Financing and takeovers

This paper analyzes the interaction between financial leverage and takeover activity. We develop a dynamic model of takeovers in which the financing strategies of bidding firms and the timing and terms of takeovers are jointly determined. In the paper, capital structure plays the role of a commitment device, and determines the outcome of the acquisition contest. We demonstrate that there exists an asymmetric equilibrium in financing policies with endogenous leverage, bankruptcy, and takeover terms, in which the bidder with the lowest leverage wins the takeover contest. Based on the resulting equilibrium, the model generates a number of new predictions. In particular, the model predicts that the leverage of the winning bidder is below the industry average and that acquirers should lever up after the takeover consummation. The model also relates the dispersion in leverage ratios to various industry characteristics, such as cash flow volatility or bankruptcy costs.     

Investor protection and the Coasian view

The corporate charters of a sample of Mexican firms show that private firms often significantly enhance the legal protection offered to investors, but public firms rarely do so. We construct a model that endogenizes the degree of investor protection that firms provide, using as a springboard the assumption that legal regimes differ in their ability to enforce precisely filtering contracts that provide protection only in those cases where expropriation can occur. Our model generates predictions about the types of contracts that would be employed and the levels of investor protection that would prevail across different legal regimes in both private and public firms.     

Investor protection and cash holdings: Evidence from US cross-listing

This paper examines (i) whether the level of firms’ cash holdings differ depending on the strength of investor protection, (ii) whether excess cash holdings are valued more with better investor protection, and (iii) whether cross-listed firms that improve investor protection through “bonding” hold relatively more cash than non-cross-listed firms. We analyze 1405 ADR firms and their corresponding matched firms from 39 different countries and document that ADR firms have significantly higher cash holdings relative to their non-cross-listed peers, especially in recent years. The increase in cash holdings is much higher for emerging market firms because of their transition from particularly poor home country investor protection and accounting standards before cross-listing to much higher standards after cross-listing. In addition, firms with level III ADR listing, which represents the strongest investor protection, have higher cash holdings relative to other types of ADR firms.     

Firm growth type and capital structure persistence

We find that growth type (identified by a two-way sort on firm initial market-to-book ratio and asset tangibility) can parsimoniously predict significantly dispersed and persistently distinct future leverage ratios. Growth type is persistent; growth-type-sorted cross-sections of corporate fundamental variables (such as tangible versus intangible investment style) are also meaningfully persistent. As economic and market conditions improve, low growth type firms are keener to issue new debt than equity, whereas high growth type firms are least likely to issue debt and keenest to issue equity. These findings demonstrate that firms rationally invest and seek financing in a manner compatible with their growth types. Consistent with a generalized Myers–Majluf framework, growth type compatibility enables distinct growth types and hence specifications of market imperfection or informational environments to persist. Growth type is apparently a fundamental factor for capital structure persistence.     

Controlling shareholders and market timing in share issuance

We examine market timing in the equity issuance of firms controlled by large shareholders using a hand-collected data set of controlling shareholders' ownership stakes in Chile between 1990 and 2009. When a firm issues shares, the controlling shareholder can either maintain or change his ownership stake depending on how many of the new shares he subscribes. Issuance predicts poor future returns and is preceded by high returns, but only when the controlling shareholder's stake is significantly reduced. Consistent with market timing, the results are stronger in the absence of institutional investors and in hot issuance markets.     

Investor protection and the value effects of bank merger announcements in Europe and the US

Investor protection regimes have been shown to partly explain why the same type of corporate event may attract different investor reactions across countries. We compare the value effects of large bank merger announcements in Europe and the US and find an inverse relationship between the level of investor protection prevalent in the target country and abnormal returns that bidders realize during the announcement period. Accordingly, bidding banks realize higher returns when targeting low protection economies (most European economies) than bidders targeting institutions which operate under a high investor protection regime (the US). We argue that bidding bank shareholders need to be compensated for an increased risk of expropriation by insiders which they face in a low protection environment where takeover markets are illiquid and there are high private benefits of control.     

Investor sentiment,executive compensation,and corporate investment

We develop a model that predicts corporate investment level increases with investors’ optimism and that the relationship between investment level and executive compensation depends on investor sentiment and other parameters. The empirical test shows that optimism is significantly and positively related to the level of investment and that executive compensation is insignificantly related to the level of investment. The managerial share ownership is positively related to the level of investment, conditional on the degree of optimism. The empirical results suggest that executives make investment decisions that not only cater to investor sentiment but also reflect their own interest in the company.     

Corporate social responsibility and stakeholder value maximization: Evidence from mergers

Using a large sample of mergers in the US, we examine whether corporate social responsibility (CSR) creates value for acquiring firms' shareholders. We find that compared with low CSR acquirers, high CSR acquirers realize higher merger announcement returns, higher announcement returns on the value-weighted portfolio of the acquirer and the target, and larger increases in post-merger long-term operating performance. They also realize positive long-term stock returns, suggesting that the market does not fully value the benefits of CSR immediately. In addition, we find that mergers by high CSR acquirers take less time to complete and are less likely to fail than mergers by low CSR acquirers. These results suggest that acquirers' social performance is an important determinant of merger performance and the probability of its completion, and they support the stakeholder value maximization view of stakeholder theory.     

Distracted directors: Does board busyness hurt shareholder value?

We use the deaths of directors and chief executive officers as a natural experiment to generate exogenous variation in the time and resources available to independent directors at interlocked firms. The loss of such key co-employees is an attention shock because it increases the board committee workload only for some interlocked directors—the ‘treatment group’. There is a negative stock market reaction to attention shocks only for treated director-interlocked firms. Interlocking directors? busyness, the importance of their board roles, and their degree of independence magnify the treatment effect. Overall, directors? busyness is detrimental to board monitoring quality and shareholder value.     

Capital gains taxation and shareholder wealth in takeovers

Before December 1999, the capital gains of shareholders who sold their shares into Australian takeovers have been taxable irrespective of payment method. Subsequently, shareholders can elect to rollover capital gains in equity takeovers. We examine the effect of this change on the association between target shareholder capital gains and bidder and target firm shareholder wealth. The results indicate that prior to the regulatory change, cash consideration results in higher target shareholder returns for non‐taxation reasons. After the introduction of capital gains tax rollover relief, we find that target and acquiring firm shareholders earn lower returns when cash consideration is offered to shareholders with greater capital gains.     

Does corporate social responsibility affect the cost of capital?

We examine the effect of corporate social responsibility (CSR) on the cost of equity capital for a large sample of US firms. Using several approaches to estimate firms’ ex ante cost of equity, we find that firms with better CSR scores exhibit cheaper equity financing. In particular, our findings suggest that investment in improving responsible employee relations, environmental policies, and product strategies contributes substantially to reducing firms’ cost of equity. Our results also show that participation in two “sin” industries, namely, tobacco and nuclear power, increases firms’ cost of equity. These findings support arguments in the literature that firms with socially responsible practices have higher valuation and lower risk.     

Firm characteristics and long-run stock returns after corporate events

The well-documented abnormal long-run buy-and-hold returns to firms issuing equity in initial public offerings and seasoned equity offerings, firms bidding in mergers, and firms initiating dividends can be attributed to imperfect control-firm matching. In addition to firm size and market-to-book ratio, event firms on average differ from control firms in terms of idiosyncratic volatility, liquidity, return momentum, and capital investment, each of which also explains returns. We propose a simple regression-based approach to control for differences in firm characteristics across event and control firms, and we show that long-run abnormal returns do not differ significantly from zero for event firms in the 1980 to 2005 period. The returns to event firms are, therefore, consistent with patterns known to exist for the broad stock market and do not require event-specific explanations.     

Investor Recognition and Post‐Acquisition Performance of Acquirers

The literature has documented a negative relation between investor recognition and expected returns. This negative relation is consistent with the prediction in Merton (1987, Journal of Finance 42, 483–510). This paper investigates whether the changes in investor recognition of acquirers around the time of the acquisitions can explain the post‐acquisition underperformance of acquirer stocks. Using a large sample of U.S. acquisitions from 1980 to 2010, this paper finds that investor recognition, proxied by the number of institutional investors and the number of common shareholders, increases significantly during acquisitions. Once the increases in investor recognition are controlled for, the “puzzling” long‐run underperformances of acquirers disappears.     

Investment decisions and internal capital markets: Evidence from acquisitions

In this paper, we examine the workings of internal capital markets in diversified firms that engage in related and unrelated corporate acquisitions. Our evidence indicates that bidders invest outside their core business (diversify) when the cash flows of their core business fall behind those of their non-core lines of business. However, bidders invest inside their core business (i.e., undertake non-diversifying investments) when their core business experiences superior cash flows. We also find that bidders whose core business are in industries with low growth prospects engage in diversifying acquisitions while bidders whose core business are in high growth industries undertake non-diversifying acquisitions. The pre-acquisition evidence, then, suggests that firms tend to diversify when the cash flows and the growth opportunities of their core business are considerably lower than those of their non-core business. Subsequent to acquisitions we find that diversifying bidders continue to allocate financial resources from less profitable business segments (i.e., core business) to more profitable business segments (i.e., non-core business). Given the low profitability of diversifying bidders’ core business, this capital resource allocation suggests that diversification increases do not result in capital allocation inefficiencies. The evidence for non-diversifying bidders, however, supports the existence of “corporate socialism” in the sense that there is transfer of funds from the profitable (core) to the less profitable (non-core) business segments in multi-segment bidders. We find that the capital expenditures of bidders’ non-core business segments rely on both core and non-core cash flows.     

Does international cross-listing improve the information environment

We investigate whether cross-listing in the U.S. affects the information environment for non-U.S. stocks. Our findings suggest cross-listing has an asymmetric impact on stock price informativeness around the world, as measured by firm-specific stock return variation. Cross-listing improves price informativeness for developed market firms. For firms in emerging markets, however, cross-listing decreases price informativeness. The added analyst coverage associated with cross-listing likely explains the findings in emerging markets, rather than changes in liquidity, ownership, or accounting quality. Our results indicate that the added analyst coverage fosters the production of marketwide information, rather than firm-specific information.     

Productivity,restructuring, and the gains from takeovers

This paper investigates how takeovers create value. Using plant-level data, I show that acquirers increase targets' productivity through more efficient use of capital and labor. Acquirers reduce capital expenditures, wages, and employment in target plants, though output is unchanged. Acquirers improve targets' investment efficiency through reallocating capital to industries with better investment opportunities. Moreover, changes in productivity help explain the merging firms' announcement returns. The combined announcement returns are driven by improvements in target's productivity. Targets with greater productivity improvements receive higher premiums. These results provide some first empirical evidence on the relation between productivity and stock returns in takeovers.     

Investor protection and convertible debt design

An important issue that firms consider when designing convertible debt is to specify security features such as conversion ratio, maturity date and call period. Following Lewis et al. [Lewis, M., Rogalski, R., Seward, J., 2003. Industry conditions, growth opportunities and market reactions to convertible debt financing decisions. Journal of Banking and Finance 27, 153–181], we employ a single measure that simultaneously considers all of these features: the expected probability (measured at issue date) that the convertible will be converted to equity at maturity. We find that firms in countries with stronger shareholder rights issue convertible debt with a higher expected probability of converting to equity. The positive association between the expected probability of conversion and shareholder rights is less pronounced in firms for which ownership structures create potentially high managerial agency costs. Specifically, in countries with stronger shareholder rights, firms with higher separation of control rights and cash flow rights tend to issue convertibles with lower probability of conversion. Furthermore, we find that large non-management block ownership strengthens the likelihood of issuing convertible debt with higher probability of conversion in countries with stronger shareholder rights. In contrast, firms in countries with stronger creditor rights issue convertibles with lower probability of conversion. We also document that the negative association between creditor rights and probability of conversion is more pronounced in firms with higher separation of control rights and cash flow rights.     

Who makes acquisitions? CEO overconfidence and the market's reaction

Does CEO overconfidence help to explain merger decisions? Overconfident CEOs over-estimate their ability to generate returns. As a result, they overpay for target companies and undertake value-destroying mergers. The effects are strongest if they have access to internal financing. We test these predictions using two proxies for overconfidence: CEOs’ personal over-investment in their company and their press portrayal. We find that the odds of making an acquisition are 65% higher if the CEO is classified as overconfident. The effect is largest if the merger is diversifying and does not require external financing. The market reaction at merger announcement (-90$-90$ basis points) is significantly more negative than for non-overconfident CEOs (-12$-12$ basis points). We consider alternative interpretations including inside information, signaling, and risk tolerance.     

A century of corporate takeovers: What have we learned and where do we stand?

This paper reviews the vast academic literature on the market for corporate control. Our main focus is the cyclical wave pattern that this market exhibits. We address the following questions: Why do we observe recurring surges and downfalls in M&A activity? Why do managers herd in their takeover decisions? Is takeover activity fuelled by capital market developments? Does a transfer of control generate shareholder gains and do such gains differ across takeover waves? What caused the formation of conglomerate firms in the wave of the 1960s and their de-conglomeration in the 1980s and 1990s? And, why do we observe time- and country-clustering of hostile takeover activity? We find that the patterns of takeover activity and their profitability vary significantly across takeover waves. Despite such diversity, all waves still have some common factors: they are preceded by technological or industrial shocks, and occur in a positive economic and political environment, amidst rapid credit expansion and stock market booms. Takeovers towards the end of each wave are usually driven by non-rational, frequently self-interested managerial decision-making.     

Hedge fund activism,CEO turnover and compensation

This paper examines the governance role of hedge fund activists by analyzing the impact of these activists on CEO turnover, CEO pay, and CEO pay-performance link in targeted companies. Using the difference-in-difference approach, we first find significantly higher CEO turnover following hedge fund activism. After we split target companies into the CEO-turnover and non-CEO-turnover sub-samples, we find that only new CEOs in targeted companies get more compensation following hedge fund activism while incumbent CEO pay does not significantly change. The relationship between CEO bonuses and return on assets following hedge fund activism also differs across the subsamples split by CEO turnover. Pay-performance relationship is enhanced by hedge fund activism for new CEOs, but not for incumbent CEOs. In additional analyses, we document that CEO turnover is positively associated with Tobin’s Q and shareholder votes on Say on Pay in target companies after hedge fund activism.