Director Networks and Takeovers

The following post comes to us from Luc Renneboog, Professor of Finance at Tilburg University, and Yang Zhao of the Accounting and Finance Section at Cardiff University.

In our paper, Director Networks and Takeovers, which was recently made publicly available on SSRN, we study the impact of corporate networks on the takeover process. In recent years, some scholars have applied graph theoretical methods in the research on the impact of director networks on managerial decision-making. They found relations between networks and remuneration contracting, the managerial labor market (hiring and firing of top management, attracting non-executive directors), corporate restructuring, and firm and fund performance.

In this paper, we examine the effect of the connections between the acquirer and target firms on the takeover process, more specifically on M&A frequency, the M&A negotiation success and duration, the means of payment in the offer, the M&A expected performance (as reflected in the short term wealth effects of the bidder), the bidder’s CEO compensation subsequent to the M&A, and target director retention rate in the merged company. The idea is that direct connections enable both parties to gather information more easily on the counter party which establishes trust, and that the overall network (which includes the indirect connections) enable firms to scout for suitable takeover targets and collect relevant information on the whole takeover market.

We find that director networks play an important role in UK takeovers in the following ways. First, we find strong evidence that connections through directorships between bidder and acquirer lead to more takeover activity. We find that both direct connections between bidder and target and indirect connections between the board and the CEO of the bidding firms are important. In a nutshell, better-connected companies are more active bidders. Second, the above conclusion raises the question as to whether connected bidders just make more acquisition attempts or are more successful in completing the M&A negotiations. We demonstrate that when a bidder and a target have one or more directors in common, the probability that the takeover transaction will be successfully completed significantly augments. Only direct connections have an impact on the M&A process. Third, connections also significantly reduce the time used in the negotiation process (both for successful or failed negotiations). Fourth, we expect that connections yield an informational advantage that could also build trust between the parties that would in turn be reflected in the more frequent use of offers that involved equity. We confirm that equity is indeed used more often when bidder and target are connected. Fifth, the market reaction to the M&A announcement of the bidder is not related to connected takeovers. This suggests that the market either does not pick up that the two parties involved are connected or that they do not believe it to be important. Sixth, while earlier research found a positive relation between a CEO’s level of connectedness and his remuneration, we do not find evidence that CEOs of connected bidders are paid more subsequent to completing a connected M&A. Finally, the target directors (without prior connections to the bidding firm) have a better chance to be invited to the board of the combined firm when bidder and target were directly connected.

Our paper contributes to understanding of M&As and director networks. At first sight, interlocked directors and directors’ information collection ability (proxied by centrality measures) makes the M&A process more efficient: the degree of connectedness increases the number of M&A transactions, increases the successful completion rate, reduces the negotiation time, and enables the bidder to offer equity. Still, it seems that the market does not recognize the fact that the parties involved are connected or attaches little value to it, as the announcement share price reactions in connected M&As are small and not difference from those of unconnected M&As.

The full paper is available for download here.

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