Antitakeover Provisions and Firm Value: New Evidence from the M&A Market

A vast literature studies the effects of antitakeover provisions (ATPs) on firm value. The academic consensus is that ATPs harm firm value because they partly insulate managers from the threat of takeover, and that view has become very influential. Prominent studies find that empire building through corporate acquisitions is the main channel of value destruction by entrenched managers (Masulis, Wang, and Xie, 2007; Harford, Humphery-Jenner, and Powell, 2012). Managers protected by ATPs are more likely to pursue self-interested deals that further increase their entrenchment, which harms shareholder value. A major limitation of the existing empirical studies is their reliance on a single data set, the Investor Responsibility Research Center (IRRC) data, although it is well established that market effects of corporate governance are context-specific (Karpoff and Whittry, 2018).

My paper is the first to reexamine the relation between ATPs and firm value in a new institutional setting, using a hand-collected database. The research design builds on the conjecture that ATPs may increase agency costs and hence harm firm value in institutional contexts relying on external governance mechanisms, such as the market for corporate control. By contrast, ATPs may benefit firms in settings where internal governance mechanisms, such as blockholder monitoring, are more relevant, because they may help reduce takeover market-induced pressure that can lead to value-destroying managerial short-termism. Intuitively, strong internal governance is sufficient to discipline managers, so ATPs do no harm. However, ATPs can still protect firms from short-termism and hence add value in institutional contexts where internal governance is relatively strong.

The empirical results from a sample of German acquirers support this view. Acquirer returns increase by about 0.5 percent per adopted ATP, which is a non-trivial figure given average announcement-related acquirer returns of 0.63 percent. Germany provides an ideal context to study the ATP-value relation because internal governance mechanisms such as blockholder monitoring, two-tier board structures, and employee representation on the supervisory board are very pronounced (Dissanaike, Drobetz, Momtaz, Rocholl, 2019). Germany’s reliance on internal governance plausibly marginalizes agency costs from ATP adoption, while ATPs are still effective against takeover market-induced short-termism. Importantly, the results suggest that ATPs may create value not only in Germany, but also in many other countries, as well as in industries and product markets in which firms rely more on internal governance.

To better understand how ATPs can have positive effects on firm value, I examine whether ATPs affect deal characteristics and find three main explanations. First, entrenched managers are more likely to import blockholders of stock, and hence increase institutional monitoring, by paying with equity in acquisitions of public targets involving institutional investors. Second, ATPs increase the probability of acquiring targets listed on multiple stock exchanges, whose regulations reduce management discretion. Third, entrenched managers are less likely to acquire companies in declining industries, transactions that often destroy value when shareholder rights are weak. Overall, there is strong evidence that entrenched managers are more likely to make governance-improving deals that increase long-term firm value.

The remainder of the paper sheds light on why ATPs enhance firm value. A potential explanation is that ATPs curb managerial short-termism (Stein, 1988, 1999), which arises as a consequence of takeover-market pressure. Indeed, I find that firms that are surrounded by many takeovers directly related to their business models react myopically and destroy value in long-term investments such as corporate acquisitions, suggesting that short-termism has real effects on firm value. However, consistent with theoretical predictions, ATPs mitigate the value-destroying effect of managerial short-termism. Thus, ATPs effectively eliminate short-termism.

Finally, the paper finds three ways that ATPs help managers defy short-termism. First, firms that are difficult to value (e.g., medical and pharmaceutical companies) are also more likely targets of opportunistic takeovers and hence more subject to short-termism. The value-increasing effect of ATPs is particularly pronounced in this type of firm. Second, managers protected by ATPs significantly increase R&D investment associated with acquisitions, and this type of investment is also more likely to create long-term value if the management is entrenched. Third, at firms with a relatively high number of ATPs, entrenched managers are more likely to make good investments generally.

The results are tested for robustness in several ways. Endogeneity concerns are also discussed. Spurious correlation seems unlikely given that the results do not change at all when I control, inter alia, for overall management quality (Dissanaike, Drobetz, Momtaz, 2019). The reverse causality argument is also examined (i.e., it is not that ATPs increase firm value because they improve management decisions, but that good managers pick firms with many ATPs). If reverse causality would be an issue, I would expect at least some variation in the use of ATPs around CEO turnovers. However, I fail to find any significant time-series variation in the use of ATPs at all.

Overall, this study marks a new era in examining ATPs and firm value in the spirit of the recent work by Karpoff and Whittry (2018), who argue that the effect of ATPs depends on the institutional context. Using a novel dataset, the paper shows that ATPs may increase firm value because the myopia-eliminating effect outweighs the agency-effect when internal governance is strong. Rather than being only instruments for self-interested managers to pursue agency-oriented objectives, depending on the institutional context, ATPs may serve as managerial incentives to make value-creating, long-term investments.