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E-MailAndrey Golubov is Assistant Professor of Finance at Rotman School of Management, University of Toronto. This post is based on an article by Professor Golubov; Olivier Dessaint, Assistant Professor of Finance at Rotman School of Management, University of Toronto; and Paolo Volpin, Professor of Finance at Cass Business School, City University London.
Cost reductions in the pursuit of economies of scale and scope are commonly believed to be a major driver—and a key source of synergies—in corporate takeovers. Restructuring the workforce, largely in the form of layoffs, is presumed to be one of the primary channels through which such cost reductions are obtained. However, despite the central role of labor force issues in takeovers, there is no systematic empirical evidence on the importance of workforce restructuring as a driver of the market for corporate control and as a source of merger synergies. This is partly because labor regulations are largely uniform within countries, and any cross-country variation comes with a host of other pertinent differences. Our new paper, entitled Employment Protection and Takeovers, which was recently made publicly available on SSRN, fills this void and provides the first systematic evidence on the link between labor regulation and takeovers.
Restrictions to labor force restructuring are expected to affect takeover dynamics in several ways. First, if workforce restructuring represents an important consideration in takeovers, then fewer takeover attempts are likely to materialize when employment is highly protected and redundancies are costlier. Second, where bids are made, the rigidity of labor regulation is expected to reduce the synergy gains from mergers and acquisitions, and acquirers are expected to pay lower premiums. Finally, there may be further distributional effects on acquirer performance depending on the offer price adjustment. If offer prices do not fully adjust for the lower expected synergies (e.g., price-insensitive empire-builders), rational acquirers may be crowded out from the market, resulting in more overpayment, lower average acquirer returns, and potentially a dead-weight loss in efficiency.
We exploit the cross-country and time-series variation in employment protection to identify the causal impact of labor market rigidity on takeover activity and related economic outcomes. As a prequel to our main analysis, we begin with a simple cross-country test and show that the national level of employment protection explains a large part of cross-country differences in M&A activity and takeover premiums. We then turn to a difference-in-differences research design exploiting major employment protection reforms across a panel of 21 developed economies and show that employment protection changes have statistically significant and economically large effects on the market for corporate control. We begin by showing that the number of takeover deals drops by almost 15% in response to major employment protection increases. Similarly, deal volumes drop by almost 30%. These effects are consistent with workforce restructuring being a major driver of corporate mergers and acquisitions, in line with the neoclassical, efficiency-seeking motive of takeovers.
We then show that, following major employment protection increases, the combined firm cumulative abnormal returns (CAR) around merger announcements decline by two percentage points, relative to the unconditional combined firm CAR of 2.4%. In an efficient stock market, the value change of the merging firms in response to deal announcement can be interpreted as the expected synergy gain brought about by the combination. The magnitude of our estimate indicates that labor force restructuring represents roughly 80% of the typical efficiency gain in takeover deals. Consistent with the synergies result, we further find that, in response to tighter labor regulation, takeover premiums drop by about 10-11 percentage points, relative to the unconditional takeover premium of 34% in the overall sample. Thus, if acquirers fully adjusted the takeover premium for the changes in synergies, these results would suggest that workforce restructuring generates roughly a third of merger gains.
We further break down the combined firm CAR into the acquirer CAR and target CAR components (the latter largely reflecting the premium). While the target CAR declines in line with the premiums result, the acquirer CAR is also reduced. This suggests that, although acquirers reduce offer prices following increases in employment protection, they do not adjust them enough. We present corroborating evidence by showing that i) the dollar value of the premium does not decline one-for-one with the synergies, with the difference roughly adding up to the decline in acquirer dollar gains; ii) the expected synergy gain per dollar of premium offered declines; and iii) acquirers are more likely to overpay, as manifested in a higher incidence of negative acquirer returns. These results are consistent with price-insensitive empire-building or hubristic acquirers crowding out rational efficiency-seekers. To support this interpretation, we show that the negative impact of tighter employment protection on acquirer gains is less pronounced—and the offer price adjustment is greater—when acquirers come from countries with better governance.
Our main results are robust to the usual methodological concerns, such as pre-treatment differences between treated and control firms, omitted variables (for instance, contemporaneous reforms in areas other than employment protection), and reverse causality. We show that, for each of the outcomes, there are no discernible effects of the labor reforms in the years prior to their passage, and a permanent effect immediately following the reform. To address the omitted variables concern we exploit cross-sectional differences within country-years and establish heterogeneous treatment effects that are in line with the labor channel. We show that, for acquirer-target combinations with a high degree of business overlap (domestic intra-industry deals), increases in employment protection are associated with a further reduction in the combined CAR as compared to deals with little business overlap in the same country and year. We also show that increases in employment protection are associated with a greater reduction in takeover gains for targets with poorer productivity relative to the acquirer, in sectors with greater average workforce turnover following mergers, and in mature sectors. These latter tests include country-year fixed effects, which eliminates any time-varying heterogeneity between the reforming and non-reforming countries.
Finally, to cement the labor force channel interpretation of the documented effects, we show that stronger employment protection reforms are, indeed, associated with a smaller reduction in the combined firm workforce following mergers. We close with a tentative discussion of the implications of our findings for welfare. To the extent that an active market for corporate control has positive externality effects, for example, through disciplining governance effects or creative destruction, the likely impact of stronger employment protection on welfare via the takeover channel is negative.
The full paper is available for download here.
