Who Acquires Toxic Targets?

Dr. Chelsea Liu is senior lecturer at University of Adelaide Business School and Alfred Yawson is professor of Corporate Finance at the University of Adelaide. This post is based on their recent article, recently published in the Journal of Empirical Legal Studies.

Growing media attention is devoted to corporate environmental misconduct, as more investors and consumers consider environmental performance in making green choices. There is, however, limited academic research on the consequences of corporate environmental violations: Karpoff et al. (2005) find that firms accused of environmental infractions suffer share price declines, however, such losses of market value only reflect the legal penalties incurred, but no additional reputational penalties. Similarly, researchers find no evidence that executive officers incur personal job-market consequences after their firms are accused of environmental breaches (Aharony et al., 2015; Liu et al., 2016).

In our article, Who Acquires Toxic Targets?, recently published in the Journal of Empirical Legal Studies, we investigate the consequences of environmental lawsuits in the mergers and acquisitions (M&A) market. We use a sample of environmental lawsuits filed against the Standard & Poor’s 1500 firms in the United States Federal Courts during 2000–2007 to examine four key questions:

  • Are sued firms less likely to be acquired?
  • Are sued firms less likely to acquire other firms?
  • Is it value-creating to acquire targets that have been sued for environmental breaches?
  • What type of acquirers would purchase such sued targets?

Corporate Environmental Misconduct

BP’s Gulf of Mexico oil spill in 2010 and Volkswagen’s emissions testing scandal in 2015 have highlighted the extreme cases of environmental violations. However, most environmental lawsuits are concerned with more routine incidences and practices. In our sample, the most common causes of action involve allegations brought against firms under the Clean Water Act 1972, Clean Air Act 1963, Comprehensive Environmental Response, Compensation, and Liability Act 1980, and Resource Conservation and Recovery Act 1976. Our study is the first to examine the impacts of environmental lawsuits on sued firms in the market for corporate control.

Dampened M&A Activities

We expect environmental litigation to be associated with reduced M&A activities for the sued firms, as both acquirers and targets, following the lawsuit filings.

From the acquirers’ perspective, we find that firms sued for environmental violations subsequently engage in fewer M&A activities during the three-year post-lawsuit period. One possible explanation, drawn from prior evidence, is that litigation can lead to constraints on the sued firms’ financial resources, which in turn limits their abilities to acquire other firms (Autore et al., 2014; Arena and Julio, 2015).

From the targets’ perspective, we find some evidence that sued firms are less likely to be targeted by prospective acquirers for M&A deals during the five-year period following the lawsuits. However, this relationship only exists when the target firms face low bankruptcy risks.

Acquirer Beware

We then examine the reason why sued targets may be shunned by prospective acquirers. Is it value-creating or value-destroying for acquirers to target firms that have experienced environmental lawsuits? We answer this question by examining the stock market reactions by the acquirers’ shareholders to the announcements of the M&A deals. Our evidence shows that it is value-destroying for acquirers to purchase sued targets: such deal announcements trigger more negative market reactions. These observations indicate that the acquirers’ shareholders see these deals as undesirable and destructive to firm value.

Who Acquires Toxic Targets?

A natural question that follows is why some acquirers choose to engage in such value-destroying takeovers of sued targets. Prior research suggests firms tend to make poor acquisition decisions when their managers are overconfident or entrenched (Masulis et al., 2007; Malmendier and Tate, 2008; Harford et al., 2012). In those circumstances, the acquirer firms’ managers may underestimate the potential exposure to legal liabilities associated with taking over sued targets, which can lead to overpayment for the targets. Consistent with this view, we find that bidders with lower corporate governance quality and poorer alignment of shareholder-manager interests are more likely to engage in such acquisitions of targets with previous environmental lawsuits.

In the article we conduct a series of robustness tests, including falsification tests using securities and contractual lawsuits, controlling for endogeneity using an instrumental variable approach, propensity score matching, employing an alternative lawsuit sample, and alternative control variables and model specifications. The results from these robustness tests confirm our findings.


Corporate environmental performance is an increasingly important issue for managers, investors, and lawmakers. Our findings show that firms accused of breaching environmental laws face consequences in the M&A market. Acquisitions of sued targets are also value-destroying for the acquirers. Our evidence makes novel contributions to both the growing literature examining the consequences of corporate environmental wrongdoing (e.g. Karpoff et al., 2005; Aharony et al., 2015), and the ongoing examination of the sources of value-destruction in mergers and acquisitions (e.g. Masulis et al., 2007; Harford et al., 2011; Harford et al., 2012).

The complete article is available here.

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