Price and Probability: Decomposing the Takeover Effects of Anti-Takeover Provisions

Vicente Cuñat is Associate Professor of Finance at the London School of Economics & Political Science (LSE). This posts is based on a paper by Professor Cuñat; Mireia Gine, Assistant Professor of Financial Management is the IESE Business School at the University of Navarra; and Maria Guadalupe, Associate Professor of Economics and Political Science at INSEAD. Related research from the Program on Corporate Governance includes What Matters in Corporate Governance? by Lucian Bebchuk, Alma Cohen and Allen Ferrell (discussed on the Forum here).

Anti-takeover provisions are major governance mechanisms that affect firm value. It is often argued that they allow managers to bargain for a higher price in the event of a hostile takeover at the expense of reducing or delay the possibility of a takeover. However, there is little causal evidence on this trade-off.

Our paper, Price and Probability: Decomposing the Takeover Effects of Anti-Takeover Provisions, is the first to provide estimates of this trade-off that can be interpreted as causal, and not simple correlations. First, we show by how much takeovers are deterred when firms are protected. Second, we provide evidence that takeover premiums are lower when firms are more protected—which reverses the commonly held view that anti-takeover provisions increase takeover premiums by giving managers more bargaining power.

Hence, we find no apparent trade-off between the takeover price (the premium) and probability. This trade-off is typically offered by managers as a rationale to justify the adoption of anti-takeover provisions. In our results both price and probability are significantly lower when the anti-takeover provision is in place. In fact, the division of gains from dropping an anti-takeover provision accrues almost exclusively to the target shareholders.

The starting point of our analysis is to identify the different moving parts that constitute the expected takeover premium arising from the adoption of anti-takeover provisions. We show it has three components: First, the causal effect that the anti-takeover provision has on the probability of being acquired (i.e. the deterrent effect); Second, the causal effect of the anti-takeover provision on the premium paid if the acquisition is successful (i.e. the price effect); and lastly the selection effect arising from the fact that adopting an anti-takeover provisions changes the population of firms that become targets. The first two are important in themselves and each has given rise to a substantial literature. The third, albeit seldom discussed, is essential in as much as one cannot infer the takeover premium from directly comparing firms that are taken over with and without anti-takeover provisions because the population of target firms changes when anti-takeover provisions are in place. This selection, is inherent to the problem studied (rather than an issue with the data) and needs to be taken into account.

Our empirical strategy is then designed to identify each of these components. In order to provide causal estimates, we first need some form of “random assignment” in the adoption of anti-takeover provisions. In other words, we need something that operates like an “experiment” where some firms randomly adopted and others did not adopt the provision, such that we can compare their effect on arguably identical firms. We use two different techniques for this. The first is a “regression discontinuity” approach that involves essentially comparing outcomes in narrow interval around the vote majority threshold of shareholder-sponsored proposals to drop anti-takeover provisions (see Cuñat, Gine, Guadalupe, 2012, 2013). Then, we generalize the results and extrapolate them to firms with vote outcomes away from the discontinuity using a strategy developed in a recent paper by Angrist and Rokkanen (2015).

Using data from all shareholder-sponsored proposals to remove an anti-takeover provision voted on at annual meetings of S&P 1500 firms between 1994 and 2013, we find that voting to remove an anti-takeover provision has a significant positive impact on the probability of a firm being taken over in the future, both for firms around and away from the majority threshold. For firms away from the discontinuity voting to remove an anti-takeover provision increases the probability of takeover within five years by 4.5%. It also increases the expected unconditional takeover premium by 2.8%.

The causal effect on the expected/unconditional premium is not subject to the inherent selection problem of anti-takeover provisions altering the population of firms that are taken over. This is because the unconditional premium includes both firms that experienced a takeover (and realized a takeover premium) and those that did not (with an imputed takeover premium of zero), so the populations of the treatment and control groups are comparable. However, we would also like to know whether a given firm is able to obtain a higher or lower premium if it drops the anti-takeover provision conditional on a given target being taken over. For this, we cannot just directly compare the premium of firms that are taken over with or without anti-takeover provisions. The significant effects of anti-takeover provisions on the amount of takeovers, imply that the population of firms that are taken over with and without anti-takeover provisions are not comparable. We therefore need to account for different selection patterns in the two groups. Once we account for this (using the bounding methodology in Lee, 2009) we find that the causal effect of voting to remove a provision on the conditional premium is between 0.3% and 5.5%. This estimate is always positive, suggesting that more shareholder value is created in less protected firms. Therefore, we can clearly rule out the common view of a negative effect of dropping an antitakeover provision on premiums through a bargaining channel. Although we cannot rule out that such effect may exist, other effects are at play and are quantitatively more important and go in the opposite direction.

We also investigate the determinants of the positive conditional premium result. We find that in fact the higher premium for less protected firms is related to the fact that there is de facto more competition for those firms: they attract more bidders, more unsolicited bids, more challenged deals and more deals paid in cash. We also find that while we cannot establish the sign of the effect on the acquirer premium, total value creation (adding up the dollar value of the acquirer and target premia) is positive. This net value creation across both shareholder groups seems to come partly from the fact that acquisitions are more likely to take place in related industries (with higher potential for hard synergies) and partly from the fact the (positively selected) targets are matched to more valuable acquirers.

The previous results, allow us to calculate what fraction of the overall increase in value from removing anti-takeover provisions comes from its different components. We find that the increase in value operates largely via quantities: 49% of the shareholder value comes from the increased probability of mergers. The premium effect represents between 1% and 27% of the shareholder value (according to the calculated bounds), and therefore the selection effect is positive and its influence is between 24% and 49% of the overall value created. This decomposition highlights that the main source of value creation is the quantity effect and that, accounting for selection is key to understanding how takeovers create value in the market. The pure price effect (premium) may or may not be very important, but, in any case, it is not negative as often suggested.

An important contribution of this paper is that our methodology addresses the endogeneity of adopting/removing anti-takeover provisions as well as the sample selection of who becomes a takeover target. In fact, we are able to provide an estimate of the role of sample selection in overall value changes. The earlier literature on this question suggests that anti-takeover provisions are not randomly adopted, hence correlations are likely to be subject to endogeneity bias. We are also able to provide a quantitative estimate of the role of selection.

In contrast to the existing literature which provides scant causal evidence, our methodology addresses the endogeneity of adopting/removing anti-takeover provisions as well as the sample selection of who becomes a takeover target. We are able to provide a quantitative estimate of the role of selection. We find large and significant effects of removing anti-takeover provisions. This is all the more important given that studies of the correlation between anti-takeover provisions and takeover probabilities and premiums have often found contradictory or no effects. We also explain what seems to be driving the clear and strong premium effects (more competition, better matching) and that the types of mergers that take place under less protection lead to overall shareholder value creation.

While we present new results and answer a number of previously unanswered questions, our analysis leaves a number of open questions. For example, we take all anti-takeover provisions as identical and do not consider heterogeneity of effects for different types of proposal or different kinds of firms. Furthermore if these deals are good for the shareholders of target firms and for the economy as a whole, why do so many firms keep anti-takeover provisions in place? We conjecture that the answer has to do with internal governance and the political economy of decision making within firms. These are important avenues to explore and are left to future research.

The full paper is available for download here.

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