Director Histories and the Pattern of Acquisitions

It is well-known in finance and economics that firms possess private information about their own fundamental values. In our paper, Director Histories and the Pattern of Acquisitions, which was recently made publicly available on SSRN, we contribute to this literature by examining, in the context of the market for corporate control, how the transmission of non-public information about potential targets influences mergers and acquisitions. This is interesting because, despite extensive research on the determinants of acquisitions, we can still only imperfectly predict which firms will choose to initiate acquisitions and, for those that do, how they choose among potential targets.

We capture a potential acquirer’s exposure to target-specific non-public information by tracking the service histories of its directors over time. If a current director was formerly on the board of another firm, we say that the two firms have an historical interlock. We treat these directed firm-pair interlocks as containing information about the firm where the current director once served, and estimate the impact of this information on the decision to initiate an acquisition of that firm. Our main results indicate that a given firm is about five times more likely to initiate an acquisition of a historically-interlocked target than some other unlinked firm.

Unlike contemporaneous interlocks (in which a director simultaneously sits on two firms’ boards), our historical interlocks are also directional, meaning that there is a clear prediction about the flow of information (from potential target to acquirer), and we show that target-to-acquirer flows affect merger pairings but that acquirer-to-target flows do not. We also find that the effects of historical interlocks are stronger when the acquirer has better corporate governance, the director has a larger ownership stake at the acquirer, or the director played a more important role during past service at the potential target.

Persistent and unobserved network connectedness between firms could also pose a threat to the validity of our informational mechanism. Unobserved factors that might influence common director selection include governance structures, network connectedness, CEO entrenchment, board size, industry positioning, firm size, and organizational strategy, among others. We control for such unobserved and time-invariant factors with a fixed-effects technique that includes a unique dummy variable for each firm and firm-pair in the sample. The analysis indicates even stronger effects of historical interlocks on the propensity to merge, and suggests that firm-pair specific network effects are not driving our results.

There are many studies in which experience in executing particular corporate actions passes across firms through director linkages. These actions include the use of poison pills (Davis (1991)), option backdating (Bizjak, Lemmon, and Whitby (2009)), repeat acquisitions (Haunschild (1993)), and taking firms private (Stuart and Yim (2010)). But gaining know-how from another firm in executing a corporate action does not necessarily imply that fundamental information was passed about that firm. Other studies more related to ours use contemporaneous director linkages to examine how cross-firm information may affect the decision to initiate an acquisition or joint venture (e.g., Gulati and Westphal (1999), Schonlau and Singh (2009)), yet contemporaneous director linkages could be forged as part of a plan for acquisition and thus not necessarily reflect the transmission of information about the target to the acquirer.

There is a large literature on social connectivity and how it affects corporate decisions, but it is not obvious whether social networks are channels for information flows or sources of agency problems (Freeman (1979)). Our use of historical interlocks controls for observed contemporaneous inter-firm connectedness, and we show across a variety of specifications that historical interlocks still exert an independent and positive influence on acquisitions.

The full paper is available for download here.