Blood in the Water: The Value of Antitakeover Provisions During Market Shocks

Scott Guernsey is Assistant Professor of Finance at the University of Tennessee Haslam College of Business; Simone M. Sepe is Professor of Law and Finance at the University of Arizona James E. Rogers College of Law; and Matthew Serfling is Associate Professor of Finance and Truist Professor of Finance at the University of Tennessee Haslam College of Business. This post is based on their recent paper, forthcoming in the Journal of Financial Economics. Related research from the Program on Corporate Governance includes The Case Against Board Veto in Corporate Takeovers by Lucian Bebchuk.

There is an active debate in the literature as to whether antitakeover provisions (ATPs) that shield managers from takeovers create or destroy firm value. While most studies focus on the average effects of ATPs across all firms and time, the recent COVID-19 pandemic and the massive drop in share prices the pandemic caused raised another important question in this debate: When market-wide shocks cause large declines in share prices, do ATPs exacerbate or mitigate the effects of these “market shocks” on firm value?

In Blood in the Water: The Value of Antitakeover Provisions During Market Shocks, forthcoming in the Journal of Financial Economics, we explore this question, focusing on significant market declines (of more than 10%) over the period 1983-2020. We find that while ATPs have no effect in normal times, they have a positive effect on firm value and stock returns during market declines, even after controlling for firm-level ATPs. Our analyses point to two mechanisms as explaining these results. First, firms with state-level ATPs that are taken over during market downturns receive larger takeover premiums. Second, the effects are stronger for more R&D intensive firms and for firms that engage in more joint ventures, suggesting that ATPs protect such firms’ investments in relationship-specific capital that would be destroyed during takeovers.

Following the large drop in share prices due to COVID-19, many lawyers and practitioners recommended that firms adopt ATPs to protect against the heightened takeover threat arising from the crisis-induced depressed share prices. However, the empirical evidence on the effects of ATPs during the COVID pandemic is mixed, with some studies documenting positive stock market reactions and others finding, instead, lower stock returns for firms with more ATPs. Several reasons could account for these mixed findings, including idiosyncrasies associated with small samples, institutional differences across countries, using endogenously chosen firm-level ATPs, and the uniqueness of the COVID-19 shock.

In our study, we move past these challenges by conducting a systematic analysis of the relationship between ATPs and firm value for a broad sample of firms incorporated in the United States (U.S.) during 14 distinct market shocks. We construct a sample covering the near universe of U.S. publicly listed firms over 149 quarters (1983Q1-2020Q1) and examine how firm value changes during market shocks conditional on the degree to which a firm has ATPs codified in state-level laws. We measure the strength of a firm’s takeover defenses using an ATP index that ranges from zero to five based on the number of state-level corporate antitakeover statutes (i.e., business combination, control share acquisition, directors’ duties, fair price, and poison pill laws) that a firm’s state of incorporation has adopted. We use state-level ATPs rather than firm-level ATPs because state-level provisions are more likely exogenous to a given firm. Firms endogenously choose to adopt ATPs based on their current condition, and some of these provisions can be implemented relatively quickly (e.g., pulling a poison pill off the shelf). In contrast, state-level ATPs are statutes passed by states and not endogenously driven by firm-specific conditions.

Using Tobin’s Q and shareholder returns as measures of firm value, we find that firms incorporated in states with more ATPs experience a less drastic reduction in valuations during market shocks. For firms without ATPs, market shocks reduce Tobin’s Q by about 19% relative to the mean and shareholder returns by about 35%. In contrast, for firms incorporated in states that have adopted all five ATPs, market shocks reduce Tobin’s Q and shareholder returns by about 14% and 29%, respectively, implying that the negative valuation effect caused by market shocks is, respectively, 26% and 17% lower for these firms. We confirm these valuation results using a portfolio trading strategy. Our findings are also not shock-specific. Further, our results continue to hold when we: (i) control for lagged firm characteristics interacted with our shock variable to alleviate the concern that these characteristics drive the effect of ATPs on firm value during shocks, (ii) employ a matched sample to further control for differences in firm characteristics in a nonparametric way, and (iii) control for firm-level ATPs, including poison pills and staggered boards.

These results are inconsistent with theories predicting that ATPs destroy value during shocks by exacerbating agency and entrenchment problems. Nor do they suggest that investors revise downward their expectations that a firm with more ATPs will be acquired. Conversely, our results are consistent with theories predicting that ATPs preserve value during market shocks, (i) by increasing the targeted firm’s bargaining power in takeovers thus enabling a target’s board to extract a higher offer premium (the “bargaining hypothesis”); and/or (ii) by bonding a firm’s commitments with its stakeholders and thus decreasing the risk that opportunistic takeovers will disrupt the firm’s operations and impose costs on stakeholders (the “bonding hypothesis”).

We empirically verify the above hypotheses and find evidence consistent with both. First, consistent with the bargaining power hypothesis, we show that conditional on receiving a takeover bid during a shock, targets with more ATPs receive between 14.5% and 25.5% higher premiums during market shocks. Second, we use research and development expenditures and the presence of joint ventures and strategic alliance partners as proxies for the importance of relationship-specific investments (RSIs) to test the bonding hypothesis and find that the value preserving effect of ATPs during market shocks is greater for firms operating in industries with: (i) higher R&D intensity, (ii) downstream customers that invest more in R&D, (iii) upstream suppliers that invest more in R&D, and (iv) a higher use of joint venture and strategic alliance partnerships.

Overall, our study shows that there is important time-series heterogeneity in the benefits of ATPs that is conditional on aggregate market conditions, making the estimated effect of these provisions sensitive to the sample period analyzed. Indeed, while we do not find that state-level ATPs affect firm value during normal times, a key takeaway from our analyses is that these laws are value-enhancing during market shocks and represent one benefit of incorporating in states with more ATPs.

The complete paper is available for download here.

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