Dual Ownership, Returns, and Voting in Mergers

Andriy Bodnaruk is Assistant Professor of Finance at University of Notre Dame; Marco Rossi is Visiting Assistant Professor of Finance at Texas A&M University. This post is based on a recent paper authored by Mr. Bodnaruk and Mr. Rossi.

In our paper, Dual Ownership, Returns, and Voting in Mergers, recently published in the Journal of Financial Economics, we study how the joint ownership of target’s equity and debt affects investors’ behavior and outcomes of M&A transactions.

Prior research in this area implicitly assumes that each investor holds either stocks or bonds, but not both types of securities simultaneously. We document, however, that a significant (and steadily rising) percentage of the equity of many U.S.-listed corporations is owned by financial conglomerates whose affiliates are also major company bondholders. If affiliated fund managers coordinate their actions around M&A deals, financial conglomerates with dual ownership of target equity and debt—“dual holders”—have different incentives than pure shareholders. Our results could be broken down in the following three groups.

First, when a more risky company becomes a target of a takeover bid by a less risky bidder, both its equity and debt, on average, appreciate in value. Dual holders have an incentive to accept a lower premium on their equity because they would also benefit from appreciation of their bond positions. In essence, a financial group, as a whole, should be indifferent about how it is compensated for parting with its voting rights in the target, i.e., whether it happens directly through appreciation of its equity positions or indirectly via increase in value of its other claims on the company, as long as the overall compensation package is deemed satisfactory. We show that targets with larger equity ownership by dual holders have lower M&A equity premia.

Second, dual holders are in effect bondholders with (some) voting rights in the company. This makes them better protected than pure bondholders in takeovers. We corroborate this argument by showing that abnormal bond returns in M&As are larger, the larger the presence of dual holders among target shareholders.

Third, since dual holders derive gains from both equity and bonds, they have stronger incentives—compared to pure shareholders—to facilitate the completion of the deal. The most direct way to achieve this goal is to vote in favor of the merger proposal. We show that equity mutual funds holding target shares are considerably more likely to support the merger if affiliated bond funds hold target bonds.

Our research has several corporate finance implications. First, the conflict between shareholders and debtholders might not be as acute as previously thought. In a large number of publicly listed companies, many investors hold positions in both types of securities, which should mitigate asset substitution problem. Second, conflicts among shareholders can arise along dimensions other than the size of their equity stake. Lastly, returns to investors in corporate events cannot be determined by considering returns on individual securities, but require a portfolio approach in which the holdings of investors across different securities are taken into account.

The full paper is available for download here.

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