How Has Takeover Competition Changed Over Time?

Since the boom in takeovers in the 1980s, research in both law and financial economics has debated the role of takeover impediments such as poison pills, staggered boards, and state antitakeover laws. Have these impediments entrenched target management to the detriment of shareholders? Or have they increased the bargaining power of target boards of directors and left shareholders, if not better off, then at least unharmed? In their study published recently in the Journal of Corporate Finance, the authors provide new answers to these questions with a detailed analysis of takeover competition during the period 1981 through 2014. Using a random sample of 388 completed and withdrawn deals from this 34‐year period, the authors begin by confirming the already well‐documented increase in the use of takeover impediments over time. They then report evidence that takeover competition has not declined during this period. First of all, takeover premiums—the average percentage over market paid by acquirers to consummate transactions—have remained steady over time. Second, and the most striking of the authors' findings, is that the corporate auction process has “gone underground” since the 1980s. Although we now see fewer hostile attempts and publicly reported takeover bidding contests, the amount of competition for targets has remained largely unchanged when one takes account of “private” as well as public auctions—that is, contests that, as the authors discovered, included unidentified bidders. The authors view such a fundamental change in the takeover auction process as a response to the widespread growth of takeover impediments. In this sense, as Bill Schwert commented years ago, “hostile takeovers are less about shirking target management than about the bargaining tactics of targets and bidders.” Or as the authors put it, “the greater bargaining power provided by state laws and other takeover impediments has changed the manner in which takeover auctions are conducted,” but without greatly affecting the goal of economic efficiency that such transactions are designed to help bring about.     

The Nature of Discipline by Corporate Takeovers

This paper provides a comprehensive examination of the disciplinary role of the corporate takeover market using a sample of U.S. target firms over the period 1979 to 1998. The time period spanned allows a broader study not only of the disciplinary role of the takeover market in general, but also of the interaction between the takeover market and alternative governance mechanisms during the 1980s and 1990s. Overall, our evidence is consistent with the view of the corporate takeover market as a “court of last resort,” that is, it is an external source of discipline that intercedes when internal control mechanisms are relatively weak or ineffective.     

Merger Negotiations with Stock Market Feedback

Do preoffer target stock price runups increase bidder takeover costs? We present model‐based tests of this issue assuming runups are caused by signals that inform investors about potential takeover synergies. Rational deal anticipation implies a relation between target runups and markups (offer value minus runup) that is greater than minus one‐for‐one and inherently nonlinear. If merger negotiations force bidders to raise the offer with the runup—a costly feedback loop where bidders pay twice for anticipated target synergies—markups become strictly increasing in runups. Large‐sample tests support rational deal anticipation in runups while rejecting the costly feedback loop.     

The Performance of the European Market for Corporate Control: Evidence from the Fifth Takeover Wave

This paper presents an in‐depth analysis of the performance of large, medium‐sized, and small corporate takeovers involving Continental European and UK firms during the fifth takeover wave. We find that takeovers are expected to create takeover synergies as their announcements trigger statistically significant abnormal returns of 9.13% for the target and of 0.53% for bidding firms. The characteristics of the target and bidding firms and of the bid itself are able to explain a significant part of these returns: (i) deal hostility increases the target's but decreases bidder's returns; (ii) the private status of the target is associated with higher bidder's returns; and (iii) an equity payment leads to a decrease in both bidder's and target's returns. The takeover wealth effect is however not limited to the bid announcement day but is also visible prior and subsequent to the bid. The analysis of pre‐announcement returns reveals that hostile takeovers are largely anticipated and associated with a significant increase in the bidder's and target's share prices. Bidders that accumulate a toehold stake in the target experience higher post‐announcement returns. A comparison of the UK and Continental European M&A markets reveals that: (i) the takeover returns of UK targets substantially exceed those of Continental European firms. (ii) The presence of a large shareholder in the bidding firm has a significantly positive effect on takeover returns in the UK and a negative one in Continental Europe. (iii) Weak investor protection and low disclosure in Continental Europe allow bidding firms to adopt takeover strategies enabling them to act opportunistically towards the target's incumbent shareholders.     

Footprints in the market: Hedge funds and the carry trade

This paper uses a new database provided by the Commodity and Futures Trading Commissions to examine the price impact of hedge fund carry trades in “hot” and “cold” markets. We find that hedge funds significantly increase their carry trade positions during hot markets (periods with very high currency returns). Consistent with currency overpricing, positions in hot markets are followed by exchange rate reversals. Optimism in the stock market seems to have a spillover effect on hedge fund speculation in the currency market: controlling for the variance risk premium fully accounts for the reversal effect. Overall, our results add to a growing body of empirical evidence that institutional demand can move asset prices.     

The dynamics of the free-rider problem in takeovers

We explore the dynamics of a takeover bid. In contrast to precedingmodels, if the initial takeover bid is unsuccessful a raideris allowed to make a new tender offer in order to try and securethe remaining shares. Numerical analysis shows that the raider'stender offer rises over time as be accumulates more shares.The anticipation of a higher tender offer in the future makesshareholders more inclined to hold their shares and forces theraider to offer a higher premium than is predicted by statictheories. As the time between tender offers goes to zero, weshow analytically that the expected profit from engaging ina takeover goes to zero.     

Failed bank takeovers and financial stability

Current discussion about the design of bank resolution frameworks suggests that the takeover of a failed bank by an incumbent one has two effects on financial stability. First, the incumbent takeover may boost financial stability by providing bankers with incentives to be solvent so as to profit from their competitors’ failure. Second, the incumbent takeover may spoil financial stability by creating “Systemically Important Financial Institutions”. The innovation of this paper is to capture these two effects in a theoretical model. We show that when incumbent bankers are impatient enough (i.e., they have high discount rates), the second effect prevails over the first one. We discuss the implications of this result for the design of bank resolution policies.     

Momentum and Foreign Investors: Evidence from the Korean Stock Market

Abstract:

We examine whether the price impact of foreign investors on the Korean stock market from December 2000 to February 2007 generated a momentum phenomenon. In our empirical results, foreigners seem to have exerted a significantly positive impact on prices in “up” markets (periods of positive stock returns), but have had little impact on prices in “down” markets (periods of negative returns). We document that the impact of foreigners’ trades is concentrated in large companies. Most importantly, when the market is in the up state, the returns of stocks of large companies that were positively affected by foreign investors in the previous six-month period continue to increase in the subsequent six-month period. As a result, the subsequent six-month return on a past “winner” stock portfolio is significantly higher than that on a past “loser” stock portfolio. This brings to mind a momentum phenomenon that has been reported not to exist in the Korean stock market.     

The affect heuristic and stock ownership: A theoretical perspective

We consider asset prices and informational efficiency in a setting where owning stock confers direct utility due to an affect heuristic. Specifically, holding equity in brand name companies or those indulging in “socially desirable” activities (e.g., environmental consciousness) confers positive consumption benefits, whereas investing in “sin stocks” yields the reverse. In contrast to settings based on wealth considerations alone, expected stock prices deviate from expected fundamentals even when assets are in zero net supply. Stocks that yield high direct utility are, on average, more informationally efficient as they stimulate more entry into the market for these stocks and, consequently, more information collection. The analysis also accords with a value effect, high valuations of brand‐name stocks, abnormally positive returns on “sin stocks,” volume premia in the cross‐section of returns, proliferation of mutual funds and ETFs, and yields untested implications. If, as psychological literature suggests, agents derive greater utility from successful companies by “basking in reflected glory,” then asset prices react to public signals non‐linearly, leading to booms and busts, as well as crashes and recoveries.     

The effects of anticipated future investments on firm value: evidence from mergers and acquisitions

I examine the long-term valuation consequence of investment in mergers and acquisitions on acquiring firms through the “anticipation effect,” in which forward-looking prices embed investors’ expectations about the profitability of firms’ future acquisitions. Using a sample of firms with past acquisitions, I find that their market valuations depend on both the profitability of their past acquisitions and their current free cash flow. Among firms with positive free cash flow (when future acquisitions are likely), those with a worse history of value-destroying acquisitions experience lower market valuations. Among firms with negative free cash flow (when future acquisitions are less likely), firm value is not systematically related to acquisition history. These findings are consistent with investors forming expectations about the profitability of future acquisitions based on realized acquisition outcomes and valuing these firms based on their likelihood of making future acquisitions. They also provide support for using observed market prices as a proxy for investors’ expectations about future investment opportunities.     

Leverage and Corporate Performance: Evidence from Unsuccessful Takeovers

This paper finds that, on average, targets that terminate takeover offers significantly increase their leverage ratios. Targets that increase their leverage ratios the most reduce capital expenditures, sell assets, reduce employment, increase focus, and realize cash flows and share prices that outperform their benchmarks in the five years following the failed takeover. Our evidence suggests that leverage-increasing targets act in the interests of shareholders when they terminate takeover offers and that higher leverage helps firms remain independent not because it entrenches managers, but because it commits managers to making the improvements that would be made by potential raiders.     

Does insider trading explain price run‐up ahead of takeover announcements?

This study empirically examines the impact of changes in substantial shareholdings ahead of 450 Australian takeover offers between the years 2000 and 2009. Previous studies have attributed a significant proportion of the price run‐up effect in takeover targets to insider‐trading behaviour. This study examines the contribution of a broad range of public information sources that are known to typically generate market anticipation, including the acquisition of toeholds ahead of takeover announcements. Our findings show no significant pre‐bid run‐up for takeover targets after considering these sources. We conclude from these results that previous findings attributing pre‐bid share price run‐up to illegal insider trading may overstate the existence of such conduct.     

Corporate Governance and Value: Evidence from “Close Calls” On Shareholder Governance Proposals

The authors summarize the findings of their recent study of the effects of specific corporate governance provisions on firm value. Using a sample of governance provisions that were subjected to shareholder votes during the period 1997–2011, this study analyzes cases in which shareholder‐sponsored corporate governance proposals were either rejected or passed by a small margin (no more than 5% of the vote). By so doing, this study helps correct two limitations of the existing governance literature: (1) that the effects of expected governance changes are already incorporated in share prices (the “expectations” problem); and (2) that governance policies are often a consequence rather than a cause of other variables such as corporate performance and are thus correlated with many other firm characteristics (the “endogeneity” problem). The authors' findings show that expected improvements in corporate governance through the adoption of particular corporate governance provisions—particularly the removal of anti‐takeover provisions—is associated with both positive abnormal stock returns and improvements in long‐term firm operating performance. The authors estimate that the adoption of such governance proposals increases shareholder value by 2.6%, on average. Moreover, these returns are consistent with, and thus accurate predictors of, future changes in corporate investment (reductions of capital spending, in most cases) and improvements in operating performance.     

Do Private Equity Funds Increase Firm Value? Evidence from Japanese Leveraged Buyouts

The author summarizes the findings of his recent study of 62 buyouts of listed Japanese companies by both Japanese and “foreign” private equity funds that were transacted between 2000 and 2007. Roughly half of the author's sample of transactions were accomplished by means of takeover bids by PE funds, and such deals were transacted at prices that represented a premium (of roughly 12%) to current market values. Most of the other PE transactions were privately negotiated deals in which the purchase prices involved discounts (of about 15% on average) to current value. For both sets of deals, however, the announcements of such buyouts were associated, on average, with a significantly positive stock market reaction. By the cutoff date of the study (May 2010), 30 of the 62 acquired firms had realized “exits.” Those companies (though not the others) experienced significant average improvements in operating performance; and the extent of such improvements were roughly consistent with the size of the positive market reaction to the buyout announcements. The test results suggest that the value increases can be attributed to the more efficient use of assets and reduction of operating costs. Meanwhile, there was no evidence suggesting that the acquired firms cut back on their research and development, capital investments, or employee wages and growth. What's more, examination of the operating performance of the 30 companies after their exits showed no deterioration in profitability or investment spending.     

The leverage effect and the basket-index put spread

Benchmark models that exogenously specify equity dynamics cannot explain the large spread in prices between put options written on individual banks and options written on the bank index during the financial crisis. However, theory requires that asset dynamics be specified exogenously and that endogenously determined equity dynamics exhibit a “leverage effect” that increases put prices by fattening the left tail of the distribution. The leverage effect is larger for puts on individual stocks than for puts on the index, thus increasing the basket-index spread. Time-series and cross-sectional variation in the leverage effect explains option prices well.     

The Disposition Effect and Underreaction to News

This paper tests whether the “disposition effect,” that is the tendency of investors to ride losses and realize gains, induces “underreaction” to news, leading to return predictability. I use data on mutual fund holdings to construct a new measure of reference purchasing prices for individual stocks, and I show that post‐announcement price drift is most severe whenever capital gains and the news event have the same sign. The magnitude of the drift depends on the capital gains (losses) experienced by the stock holders on the event date. An event‐driven strategy based on this effect yields monthly alphas of over 200 basis points.     

Managers, Workers, and Corporate Control

If management has high private benefits and a small equity stake, managers and workers are natural allies against takeover threats. Two forces are at play. First, managers can transform employees into a “shark repellent” through long‐term labor contracts and thereby reduce the firm's attractiveness to raiders. Second, employees can act as “white squires” for the incumbent managers. To protect their high wages, they resist hostile takeovers by refusing to sell their shares to the raider or by lobbying against the takeover. The model predicts that wages are inversely correlated with the managerial equity stake, and decline after takeovers.     

Governance Mechanisms and Equity Prices

We investigate how the market for corporate control (external governance) and shareholder activism (internal governance) interact. A portfolio that buys firms with the highest level of takeover vulnerability and shorts firms with the lowest level of takeover vulnerability generates an annualized abnormal return of 10% to 15% only when public pension fund (blockholder) ownership is high as well. A similar portfolio created to capture the importance of internal governance generates annualized abnormal returns of 8%, though only in the presence of “high” vulnerability to takeovers. The complementarity effect exists for firms with lower industry‐adjusted leverage and is stronger for smaller firms.     

Takeover Prediction and Portfolio Performance: A Note

This paper empirically tests whether it is possible to generate abnormal returns from investing in a portfolio of predicted successful takeover targets. Portfolios are formed on the basis of predictions from models similar to those estimated by Palepu (1986). However, unlike Palepu (1986), the portfolios in this paper are formed using a decision rule that results in smaller portfolios with higher average takeover probabilities. This provides a stronger test of whether share prices reflect future takeover probabilities. The results show that while the models have significant explanatory power, the portfolios fail to beat the return on the market over a 12-month holding-period.     

Is the grass on the other side greener? Testing the cross-border effect for U.S. acquirers

Why do U.S. acquirers fare worse when acquiring targets in foreign countries than when acquiring domestic targets? This paper investigates reasons for the so called “cross-border effect” by examining the influence of target public status and competitiveness of the takeover market in the target country. Our findings show that the listing status of the target drives the cross-border effect in two opposite directions: acquirers of private targets fare worse in cross-border takeovers, while acquirers of public targets experience significantly higher gains in acquisitions of foreign targets. The positive cross-border benefit for acquirers of public targets is more pronounced if the target is from a country with a less competitive takeover market.