Dutch discount, does it exist? : to what extent do investors discount Dutch firm values for the level of anti-takeover defense mechanisms?

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Dutch Discount, does it exist?

To what extent do investors discount Dutch firm values for the level of anti-takeover defense mechanisms?

Thesis

Executive Master of Finance and Control

Author H.H.E. van Baal

Student number 10714758 Supervisor dr. J.E. Ligterink

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Abstract

Research objective in this study is to find supporting evidence for the existence of the Dutch Discount phenomenon. The relationship between the level of protection by takeover defenses and firm value is empirically investigated for Dutch listed firms. Arguments in favor and against having takeover defenses are commonly explained under two competing hypotheses: the managerial entrenchment hypothesis vs. the shareholder interest

hypothesis. From a controller’s perspective, the essence is to find the right balance

(optimum) within the applied defense strategy. Takeover defenses should therefore provide protection for management to formulate the highest value creating (long term) strategy, but should not limit the accessibility to financial resources needed for the execution of the business plans. The empirical outcomes in this study (via an event study and a market to book value analysis) are ambiguous: the wealth effects resulting from news events show evidence that takeover defenses are at the expense of stockholders in the short run (event study), but there is no supporting evidence that Dutch firm values are in general significantly lower caused by having anti-takeover defenses in place (market to book value analysis).

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1. Introduction

1.1 Introduction

This research examines the Dutch Discount phenomenon, which has recently become

subject of discussion again in Dutch financial newspapers1. The Dutch Discount hypothesis

was, and still is, that investors discount Dutch companies in terms of reduced market value compared to their foreign peers, caused by adopting a protection strategy to discourage potential hostile takeovers (De Nijs Bik et al. 2013).

The relevance of this research comes from recent discussion about the protection schemes used by KPN and Fugro, obstructing a hostile takeover by respectively América Móvil and Boskalis. Furthermore, ABN AMRO Bank is currently implementing a protection strategy for its prospective initial public offering (2015). Its owner (the Dutch State) faces a tradeoff between realizing the highest possible selling price (without being penalized for having a protection scheme) and the threat of a future hostile takeover as a consequence.

1.2 Research objective

Companies that have takeover defenses in place are considered to suffer a negative impact under the Dutch Discount hypothesis, despite any possible positive influences. The adoption of takeover defenses is usually explained by two competing hypotheses (DeAngelo et al., 1983; Mahoney et al. 1993). On the one hand, takeover defenses may protect poorly functioning management (managerial entrenchment hypothesis). Under this hypothesis, it is assumed that corporate takeovers serve as a governance mechanism to reduce management entrenchment and improve productive efficiency of management (Jensen, 1993). Takeover defenses might interfere with this governance mechanism. On the other hand, takeover defenses allow management to focus on long term strategies of the firm (shareholder interest hypothesis). Several arguments could be considered in favor or against adopting takeover defenses. It depends on the level of protection and its initial purpose which outcome prevails (Van Heel 2001). When the implemented defense strategy is received as managerial entrenchment by investors, financial markets will penalize the firm via reduced firm value. If the defense strategy is providing the desired level of protection for management to focus on long term value creation and this purpose is successfully communicated, investors will appreciate the takeover defenses to this extent. Apart from shareholders, other stakeholders also value takeover defenses. Studies by Farre-Mensa

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Financieel Dagblad, 03-10-2014 “Midkap leidt onder Dutch Discount” and several other publications (a.o.01-04-2014, 05-01-2015, 19-02-2015).

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(2010) show that firms with few anti-takeover defenses face a higher cost of debt because creditors are concerned that a takeover may result in leverage increases. The overall appreciation by suppliers of equity and debt is reflected in the cost of capital of the firm. In other words, the implemented anti-takeover defense strategy influences the costs against which a firm could obtain funds for its activities.

The (corporate) control function within a company is interrelated with the creation and

execution process of the corporate strategy (Strikwerda, 2008). From a controller’s

perspective, the essence is to find the right balance within the applied defense strategy. Takeover defenses should therefore provide protection for management to formulate the highest value creating (long term) strategy, but should not limit the accessibility to financial resources needed for the execution of the business plans. When the implemented anti-takeover strategy results in either the wrong (myopic) strategy or increased cost of capital, the creation and execution process of the strategy and consequently the continuity of the firm might be at risk. To find the right balance within the applied takeover defense strategy, a better understanding and insight on the real economic impact of defense strategies on Dutch firm values is necessary.

The most common type of defense mechanisms implemented in the Netherlands is the adoption of preferred shares (Kabir et al. 1997, Jansen et al. 2014). In this mechanism, an option to issue preferred shares is granted to an affiliated party which can be executed at any time in order to temporarily dilute the stake of all present shareholders. The mechanism itself provides protection towards external investors but bears significant costs. Main problem resulting from the dilution (and the reduction in voting power) for existing shareholders is the creation of disturbance within the corporate governance structure. Takeover defenses could seriously harm this fragile balance between management and shareholders (Van Heel, 2001). In financial markets Dutch listed firms have become the reputation of being overly defensive with regard to their anti-takeover strategies (Molenaar, 2015). Kabir (1997, 2007) states that this has resulted in a bad reputation for Dutch corporate governance quality in general. An additional problem of takeover defenses adopted by Dutch firms is the way they are structured, mostly in a complex and non-transparent form, making them difficult to understand for external investors (Visser et al. 2011). Altogether, these arguments support the hypothesis for a discount on Dutch firm values resulting from too defensive and too complex anti-takeover strategies.

To analyze the economic effect of takeover defenses a distinction is made between the initial adoption of such a mechanism (creating the possibility) and the actual use of the defense mechanism. With regard to the installment of takeover defenses, still no consensus exists in

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academic literature on the fundamental questions whether takeover defenses benefit or harm shareholder’s wealth and why different companies adopt varying levels of defenses (Hatfield, 2011). The effect of the actual use of takeover defenses is especially difficult to observe, since other news events may drive abnormal returns simultaneously during (hostile) takeover activity.

Research objective in this study is to find supporting evidence for the existence of the Dutch Discount phenomenon. Two statistical approaches will be exploited to this matter. First, an event study will investigate the (short term) effect on stock prices of announcements of the use and dismantle of takeover defenses, based on prior research about wealth effects created by takeover defenses (DeAngelo et al., 1983; Mahoney et al., 1993; Kabir et al. 1997). Second, a market to book value analysis will show whether Dutch firms have a long term significantly different (lower) market to book value in comparison to a foreign peer group (United Kingdom) caused by having takeover defenses. This analysis is based on the work of McWilliams (1993) and Roosenbom et al. (2003) who have studied the association between takeover defenses and market to book value. Roosenboom finds a positive relationship between the level of takeover defenses and IPO market to book value, whereas McWilliams documents no effect and states that firms that implement takeover defenses do not have a significantly different market to book ratio.

Since prior analyses for both approaches has been dated about one or two decades ago, this study will add renewed evidence. The scope of the analyses performed will be Dutch listed firms in the period after Kabir’s findings in 1997.

1.3 Central problem statement, sub questions and research model

In order to achieve the research objective of this study, the following problem statement has been formulated.

Problem statement: To what extent do investors discount Dutch firm values for the level of

anti-takeover defense mechanisms?

To answer the problem statement above, the following supporting sub questions have been derived:

1. What are the main findings in prior research on the existence of the Dutch Discount phenomenon?

2. How do defense strategies influence corporate governance quality and consequently firm value, given the Dutch legal environment?

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3. What is the rationale behind takeover defense strategies and what is the economic impact?

4. What types of defense strategies are used among Dutch listed firms?

5. Based on statistical research (event study and market to book value analysis), to what extent do the derived hypotheses hold?

6. What are the implications of the statistical and economical significant outcomes? To what extent does the hypothesis claiming the existence of the Dutch Discount hold?

These research questions together form the research model as shown in Figure 1 below.

Figure 1

Figure: Research model applied in order to answer the central problem statement

1.4 Structure of this paper

In the following chapter the theoretical framework will be elaborated, including a description on the types of defense strategies within the Dutch legal environment. The third chapter will introduce the two statistical approaches, the applied methodologies and datasets. The empirical results will be presented and analyzed in chapter 4. The implication of the empirical outcomes and the conclusion of this study will be drawn in the final chapter 5.

Prior research on the effect of takeover defenses. The relation between takeover defenses and

corporate governance quality and its impact on firm value (a.o. Kabir et al., La Porta et al.) Drivers for having anti-takeover

defense mechanisms, it’s economic impact and their complexity (a.o. Visser at al.) Legal/regulatory developments

in past decades

Conclusion on the relation between a discount on Dutch firm values and the

level of anti-takeover defense mechanisms Null hypotheses on relation

between discount on Dutch firm values and the level of anti-takeover defense

mechanisms

Statistical analysis I

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2. Theoretical Framework

As mentioned in the introduction, the hypothesis for a discount on Dutch firm values resulting from takeover defenses seems to be supported by several studies. The research on this matter has been done by Kabir et al. (1997, 2007) claiming the existence of the Dutch Discount phenomenon. Their findings will be the starting point for this research, combined with studies by La Porta et al. (1998, 2002, 2007) about shareholder protection and corporate governance quality and the descriptive work of Visser et al. (2011) about the complexity of takeover defenses. To interpret and apply these findings correctly for a specific country, its legal environment should be taken into account as well. The differences between common law and civil law explained in the Legal Origin Hypothesis (La Porta et al. 1998) will therefore be incorporated in the peer group selection for the second statistical analysis. Furthermore, the drivers for implementing an anti-takeover strategy and its economic impact will be discussed in this chapter. These building blocks together form the theoretical framework for this research as shown in Figure 2. In the next section a brief overview of the literature and its development in the past decades will be presented.

Figure 2

Figure: Theoretical framework of this research Adoption of anti-takeover defense

mechanisms is received as managerial entrenchment, resulting in bad reputation for Dutch corporate

governance quality (De Jong 2005, Kabir 2007). Dutch Discount firstly examined by Kabir et al. (1997)

Low corporate governance quality results in lower firm value (La porta et al. 1998, 2002, 2007)

Anti-takeover defense mechanisms are complex and non transparant, making them difficult to understand for external investors (Visser et al. 2011)

Research question:

To what extent do investors discount Dutch firm values for the level of anti-takeover defense mechanisms?

Legal environment:

Civil law system tends to be less market friendly than common law system towards investors, Legal Origin Hypothesis (La Porta, Lopez-de-Silanes, Schleifer and Vishny, 1998).

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2.2 First findings on the Dutch Discount phenomenon

Many studies have tried to capture the (short term) effect of takeover defenses on stock prices via the event study method. An event study investigates whether significant abnormal returns are observed between actual stock returns and expected stock returns, upon the announcement of a certain event. During the last decades of the past century, the central point of debate were the competing hypotheses on whether takeover defenses are in the best interest of shareholders of firms that adopt them. Most studies have examined samples of U.S. firms for wealth effects caused by announcements of adopting takeover defenses and show mixed outcomes. The early work of DeAngelo et al. (1981) shows no significant results for a sample of 100 events in the period 1971-1979. The work of Linn et al. (1982) finds evidence for a positive wealth effect (cumulative abnormal return of 0,86%) for the announcement of anti-takeover amendments during the event window from the announcement date until 90 days after (sample: 475 events; period: 1960-1980). Mahoney et al. (1993) find negative outcomes for this effect (sample: 316 events; period: 1980-1988; cumulative abnormal return: -1,90%; event window: 0-60 days). Coates (1999) has tried to summarize 20 years of economic studies to this matter and states that it is almost impossible to draw any strong conclusion on the prior research, because the provided evidence is too weak and not pointing in the same direction. Hatfield (2011) has recently confirmed this statement that still no agreement exists on the true economic impact of the adoption of takeover defenses. According to Hatfield the developed analytical frameworks to investigate the effects have been inadequate to produce useful results.

In the past decade, the attention in academic literature has broaden from observing wealth effects towards a welfare analysis. Apart from shareholders, other stakeholders (and society in general) are taken into account to analyze the overall effect, to identify drivers for adopting takeover defenses and to find the optimal level of protection. Farre-Mensa (2010) investigates the effect on suppliers of debt in his analysis. As mentioned in the introduction, he documents that lenders view takeover defenses as valuable resulting in a lower cost of debt. With regard to the optimal level Hatfield (2011) states that shareholders do not always prefer the lowest level of takeover defenses and management does not always prefer the highest. He finds that the level of takeover defenses preferred by both shareholders and managers varies depending on several firm specific characteristics. These include the degree of uncertainty about the value of the firm as a going concern and the potential synergy gains for the acquirer. Accordingly, firms for which an acquirer is likely to pay the highest premiums are in general more likely to implement stronger takeover defenses. In other research, Cremers et al. (2007) study the interaction between takeover defenses and product market competition. They find that firms in competitive relationship industries have

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more takeover defenses. When the (long term) relationship between a company and its stakeholders is vital for the company’s performance, the potential disruption caused by (hostile) takeovers could be harmful. Takeover defenses have even been studied in relation to scandals around earnings management (Jiraporn, 2009). He finds an abnormal degree of accruals for specific takeover defenses in the U.S. Altogether, takeover defenses have been studied and related to a broad field of causalities in recent literature. The main factors driving takeover defenses will be further elaborated in section 2.4, the economic impact will be discussed in section 2.5.

Rather few studies have examined the impact of takeover defenses on Dutch listed firms. The existence of a wealth effect has been statistically examined at first by Kabir et al. in 1997. Their study empirically analyzes the relationship of takeover defenses to both ownership structure and firm value and provides two important insights. Firstly, Kabir et al. document evidence for less use of takeover defenses when shareholdings and ownership are more concentrated. Secondly, they find a negative effect on the stock price when the defense mechanism (announcement of preferred shares issuing) is executed. As mentioned in the introduction two phases can be distinguished in practicing defense strategies: the creation and the execution of the defense mechanism. When the defense mechanism is installed the current shareholders approve the necessary charter amendment. Kabir finds that to this extent the defense mechanism is beneficial to the shareholders (sample: 17 events; period: 1984-1990; cumulative abnormal return: 1,23%; event window: 0-1 days). With respect to the execution of the defense mechanism however, Kabir finds a negative impact on the stock price. Although defense mechanisms are beneficial to a certain extent in the first phase, the benefits evaporate when the defensive wall is operational. The actual issue of the preferred shares results in a cumulative abnormal return of -4,09% (sample: 44 events; period 1984-1990; event window: 0-1 days). Furthermore, evidence is shown that the first preferred share issue is more damaging than subsequent issues. Van Heel (2001) has studied the impact of the level of protection for Dutch listed firms via a comparable event study analysis (sample period: 1973-1992). He finds that the initial installment of multiple takeover defenses has a larger (positive) impact than a single takeover defense. Furthermore, he concludes that when the level of takeover defenses has reached a (firm specific) optimum, additional installment beyond this optimum results in a negative wealth effect (managerial entrenchment).

In later work based on Kabir’s findings, Roosenboom et al. (2003) find that adopting takeover defenses is negatively correlated to various measures of IPO firm value for Dutch

IPO firms. He estimates Poisson regressions to investigate the determinants of IPO firms’

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Their analysis shows that few factors can consistently explain the use of takeover defenses at IPO. From this, they infer that takeover defenses are motivated by managerial entrenchment. In addition he performs OLS regressions on market to book value related to the number of takeover defenses. His outcomes show lower market to book values for the amount of takeover defenses used. Despite this evidence, Roosenboom et al. (2003) report that over 90 percent of Dutch IPO firms adopt at least one takeover defense before going public. As shown in Table 1, this trend has been present in the past decade as well (most

recent example: ABN AMRO Bank).

Table 1

Firm Defense mechanism Year

TomTom Preferred shares 2005

Delta Lloyd Preferred shares 2009

USG People Preferred shares 2009

TNT Express Preferred shares 2011

Nationale Nederlanden Preferred shares 2014

ABN AMRO Bank Under construction 2015

Table: Anti-takeover defense mechanisms created by Dutch IPO firms

Kabir states in his later work in 2007 that practicing anti-takeover defense strategies by Dutch listed firms has resulted in a bad reputation for Dutch corporate governance quality. This statement is based on the findings of De Jong et al. (2005) who evaluate the impact of self-regulation within the Dutch corporate governance practice via an event study. They show that the pressure from corporate governance mechanisms has been very limited in the Netherlands. Implicitly, a causal relationship between level of protection, corporate governance quality and firm value is assumed (Kabir 1997, 2007). To understand this thinking two questions need to be answered: how do defense strategies affect corporate governance quality, and how does corporate governance quality affect firm value? These questions will be answered in the following section.

2.3 Shareholder protection, corporate governance quality and its impact on firm value

Corporate governance is about how “suppliers of finance to corporations assure themselves of getting a return on their investment” (Shleifer et al. 1997). Furthermore, corporate governance can be defined as a system of institutional procedures, rules and structures under which all stakeholders of the firm are obliged to operate (Moerland, 1995). The need for corporate governance emerges from (possible) conflicts of interest between ownership and control within firms. Conflicts of interests can easily evolve when the disciplinary power (towards the management) within the applied corporate governance framework is insufficient. Prior research suggests that voting rights are the most important tool for

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shareholders to influence management (Zingales, 1994). Consequently, takeover defenses and their limiting effect on voting power could deteriorate the fragile balance between shareholders and management (Van Heel, 2001).

La Porta et al. (1999, 2002, 2007) relate ownership structure in countries to their legal origin and investor protection. They state that if shareholders are weakly protected they lack the disciplinary power towards the management. Under such conditions, the corporate governance quality is low. Furthermore, they find evidence that poor shareholder protection is penalized with lower firm valuation. Consequently, firms will face difficulties accessing

capital from external investors. La Porta et al. document large ownership concentration

especially in countries with weak investor protection. In their study however, the impact of ownership structure (e.g. dispersed ownership, family ownership, cross holdings etc.) on firm value remains unclear. Ownership structure may affect firm valuation in the same way as shareholder protection. When ownership is dispersed, the monitoring power of shareholders suffers from the free-riding problem. Under concentrated ownership the monitoring power increases which may positively affect firm value (Schleifer et al. 1986). Although this causality is conceptually difficult to study due to the endogeneity problem, some studies

have tried. Holderness et al. (1988) find that family firms have a lower Tobin’s Q than

nonfamily firms, while Anderson et al. (2003) find the opposite relation.

The studies by La Porta et al. (1999, 2002, 2007) have been dominating the debate on the influence of legal origin on corporate governance quality in the past decades. Their main hypothesis is that the greater the protection of shareholders and creditors by a countries legal system, the more external financing firms could obtain. They composed an index to statistically measure investor protection and find that legal rules have a quantifiable effect on financial developments. Their second finding is that the quality of legal institutions varies with the origin of the legal system. According to their research, the Netherlands falls into the (French-origin) civil law system. In general, civil law tends to be less market friendly towards investors compared to common law (La Porta et al., 1998). The findings by La Porta et al. on the legal origin have been challenged by Cools (2005) who argues that the differences in degree of shareholder protection between common law an civil law countries are often overestimated. The model used in her study consists of a broad array of social and economic elements, which have not been included in the model by La Porta et al. From this model she concludes that if there is such a difference in shareholder protection between common law and civil law it is much smaller than suggested.

As mentioned in the introduction, the implementation of takeover defense strategies could either be received positively or negatively by its stakeholders, depending on the composition

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and aim of the defense structure. When the adopted takeover defenses excessively increase the gap between shareholders and management in both disciplinary power and understanding, these will be objected by the shareholders. This will consequently lead to a deterioration of corporate governance quality for which investors discount firm value (La Porta et al., Kabir et al.). Additionally, Dutch companies operate under the civil law system making these companies less attractive for investment in terms of shareholder rights (La Porta et al.). In sum, these insights support the hypothesis that (excessively) adopting takeover defenses results in lower valuation of Dutch firms.

2.4 Drivers for adopting takeover defenses

To get a grasp on the rationale behind the existence and use of takeover defenses, it is necessary to understand the tradeoff between its arguments in favor and against. Although takeover defenses play an important role as well in private (limited) firms, the scope in this study only includes takeover defenses used by publically traded (listed) firms. Takeover defenses are generally used for several purposes (Visser et al. 2011, pp. 11-14):

 To maintain and preserve the current position and interests of founders, families and

other shareholders;

 A defense strategy limits the shareholder’s influence and therefore protects the

interest of other stakeholders. The ‘stakeholder model’ under Dutch law does not allow the shareholder’s influence to be decisive on the company’s strategy;

 To prevent for and discourage shareholder activism and other unwanted external

influences;

 It allows management to keep focus on the operational activities instead of worrying

about future hostile bids. Furthermore, it allows the management to have a long term focus instead of myopic behavior. This would lead to (long term) value creation for shareholders (shareholders interest hypothesis);

 It creates stronger bargaining power for the management in times of takeover

activity resulting in a higher selling price;

 To safeguard the position and interest of the employees. Mergers often result in

reorganizations and personnel reductions for synergy purposes;

 To prevent for voting power of a random and accidental majority on the general

meeting of shareholders when attendance is low.

Furthermore, without takeover defenses the market for mergers and acquisitions would become overheated, demanding governments to intervene and impose regulatory power (Visser et al., 2011). Takeover defenses are mostly approved by shareholders. In other

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words, they have co-created them serving an (initially) joint interest instead of leading to a conflict of interest.

In contrary to the benefits of using a defense strategy presented above, the following arguments can be formulated against the use of takeover defenses (Visser et al., 2011):

 Takeover defenses constraint shareholder’s rights. Shareholders face financial risk

with limited influence;

 When takeover defenses grant exclusive power and rights to a specific group (e.g.

priority shares), this group mostly has no accountability to the rest of the firm it controls;

 Takeover defenses could lead to opportunistic behavior by the current management.

When monitoring fails, the management can easily act in its self-interest;

 It increases the gap between shareholders and management and decreases

shareholders involvement and monitoring;

 The corporate governance structure becomes less transparent which leads to a

deterioration of corporate governance quality;

 Takeover defenses reduce the disciplinary power of the takeover market;

 Economically optimal and efficient mergers could be obstructed;

 Takeover defenses need to be designed and maintained, these impose

administrative costs.

Apart from these arguments, other factors may influence the decision for implementing takeover defenses. As mentioned in section 2.2 studies by Hatfield et al. (2011) and Cremers et al. (2007) show causality for respectively expected takeover premiums and industry type. In addition, Coates (1999) finds that company size matters. For large companies (by market capitalization) potential bidders face a financing constraint, and may be therefore less vulnerable to takeover bids. For small companies however, underlying data shows that these are less likely as well to adopt anti-takeover defense mechanisms than bigger companies. Rationale behind this observation might be that smaller companies have a smaller (concentrated) shareholders base, mostly consisting of (well-)known domestic investors. Kabir (1997) finds to this extent that companies use less takeover defenses when shareholdings and ownership are more concentrated, based on the assumption that block holders are more effective in the monitoring of managers. Other argument could be found in the fact that small companies are signaling their availability for a takeover (De Groot et al. 2015). Furthermore, both outperforming and underperforming companies may find reason to adopt takeover defenses, being an interesting target either for its growth potential or synergies. However, only weak evidence is found between the adoption of takeover

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defenses for both operating performance and sales growth (Coates, 1999). Altogether, these relationships need to be taken into account when investigating the impact of using takeover defenses on firm value. Therefore these factors will be incorporated as control variables in the second statistical analysis (see Chapter 3).

This section has given insight in the pros and cons with regard to takeover defenses. In the following section another dimension will be added to this tradeoff: the potential economic impact of takeover defenses.

2.5 Economic impact of takeover defenses

To analyze the potential economic effects of takeover defenses, the created wealth effect for shareholders of the target company is being investigated around takeover activity as well as its impact on the cost of capital.

The literature is unanimous that being a takeover target increases the wealth of shareholders (Goergen et al. 2002). According to their study the average premium amounts 20-30% over the pre-announcement share price. At first sight, takeover premiums seem to imply that takeover resistance is bad since it lowers the probability of a takeover and consequently the pay-out of a premium. However, the case is not that simple.

Rubeck (1987) describes that the market value of a firm is the sum of two components: the value of the firm when the same management team retains; and the expected change in value of the firm from a corporate control change multiplied by the probability of a takeover.

𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑓𝑖𝑚 = 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑓𝑖𝑟𝑚 𝑤𝑖𝑡ℎ 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑚𝑎𝑛𝑎𝑔𝑒𝑟𝑠 + 𝑃𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝑎 𝑐𝑜𝑛𝑡𝑟𝑜𝑙 𝑐ℎ𝑎𝑛𝑔𝑒 ∗ 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑣𝑎𝑙𝑢𝑒 𝑓𝑟𝑜𝑚 𝑎 𝑐𝑜𝑛𝑡𝑟𝑜𝑙 𝑐ℎ𝑎𝑛𝑔𝑒

Following this formula, different forces may be at work before a wealth effect is observed. Takeover defenses may lower the probability of a takeover, they also strengthen the bargaining position resulting in a higher offer price. Moreover, takeover defenses may increase the value even if the company is not acquired. The value of the firm with the current management team could either increase or decrease, following the two competing hypothesis to this matter (shareholders interest vs. management entrenchment).

It is difficult to assess whether the impact on firm value will be positive or negative. Therefore it is necessary to examine the rationale behind the use of takeover defenses from the management perspective. Roughly three reasons can be distinguished to this matter. First, the management believes that the firm has hidden values. If these hidden values (plans,

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ideas, patents) are based on private information the market has not incorporated them in the market price. Hatfield (2011) refers to this as the empowerment of corporate insiders. Even though these insiders might be unfaithful agents, their informational advantage could ultimately lead into a higher price in the benefit of the shareholders. Problem here is that managers are mostly overly optimistic, claiming that their company is undervalued (Rubeck, 1987). Second, the management believes that takeover defense will increase the offer price. Since takeover defenses slow down the bidding process, potential other buyers will get the opportunity to join the bidding process. This may result in a higher takeover premium. Third, the management wants to retain its position. In case of a takeover the management faces the threat to be replaced. This threat may divert managerial effort from productive to defense activities and may consequently lead to value destruction (Chakraborty, 2000). The first two reasons could potentially create a positive wealth effect for shareholders, the latter is more likely to create a negative effect. According to Jansen et al. (2014), most takeover defenses implemented by Dutch listed firms are executed to gain time in the bidding process and to strengthen the bargaining position of the target company.

A firm’s cost of capital plays a critical role in determining the profitability of the firm’s current investments and its prospective investment decisions. As mentioned in the introduction, from a controllers perspective the execution process of the strategy might be at risk when funding for (both current and new) business plans becomes more expensive. Therefore, factors that influence the cost of capital affect the long term economic value of the firm. If external investors penalize the installment of takeover defenses the share price decreases. On the other hand, suppliers of debt value takeover defenses because they are concerned that a takeover results in increased leverage (Farre-Mensa, 2010). Moreover, Garvey et al. (1999) show that protected firms are less likely to increase leverage when takeover defenses are installed. These arguments together should lead to lower cost of debt caused by takeover defenses. The overall effect on the accessibility of financial resources however is therefore ambiguous.

Apart from measuring economic impact via indicators in financial markets, (long term) value creation could also be observed from other business variables. If takeover defenses lead to a shift from myopic behavior towards focus on long term value creation by the management, indicators like increased R&D expenses (or other firm specific critical success factors for value creation) could show this effect. Unfortunately, relevant studies to this matter have not been developed so far in academic literature.

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2.6 Anti-takeover defense mechanisms in the Netherlands

Since Dutch takeover defenses are the central point of discussion in this research and serve as the explanatory variable in the second statistical analysis, some insight on the different types and uses is presented in this section. According to Visser et al. (2011), Dutch takeover defenses can take many forms and are mostly structured in a complex and non-transparent form. This makes them difficult to understand by external investors. Grazell and Kabir (2001) use the following definition for anti-takeover defense mechanisms:

“Anti-takeover defense mechanisms include all measures taken by the board in order to (1) reduce shareholders rights and (2) prevent for a hostile takeover.”

Under Dutch legislation, defense strategies are primary allowed to guarantee the continuity of the firm and the interests of its stakeholders, unless:

 The defense mechanisms are contrary to rules under compulsory law (e.g. Dutch

law: art. 2:92 BW, art. 2:9 BW, 2:8 BW, 3:13 BW);

 The defense mechanisms are contrary to the statutes of the firm;

 In case of exceptional circumstances.

Foreign companies which have their statutory seat in the Netherlands are also allowed to adopt takeover defenses under Dutch law. Some firms have chosen to settle in the Netherlands for this strategic reason. Currently Mylan Pharmaceutical (a U.S. origin company) is located in the Netherlands and trying to survive a hostile takeover attempt by its competitor Teva, via Dutch takeover defense mechanisms. International investors therefore blame and reject the Dutch legal system for providing protection to this matter (Molenaar, 2015).

Dutch anti-takeover defense mechanisms can be sub-divided in statutory measures, non-statutory measures, legal measures and other types of defense strategies. Some measures are temporary by nature and only used in case of a hostile takeover threat, others are permanent and might cause continues distortion. Most firms use a combination of multiple anti-takeover defense mechanisms.

 Statutory measures

Preferred shares

Preferred shares typically yield a fixed (cumulative) return and face seniority above common shares. The issuing of these shares dilutes the stake of all present shareholders and consequently diminishes the voting power and influence of the hostile shareholder. The use of this defense mechanism is relatively cheap, effective

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and can easily be undone when the threat is over (temporary by nature). As mentioned earlier, two phases can be distinguished to this matter: the creation and the execution of the defense mechanism. When the defense mechanism is created the current shareholders approve the necessary charter amendment. An option on these shares is granted to an affiliated party, this can be either a put or a call option. In the execution phase when new preferred shares are issued, current shareholders are not able to use their pre-emptive rights on the new issuing (Dutch law: art. 2:96a lid 3 BW). The issuing price normally equals the nominal value of the share, for which a full deposit is mostly not required (Dutch law: art. 2:80 BW). The issue of preferred shares is the most common type of defense mechanisms used in the Netherlands (Kabir et al. 1997).

Priority shares

A company can issue priority shares (commonly known as ‘golden shares’) which hold specific rights (Dutch law: art. 2:92 lid 3 BW). These rights mostly relate to binding nomination of board members and compulsory approval for strategic decisions. Except for the specific rights, these shares do not hold any seniority above other common shares. This defense mechanism is permanent by nature.

Agenda threshold

When shareholder’s initiative wants to add items on the agenda of the general meeting of shareholders, normally a threshold of 1% of placed capital has to be met. This threshold can be statutory increased to 3% in order to decrease agenda setting power and consequently shareholder’s influence (art 2:114a BW). Even when the 3% threshold is met, certain topics for discussion can be rejected by the board. Recently,

Boskalis has tried to put Fugro’s defense strategy at debate at Fugro’s annual

general meeting of shareholders. Despite their 25% ownership, their claim was rejected by the court since Fugro’s independent position is considered to be part of the corporate strategy. The corporate strategy is the responsibility of the board and does not to be approved by the shareholders (Lalkens 2015).

Binding nomination

The appointment of members of the executive and supervisory board is normally done by its shareholders. However, firms can statutory define a binding nomination procedure by which the board can nominate two candidates (art. 2:133 BW). This procedure can only be undone by a two third majority.

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 Non-statutory measures

Depository receipt of shares

For this defense mechanism an affiliated administration office is founded. The (listed) company issues shares to the administration office which holds these under management. Certificates are then issued by the administration office to the investors. In this construction a split is made between economic rights (dividend) for the investor and the voting rights for the administration office. The exchangeability of these certificates into real shares (to execute voting rights) can be unlimited, limited or ruled out. Obviously, the defense mechanism only works when exchangeability is restricted. This defense mechanism is permanent by nature.

Under the Dutch Corporate Governance Code (Code Tabaksblat) eight conditions have been defined for using depository receipts of shares (‘Bepaling IV.2.1 – IV.2.8’). Main purpose of these conditions is to safeguard the independent character of the administration office and consequently the influence of the certificate holders. Studies by De Vries et al. (2005) show however that compliance with these conditions is weak in practice and increased adherence is necessary.

 Legal measures

Structuurvennootschappen

The law on ‘structure companies’ compels large firms to establish a supervisory board. The supervisory board holds specific rights, most importantly the right to appoint and dismiss the executive board and the compulsory approval of strategic decision. The composition of this supervisory board is subject to specific rules (fixed number of outsiders and representatives of different groups). However, since the structure regime does not provide full protection its real impact is at debate. The shareholders can dismiss the current supervisory board (Dutch law: art. 2:161a BW) and appoint a new one (Dutch law: art. 2:158 lid 4 BW).

When adoption of the structure regime is voluntary, this mechanism can be seen as a defense mechanism imposed by the company. Since many large Dutch firms are mandatory subject to this law this defense mechanism is part of the Dutch legal environment. This law is unique in its form compared to other countries under civil law. This law therefore supports the general belief that the Dutch legal environment worsens the Dutch corporate governance quality, as stated by Kabir (2007).

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 Other

Ownership concentration

When ownership is concentrated, a single or a few shareholders hold a large stake in the company. These blockholders often send representatives to the board to exercise their control and influence. This dominant position may discourage other investors to acquire the firm and can therefore be seen as a takeover defense.

White knight

When other takeover defenses are not effective, the target company can also find shelter and protection via an affiliated company. This ‘white knight’ can place a public bid, or the target can issue shares to the affiliated company.

Divestment

Acquiring companies are mostly interested in specific activities of the target firm. The target firm can choose to divests these ‘crown-jewels’ to become less attractive for the acquirer (for example ABN AMRO sold LaSalle in 2007 after hostile bid RBS/Santander/Fortis consortium). Apart from divesting the activity of interest, the firm could also place it in a joint venture. Since (large) divestments can be seen as important strategic decision and even a change in the identity of the firm, these actions can be subject to approval by the supervisory board or shareholders (art. 2:164 BW). This may lead to lawsuits between shareholders and the board.

Although takeover defenses might obstruct a hostile takeover, they cannot fully prevent for them. It depends on the persistence of the acquiring party to what extent it is able to break through the constructed defensive wall. Jansen et al. (2014) state that it is more important to get into a constructive dialogue with the current management than to fight the defenses mechanisms itself. Obviously, the list of takeover defenses presented above is non exhaustive and each type could be applied in many forms. The statistical analyses in the following chapters will examine the impact of three types of takeover defenses, namely preferred shares, priority shares and certificates. This selection will further be explained in the following section.

2.7 Legal and regulatory developments in past decades

To properly analyze the impact of using takeover defenses over time it is important to take specific trends into account. Changes in these trends are mainly due to legal and regulatory developments and market influences. At first, defence strategies were intensively practiced in the last decades of the past century (Kabir 1997, 2007). During this period however,

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concerns about Dutch corporate governance quality grew. A committee was appointed (Commissie J. Peters) to investigate the Dutch corporate governance quality. Although this study did increase the awareness of the lacking quality of Dutch corporate governance, it only came with a list of recommendations. A real turning point was reached when the Dutch Corporate Governance Code (Code Tabaksblat) was adopted in 2004. The code pursues (amongst other objectives) a reinforcement of influence and protection of shareholders. With regard to defense mechanisms the code discommends (but does not disallow) the use of certificates. The code is less dissuasive however when it comes to the use of other takeover defenses (De Groot et al. 2015).

After the introduction of the code in 2004, Dutch companies slowly started to dismantle priority shares and certificates as a protection strategy as shown in Table 2 and Figure 3 (Visser et al. 2011). These events will be subject to the first statistical analysis to observe whether the dismantles have created any wealth effect (Chapter 3).

Table 2

Table: Firms dismantle priority shares and certificates as protection strategy

Compliance to the Dutch Corporate Governance Code is mandatory for listed firms in the Netherlands. Although adoption of the new code improved the quality of Dutch corporate governance, the Dutch regulators were reluctant to take further measures. Illustrative to this

matter was the hesitant acceptance of a new (13th) EU takeover directive in the

Netherlands, which was directly adopted by many other European countries like Germany and Sweden (Goergen et al. 2005, Siems et al. 2009). This directive was created to harmonize takeover laws across Europe and to encourage value-creation via takeover activity. Part of the directive is a mandatory public bid if any shareholder acquires a controlling interest (between 30%-40%). Critics state however that the combination of a mandatory bid rule with a minimum price rule increases managerial entrenchment and the cost of takeovers (Humphery, 2011). In the same period a new law on substantial shareholdings was created. When any shareholder reaches a substantial holding in a

Company Index Dismantled

defense mechanism

Announcement date

Wessanen ASCX Certificates 11/04/2005

Wolters Kluwer AEX Certificates 12/12/2005

ASML Holding AEX Priority shares 18/01/2006

Neways Electronics ASCX Priority shares 04/12/2006

Corbion AMX Certificates 19/12/2006

MTY Holdings ASCX Certificates 08/04/2011

Vastned Retail AMX Priority shares 14/10/2011

NSI AMX Priority shares 13/12/2011

Grontmij ASCX Certificates 28/03/2012

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company (threshold starting from 3%), this position has to be notified at the Dutch Financial Markets Authority. This law aims to obstruct investors who are trying to incrementally gain control of a firm.

Sentiment on takeover defenses changed back again when ABN AMRO was split up after a hostile bid from the RBS/Santander/Fortis consortium during the credit crisis in 2007. Since acquisition activity in the early years after the credit crisis was low, the public debate has only been risen recently. As shown in Table 3, many listed Dutch firms have been equipped with takeover defenses in 2014. It shows that the issue of preferred shares is the most practiced defense mechanism together with concentrated ownership and a binding nomination. Although the structure regime is associated with large companies, relatively few Dutch listed firms qualify for mandatory adoption.

Table 3

Anti-takeover defense mechanism

Index # firms Preferred shares Priority shares Depository receipt of shares Structure companies Concentrated ownership Agenda threshold Binding nomination AEX 22 13 1 3 4 11 7 8 AMX 22 12 4 2 4 10 8 13 ASCX 22 9 2 4 6 9 5 6 Total 66 34 7 9 14 30 20 27 52% 11% 14% 21% 45% 30% 41%

Table: Anti-takeover defense mechanisms used by Dutch listed firms (2014)

AEX excluding Arcelor Mittal (legal origin: Luxembourg), Uniball Rodamco (legal origin: France) and Ziggo (recently acquired), AMX excluding Air France KLM, Aperam (legal origin: France) and Arseus (legal origin: Belgium), ASCX excluding Galapagos (legal origin: Belgium) and Groothandelsgebouwen

Source: Jansen et al. (2014)

The use of preferred shares has remained the most popular mechanism, as well for IPO firms adopting them as mentioned in section 2.2. Both priority shares and certificates however show a downward trend during the last two decades (Figure 3). According to Visser et al. (2011) preferred shares, priority shares and certificates have dominated the landscape on takeover defenses for Dutch listed firms. Therefore these three types will be input for the statistical analyses in Chapter 3 and 4.

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Figure 3

Figure: Trend of Dutch listed companies having adopted preferred shares, priority shares and certificates as takeover defense mechanism

The takeover attempt of KPN by América Móvil has even triggered a new topic for discussion, involving the Dutch Minister of Economic Affairs. He claims that the government should have more power and influence in (hostile) takeover activity when companies holding a strategic or vital positions for Dutch society are involved. KPN has such a vital position in the Dutch telecommunication market and telecommunication infrastructure, therefore foreign influence might be undesirable. Since the Dutch State gave up its golden share in KPN (as a former state owned company) in 2005, the government did not have any power to intervene in the bidding process. It is expected that a new law on this matter will be proposed in 2015, which could prelude a new chapter in the discussion of shareholder protection within the Dutch legal environment (Jansen, 2014).

2.8 Conclusion and development of hypotheses

In the previous sections the theoretical framework has been set to formulate the null and alternative hypotheses for the existence of the Dutch Discount phenomenon. The causal relationship between the implementation of defense strategies, corporate governance quality and consequently firm value has been explained theoretically. Furthermore, some background has been given on the drivers for adopting takeover defenses and its potential economic impact. From the field of controlling, excessive adoption of takeover defenses could jeopardize the creation and execution process of the firm. The empirical study in the following two chapters will investigate whether an economic impact is observed on Dutch

listed firms resulting from takeover defenses.

The first statistical analysis in this research will investigate whether Kabir’s claim for

existence of the wealth effect for Dutch companies still holds after nearly two decades. As described in previous sections, the conventional event study method has been widely

0% 10% 20% 30% 40% 50% 60% 70% 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 Preferred Shares Pririty Shares Certificates

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applied in financial economics literature to test for (short term) abnormal returns around announcements of takeover defenses. Therefore, a comparable event study approach will be used investigating two types of news events. First, the event of practicing a defense strategy (issue of preferred shares), second the effect of dismantling takeover defenses. The second statistical analysis performed in this research tries to capture the possible lower firm value based on the approach (via market to book value) used by Roosenboom et al. (2003). The (long term) impact of having takeover defenses on firm value is analyzed for a portfolio of Dutch listed companies. In addition, the gap in market to book values between Dutch companies and those of a selected peer group (from a different legal origin) is analyzed, to investigate whether the deviation is caused by the use of takeover defenses. To eliminate any possible effect of the legal origin, all peer companies are selected from a single common law jurisdiction (see Chapter 3).

In order to answer the research question, the following hypotheses have been derived: Statistical approach I – event study:

𝐻𝑜: 𝑇ℎ𝑒 𝑎𝑛𝑛𝑜𝑢𝑛𝑐𝑒𝑚𝑒𝑛𝑡 𝑜𝑓 𝑡𝑎𝑘𝑒𝑜𝑣𝑒𝑟 𝑑𝑒𝑓𝑒𝑛𝑠𝑒𝑠 𝑑𝑜𝑒𝑠 𝑛𝑜𝑡 𝑝𝑟𝑜𝑣𝑖𝑑𝑒 𝑎𝑛 𝑎𝑏𝑛𝑜𝑟𝑚𝑎𝑙 𝑟𝑒𝑡𝑢𝑟𝑛 𝑖𝑛 𝑡ℎ𝑒 𝑒𝑣𝑒𝑛𝑡 𝑝𝑒𝑟𝑖𝑜𝑑

𝐻1: 𝑇ℎ𝑒 𝑎𝑛𝑛𝑜𝑢𝑛𝑐𝑒𝑚𝑒𝑛𝑡 𝑜𝑓 𝑡𝑎𝑘𝑒𝑜𝑣𝑒𝑟 𝑑𝑒𝑓𝑒𝑛𝑠𝑒𝑠 𝑑𝑜𝑒𝑠 𝑝𝑟𝑜𝑣𝑖𝑑𝑒 𝑎𝑛 𝑎𝑏𝑛𝑜𝑟𝑚𝑎𝑙 𝑟𝑒𝑡𝑢𝑟𝑛 𝑖𝑛 𝑡ℎ𝑒 𝑒𝑣𝑒𝑛𝑡 𝑝𝑒𝑟𝑖𝑜𝑑

Statistical approach II – market to book value analysis:

𝐻00: 𝑇ℎ𝑒 𝑚𝑎𝑟𝑘𝑒𝑡 𝑡𝑜 𝑏𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝐷𝑢𝑡𝑐ℎ 𝑙𝑖𝑠𝑡𝑒𝑑 𝑐𝑜𝑚𝑝𝑎𝑛𝑖𝑒𝑠 𝑖𝑠 𝑛𝑜𝑡 𝑟𝑒𝑙𝑎𝑡𝑒𝑑 𝑡𝑜 𝑡ℎ𝑒 𝑎𝑑𝑜𝑝𝑡𝑖𝑜𝑛 𝑜𝑓 𝑡𝑎𝑘𝑒𝑜𝑣𝑒𝑟 𝑑𝑒𝑓𝑒𝑛𝑠𝑒𝑠 𝐻11: 𝑇ℎ𝑒 𝑚𝑎𝑟𝑘𝑒𝑡 𝑡𝑜 𝑏𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝐷𝑢𝑡𝑐ℎ 𝑙𝑖𝑠𝑡𝑒𝑑 𝑐𝑜𝑚𝑝𝑎𝑛𝑖𝑒𝑠 𝑖𝑠 𝑟𝑒𝑙𝑎𝑡𝑒𝑑 𝑡𝑜 𝑡ℎ𝑒 𝑎𝑑𝑜𝑝𝑡𝑖𝑜𝑛 𝑜𝑓 𝑡𝑎𝑘𝑒𝑜𝑣𝑒𝑟 𝑑𝑒𝑓𝑒𝑛𝑠𝑒𝑠 And: 𝐻000: 𝑇ℎ𝑒 𝑟𝑒𝑙𝑎𝑡𝑖𝑣𝑒 𝑣𝑎𝑙𝑢𝑒 𝑔𝑎𝑝 𝑖𝑛 𝑚𝑎𝑟𝑘𝑒𝑡 𝑡𝑜 𝑏𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑏𝑒𝑡𝑤𝑒𝑒𝑛 𝑡ℎ𝑒 𝐷𝑢𝑡𝑐ℎ 𝑝𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑎𝑛𝑑 𝑖𝑡𝑠 𝑝𝑒𝑒𝑟 𝑝𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑖𝑠 𝑛𝑜𝑡 𝑟𝑒𝑙𝑎𝑡𝑒𝑑 𝑡𝑜 𝑡ℎ𝑒 𝑎𝑑𝑜𝑝𝑡𝑖𝑜𝑛 𝑜𝑓 𝑡𝑎𝑘𝑒𝑜𝑣𝑒𝑟 𝑑𝑒𝑓𝑒𝑛𝑠𝑒𝑠 𝐻111: 𝑇ℎ𝑒 𝑟𝑒𝑙𝑎𝑡𝑖𝑣𝑒 𝑣𝑎𝑙𝑢𝑒 𝑔𝑎𝑝 𝑖𝑛 𝑚𝑎𝑟𝑘𝑒𝑡 𝑡𝑜 𝑏𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑏𝑒𝑡𝑤𝑒𝑒𝑛 𝑡ℎ𝑒 𝐷𝑢𝑡𝑐ℎ 𝑝𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑎𝑛𝑑 𝑖𝑡𝑠 𝑝𝑒𝑒𝑟 𝑝𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑖𝑠 𝑟𝑒𝑙𝑎𝑡𝑒𝑑 𝑡𝑜 𝑡ℎ𝑒 𝑎𝑑𝑜𝑝𝑡𝑖𝑜𝑛 𝑜𝑓 𝑡𝑎𝑘𝑒𝑜𝑣𝑒𝑟 𝑑𝑒𝑓𝑒𝑛𝑠𝑒𝑠

These hypotheses will be statistically and economically tested and challenged in Chapter 3 and 4.

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3. Data & Methodology

Starting point for the empirical study in this research are the findings of Kabir (1997) on wealth effects caused by the announcement of takeover defenses. The first part of the statistical analysis will be in line with this approach using the conventional event study methodology. For two samples of news events, the deviation of actual stock returns from expected stock returns will be investigated. The second statistical approach will examine the relationship between the market to book value and the adoption of takeover defenses. A sample of listed Dutch companies will be constructed to test for this relation. In addition, the portfolio of listed Dutch companies (operating under civil law) will be matched with peers from the United Kingdom (operating under common law) to test whether the deviation between their corresponding market to book values is caused by having an anti-takeover strategy. Taking Tobin’s Q as dependent variable, the independent explanatory variables will consist of several dummies for protection level together with a few selected control variables. In the following sections the applied datasets and methodologies will be further elaborated, the empirical results will be presented in Chapter 4.

3.2 Statistical analysis I – event study

To find statistical evidence whether shareholders experience a short term wealth effect when news on takeover defenses is announced, the event study methodology is used. Two types of news effects will be investigated: a sample of events announcing the actual use of a defense mechanism (preferred shares), and a sample of events announcing the dismantle of takeover defenses. Indirectly, the latter will provide insight for a wealth effect on having an anti-takeover strategy. Rationale behind the analyses is the assumption that the actual use of takeover defenses is disapproved by the shareholders, reflecting in an (abnormal) stock price decrease consistent with the findings of Kabir (1997). As discussed in the previous chapter, it may cause a disturbing effect within the corporate governance structure. The expected wealth effect for dismantles of takeover defenses cannot be predefined, given the different outcomes by Van Heel (2001) for different levels of protection. In the previous chapter, the following hypotheses have been derived for this analysis:

𝐻𝑜: 𝑇ℎ𝑒 𝑎𝑛𝑛𝑜𝑢𝑛𝑐𝑒𝑚𝑒𝑛𝑡 𝑜𝑓 𝑡𝑎𝑘𝑒𝑜𝑣𝑒𝑟 𝑑𝑒𝑓𝑒𝑛𝑠𝑒𝑠 𝑑𝑜𝑒𝑠 𝑛𝑜𝑡 𝑝𝑟𝑜𝑣𝑖𝑑𝑒 𝑎𝑛 𝑎𝑏𝑛𝑜𝑟𝑚𝑎𝑙 𝑟𝑒𝑡𝑢𝑟𝑛 𝑖𝑛 𝑡ℎ𝑒 𝑒𝑣𝑒𝑛𝑡 𝑝𝑒𝑟𝑖𝑜𝑑

𝐻1: 𝑇ℎ𝑒 𝑎𝑛𝑛𝑜𝑢𝑛𝑐𝑒𝑚𝑒𝑛𝑡 𝑜𝑓 𝑡𝑎𝑘𝑒𝑜𝑣𝑒𝑟 𝑑𝑒𝑓𝑒𝑛𝑠𝑒𝑠 𝑑𝑜𝑒𝑠 𝑝𝑟𝑜𝑣𝑖𝑑𝑒 𝑎𝑛 𝑎𝑏𝑛𝑜𝑟𝑚𝑎𝑙 𝑟𝑒𝑡𝑢𝑟𝑛 𝑖𝑛 𝑡ℎ𝑒 𝑒𝑣𝑒𝑛𝑡 𝑝𝑒𝑟𝑖𝑜𝑑

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 Step 1

Compose a dataset of news events around takeover defenses for Dutch listed companies;

 Step 2

Find the exact event date for each announcement to capture the true causal effect;

 Step 3

Calculate the cumulative average abnormal returns for all stocks and perform a t-test to reject or accept the null hypothesis.

The data and methodology will be further explained in the following sections.

3.2.2 Dataset

The news events used in the dataset for this study are chosen from the period after the year of Kabir’s latest event study for Dutch listed firms (1997). It is crucial to identify the exact announcement date for an event study to capture the true impact of the analyzed effect (Coates, 1999). Unfortunately, not all exact announcement dates could have been identified for the events in the beginning of this century. The number of observations in this study is therefore relatively small. Nevertheless, two useful samples have been constructed as shown in Table 4. The first sample shows companies issuing preferred shares in the heat of takeover activity. The second sample consists of companies announcing a dismantle of their takeover defenses. The companies are distributed among a broad range of industries and are part of the three major indices of the Dutch stock market: AEX (4), AMX (5) and ASCX (6).

Table 4

Table: Announcement date of takeover defenses used and dismantled

3.2.3 Methodology

As discussed in Chapter 2, the conventional event study method has been widely applied to test for abnormal returns around announcements of takeover defenses. The purpose of this method is to estimate the deviation of actual stock returns from expected stock returns and

Company Used defense mechanism Announcement date Company Used defense mechanism Announcement date HBG Preferred shares 28/02/2000 Wessanen Certificates 11/04/2005 STORK Preferred shares 20/12/2006 Wolters Kluwer Certificates 12/12/2005 ASMI Preferred shares 15/04/2008 ASML Holding Priority shares 18/01/2006 KPN Preferred shares 29/08/2013 Neways Electronics Priority shares 04/12/2006 Corbion Certificates 19/12/2006 MTY Holdings Certificates 08/04/2011 Vastned Retail Priority shares 14/10/2011 NSI Priority shares 13/12/2011 Grontmij Certificates 28/03/2012 Wereldhave Priority shares 28/02/2014 Announcements of takeover defenses dismantles Announcements on used takeover defenses

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to test whether these are significantly different from zero. The event study in this analysis is based on the approach as described by MacKinley (1997).

First, the expected stock return is estimated via the Market Model formula: 𝑅_𝑖,𝑡 = 𝛼_𝑖+ 𝛽_𝑖𝑅_𝑚,𝑡+ 𝑒_𝑖,𝑡

Where:

𝑅𝑖,𝑡 = Continuously compounded return of stock i in period t

𝑅𝑚,𝑡 = Continuously compounded market return of stock i in period t

𝛼𝑖, 𝛽𝑖 = Stock specific and time independent parameters of stock i

𝑒𝑖,𝑡 = The error term of stock i in period t

The period for estimating the parameters of the Market Model presented above is set as the period of 200 days before the start of the event period. The event period itself covers 20 days before the announcement until 20 days after the announcement. The impact of the news events is measured over several event windows within this time period. The defined event windows are equal to those used by Kabir (1997), in order to compare the direction of the outcomes between these studies. To calculate the market returns a single market portfolio needs to be selected against which all beta’s are estimated. The AEX index is the largest Dutch stock index and is therefore chosen as the market portfolio. To check the robustness of these outcomes the beta’s have also been estimated against the Dutch

Allshare index, as shown in Table 5. The beta’s are estimated via time series OLS

regression analysis (see section 3.3.3 for more background on OLS regression analysis). Since the estimated beta for MTY Holdings is not significant at a 10% confidence level for both indices, MTY Holdings is excluded from the sample.

Table 5

Table: Estimated beta’s for AEX-index and Allshare-index

Beta Prob. Beta Prob. Beta Prob. Beta Prob.

HBG 0.27 0.05 0.27 0.07 Wessanen 0.32 0.04 0.33 0.04

Stork 0.76 0.00 0.84 0.00 Wolters Kluwer 0.87 0.00 0.88 0.00

ASMI 0.98 0.00 1.04 0.00 ASML Holding 1.31 0.00 1.26 0.00

KPN 1.29 0.00 1.40 0.00 Neways Electronics 0.70 0.00 0.80 0.00 Corbion 0.59 0.00 0.62 0.00 MTY Holdings -0.20 0.19 -0.20 0.20 Vastned Retail 0.70 0.00 0.73 0.00 NSI 0.42 0.00 0.48 0.00 Grontmij 1.03 0.00 1.10 0.00 Wereldhave 0.74 0.00 0.83 0.00

Announcements on used takeover defenses Announcements of takeover defenses dismantles

AEX-index Allshare-index AEX-index Allshare-index

(28)

Next step is to calculate the abnormal return. The abnormal return is the difference between the actual return during the event period and the return predicted from the estimation period:

𝐴𝑅_𝑖,𝑡= 𝑅_𝑖,𝑡− 𝛼̂_𝑖,𝑡− 𝛽̂_𝑖,𝑡𝑅_𝑚,𝑡

The abnormal returns are averaged across all stocks to get average abnormal returns for each day. To obtain cumulative average abnormal returns (CAAR), the abnormal returns are aggregated over different time intervals around the announcement date. For the aggregation it is assumed that there is no overlap among the event windows. If there is overlap, the event returns would influence the estimated normal returns. In other words, both the normal returns and the abnormal returns would then capture the event impact. This violates the underlying assumption that the abnormal returns and cumulative abnormal returns are independent across securities. Since there is overlap between event windows in the second sample for 2005 (ASML and Wolters Kluwer) and 2006 (Neways and Corbion), either one of the overlapping stocks will be dropped out the sample to eliminate this effect. Finally, a t-test is performed to test whether the abnormal returns are significantly different from zero. Under the null hypothesis for the t-test, the abnormal returns will be jointly normally distributed with zero mean and zero variance. The t-value is calculated by dividing the CAAR by its standard deviation calculated from the estimation period (standard error of the regression) multiplied by the length of the event window. When the t-value shows a significant value, the event does have impact on the behavior of returns. This could imply supporting evidence for existence of the Dutch Discount phenomenon.

The empirical outcomes of the event study will be presented and interpreted in Chapter 4, in the following section the second statistical analysis will be introduced.

3.3 Statistical analysis II – market to book value analysis

As mentioned in the introduction of this chapter, the second statistical approach investigates the relation between market to book value (measured by Tobin’s Q) and the amount of protection from having takeover defenses. The approach in this analysis differs from previous studies by Roosenboom (2003) and McWilliams (1993) since the causality will be investigated for a portfolio of listed companies (instead of IPO firms) and by performing a comparison with a foreign peer group portfolio. Following the theory on legal origin to this matter (La Porta, 2008), the peers are selected from a (single) common law jurisdiction. The United Kingdom is chosen as peer group home country since takeover defenses are practically non-existent among British companies. Even stronger, Seretakis (2013) states that the United Kingdom has been a pioneer in adopting and promoting an absolute ban on takeover defenses across Europe. The United States has also been considered as peer

Dutch discount, does it exist? : to what extent do investors discount Dutch firm values for the level of anti-takeover defense mechanisms?