Do Freezeouts Affect the Performance of the Controlling Shareholder?

The following post comes to us from Fernan Restrepo of Stanford Law School.

Some works in the literature on mergers and acquisitions suggest that mergers do not generate any efficiency for the acquirer and that, in fact, they have a negative effect on operating performance. This work examines whether freezeouts (that is, transactions in which a controlling shareholder acquires the remaining shares of a corporation for cash or stock) also produce a negative effect on the performance of the acquirer.

On a theoretical level, there are legitimate reasons to think that freezeouts should not generate any significant efficiency for the controlling shareholder, especially because, after completing the deal, he maintains control over the same assets he was already controlling before. From this perspective, the only gain arising from a freezeout is the savings in regulatory costs associated with the public status of the target, without much room for significant synergies. Moreover, it is possible that the reduction in public monitoring of the target that results from a freezeout could not only translate into long-term losses for that company, but also affect negatively the controlling shareholder in an indirect way. In this sense, a freezeout could actually be expected to lead to drops in the controlling shareholder’s operating performance.

From another perspective, however, it is also possible that freezeouts generate efficiencies because they contribute to a better alignment of the incentives of the controlling shareholder and the target, which could in turn improve the performance of both companies. More specifically, controlling shareholders that hold less than one hundred percent of the shares of a corporation eventually bear a disproportionate share of the costs of pursuing new projects or lines of business but are only entitled to a proportional part of the gain. This in turn implies that, in the context of controlled companies, there is a disincentive for the controller to explore unexploited synergies and, consequently, freezeouts can fix those disincentives.

In light of this, whether or not freezeouts are efficiency-generating transactions is a question that cannot be responded at the level of theory. The purpose of this work, therefore, is to make a first step to respond that question empirically. As further discussed in the paper, the results indicate that although the controlling shareholder does not experience statistically significant drops in ROA, Tobin’s Q generally falls. In the baseline regressions, this drop ranges from seven to ten percent points relative to a control group of industry peers, and the change is statistically significant at 5% for the shortest time window considered in the paper (one year around the execution of the deal) and at 1% for the rest of the windows (two and three years around execution). These results have implications for the regulation of freezeouts, especially in terms of standards of judicial review.

The paper is divided in six parts. Section 1 introduces it, Section 2 reviews the prior literature, Section 3 presents the methodology and the data, Section 4 presents the results, Section 5 discusses the policy implications, and Section 6 concludes.

The full paper is available for download here.

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