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E-MailWilliam C. Johnson is Associate Professor of Finance at Suffolk University School of Management; Jonathan M. Karpoff is Professor of Finance at University of Washington Foster School of Business; and Michael Wittry is Visiting Instructor of Finance at the Fisher College of Business at The Ohio State University. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Toward a Constitutional Review of the Poison Pill by Lucian Bebchuk and Robert J. Jackson, Jr. (discussed on the Forum here); The Case Against Board Veto in Corporate Takeovers by Lucian Bebchuk and What Matters in Corporate Governance? by Lucian Bebchuk, Alma Cohen, and Allen Ferrell.
How consequential is a firm’s adoption of a poison pill for the firm’s directors? Prior research reflects three conflicting views about this question, which reflect conflicting views about pills themselves. The entrenchment view holds that poison pills entrench managers at shareholders’ expense, implying that directors who adopt pills face the risk of shareholder backlash and negative career consequences (E.g., Malatesta and Walkling (1988)). The shareholders’ interest view holds that pills serve primarily to improve the firm’s operations or increase expected takeover premiums, implying that directors who adopt pills are valuable to shareholders and should enjoy career benefits (E.g., Grossman and Hart (1980)). A third view is that the explicit adoption of a poison pill has little impact, either because the actual adoption of a pill is not meaningful (because all firms have latent pills) or because the director labor market does not react strongly to directors’ actions (E.g., Coates (2000)). This view implies that directors who adopt pills should experience neither negative nor positive career consequences.
Our paper examines the career outcomes for directors who serve on boards that adopt poison pills, and therefore sheds light on the debate over whether pills have negative, positive, or inconsequential effects on the firms that adopt them. We focus on the professional consequences to first-time pill adopters. These are directors who serve on boards that adopt poison pills, but who previously had never served on a pill-adopting board. We show that first-time pill adopters suffer negative career consequences. They receive lower vote support in subsequent board elections at both the pill-adopting firm and in their other directorships. They are more likely to leave the boards on which they currently serve, and are less likely to be appointed as new directors at other firms.
We supplement our main analysis with tests using two distinct types of instrumental variables that capture orthogonal variation in poison pill adoption. The first instrument relies on evidence of strong peer affects among directors on interlocked boards (e.g., Davis 1991; Davis and Greve 1997) and reflects the number of a first-time pill-adopting director’s fellow directors who serve on boards of other non-industry firms that adopt pills. The second instrument is based on a director’s exposure—through her fellow directors—to legal developments regarding poison pills such as important court decisions and state laws that affect pills’ legal status. The results of these instrumental variable tests support a causal interpretation for the relation between pill adoption and directors’ adverse career consequences. That is, first-time pill adopting directors lose votes, lose directorships, and find fewer new directorships, all because of their association with the adoption of a poison pill.
Next, we examine an alternative measure of a director’s labor-market value based on the stock price reaction to news that a director either leaves a firm’s board or dies. Consistent with prior research (E.g., Fich and Shivdasani (2007), Hayes and Schaefer (1990), Salas (2010) and Fracassi and Tate (2012)), we find that the unconditional average abnormal stock price reactions to a director’s departure and a director’s death are both positive. However, we find that this positive stock price reaction is almost entirely attributable to pill-tainted directors, i.e., directors who served on boards that adopted poison pills. For example, the deaths of directors who were not associated with poison pill adoptions are associated with a zero average stock price reaction. These results help explain the prior findings regarding directors’ departures and deaths, and provide further support for the inference that directors who are associated with the adoption of a poison pill are valued less by shareholders compared to other directors.
Finally, we examine whether a director’s career consequences depend on the age of the firm adopting the poison pill. Johnson, Karpoff, and Yi (2019) argue that the value impact of takeover defenses follows a life cycle and is, in general, positive for young firms and negative for more seasoned firms. The adverse consequences we document—lower vote margins, higher termination rates, and fewer new directorships—are most pronounced among directors who oversee the adoption of poison pills at seasoned firms. This is consistent with previous findings that investors generally view takeover defenses as having negative impacts on the values of older firms, but not necessarily for young firms.
Our paper thus makes four three contributions to the corporate governance literature. First, by examining the impact of pill adoption on directors, we shed light on the debate over whether poison pills affect firm value, and in which direction. Our results consistently support the entrenchment view of poison pills for seasoned firms, suggesting the use of such devices destroys shareholder value at seasoned firms.
Second, our results reject the argument that explicit poison pills are inconsequential because all firms have latent pills. To the contrary, the actual adoption of a poison pill, particularly at a seasoned firm, imposes a meaningful career cost on the adopting directors by lowering their values in the director labor market. This finding, in turn, implies that investors view the actual deployment of a poison pill as different from the mere option to deploy a pill. In documenting the labor market reaction to poison pills, our paper provides an empirical rationale for why firms may hesitate to adopt a pill and instead rely on other firm defenses or state takeover statutes, even if the poison pill is particularly effective in deterring takeovers.
Third, our tests help to broaden understanding of the forces that influence directors’ vote margins, termination, appointments, and contributions to firm value. Our results demonstrate that the labor market for directors imposes reputational penalties on directors who do not act in what is perceived by shareholders as acting in the best interests of the firm, as proposed by Fama (1980). Thus, the labor market for directors could play a more important role in a firm’s governance structure than previously thought.
The full paper is available here.
