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XX: Empirical Evidence On Takeover Activity A. Takeover Returns: A Summary Do firms benefit from takeover activity?

What types of takeover activities benefits firms? Do all firms and stakeholders benefit or do only some benefit? Many complications arise in determining the effects of takeovers on firms and their various stakeholders. Accounting statement-based performance measures depend on GAAP and other accounting principles that can be very difficult to translate into wealth effects. Many studies use event study methodology, which works if equity investors and markets efficiently price securities to reflect the impact of takeover information. This chapter reviews empirical literature examining the effects of takeovers on investor wealth, with a particular emphasis on studies employing statistics and the event study methodology. Table 1 depicts abnormal stock returns around announcement dates of certain takeover events. This table was compiled from a 1983 Jensen and Ruback review of other papers. While these results were compiled and averaged from several studies that are now more than twenty years old, numerous more recent studies have produced roughly comparable statistical results. Nonetheless, there are many other types of takeover scenarios to study and many sub-groups to analyze. Furthermore, there still exist substantial debate concerning whether acquiring firm shareholder returns are negative. The event study methodology discussed earlier is typical of the technique used in the studies summarized in the table above. Abnormal short-term stock returns around the takeover event were averaged for the table. In a slightly earlier study from this era, Bradley, Desai & Kim [1982] report that combined target and bidder returns total 10.5 percent, on average. Despite this high average return, it was found to be statistically insignificant, in part due to the wide variations in overall takeover returns. Jensen and Ruback [1983] suggest that the initial gains associated with takeovers may survive only the short term and that longer term gains are actually negative. However, Franks, Harris and Titman [1991] argue that these negative longer-term residuals result from benchmark specification; that is, there may be difficulties in selecting the correct benchmarks for normal returns. In any case, the effects of takeovers on combined and acquiring firm returns remain a source of debate. Why might target firms benefit from takeovers? Monopoly power is an easy response. Eckbo [1983] and [1992] found that combinations of related firms (firms operating in similar industries or with similar operating characteristics) generate higher returns than combinations of unrelated firms. However, his analyses (also cited in Section C below) of competing firms in the same industries revealed that these gains did not result from monopoly power. If monopoly power had been the source of gains to the combining firms, then other competing firms would have lost value on merger announcements. Ekbo did not find that takeovers caused other firms in the same industry to lose value. The failure of market power to explain these residuals suggests that one source of gains for related combinations might be operating synergies and that takeovers that focused the acquirers core business might create value. This result seemed to be confirmed by Berkovitch and Narayanan [1993] who found a strong positive correlation between target and acquiring firm gains. This positive correlation suggested that synergies were significant, perhaps more so than managerial hubris or agency gains in explaining post-merger firm performance. Does the market for corporate control actually provide a source for managerial discipline? An important research paper by Lang, Stulz and Walkling [1989] was concerned with whether stronger management teams acquiring firms with weaker management teams earn higher
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returns than weaker management teams acquiring firms with stronger management teams. They first categorized firms into high and low q (Tobin's q = Market value of assets Replacement value of assets). Tobin's q is often interpreted as an indicator of management quality. For example, a high quality manager is able to generate a high market value for a set of assets with a given replacement value; hence, q for such a well-managed firm is likely to be high. Many researchers often substitute book value of assets for replacement value of assets since book value is more readily available from accounting statements. Lang, Stulz and Walkling found that high q firms earn significant positive returns when taking over low q firms; low q firms taking over high q firms earn significant negative residuals. Thus, managerial quality seems to be a factor in determining returns associated with takeover. These results were confirmed by Servaes [1991]. Bruner [2004] summarizes findings that target, acquiring and combined firm takeover returns are roughly comparable between purely domestic and cross-border takeovers. He cites statistical evidence that U.S. target firms do realize higher returns when taken over by foreign acquirers than by domestic acquirers (See, for example, Wansley, Lane and Yang [1983] and Marr, Mohta and Spivey [1993]). These higher returns may be due to special local knowledge and market access provided by the domestic target that the foreign buyer might not otherwise have access to (See Kohers and Kohers [2000]). In addition, acquisition of the domestic firm provides the foreign company entry into the domestic legal regime. B. Post-Merger Firm Performance: Combined Firm Results The statistical evidence concerning overall post-merger performance is rather mixed. On one hand, a study by Healy, Palepu and Ruback [1992] suggests that post-acquisition performance (as measured by cash flow returns) of acquired firms improves relative to industry benchmarks.12 They found that asset productivity improves relative to merged firm industries, cash flows increased relative to industry benchmarks and they found no evidence that capital or R&D expenditures declined. Consistent with these accounting statement-based performance improvements, they also found that the market appropriately anticipates the improved performance, with abnormal returns during announcement periods being directly related to the level of accounting statement-based post-merger performance. Their results for improved overall performance were consistent with those of an earlier study by Bradley, Desai and Kim [1988], who also found that target firm shareholders average 31 percent returns and bidders earn slightly less than 1 percent. In a later and somewhat more comprehensive study, Andrade, Mitchell and Stafford [2001] found improvements in operating performance and that merger returns for the combined firms average approximately 2 percent. On the hand, Franks, Harris and Titman [1991] found no evidence of abnormal stock returns for combined firms over the three-year period following the last bid date preceding a takeover. Worse still, Agrawal, Jaffe and Mandelker [1992] found insignificant abnormal returns over five-year periods following effective dates of tender offers, and negative 10 percent abnormal returns following effective dates of mergers. Even worse, Loughran and Vijh [1997] found that firms completing stock mergers (pay for target firm with stock) post negative 25 percent abnormal returns over five-year periods following mergers. On the other hand, they found that firms completing cash takeovers earn positive 61.7 percent abnormal returns over

Cash flow returns may be defined as Revenues minus Cost of Goods Sold minus Selling and Administrative Expenses plus Depreciation and Goodwill Expenses, then divided by Total Market Value of Assets.

periods of the same length. One widely cited example of a merger gone bad is the 2000 merger between Time Warner, a provider of a variety of magazines, television and other media services, and AOL, an Internet service provider. This was the largest takeover in history as of 2000 and numerous articles and books have highlighted this merger as ranking among the worst ever. Within three years of the takeover, AOL Time Warner had experienced a share price drop exceeding 80 percent. However, during this same period, AOL Time Warner did manage to outperform pure Internet stocks, suggesting that AOL shareholders were better off due to their acquisition of Time Warner, while Time Warner shareholders lost value. Yet, because of the weakened economy following the takeover, especially in the communications industries, it is not clear whether the securities performances would have been better if the firms had remained as separated operating entities. Furthermore, consider the reduction in dial-up ISP usage and its effect of AOL. Was the merger the culprit to AOL and Time Warner shareholders, or was the real culprit overvalued AOL shares prior to the merger?3 While there is certainly no consensus concerning the results of post-merger performance results for combined firms, much of the statistical evidence seems to lean towards less than impressive results. Warren Buffet, in the 1981 Berkshire Hathaway Annual Report stated Many mangers were apparently over-exposed in impressionable childhood years to the story in which the imprisoned, handsome prince is released from the toads body by a kiss from the beautiful princess. ... Weve observed many kisses, but very few miracles. Nevertheless, many managerial princesses remain serenely confident about the future potency of their kisses, even after their corporate backyards are knee-deep in unresponsive toads. Nonetheless, as of 2006, the jury is still out on overall post-merger performance. Perhaps conduct of more narrow studies may shed some light on this performance debate. In one such narrower study, Cornett and Tehranian [1992] found that post-acquisition returns of banks improves relative to the banking industry as a whole. They attribute the superior performance to superior abilities to attract loans and deposits, improved employee productivity and profitable asset growth. As in the Healy, Palepu and Ruback study, Cornett and Tehranian found that the market appropriately anticipates the improved performance, bidding up share prices during the takeover process. The results of Becher [2000] were similar, attributing 3 percent merger returns in the post-deregulatory period in the banking industry to banking synergies. Hence, perhaps the sample selection method may have a significant impact on the evaluation of post-merger performance. In particular, focus-increasing takeovers may produce superior results. In addition, where deregulation permits consolidation in an industry with too many firms, takeovers may lead to significant profits. Thus, this industry in particular may not be representative of business as a whole. Consider a second issue raised by a theoretical paper by Schleifer and Vishny [2003]. In their model of bidding method, acquirers offer cash for target firms when they believe target firms shares are under valued. Acquirers offer stock when they believe that their own firms are overvalued. Hence, target firms acquired with cash should indicate superior post-merger performance; firms acquired with stock should anticipate weaker performance. This theoretical result is consistent with statistics above quoted by Loughran and Vijh who found that stock mergers post negative 25 percent abnormal returns while cash takeovers earn 61.7 percent abnormal returns. While these theoretical and statistical results do not necessarily suggest that the actual acquisition method actually leads to superior or inferior operating performance, they
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See Bruner [2004] for further discussion on this and related issues. 3

may suggest that managers with superior information make use of their superior knowledge concerning future prospects in the acquisition process. That is, managers who believe that their firms will increase in value make cash purchases while managers who think that their firms are overpriced use their overvalued stock for acquisitions. Nonetheless, if mergers were ultimately to destroy firm value as reported in studies quoted in the beginning of this section, why do they continue to occur with such frequency? Do managers actually want to destroy value? Two leading theories are that many mergers are motivated by managerial self-interest (agency or managerialism hypotheses) and others are motivated by managerial hubris. Managerialism theories hold that managers consummate mergers out of self-interest. Managers consummate mergers to increase their compensation, to diversify their own risks and to engage in empire building. Hubris theories hold that managers are simply overconfident about their own abilities and successful bidders for target firms are more likely to overpay. We will discuss the hubris hypotheses below in Section D. C. Target Firm Returns Statistical data has made it quite clear that target firms earn significant profits due to announcement of takeover attempts. For example, Malatesta [1983] found in his sample of 30 successful mergers that target firm value increases averaged $18.6 million (t = 5.41). But, what are the sources of these takeover gains? As we discussed earlier, Eckbo [1983] and [1992] concludes that horizontal merger profits do not result from market power, based on the lack of rival firm abnormal price reactions to announcements. Holderness and Sheehan [1985] found that their sample of six corporate raiders were able to systematically find undervalued target firms and improve their management. Thus, some takeovers result from astute investors (raiders) who create value when they take control of firms. Walkling and Edmister [1985] found that the tender offer premium increases under the following circumstances: 1. 2. 3. 4. 5. as the target firm's debt to equity ratio decreases as the market to book value ratio decreases if there is competition to acquire the firm when the bidder seeks at least 50 percent of the firm and as the percentage of stock held by the bidder decreases.

Malatesta [1983] finds that smaller firms taking over larger firms generate significant negative overall returns. In fact, as the size of the target firm relative to the bidding firm increases, overall merger percentage returns decrease. In an event study involving 194 takeovers from 1975-78, Keown and Pinkerton [1981] found that target firms averaged returns of 13.3 percent from 25 days to 1 day prior to the takeover announcement. Short-term returns on the date of and immediately after the announcements averaged 12 percent. While the announcement date returns were expected, Keown and Pinkerton interpreted the pre-announcement run-ups as evidence of insider trading. Jarrell and Poulson [1989] found similar statistical run-ups during the early 1980s, but argued that these returns were related to market anticipation, resulting from speculative behavior on the part of investors and prospective bidders along with accompanying expectations and rumors. However, Sanders and Zdanowicz [1992] found that the price run-ups started on the actual dates when the takeovers were initiated, prior to the takeover announcements. Takeover initiation dates are not known by the general public until they are revealed when the takeovers are actually
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announced. Hence, Sanders and Zdanowicz provided significant evidence that the run-ups were at least in part due to illegal insider trading, unless traders anticipated even the dates of initiations of takeover discussions. Meulbroek [1992] seemed to confirm this result in an examination of known illegal insider trades, finding that substantial portions of the run-ups occur on the actual dates of trades that were later determined to be illegal. D. ACQUIRING FIRM RETURNS We saw above that is clear that target firms earn significant profits due to announcement of takeover attempts. However, the evidence regarding bidding firm residuals is quite inconsistent. For example, Asquith [1983] argues that target firms achieve significant positive abnormal returns during the merger process while bidding firms do not. On the other hand, Malatesta [1983] finds that acquiring firm value increases averaged $13.8 million (t = 0.91, a statistically insignificant result). Moeller, Schlingemann and Stulz [2003] find that acquiring firms earn small, but statistically significant abnormal returns on takeover announcements. Other studies such as those of Byrd and Hickman [1993], Servaes [1991] and Jennings and Mazzeo [1991] suggest that acquirers earn statistically significant negative residuals. Generally, the bulk of statistical evidence suggests that acquirers earn negative residuals. Why does the statistical evidence suggest that target firms earn positive returns while acquiring firms do not? That is, why does it appear that acquiring firms do not participate in the gains that their takeover initiations create? There are several potential explanations for this apparent phenomenon: 1. Schipper and Thompson [1983] argue that acquiring firm returns are very difficult to measure because bidding activity is likely to be part of an ongoing program by the acquiring firm. They argue that acquisitions do not occur in isolation. One cannot easily ascertain exactly when this program begins; thus, one cannot easily measure its return, especially based on short-term residuals produced in an event study. Perhaps acquiring firm long-term returns are higher than short-term cumulative average residuals would indicate. Acquiring firm competition for sources of efficiency may enable target firms to capture all of the gains from a takeover. This explanation seems consistent with the finding that acquiring firm returns prior to passage of the Williams Act of 1968 were higher than after passage. The Williams Act made it easier for competing bidders to enter the market for target firms. Yet, this explanation would not explain the negative returns often observed for acquiring firms. Announcement of a takeover attempt intensifies the interest in the target firm as it is revealed to be an attractive takeover target. Target firm managers frequently contribute to this interest, seeking white knights and other potential acquirers. Acquiring firm managers may benefit from a takeover even when their shareholders do not. Such benefits may include higher compensation due to the increased firm size or complexity or increased diversification enjoyed by managers. In their study of 3,333 takeovers from 1990 to 2003, Masulis, Wang and Xie [2005] demonstrate that more entrenched managers protected by anti-takeover amendments are more likely to make negative NPV acquisitions, suggesting that they are motivated by personal benefits of takeover activity. Similarly, entrenched managers are more likely to make diversificationincreasing acquisitions. Amihud and Lev (1981) and Morck, Shleifer, and Vishny (1990)
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2.

3.

4.

5. 6.

find that diversifying acquisitions tend to reduce shareholder wealth and are likely to benefit self-interested managers, particularly when they cannot diversify portfolio or employment risk. Some acquirers simply make mistakes. Roll [1986] suggests that managers overrate their own abilities (hubris) and consequently overvalue the targets that they acquire. In a bidding contest, the management team that bids the most for the target acquires the target, but is most likely to have experienced the Winners Curse, overpaying for the target. One falls victim to the Winners Curse when winning an auction by overvaluing the asset. Roll [1986] focused on this managerial hubris motivation, arguing that if takeovers are motivated by managerial hubris, then target firm returns should be positive (consistent with Table 1) acquiring firm returns should be negative (inconsistent with Table 1, but consistent with findings in other studies) and combined firm returns could be positive or negative. Target firms are usually smaller than acquiring firms, such that a fixed amount of dollar profit has a larger impact on percentage target firm returns than on acquiring firm returns. Information and signals mat play a role in acquiring firm announcement date returns. Acquiring firm announcement residuals tend to be positive when the acquisition is paid for with cash. Acquiring firm announcement residuals when the target is to be purchased with stock. The market may take stock deal announcements as signals that acquiring firm managers believe that their stock is overpriced.

Studies conducted on conglomerate takeovers using data collected after the 1960s seem to suggest that corporate diversification reduces shareholder wealth. For example, Mork, Shleifer and Vishny (1990) and Servaes (1996) find that diversifying acquisitions tended to decrease acquiring firm values and John and Ofek (1995) find that when a firm sells an asset that is outside its primary scope of operations, greater returns result than when the asset lies within that scope of operations. Furthermore, Lichtenburg (1991) finds that plant productivity is higher among firms with narrow scopes of operations. With similar implications, Ravenscraft and Scherer (1987) find that sell-off units were more efficient as stand-alone operations (or when sold to firms in similar businesses) than as part of the conglomerates they formerly operated under. Bhide (1989) states "My research suggests that the real source of gains in hostile takeovers lies in splitting up companies. Results of early studies (e.g., Schipper and Thompson [1983]) finding positive returns to conglomerate mergers were based on data taken from the 1960s. Later studies conflict. Matsusaka and Nanda [1996] and Hubbard and Palia [1999] argue that lack of information flows in external capital markets during the 1960s restrained firms abilities to raise funds. The takeover markets represented an opportunity to expand internal capital availability. Thus, diversification per se did not generate conglomerate firm returns; increased capital availability did. As external capital markets became more informationally efficient, conglomerate takeover returns disappeared. This result seems strengthened by the findings of Khanna and Palepu [1997] who observed conglomerate takeovers in India, an emerging financial market. E. MERGER EFFECTS ON BONDS To this point, our discussions have been focused on how shareholders are affected by takeover activity. However, bondholders and other creditors also have large sums of money invested in firms involved in takeovers. How are bondholders affected by takeovers? Do these
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effects, if they indeed exist, result from changes in performance or from wealth redistributions? One problem that arises when addressing these questions is that bonds are traded less frequently than stocks and regular bond price series are more difficult to obtain and to analyze. The issue of merger impacts on bond values has not yet been settled in the corporate finance literature. Studies of the impact of mergers on bond prices seem to have picked up offsetting effects on bond prices. That is, takeovers produce a coinsurance effect that we discussed in Chapters 4 and 5. However, takeovers are also frequently associated with increased leverage and increased risk. For example, Asquith and Kim [1982], Denis and McConnell [1985] and Kim and McConnell [1977] all conclude that non-convertible bond prices are not significantly affected by the announcement of a merger. These papers suggest that although many mergers had been accompanied by increases in leverage that would tend to decrease bond prices, a co-insurance effect seems to offset this leverage effect. The co-insurance effect exists where the equity of both firms involved in the merger serves to insure payment of debt for both of the firms. This co-insurance effect had been demonstrated theoretically by Higgins and Schall [1975] and Galai and Masulis [1975] to show that a merger of firms with imperfectly correlated return structures will increase the value of a firm's debt at the expense of shareholders. Hence, the equity of both firms serves as "insurance" that the debt of each firm will be paid. Billett, King and Mauer [2004] find evidence of a target firm co-insurance effect, with a significant wealth redistribution to target firm bondholders from target firm shareholders. They find that during takeover announcement periods, acquiring firm bondholder abnormal returns are negative while target firm bondholder returns are positive, particularly for holders of speculative grade target firm bonds. Target bondholder returns are significantly larger when the merger reduces asset risk and when the target firm is riskier than the acquirer (See also Shastri [1990]). Target firm bondholders also gain when the target bond rating is below the acquirer bond rating, when the pre-merger leverage of the target is greater than the pre-merger leverage of the acquirer, and when the average target bond maturity is shorter than the average acquirer bond maturity (Again, See Shastri [1990]). In addition, both target and acquirer abnormal bond returns are smaller if the offer is hostile. Bond returns are also higher in 1990s takeovers due to the introduction of new bondholder risk protections. Target stockholder dollar gains are reduced when target bondholder dollar profits increase, suggesting that target firm bondholder gains in takeovers redistributed from target firm stockholders. However, the study did not find evidence of wealth redistributions among acquiring firm security holders. F. GOING PRIVATE, DIVESTITURE AND ESOP TRANSACTIONS We discussed results of several empirical studies on going private transactions in Chapter 6. In addition, DeAngelo, DeAngelo and Rice [1984] found statistically significant residuals averaging 30.4 percent in the 40-day period prior to the announcement of a going private proposal. Their L.B.O. sample averaged 29.1 percent returns. This suggests that minority freeze outs (pressure on minority shareholders to tender their shares) do not hurt minority shareholders; in fact, they may even have benefited from their blocking power. Furthermore, there is statistical evidence from accounting statement data that these significant returns anticipated improvements in operating performance. Even more striking is testimony given by Professor Michael Jensen to Congress in 1989, stating that the average LBO doubled in value during its four years as a private company. With debt-to-asset ratios averaging 85 percent, the median return to LBO acquirers was 785 percent.1 Several studies have attributed these returns from a combination of
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See Jensen [1989] and Bruner [2004]. 7

operational efficiencies and other improvements as well as tax savings from debt and depreciation. Summarizing results from other studies, Bruner [2004] attributes returns to equity carveouts, spin-offs and tracking stock issuance ranging from 2 percent to 4 percent. Such transactions are often expected to improve the management of the disposed assets. Slovin, Sushka and Ferraro [1995] found that rival firms lose 1 percent on announcements of equity carve-outs (IPOs of subsidiary equity). These returns seem consistent with negative returns earned by rivals of other types of IPO firms. Gordon and Pound [1990] find that establishing ESOPs decreases shareholder wealth if there is a transfer of voting power away from shareholders or if the ESOP formation would reduce the probability of a takeover. They find that the establishment of an ESOP within the presence of takeover activity reduces share values by an average of four percent. If a large degree of voting power is transferred away from large blockholders to an ESOP, shareholder wealth is also decreased. However, if the ESOP is created through the issue of non-voting stock, shareholders experience a significant increase in wealth. Thus, according to Gordon and Pound, the effect of an ESOP on shareholders is a function of the control and incentive effects on the corporation. G. MANAGERIAL MOTIVES FOR MERGERS If it is not clear whether acquiring another firm will significantly increase acquiring firms value, why are managers so motivated to initiate takeover attempts? A number of studies have been concerned with managerial motives for mergers. For example, early studies such as that by Baumol [1962], based on his observations, argues that the primary managerial objective of the merger is to maximize firm sales. He argues that both pecuniary and non-pecuniary managerial compensation are directly related to sales levels. Reid [1968] supports this hypothesis by presenting data indicating that merger activity is more closely related to sales, asset and employee growth rates than to corporate profits and share prices. Muller [1969] drew similar conclusions based on his data collected from seven countries. He concluded that the existence of horizontal mergers that provided no efficiencies or economies of scale indicated that managers simply prefer to control larger corporations. Reid [1976] found that conglomerates were experiencing much larger market value shrinkage than other firms during the period 1970-74 while managerial compensation levels were increasing suggesting that managers benefited from takeovers while shareholder wealth was reduced. In more recent and narrower studies of bank mergers, Bliss and Rosen [2001] and Andersen, Becher and Campbell [2004] find that CEO compensation significantly increased following bank takeovers. Bliss and Rosen found that increases in managerial compensation seemed related to increased post-merger firm size, supporting the managerial empire building motivation for takeovers. However, Anderson, Becher and Campbell found that these gains were more reliably related to the size of anticipated merger gains. In effect, larger mergers that were successful produced significant increases in shareholder wealth and increased managerial compensation as a result. Levels and forms of managerial compensation can be structured to encourage valueincreasing takeover initiation, though some studies suggest that many compensation packages merely encourage takeover initiation. Bliss and Rosen (2001) found that CEO compensation typically increases after bank mergers even if the acquirers stock price declines. More generally, Grinstein and Hribar [2004] found that approximately 39 percent of acquiring firms compensate
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their managers specifically for consummating takeover transactions. For example, Exxon, HealthSouth, Bankers Trust and Travelers Group have all fairly recently paid their CEOs substantial cash bonuses ranging from $5 million to $14 million dollars for the consummations of takeover deals. Clearly, in these examples, takeovers affected compensation levels. But does compensation affect takeover returns? Datta, Datta and Rahman [2001] and [2004] found that there is a strong correlation between acquiring firm performance and proportions of equity-based managerial compensation. For example, they found that acquiring firm stock prices respond more favorably to acquisition announcement when its executives receive higher levels of equitybased compensation, suggesting that the market believes that managers with higher equity holdings initiate better takeovers. They also found that acquiring firms with larger equity-based compensation make takeover offers with lower premiums paid to target firm shareholders, again to the benefit of their employers. Managers with higher levels of equity-based compensation acquire targets with higher risk but also with stronger growth opportunities. Finally, they found that acquiring firms whose managers receive higher equity-based compensation realize superior long-term stock performance on a risk-adjusted basis following consummation of the takeover. All of this suggests that increased equity-based compensation encourages stronger acquisition performance. Lewellen, Loderer and Rosenfield [1985] found that managers with large stock holdings are more likely to initiate positive NPV takeovers than managers with smaller holdings. Furthermore, a large number of studies have been concerned with managerial resistance to takeover attempts. For example, Walkling & Long [1984] found that managers who perform poorly are more likely to resist takeover bids. Lambert & Larcker [1985] found that golden parachute provision installations increase stock prices. In their sample, golden parachutes averaged 1.7 percent of target firm assets. Why should golden parachute provisions increase share prices? Some observers have argued that golden parachutes make takeover targets more expensive. On the other hand, golden parachute installations may signal to investors that managers are worried about losing their positions; that is, managers are signaling that takeover attempts are to follow soon. In another study of takeover defenses, DeAngelo and Rice [1983] found that supermajority, staggered board, fair price and lock-up amendments to the corporate charter do not result in significant residuals. Kummer and Hoffmeister [1978] found that target firm profits are higher when management does oppose a takeover attempt. However, in those opposed takeover attempts that eventually resulted in the firm not being acquired, target firm shareholders realized negative abnormal returns. Thus, it appears that successful oppositions lead to losses for target firm shareholders unless the opposition ultimately leads to higher takeover premiums. Nonetheless, evidence provided by Dodd [1980] suggested that managerial opposition to takeover attempts reduced shareholder residuals. Dann and DeAngelo [1983] found that standstill agreements also resulted in negative residuals. Target firm directors may also have a strong incentive to contest takeover attempts. Harford [2002] finds that directors of target firms are rarely retained after takeovers are consummated. Furthermore, displaced directors usually hold fewer directorships after they are replaced (it appears that deposed directors have difficulties replacing their lost positions). Directors whose performance was perceived as being weaker have more difficulty finding new directorships. However, in some instances, directors will receive severance compensation when their positions are eliminated. For example, each director of Bank of America received $300,000 when it was merged into Nationsbank in 1998. According to a Bank of America official, the
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purpose also was to thank people who had, after all, voted themselves out of a job by approving the merger. H. TAKEOVER LEGISLATION AND REGULATION We discussed earlier discussed legislation and regulations affecting takeover activity and other corporate governance issues. There have been a number of statistical studies examining the impact of this body of regulation, many of which focus on its impact on shareholder returns. For example, after the Enron, Adelphia, WorldCom and number of other corporate governance debacles rocked Wall Street, Congress passed the Sarbanes Oxley Act of 2002 (SOX), imposing new standards and penalties on corporate managers. The act itself is discussed in Chapter 4. Li, Pincus and Rego [2006] studied market reactions to the deliberations and passage of SOX, finding that stocks realized net positive cumulative returns. Their results seemed consistent with investors expecting SOX to improve the market by improving the accuracy and reliability of financial reports. Their results also suggested that expected benefits were greater for shareholders of firms that had more extensively managed earnings in prior years. More generally, firms with weaker governance and information flows to shareholders experienced more significant cumulative share price reactions, with the market seeming to expect that SOX would impose greater costs on firms with less independent audit committees, on firms with more non-audit services acquired from external auditors, and on smaller firms. Link, Netter and Yang [2005] study the effects of SOX on corporate boards, finding that SOX increased the costs of boards, particularly for smaller firms. They found that board sizes have grown since passage of SOX and boards include more independent members. As intended, more boards maintain audit, compensation and nominating committees, and these committees meet more frequently. Insurance premiums for officers and directors have increased. As SOX increased the workload of directors and their risk of liability, board members' pay increased as well. Several empirical studies have been concerned with the impact of legislation and regulation on merger profitability. For example, Jarrell and Bradley [1980] and Bradley, Desai and Kim [1988] found that the Williams Amendment of 1968 increased target firm returns and decreased bidders' returns. Presumably, the Williams Act made it easier for target firms to attract competing bidders after announcement requirements were imposed on acquirers. Combined returns seemed unaffected. Nathan and O'Keefe [1989] suggest that the Williams Act effect seems either to have been gradual or delayed until 1974. Nathan and O'Keefe [1989] found that mean takeover premiums were 75 percent in the period 1974-1985, compared to 41 percent in the period 1963-1973. Why might target firm residuals have increased during the second period relative to the earlier period? One potential explanation is passage of the Williams Act of 1968. However, this explanation seems weakened by the 6-year delay in the increased returns. Concerning another body of regulation, Wier [1983] examined residuals for target and bidding firms that were involved in mergers opposed by antitrust authorities, finding cumulative abnormal returns averaging 9.25 percent for targets around announcement dates and -12.43 percent on merger cancellation dates. The relatively small target firm returns might be explained by shareholder anticipation of regulator opposition and the net loss of target firm shareholder wealth might reflect the knowledge that the target is a less attractive target for antitrust reasons. Bidding firm residuals were insignificant on both dates. I. PROXY CONTESTS
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Most studies (e.g., Dodd and Warner [1983] and Ikenberry and Lakonishok [1993]) have found that proxy contests generate significant short-term positive residuals about their announcement dates. Since most targets of proxy contests have records for poor prior performance, one might expect that proxy contests will follow series of low historical returns. For example, Ikenberry and Lakonishok find negative CARs averaging approximately -33 percent between 48 and 4 months preceding the proxy contest announcement. Positive residuals about the date of a proxy contest announcement would suggest that shareholders expect the proxy contest to lead to superior performance. However, Ikenberry and Lakonishok find that returns between proxy contest announcement and resolution are negative. Furthermore, they find that long term returns following proxy contests are negative, regardless of whether dissident shareholders prevail in their contests. This may suggest that dissident shareholders after winning control are not able to make value-increasing changes to the firm.

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Table 1: Shareholder Residuals on Takeover Announcements


Successful Target % Bidder% Takeover Technique Tender Offer Merger Proxy Contest 30 20 8 4 0 N.A. Unsuccessful Target% -3 -3 8 Bidder% -1 -5 N.A.

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