Takeover Discipline and Asset Tangibility

In the paper, Takeover Discipline and Asset Tangibility, which was recently made publicly available on SSRN, I examine whether takeover discipline has a different effect in tangible and intangible firms. The empirical evidence is strong that firms with external good governance perform on average better. A recent literature, starting with Gompers, Ishii and Metrick (2003), shows that firms with less takeover defenses have higher firm value and equity returns. However, we know less about the type of firms or industries in which takeover vulnerability matters relatively more. In this line of research, Giroud and Mueller (2010, 2011) show that firms in non-competitive industries benefit more from high takeover vulnerability than do firms in competitive industries. Cremers and Nair (2005) find that higher takeover vulnerability is associated with higher performance only when the quality of internal governance, proxied by public pension fund and blockholder ownership, is high.

I show that higher takeover vulnerability is associated with higher performance only in intangible firms. My favorite explanation is that debt already disciplines managers in tangible firms. In contrast, debt is not an appropriate disciplinary mechanism for intangible firms. Intangible firms have low liquidation values and low asset redeployability, and therefore, they might prefer to avoid debt and delegate monitoring to the market for corporate control.

The idea that debt is not suitable for intangible firms is not new. Rajan and Zingales (1998) note that:

“too much debt is bad for companies that rely on intangible or specialized assets such as customer confidence, ideas, or people.”

This is consistent with the positive association between leverage and asset tangibility documented by the empirical literature (Harris and Raviv (1991) survey, Rajan and Zingales (1995)). A concern with firm-level takeover defenses is that they are likely to be endogenous, making it difficult to establish causality. In particular, the positive association between takeover vulnerability and performance might be driven by the fact that managers of firms with low performance have incentives to adopt takeover defenses. However, this entrenchment hypothesis may explain our results only if following bad performance, managers of intangible firms are more likely to adopt takeover defenses than managers of tangible firms. Along these lines, it might be the case that high leverage is enough to deter takeovers (Stulz (1988), Harris and Raviv (1988)) in tangible firms.

In order to address endogeneity, I use the adoption of state antitakeover laws as an exogenous shock to the market for corporate control (Bertrand and Mullainathan (2003), Cheng, Nagar and Rajan (2004), Long and Wald (2007), Qiu and Yu (2009), Yun (2009), Giroud and Mueller (2010)). I focus on business combination (BC) laws which are, according to Bertrand and Mullainathan (2003), the most stringent among the second and third generation antitakeover laws. I find that the introduction of a business combination law leads to a large decrease in operating performance for intangible firms, whereas it has virtually no effect on the performance of tangible firms. In the same vein, I find that press announcements of BC laws have a significant negative effect on stock prices only for intangible firms.

I provide further evidence about the fact that the threat of bankruptcy substitutes for good external corporate governance. I find that higher takeover vulnerability has a positive impact on the performance of low-leverage firms, whereas it has no significant impact on the performance of high-leverage firms. The empirical literature on external corporate governance occasionally mentions the disciplinary role of debt. Cremers and Nair (2005) shows that the complementarity between the market for corporate control and shareholder activism exists only in low-leverage firms, pointing out that this is consistent with the disciplinary role of debt. However, they do not investigate the direct effect of takeover vulnerability on the performance of low- and high-leverage firms. Atanassov (2009) shows that the negative effect of antitakeover laws on innovation is mitigated when leverage is high. Examining a sample of 573 unsuccessful takeover attempts between 1982 and 1991, Safieddine and Titman (1999) find that the performance of former targets following failed takeovers is positively related to the change in the target’s leverage ratio. Their explanation is that leverage commits managers to make the improvements that would be made by potential raiders.

Overall, evidence in this paper indicates that the appropriate disciplinary mechanism between debt and takeovers depends on the characteristics of the firm’s assets. This has important implications for governance design. My results suggest, for instance, that owners of intangible firms should avoid installing takeover defenses at the IPO (Daines and Klausner (2001), Field and Karpoff (2002)).

The full paper is available for download here.