Takeover Defenses as Drivers of Innovation and Value-Creation

The following post comes to us from Mark Humphery-Jenner of the Australian School of Business at the University of New South Wales.

In the paper, Takeover Defenses as Drivers of Innovation and Value-Creation, forthcoming in the Strategic Management Journal, I analyze the role of anti-takeover provisions in ameliorating agency conflicts of managerial risk aversion in certain types of companies.

The desirability of anti-takeover provisions (ATPs) is a contentious issue. ATPs can lead to shareholder wealth-destruction by insulating managers from disciplinary takeovers and enabling them to engage in empire building. However, without ATPs, managers of hard-to-value (HTV) firms, which might trade at a discount due to valuation-difficulties, are exposed to ‘opportunistic takeovers’ (which aim to take advantage of low stock prices), potentially causing managerial myopia and under-investment in innovative projects. Thus, in HTV firms, ATPs might serve as credible commitments to encourage managers to make value-creating investments, but in easier-to-value firms, they might lead to inefficient governance.

This paper tests whether ATPs can ameliorate managerial myopia in HTV firms by examining the impact of entrenchment on the investments that HTV firms make. The study analyzes on one major investment: the acquisition of another firm. Thus, the paper uses an event study framework to examine whether acquirers who are HTV and have more ATPs make acquisitions that generate more shareholder wealth and innovation. Focusing on entrenchment in the acquiring firm enables the tests to assess how entrenchment influences managerial behavior. The hypothesis is that entrenched HTV acquirers (compared with non-entrenched HTV acquires or entrenched non-HTV acquirers) feature the following characteristics: 1) the market reacts more positively to entrenched HTV firms’ acquisitions, 2) these acquisitions lead to higher long-term post-takeover valuations, 3) the acquisitions are more likely to induce value-creating innovation and 4) ATPs do not induce HTV firms to overpay for acquisitions.

The results show that entrenched-HTV firms (compared with non-entrenched-HTV firms) make acquisitions that generate more shareholder wealth (as proxied by the acquirer’s abnormal returns and long-run post-takeover Tobin’s Q) and are more likely to increase innovation. These findings suggest that ATPs can serve as a credible commitment in some companies (i.e. HTV companies) but can otherwise induce inefficient governance.

The paper contributes to the literature in several ways. First, it contributes to the literature on managerial incentives and innovation, showing that ATPs can be one way to encourage innovation and mitigate managerial myopia. Second, the paper contributes to the literature on anti-takeover provisions. The results support some related literature on the relationship between governance, innovation, and investment (Becker-Blease, 2011; Banerjee and Masulis, 2012; Chemmanur and Tian, 2012; O’Connor and Rafferty, 2012; Duru et al., 2013). The finding that ATPs can be beneficial in some firms suggests that a more nuanced analysis of the relation between firm value and ATPs is necessary.

The full paper is available for download here.

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