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E-MailAnzhela Knyazeva is a Financial Economist at the U.S. Securities and Exchange Commission. This post is based on an article authored by Dr. Knyazeva, Diana Knyazeva, Financial Economist at the Securities and Exchange Commission; and Kose John, Professor in Banking and Finance at New York University. The views expressed in this post are those of Dr. Knyazeva and do not necessarily reflect those of the Securities and Exchange Commission or its Staff.
In our paper, Employee Rights and Acquisitions, which was recently featured in the Journal of Financial Economics, we consider incentive conflicts involving employees, and how they may affect firms in the context of acquisitions. More specifically, we look at the effects of variation in employee protections on shareholder value, the choice of targets, and deal characteristics. We focus on acquisitions since they are major firm investment decisions with the potential to substantially affect firm value.
Conceptually, prior research shows that shareholders and employees often have competing interests. In practice, some acquisitions that generate value for investors can negatively affect employees. For example, achieving synergies and productivity gains that increase shareholder value during the restructuring process can involve layoffs, reductions in pay or benefits, or increases in workload and effort requirements.
Such differences in shareholder and employee objective functions are expected to be more important for firm decisions when employee protections are stronger. Specifically, strong employee protections may give employees as a group more power to influence the selection of targets and negotiation of deal terms and to potentially delay or block certain deals. After the acquisition, stronger employee protections may serve to constrain firms from certain restructuring decisions, which may affect a firm’s ability to realize synergies. Employee protections may also influence employee incentives to generate productivity gains during the integration process.
Empirically, we find that the market reacts more favorably to bids announced by weak employee rights acquirers. For the average acquirer, weak employee rights are associated with 0.5% higher three-day cumulative abnormal returns on announcement, all else equal. The evidence is consistent with incentive conflicts between shareholders and employee stakeholders within the acquirer firm affecting acquisition decisions and outcomes.
We perform several sets of analyses to explore this result in more detail. First, as hypothesized, the negative effects of employee rights on acquirer returns are strongest when labor intensity is high or union participation is high, thus employees and employee bargaining power have a larger potential impact on shareholder value.
Second, some of the announcement return differential is due to systematic differences in target and deal characteristics. Strong employee rights acquirers are more likely to bid for targets with strong employee protections and high labor costs. Such acquirers are more likely to pursue diversifying deals and bid for financially stable, less risky targets, consistent with a more conservative risk preference. They also bid more frequently for publicly listed targets and targets with higher valuations. Deals involving strong employee rights acquirers have higher combined advisory fees, potentially reflecting greater complexity of such deals. However, while target and deal characteristics partly explain the effect, even after accounting for these differences, strong employee rights acquirers realize lower acquisition announcement returns.
Third, holding deal and target characteristics constant, strong employee rights acquirers may differ in their post-acquisition integration outcomes, which could explain some of the lower synergies realized from the acquisition. Indeed, we find that strong employee rights acquirers are less likely to undertake significant workforce reductions after the acquisition. Strong employee rights acquirers are also less likely to experience employee productivity gains during integration. Consistent with our hypothesis, acquisition announcement returns are related to these differences in post-acquisition outcomes.
We also look at whether lower acquirer returns merely reflect a wealth transfer to target shareholders. We do not find it to be the case. Based on the combined announcement returns for the acquirer and target firms, cumulative shareholder gains from deals involving strong employee rights acquirers are also significantly smaller.
Overall, the evidence is consistent with strong employee rights acquirers being less focused on maximizing shareholder value. Intuitively, at both target selection and post-merger integration stages, strong employee rights acquirers are more likely to favor employee interests, for example, by avoiding restructuring that involves workforce or pay reductions or increases in firm risk or effort requirements. We show that, in the context of acquisitions, stakeholder-shareholder incentive conflicts reduce shareholder gains. These lower synergies from the acquisition are anticipated by the market at the time of the announcement, resulting in lower returns around the announcement of the acquisition.
The main effects continue to hold after a number of sensitivity tests, including alternative variable definitions and sample selection criteria and a broad range of alternative explanations (such as managerial incentive conflicts and corporate governance differences; differences in observable deal characteristics; firm financials and investment opportunities; regional, state, and industry variation; differences in state business-friendliness, tax, regulatory and political environment; and merger waves). The use of state laws to proxy employee protections and the event study context provide relatively more exogenous evidence on the role of employee-shareholder conflicts of interest for shareholder value.
The full paper is available for download here.
