Luca X. Lin is Assistant Professor of Finance at HEC Montreal. This post is based on a recent paper authored by Mr. Lin; Miguel Anton, Associate Professor of Financial Management at IESE Business School; Jose Azar, Associate Professor of Economics at the University of Navarra; and Mireia Gine, Associate Professor of Financial Management at IESE Business School. Related research from the Program on Corporate Governance includes Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here); New Evidence, Proofs, and Legal Theories on Horizontal Shareholding by Einer Elhauge (discussed on the Forum here); and Horizontal Shareholding by Einer Elhauge (discussed on the Forum here).
There has been a long-standing question on why U.S. shareholders remain largely inactive in standing up against acquisitions that destroy shareholder wealth. Although not all acquisitions require the voting approval of shareholders, large shareholders can still exert their influence through other means such as the threat of exit or behind-the-scenes interventions. However, in our recently published paper in the Journal of Financial Economics, we suggest that many acquiring firm shareholders may not actually have the incentive to ex-ante prevent and ex-post oppose acquisitions that are seemingly value-destroying, even if they have the capability to do so.
Using a sample of horizontal mergers between U.S. public firms from 1988 to 2016, we first document that most top shareholders of the acquiring firms also hold shares across a significant number of non-merging industry rivals of the merging firms. There is robust and consistent evidence in the M&A literature that non-merging industry rivals on average gain upon the announcement of a merger in their industry, due to reasons such as efficiency gain at the expense of the merging firms, a change in industry structure, or takeover threats inducing an improvement in corporate policies. Therefore, it is important to study whether acquiring firm shareholders’ rival ownership can affect their incentives regarding these acquisitions.
When shareholders hold a diversified portfolio of multiple firms within the same industry, they internalize the industry externalities of an individual firm’s corporate decisions at the portfolio level. Monitoring is costly, while shareholders have limited attention and resources. Therefore, it is unlikely that diversified shareholders monitor every decision by every portfolio firm. We argue that shareholders with a diversified industry portfolio may take a portfolio approach when evaluating a firm’s corporate decisions, that is, only when a firm’s decision generates externalities large enough to have value implications for the shareholders’ overall industry portfolio will such shareholders devote resources to get involved in said decision.
