changes in state law regarding the use of corporate independent expenditures in the pre-Citizens United era, we estimate that a state is more likely to pass antitakeover statutes that entrench management when firms are allowed to make independent expenditures. We also find that this relationship is conditional on the competitiveness of a state’s electoral environment, suggesting that the threat of independent expenditures may move vulnerable legislators’ votes on less salient issues, such as corporate governance. These findings are robust to competing public interest and political economy explanations for antitakeover lawmaking, and they reveal that allowing independent expenditures may create additional agency costs for owners through public policy. Finally, these results strongly challenge the claim that state-level antitakeover laws are exogenous to firms’ activities. (JEL D72, G38, K20)

State Antitakeover Laws and Voluntary Disclosure

AbstractWe test the relationship between takeover protection and voluntary disclosure in a setting of antitakeover laws in a firm’s state of incorporation. After correcting for the endogeneity of firms’ incorporation choices, we find that firms incorporated in states with more antitakeover laws have higher levels of voluntary disclosure and stock market liquidity. Further tests do not support shareholder demands being the driving force for this association. Our findings are consistent with takeover protection and poor disclosure serving as substitute mechanisms for deterring takeovers. Therefore, as antitakeover statutes mitigate takeover threats, they enhance managers’ incentives to disclose more in order to realize capital market benefits.

Citizens United, Independent Expenditures, and Agency Costs: Reexamining the Political Economy of State Antitakeover Statutes

We test the agency theory of corporate political activity by examining the association between the legality of independent expenditures and antitakeover lawmaking in the U.S. states. Exploiting changes in state campaign finance law regarding the use of corporate independent expenditures in the pre-Citizens United era, we estimate that a state is more likely to pass antitakeover statutes that entrench management when firms are allowed to make independent expenditures to influence electoral campaigns. We also find that this relationship is conditional on the competitiveness of a state’s electoral environment, suggesting that the threat of independent expenditures may move vulnerable legislators’ votes on less salient issues, such as corporate governance. These findings are robust to competing public interest and political economy explanations for antitakeover law adoption, and they reveal that allowing independent expenditures may create additional agency costs for owners through public policy. Finally, these results strongly challenge the claim that state-level antitakeover laws are exogenous to firms’ activities.

Corporate Governance Law: Firm Heterogeneity and the Market for Corporate Domicile

This paper uses a discrete choice framework to analyze state design and firm choice of the implications of incorporation: corporate governance laws, corporate taxes and court features. Firms --- differentiated by ownership, management, industry concentration, financial profile and unobservable dimensions --- freely choose their preferred state of incorporation or reincorporation for each financial year. The revealed preference embedded in these many observable choices allows for the identification and quantification of the differential corporate governance preferences within and across firms. For example, we find that on average, firms like antitakeover statutes, but, consistent with an agency story, firms with an institutional shareholder block and venture capital backed firms dislike them. On average, firms dislike mandatory governance statutes restricting managerial power and facilitating the representation of minority shareholders; however, firms in concentrated industries are much less influenced by these laws. Additionally, all firms dislike well functioning courts, consistent with a litigation deterrence motive. We also find that firms are very responsive to incorporation and franchise taxes, which allows us to quantify their preferences for law and court features. Counterfactual policies aimed at creating uniform federal law and restricting firm choice are simulated using the firm specific preferences recovered from our model.

Venture capital and the incorporation decisions of IPO firms

This paper investigates whether IPO firms backed by venture capital investors are more likely to incorporate in states that are takeover friendly. Venture capital firms benefit when their portfolio companies are subject to the discipline of the corporate control market. State-level antitakeover statutes diminish the effectiveness of the corporate control market by making firm acquisition more costly. I find that venture capital-backed IPO firms are more likely to incorporate in a takeover-friendly state, such as Delaware. State-level antitakeover statutes are effective takeover deterrents, as my results show that firms incorporated in takeover-friendly states are more likely to be acquired in the five years following their IPO. I also find that firms incorporated in takeover-friendly states have higher Tobin's Q values than firms incorporated in takeover-unfriendly states, suggesting that state-level antitakeover statutes negatively impact firm value.

Is Delaware's Antitakeover Statute Unconstitutional? Evidence from 1988-2008

Delaware’s antitakeover statute, codified at Section 203 of the Delaware corporate code, is by far the most important antitakeover statute in the United States. When it was enacted in 1988, three bidders challenged its constitutionality under the Commerce Clause and the Supremacy Clause of the U.S. Constitution. All three federal district court decisions upheld the constitutionality of Section 203 at the time, relying on evidence indicating that Section 203 gave bidders a “meaningful opportunity for success,” but leaving open the possibility that future evidence might change this constitutional conclusion. This Article presents the first systematic empirical evidence since 1988 on whether Section 203 gives bidders a meaningful opportunity for success. The question has become more important in recent years because Section 203’s substantive bite has increased, as Exelon’s recent hostile bid for NRG illustrates. Using a new sample of all hostile takeover bids against Delaware targets that were announced between 1988 and 2008 that were subject to Section 203 (n=60), we find that no hostile bidder in the past nineteen years has been able to avoid the restrictions imposed by Section 203 by going from less than 15% to more than 85% in its tender offer. At the very least, this finding indicates that the empirical proposition that the federal courts relied upon to uphold Section 203’s constitutionality is no longer valid. While it remains possible that courts would nevertheless uphold Section 203’s constitutionality on different grounds, the evidence would seem to suggest that the constitutionality of Section 203 is up for grabs. This Article offers specific changes to the Delaware statute that would preempt the constitutional challenge. If instead Section 203 were to fall on constitutional grounds, as Delaware’s prior antitakeover statute did in 1986, it would also have implications for similar antitakeover statutes in thirty-two other U.S. states, which along with Delaware collectively cover 92% of all U.S. corporations.

Earnings quality effect of state antitakeover statutes

Existing theories suggest two opposite effects that antitakeover protection may have on earnings management: the exacerbating effect and the mitigating effect. We use the introduction of state antitakeover laws during the mid- to late-1980s as a natural experiment to test the relationship between antitakeover protection and earnings quality. The results show that firms incorporated in states that passed the laws have lower magnitudes of abnormal accruals and higher levels of earnings informativeness in the post-passage periods, suggesting that antitakeover protection mitigates earnings management and enhances earnings quality. Further evidence shows that reductions in earnings management are concentrated in firms with low firm-level antitakeover protection and in firms with serious agency problems, and that the earnings management effect of state antitakeover laws is likely to be of short-term duration.

Trapped in a Metaphor: The Limited Implications of Federalism for Corporate Governance

Trapped in a metaphor articulated at the founding of modern corporate law, the study of corporate governance has - for some thirty years - been asking the wrong questions. Rather than a singular race among states, whether to the bottom or the top, the synthesis of William Cary and Ralph Winter’s famous exchange is better understood as two competitions, each serving distinct normative ends. Managerial competition advances the project that has motivated corporate law since Adolf Berle and Gardiner Means - effective regulation of the separation of ownership and control. State competition, by contrast, does not promote a race to either the top or the bottom in shareholder-managerial relations. Rather than the vertical allocation of wealth between shareholders and managers, state competition is directed to its horizontal allocation between the state and the firm as a whole. Even as state competition shifts surplus from state to firm, thus, it is agnostic as to the distribution of that surplus within the firm. Although it may generate effective rules of corporate law, it is not determinative of the substantive quality of corporate governance. Understood as such, the metrics of “efficiency” in corporate governance - and hence the core inquiries of the corporate law literature - must necessarily shift. Prevailing approaches to questions from the potential utility of federal corporate law to the long persistence of state antitakeover statutes must likewise be reconsidered.

State Laws and Debt Covenants

Abstract We examine whether state laws impact the use of debt covenants by using a sample of U.S. public bond issues from 1987 to 2004. We consider variation in state laws with respect to the minimum asset‐to‐debt ratio necessary for a payout and with respect to antitakeover statutes. We find that firms incorporated in states with stricter restrictions on distributions are less likely to include debt covenants that constrain payouts, limit additional debt, or restrict the sale of assets. Thus, state payout restrictions appear to be a substitute for the use of these debt covenants. On the other hand, firms incorporated in states with stronger antitakeover statutes are somewhat more likely to use debt covenants. This finding is consistent with the notion that firms with antitakeover protection are more likely to suffer from agency problems and, thus, are more likely to use debt covenants to minimize agency costs.

Earnings Quality Effect of State Antitakeover Statutes

Earnings Quality Effect of State Antitakeover Statutes

The effect of state laws on capital structure

US manufacturing firms incorporated in states with stronger payout restrictions use less debt, while antitakeover statutes do not significantly reduce long-run leverage. Correcting for the endogenously determined choice of where to incorporate, we find that firms sort themselves according to state laws and capital structure needs. After accounting for self-selection, state antitakeover laws are positively associated with debt as a fraction of market value, possibly due to lower market values for these firms. Payout restrictions appear to reduce leverage for firms that have not reincorporated outside their home states. These constraints explain part of the negative relation between profitability and leverage.

The Demand for Corporate Law: Statutory Flexibility, Judicial Quality, or Takeover Protection?

This article provides an empirical examination of the determinants of firms' decisions where to incorporate. Consistent with our theoretical predictions, we find substantial evidence that firms are more likely to incorporate in states with corporate law rules that offer firms flexibility to devise their governance arrangement and significant but less robust evidence that firms are more likely to incorporate in states with higher quality judicial systems. Unlike prior studies, we find no evidence that firms are more or less likely to incorporate in states with anti-takeover statutes. The latter results are consistent with the hypothesis that anti-takeover statutes have no significant effect on a company's marginal ability to resist takeovers.

Home Bias in Corporate Investments: Evidence from U.S. Domestic M&A

In this paper, we first document that firms exhibit a strong in their M&A deals and identify some of the factors that drive this bias. We examine the spatial distribution of a sample of about 15,000 U.S. domestic M&A deals announced by public acquirers during 1990-2003. The key findings of the paper are summarized as follows: First, nearly a quarter (half) of sample targets are located within a 100 (900) kilometer radius from acquirers' locations, with the frequency of deals declining sharply as the distance between targets and acquirers increases. Firms exhibit behavior that is strikingly similar to the well-documented exhibited by portfolio investors. Second, when the state, rather than the geographical distance, is used as an observation unit, we again observe a strong home bias - firms tend to acquire a disproportionate number of targets in the home states. For example, while targets domiciled in Wisconsin account for 1.39% of the total number of sample targets, they account for 32.63% of the total acquisitions by Wisconsin firms. After the home state, the most popular target states for the Wisconsin acquirers are Illinois and Minnesota, displaying a near-home as well as home bias. Third, logistic regression analyses show that the propensity to acquire in-state targets is positively related to the size of the domicile state of the acquiring firm, reflecting the opportunities at home, and negatively related to the severity of anti-takeover statutes endorsed by the home state of the acquirer. Thus, state-level laws matter in determining where M&A takes place. Mitigating the home-state bias in M&A, anti-takeover statutes have an unexpected effect of integrating the market for corporate control. Further, good macroeconomic conditions like the level of IPO activity and the interest rate both are found to negatively affect the propensity to acquire in-state targets, possibly by affecting the acquirer's risk attitude and the cost of funding. Fourth, the propensity to acquire in-state is negatively (positively) related to the acquirer firm size and book-to-market ratio (debt ratio). Banks, oil and petroleum companies show a higher propensity for in-state M&A, while telecom and construction companies make more out-of-state acquisitions. Ceteris paribus, public targets are more likely to be acquired by home-state firms than private targets, possibly due to the political resistance to out-of-state takeover of public firms that tend to be more visible and vital to the state economy. The results are similar when we alternatively use multinomial logistic regression analyses based on geographical distance.