Target Shareholders Research Articles

Impact of Classified Board on M&A Target Shareholder Value: Nurturing Innovation through Entrenchment

AbstractWe find that classified board in the M&A target firm is positively related to the target shareholder value, but only for firms with both intensive R&D investment and strong external governance. We also find that firms with classified board exhibit superior quality innovation when they have both intensive R&D investment and strong external governance. These findings are consistent with the view that classified board provides long‐term perspectives that promote productive but risky R&D investment, which is highly valued in M&A. Our findings are distinct from the view expressed in extant literature that classified board enhances target shareholder value because of stronger bargaining power.

Does Corporate International Diversification Destroy Value? Evidence from Cross-Border Mergers and Acquisitions

This paper investigates the valuation effects of corporate international diversification by examining cross-border mergers and acquisitions of U.S. acquirers over the period 1990-1999. We find that, on average, acquisitions of fairly valued foreign business units do not lead to value discounts. Consistent with the industrial diversification discount literature, unrelated cross-border acquisitions result in a significant diversification discount of about 24 percent after accounting for the valuation of foreign targets. Furthermore, significant wealth gains accrue to foreign target shareholders regardless of the type of acquisition. Overall, our results suggest that international diversification does not destroy value while industrial diversification leads to discounts even after controlling for the pre-acquisition value of the target.

Defensive Tactics and Optimal Search: A Simulation Approach

The appropriate division of authority between a company’s board and its shareholders has been the central issue in the corporate governance debate for decades. This issue presents most vividly for defensive tactics: the extent to which the board of a potential acquisition target is allowed to prevent the shareholders from responding directly to a hostile bid. In the US today, the board’s power is extensive; control largely lies with the board. Normative evaluations of current law face two obstacles. First, defensive tactics raise the social welfare question whether, or to what extent, these tactics deter ex ante efficient takeovers. This question cannot be answered empirically because the econometrician can observe bids but cannot observe deterred bids. The social welfare issue is also difficult to resolve using current analytical techniques because the market for corporate control is unusually complex: in it, financial and strategic buyers search for mismanaged companies or synergy targets; and some synergy targets search for acquirers. Turning to targets, the question which defensive tactics level maximizes shareholder welfare also is difficult to answer because of the qualitative nature of defensive tactics: Is a poison pill more or less privately efficient than a staggered board? What are the welfare consequences of combining a pill with a staggered board or a supermajority voting requirement? In this paper, we write a search equilibrium model of the market for corporate control and solve it by simulating plausible parameters for the variables of interest. Because we specify the number of ex ante efficient acquisitions that could be made, we can estimate market efficiency – the ratio of made matches to good matches – under legal regimes that are more or less friendly to defensive tactics. Also, we argue that the common metric among defensive tactics is time: the ability of various tactics to delay bid completion and thus reduce bidder, and thereby increase target, returns. We have two important results: First, strong defensive tactics reduce market efficiency significantly. Our simulations suggest that approximately a $100 billion in deal value is lost each year in consequence of these tactics. Simulations are only suggestive and our simulated model likely overstates the welfare loss. Nevertheless, the result that defensive tactics cause economically significant welfare losses would stand even if our magnitude estimate is halved. Second, the defensive tactics level that maximizes target shareholder welfare is materially higher than the level that maximizes social welfare. These results also support a methodological claim: equilibrium analysis can illuminate regulatory issues regarding the market for corporate control.

Capital gains taxation and the cost of capital: Evidence from unanticipated cross-border transfers of tax base

In a cross-border takeover, the tax base associated with future capital gains is transferred from target shareholders to acquirer shareholders. Cross-country differences in capital gains tax rates enable us to estimate the discount in target valuation on account of future capital gains. We estimate that a 1 percentage point increase in the capital gains tax rate reduces the value of equity by around 0.3%, which suggests that the capital gains tax significantly raises firms’ cost of capital. Furthermore, we find that the implied capital gains tax burden is higher at times of high economic growth and low stock market valuation.

Judicial Deference, Procedural Protections, and Deal Outcomes in Freezeout Transactions: Evidence from the Effect of MFW

For several years, merger freezeouts were invariably subject to entire fairness review, a demanding standard of judicial review that enables courts to revise the price of a transaction when the price is challenged by the shareholders of the selling company. But this changed in 2013. In an attempt to incentivize the simultaneous use of independent director approval and majority-of-the-minority conditions, the Delaware Chancery Court held in In re MFW Shareholders Litigation (2013) that when a merger freezeout is subject to those procedural protections, the transaction would subsequently be reviewed under the deferential business judgment rule rather than under entire fairness. This paper examines the impact of MFW on transactional practice and deal outcomes. The results show that majority-of-the-minority conditions increased significantly after the opinion, from an incidence rate below 40% to a rate of more than 80%. Special committees were already the norm before 2013 and their incidence did not change after MFW. The increase in majority-of-the-minority conditions, however, was not followed by significant changes in deal premiums, target returns, changes from the controller’s first offer to the final offer, or deal completion rates. The results therefore suggest that deferential judicial review is an effective way to incentivize procedural protections in freezeout transactions and that the increase in shareholder approval conditions did not come at the cost of higher frustration rates. In addition, the results suggest that procedural protections and entire fairness review seem to have a similar effect on the gains of the target shareholders. Taken together, these results present an assessment of MFW in particular and also shed light on the role of shareholder voting in freezeout transactions more generally.

The Development of the Takeover Auction Process: The Evolution of Property Rights in the Modern Wild West

Using unique, hand-collected data, we study the interaction between the legal system and the takeover auction process from 1981 to 2015. We show a structural break in the takeover process in 1989. The strengthening of the property rights of target boards after Time Inc. decision has moved the auction process from public to a behind the scenes process where target boards control both the number of bidders and the flow of information. Target boards are more likely to initiate the auction themselves and the length of the private negotiation process has significantly lengthened. This fundamental change has benefited target shareholders.

Investment Income Taxes and Private Equity Acquisition Activity

Utilizing a novel identification strategy, we uncover evidence that investment income tax rate reductions increase acquisition activity of private equity acquirers. Applying a difference-in-difference methodology, we find that acquisitions sponsored by private equity firms nearly doubled following the Taxpayer Relief Act of 1997 and the Jobs and Growth Tax Relief Reconciliation Act of 2003. We attribute our findings to private equity firms' ability to capture the benefit of lower capital gains tax rates. These findings are robust to considering target shareholders' tax incentives as well as firm, industry, and macroeconomic factors possibly influencing acquisition activity.

The Effects of Corporate Governance Reforms in Japan on the Market for Corporate Control and Merger & Acquisition Activity

We analyze the effects that the new corporate governance regulations and other regulatory re-forms in Japan in 2004 had on the market for corporate control and especially on mergers and acquisitions. First, we analyze M&A transactions in which bidder and target share the same financial advisor, a phenomenon most prominent during the period before and around the re-forms. We do not find significant evidence that capital market participants in Japan either ex-pected or valued potential conflicts of interest in these deals. However, there is some evidence that the bidder paid a lower premium and that domestic common advisors prearranged some of these transactions to minimize their own losses as creditor. We also provide empirical evidence of a change towards a more capital-market-oriented corporate governance structure in Japan with less dependence on bank debt and an increase in foreign equity ownership as well as higher M&A activity after 2004. With respect to bidder and target shareholders, we find that the mag-nitude of the valuation effects becomes similar to US and European deals. After regulatory reforms, bidder, target and deal characteristics changed substantially. Overall, we provide some evidence for the period from 1990 to 2016 that after a challenging start due to the Japanese economic crisis and the Asian financial crisis, the corporate governance reforms in Japan in 2004 were effective by increasing the M&A activity and creating a more active market for corporate control. We also observe that some advances at best are slowly progressing.

Dividends and Takeovers: Clientele Effects and the Disappearing Dividends Phenomenon

We use merger-induced changes to shareholder structure to test for active catering to dividend clienteles. Following mergers, acquirers adjust their dividend payout toward that of the target, but only when they inherit target shareholders through stock swaps. This adjustment is stronger when legacy shareholders are more influential and reveal a greater preference for dividends through portfolio holdings and trading behavior. Country-level differences in dividend taxes, governance quality, and population age further shape the extent of adjustment in ways consistent with dividend preferences. Pre-closing, differences in dividend payout discourage the use of stock as a payment method.

Insider Tax Effects on Acquisition Structure and Value

We hypothesize that prior evidence of target shareholder capital gains tax liabilities affecting acquisition features is driven by the tax liabilities of the target firm CEO. To test this, we estimate CEOs’ capital gains tax liabilities for a large sample of acquisitions and examine the effects of such liabilities on acquisition outcomes. Results indicate that the previously documented positive relations between shareholder-level capital gains tax rates and 1) the likelihood of a nontaxable acquisition (Ayers, Lefanowicz, and Robinson 2004) and 2) acquisition premiums (Ayers, Lefanowicz, and Robinson 2003) are largely driven by CEO tax effects. We also find evidence consistent with 1) CEOs’ tax incentives leading to potential agency conflicts under certain conditions and 2) acquisition structure or premium being adjusted in response to CEOs’ taxes depending on the alternatives available to the acquirer. Our study contributes to our understanding of what and whose taxes affect acquisition structure and value.

Sold Below Value? Why Takeover Offers Can Have Negative Premiums

AbstractMany studies have acknowledged the existence of negative offer premiums where the initial bid undercuts the target's preannouncement market price. However, this phenomenon has not been explained. Negative premiums occur frequently and are no measurement error. We demonstrate theoretically and empirically that “hidden earnouts,” where target shareholders participate in the bidder's share of joint synergies, and corrections of overvaluation explain negative premiums. We find that target shareholders profit from the consummation of a takeover even if the announced offer has a negative premium. Our theory generalizes to low positive premiums with predictive power for the bottom 25% of all premiums.

Appraisal Arbitrage and Shareholder Value

Post-merger appraisal rights have been the focus of heated controversy within mergers and acquisitions circles in recent years. Traditionally perceived as an arcane and cabalistic proceeding, the appraisal action has recently come to occupy center stage through the ascendancy of appraisal arbitrage-whereby investors purchase target-company shares shortly after an announcement principally to pursue appraisal. Such strategies became more feasible and profitable a decade ago, on the heels of two seemingly technocratic reforms in Delaware: (i) the statutory codification of prejudgment interest, pegging a presumptive rate at five percent above the federal discount rate; and (ii) the Transkaryotic opinion, which effectively sanctified appraisal claims trading. Several commentators have decried appraisal arbitrage as visiting unnecessary risks and costs on deal certainty and pricing, advancing the position that it reduces / destroys target shareholder value. This paper interrogates such claims both theoretically and empirically, testing the predictions of an auction-design model that assesses appraisal's and welfare effects. We find-consistent with comparative statics of our model-that the appraisal-liberalizing events of 2007 were associated with a significant increase in deal premia, as the enhanced credibility of appraisal had the effect of raising the de facto reserve price associated with M&A auctions. We further find little evidence that liberalized appraisal rights stifled the incidence of appraisal eligible deals. When interpreted through the lens of our auction-design model, our findings suggest that target-company shareholders likely benefited ex ante from liberalized appraisal, regardless of whether they subsequently sought appraisal or not.

Advising shareholders in takeovers

This paper studies the advisory role of the board of directors in takeovers. I develop a model in which the takeover premium and the ability of the target board to resist the takeover are endogenous. The analysis relates the influence of the board on target shareholders and the reaction of the market to its recommendations to various characteristics of the acquirer and the target. I also show that the expected target shareholder value can decrease with the expertise of the board and it is maximized when the board is biased against the takeover. Generally, uninformative and ignored recommendations are not necessarily evidence that the target board has no influence on the outcome of the takeover. Perhaps surprisingly, under the optimal board structure, target shareholders ignore the recommendations of the board, which are never informative in equilibrium.

The wealth effects of public-to-private LBOs: Evidence from Europe

This study examines various features of leveraged public-to-private institutional buyouts in Europe that occurred between 1998 and 2016. We find significant excess returns of about 7.7% on the LBO announcement date. We also find evidence that LBOs harbored in countries with strong corporate governance mechanisms elicit greater wealth effects for shareholders of targets. Consistent with the free cash flow hypothesis, abundance of cash appears to be one of the driving forces of excess short-term returns. Looking at the characteristics of LBO targets, we show that mature companies with excess cash flows and less volatility seem to be candidates for LBO deals.

Merger Negotiations in the Shadow of Judicial Appraisal

The recent surge in appraisal litigation has sparked debate over the desirability of appraisal and how this remedy should be structured. Much of this debate is based on untested assertions about appraisal’s ex-ante effect on the structure and pricing of takeovers. Systematically investigating this effect, we find evidence that target shareholders receive higher abnormal returns as the strength of the appraisal remedy increases. We find no evidence that bidders offer a lower up-front price as a means to pay off dissenting shareholders post sale. Furthermore, threat of appraisal does not appear to limit takeover activity or impact method of payment. Overall, our results suggest that appraisal provides an important ex-ante protection for target firm shareholders.

The Impact of Mergers and Acquisitions on Shareholders' Value : An Empirical Analysis of Select Indian Companies

The present study analyzed the shareholder value creation by examining the short-run abnormal returns accruing to the shareholders of acquiring, target, and hypothetical combined entities on announcement of mergers and acquisitions (M&As) during 2000 - 2010 using the market-adjusted model of the popular event study methodology. This study used a sample of 29 pairs of acquiring and target firms involved in M&As during the period from April 1, 2000 to March 31, 2010. The study developed four hypotheses examining separately the impact of M&As on shareholder value of acquiring, target, and combined firms. The study reported little but significant positive abnormal returns accruing to the shareholders of acquiring firms, while shareholders of target firms were found to have suffered significant losses over a 41-day event period around the announcement of M&As, which is contrary to existing literature in Western countries, which has stated that only the targets create value, and the acquirers are value destructive. This is an important contribution to the existing literature that the theories in the Western countries may not necessarily hold valid in India, and they need to be reassessed before being implemented in the Indian context. Another important findings of the study was that M&As overall were found destroying value for the shareholders of the hypothetical combined entity.

The High Cost of Fewer Appraisal Claims in 2017: Premia Down, Agency Costs Up

This Essay considers the preliminary results of an ongoing effort to discourage appraisal litigation. In the year since the August 2016 reforms to the Delaware appraisal statute, Chancery has issued a slew of at-or-below merger price appraisal opinions in cases such as Clearwire and PetSmart, while simultaneously pinioning fiduciary litigation by reiterating the principles of Corwin. The result — as one would expect when costs are raised and benefits are reduced — has been that fewer deals are being challenged via appraisal: In 1H 2017, the number of deals challenged fell by 33%. Those who successfully advocated for curbs on the practice had argued that appraisal claims lowered deal premia by incenting buyers to withhold top dollar, thereby hurting non-appraising shareholders. On their view, curtailment of appraisal should have sent premia upwards. But year to date the average U.S. target premium of 22.4% is the lowest of any year in recent history. The average target premium in 2Q 2017 of 19.3% was the single-lowest of the fifty prior quarterly observations; thus far, 3Q 2017, at 19.6%, is tracking as the second-lowest. Amid the pronounced decline in merger premia, change-in-control payouts have expanded as a percentage of transaction value. When analyzed in concert with other measures indicative of agent rent-seeking — such as target premium to 52-week high over varying periods — the evidence points to a substantial transfer of value from target shareholders to selling CEOs, who have adapted to an environment rendered more permissive by the weakening of the shareholder litigation ‘check’ that had formerly restrained such behavior.

Law, Investor Protection and LBOs

This paper examines the impact of investor protection on the value creation of LBOs. We find that target shareholders’ wealth gain is higher in countries with better investor protection. The impact of investor protection on takeover premium is larger for LBO than non-LBO transactions. We also find evidence suggesting that club LBOs are not priced lower than non-club deals after accounting for endogeneity problem. These results suggest that investor protection law may act as an important safeguard for minority shareholders in LBO transactions.

What is the shareholder wealth impact of target CEO retention in private equity deals?

There is a widespread belief among observers that a lower premium is paid when the target CEO is retained by the acquirer in a private equity deal because conflicts of interest lead her to negotiate less aggressively on behalf of the target shareholders. Our empirical evidence is not consistent with this belief. We find that, when a private equity acquirer retains the target CEO, target shareholders receive an acquisition premium that is larger by as much as 18% of pre-acquisition firm value when accounting for the endogeneity of the retention decision. Our evidence is consistent with what we call the “valuable CEO hypothesis.” With this hypothesis, retention of the CEO can be valuable to private equity acquirers because, unlike public operating companies with managers in place, these acquirers have to find a CEO to run the post-acquisition company and the incumbent CEO may be the best choice to do so because she has valuable firm-specific human capital. When a private equity acquirer finds a target with a CEO who can manage the post-acquisition company better than other potential CEOs, we expect target shareholders to receive a larger premium because the post-acquisition value of the target is higher.

Impact of Shareholder Proposals on the Functioning of the Market for Corporate Control

AbstractFirms receiving shareholder proposals are 16% more likely to become a target of acquisition. Such companies earn approximately 7.2% lower acquisition returns compared to gains for targets with no proposals. Higher acquisition likelihood and lower target returns are primarily associated with proposals drawing a larger proportion of favorable votes, larger voter turnout, as well as with proposals submitted shortly before takeover announcements, and motivated by the removal of antitakeover provisions. Our findings suggest that shareholder proposals can assist bidders in the identification of targets or signal the willingness of target shareholders to accept bids with lower premiums.