Defensive mechanisms in mergers and acquisitions and their
effect on target firm performance
21-09-2012 Master Thesis
S.C. Bruijnis <stephanbruijnis@gmail.com> s2045184
Business Administration – Strategy & Innovation Rijksuniversiteit Groningen
2
Abstract
This thesis studies the effects of defensive mechanisms on target firm performance in the US. This study proposes a series of factors that try to make the impact of defensive mechanisms on target firm performance predictable. This research is based upon the theory of Sudarsanam (1995) on
management entrenchment and shareholder interests. It is directed at gaining understanding of when defensive mechanisms are enhancing or detracting value instead of if they are, which follows the debate described by Sundaramurthy (2000). This study made use of the event study theory proposed by Brown and Warner (1985). The results indicate that successfully defending the target firm does not depend on the number of defences employed, but on which are deployed and in which combination. Defences do achieve, in general, higher target firm performance, although target firms that are successfully defended are not able to sustain these gains. Finally, it was found that target firm performance is not driven by certain types of defences, but merely by the way defences interact and are combined. This is an important conclusion, given the lack of consistent and strong results on defensive mechanisms and their performance.
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Table of contents
1 INTRODUCTION ... 4 1.1 Background ... 4 1.2 Problem definition ... 4 1.3 Research question ... 5 1.4 Paper content ... 5 2 LITERATURE REVIEW ... 62.1 The market for corporate control ... 6
2.2 Value creation through mergers and acquisitions... 6
2.3 Hostile takeover outcome ... 7
2.4 Target firm performance... 7
2.5 Management entrenchment versus shareholder interests ... 8
2.6 Defensive mechanisms ... 9
3 DATA, SAMPLE AND METHODOLOGY... 15
3.1 Sample selection ... 15 3.2 Variable description ... 15 3.2.1 Independent variables ... 15 3.2.2 Dependent variables ... 16 3.2.3 Control variables ... 17 3.3 Model specification ... 18
3.3.1 Testing linear regression assumptions ... 19
4 EMPIRICAL RESULTS ... 21
4.1 Descriptive and sample statistics ... 21
4.1.1 Sample statistics ... 22
4.1.2 Descriptive statistics ... 22
4.2 Hypothesis One: On probability of takeover completion ... 23
4.3 Hypothesis Two: On target firm performance ... 24
4.4 Hypothesis Three: On shareholder approval and enhancing value ... 25
4.5 Hypothesis Four: On pre offer en post offer defences ... 25
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1 Introduction
1.1 BackgroundMerger activity and defensive mechanisms have been subject of considerable research and debate, because it is thought to influence both the level of economic wealth and its distribution. Mergers and acquisitions are observed in waves, literature explains this observation with the disturbance theory. Economic, technological (Gort, 1969), regulatory and macroeconomic shocks (Michell & Mulherin, 1996) create merger responses. Defence mechanisms in merger and acquisitions refer to takeover defences and anti-takeover provisions. The academic view on takeover defences is dim and built on the belief that defences reduce firm value (Coates, 2000). The reduction of firm value is based on a simple application of agency theory; in which defences increase agency costs and hinder the market for corporate control to improve performance. Academic studies on hostile takeovers show mixed evidence on performance and value creation. A takeover is considered hostile when it is unsolicited and resisted by target management. Although M&A hostility has been decreasing in the United States it is increasing in Europe (Moschieri & Campa, 2009), which makes this study an interesting and relevant topic. Defensive strategies aim at staying independent and repel potential acquirers, but their impact on future performance of the target firm is disputed. The goal of this study is to examine the defensive behaviour of target firms and the impact of different defensive mechanisms on the performance of the firm.
1.2 Problem definition
Value creation and destruction through mergers is an extensively debated subject in literature, the prevailing sentiment is that on average the impact of an M&A on the firm is at best inconclusive (Roll, 1988; Haspeslagh & Jemison, 1991; Sirower, 1997), and at worst systematic[ally] detrimental
5 1.3 Research question
The goal of this research is to examine defensive mechanisms in mergers and acquisitions and their effect on target firm performance. The role of different defensive mechanisms on the creation of shareholder wealth (stock price effect) is measured for each mechanism. Furthermore, this research will look at the deal outcome (completed versus withdrawn) to investigate the effects of defensive mechanisms. This is translated in the following research question:
What is the effect of defensive behaviour on the subsequent performance of the target firm?
Defensive behaviour can occur in different stages of the fight for corporate control, pre-offer defences are to protect the firm and discourage hostile bidders, while post-offer defences are more targeted at the specific bidder. Available defensive mechanisms are often subjected to shareholder approval and regulatory regimes. Poison pills, also known as shareholder rights plans, received the most attention in literature but is only one of the few strategies a firm can employ to defend itself against hostile
takeovers. In this study various mechanisms will be researched, therefore the literature review will include the various strategies observed.
The presence and use of defensive mechanisms may provide protection against hostile bids, but does not by definition increase firm value. In academic literature, the resistance by target management against a hostile takeover has been interpreted in two ways: the management entrenchment hypothesis and the manager-shareholder alignment hypothesis, also known as the shareholder interests
hypothesis. The first theory, on management entrenchment, is mostly based on the agency cost theory in which defensive mechanisms increase costs and managers act out of self-interest, and thus destroy firm value. The second hypothesis, on shareholder interests, is mainly positioned around the argument that defensive mechanisms provide negotiation power and thus lead to a better deal. To assess the effect of defensive mechanisms we will compare the actual target firm stock prices against the expected stock prices.
1.4 Paper content
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2 Literature review
2.1 The market for corporate control
The market for corporate control refers to the disciplining role of the market on managers (Faleye, 2004; Jensen & Ruback, 1983). Managerial teams compete for the right to manage corporate resources (Jensen & Ruback, 1983). According to Manne (1965) the mechanism of corporate control has two elements: Firstly, competing managerial teams monitor performance of the management, which serves as a threat, encouraging value maximizing behaviour. Secondly, an actual takeover if threat of a takeover is not sufficient. The bidder takes control over the firm and corrects its behaviour in order to maximize value. According to the market of corporate control poor performance relative to the firm’s potential will cause share prices to drop and makes the firm vulnerable to takeovers (Dayha & Powell, 1998). In principle the means of control over corporations are exchanged when large enough blocks of shares are traded. Takeovers are viewed as a method of external corporate control to discipline
managers of firms and allow for competition from alternative managerial teams to act in the best interests of shareholders. This view fits with the two broad motives for mergers and acquisitions: either to achieve synergies or to discipline target firm’s managers (Martin & McConnell, 1991). The mechanisms for corporate control through takeovers exist of merger, tender offer, proxy contest or a combination of these elements (Manne, 1965; Jensen & Ruback, 1983). Manne (1965) views the market of corporate control as a useful mechanism to give shareholders both power and protection proportionated to their interest in the firm.
2.2 Value creation through mergers and acquisitions
7 2.3 Hostile takeover outcome
The reaction of the target management on the bid is very important to its outcome. If the bid is resisted by the incumbent management the probability of completion is adversely affected (Wong &
O’Sullivan, 2001). A study by Jenkinson and Meyer (1991) showed that 26% of takeover bids were resisted by the incumbent target management in the period between 1983 and 1989, in a study for the period 1989-1995 O’Sullivan and Wong (1998) found similar results; 26% of the takeover bids were resisted. For hostile bids percentages are even higher; 45% of hostile bids in the period 1989-1993 were resisted (O’Sullivan & Wong, 1999). The probability for completion of a takeover is estimated 0.958 for an unopposed friendly bid compared to 0.609 for a bid which is opposed by target
management (Holl & Kyriazis, 1996). Resistance to a bid makes a firm harder to take over (Ruback, 1988). Evidence on the effect of takeover defences on bid outcome, when only hostile and unsolicited deals are considered, should be found by looking at the number of completed and withdrawn bids. Based on literature this study predicts:
Hypothesis 1a: Defended takeover attempts are less likely to be completed than undefended takeover attempts.
and:
Hypothesis 1b: The probability of a completed takeover is lower for extensively defended firms than for lightly defended firms.
2.4 Target firm performance
Resisting a takeover may lower the probability of completing the takeover; theory suggests it also may increase the offer price and further performance of the target firm (Jensen & Ruback, 1983). Three theories indicate that a hostile takeover bid might lead to improved target firm performance: (1) it gives managers the incentive to improve performance; (2) the bid process revealed unknown
information and/or firm had hidden values; (3) the company is considered to be a bid prospect in the future (Parkinson & Dobbins, 1993; Ruback, 1988). The study of Parkinson and Dobbins (1993) on the returns of successfully defended firms showed that target firms were able to sustain abnormal positive returns after resisting a takeover. Hypothesis 2 predicts, based on this observation, an increase in performance for firms that stay independent:
8 Furthermore, incumbent managerial teams have an advantage if a bid is contested; they can employ defensive mechanisms to stay in power and finance the bulk of their proxy solicitation costs from corporate funds, the outsider will only benefit if he wins (Manne, 1965; Mahle, 1990). As a result outsiders are determined to win once a fight is waged.
2.5 Management entrenchment versus shareholder interests
The resistance of target management has been interpreted in two opposing ways in the literature (Ruback, 1988; Sundarsanam, 1995). “It may manifest either manager-shareholder alignment or management entrenchment” (Sudarsanam, 1995, p.223).
According to the manager-shareholder alignment-view the target management acts in the interests of its shareholders and is directly related to the principle of maximizing shareholder wealth (Ruback, 1988; Sudarsanam, 1995). An extension of this view is that defensive mechanisms benefits shareholders, by negotiating and ensuring a fair price. This view is called the shareholder interests hypothesis and has been supported in studies by Grossman and Hart (1980), Knoeber (1986), Scherer (1988) and Stein (1988). The impact of the shareholder interests hypothesis is founded on four arguments (Berkovitch & Khanna, 1990; Harris, 1990; Knoeber, 1986); (1) defensive mechanisms create an incentive for incumbent managers to make human capital and firm-specific investments, critical to long-term performance; (2) defensive mechanisms make it more likely that managers invest in long-term projects, which enhance long run shareholder value, instead of short term results and investments in fending off threats (Pugh et al., 1992; Stein, 1988); (3) defensive mechanisms provide the target management negotiating power to appropriate higher gains (DeAngelo & Rice, 1983; Harris, 1990; Mahoney & Mahoney, 1993) and allows collective decision making which is often better than individual decision; it avoids the prisoners dilemma; (4) defensive mechanisms, in specific ‘Golden Parachutes’ provide more objectivity allowing managers to align with the shareholders since they have less incentive to protect their own position (Sundaramurthy, 2000).
The management entrenchment hypothesis is generally used to explain the unilateral adoption of defensive mechanisms by the target management (Daines & Klausner, 2001; Jarrell et al., 1988). The target management resists a bid, although the bid might be in the interests of the shareholders
9 costs associated with the defensive actions. These costs often outweigh the benefits of potentially higher premiums (Manne, 1965; Williamson, 1975). Additional veto power (and other defensive mechanisms) for incumbent managers can lead to two types of undesired managerial behaviour: risk aversion and featherbed. The latter, refers to neglecting responsibilities to shareholders without the threat of being replaced (Sundaramurthy, 2000). Risk aversive behaviour can enhance short-term earnings but may reduce long-term firm value (Comment & Schwert, 1995; Stein, 1988). Anti-takeover defences do not completely protect the firm from Anti-takeovers but typically increase bidder’s costs attempting a takeover, reducing the probability of a valuable takeover offer (Ambrose &
Megginson, 1992; Borokbovich et al., 1997; Pound, 1987; Sundaramurthy, 2000). It is thus argued that defensive behaviour reduces the effectiveness of the market for corporate control and therefore
reduces shareholder value (Sundaramurthy, 2000).
Some harmful defensive mechanisms can be blocked by voting rights, therefore this study will
distinguish between two broad categories of defensive measures those receiving approval by voting of shareholders, i.e. shareholder interests, and those adopted unilaterally by management, i.e.
management entrenchment (Jarrell et al., 1988).
In sum, empirical studies indicate that defensive mechanisms where no shareholder approval is required and non-fair price provisions have a negative impact, while fair price provisions and provisions that require shareholder approval are less harmful and in the interests of the shareholders (Sundaramurthy, 2000; Walsh & Seward, 1990). The third hypothesis tests this prediction:
Hypothesis 3: Defensive mechanisms that require shareholder approval enhance more shareholder value than those which do not require shareholder approval. Although some of the variation between empirical studies can be explained by factors such as; the choice of the event date, the event window and sample periods, there is still research gap on when value is created. The focus on when defensive mechanisms increase or decrease shareholder value is recognized as the next step in understanding defensive mechanisms in mergers and acquisitions. The entrenchment and shareholder interests hypotheses try to create an understanding on when defensive mechanisms enhance value.
2.6 Defensive mechanisms
10 literature went to the poison pill defence, caused by its dramatic, ominous character and fast rise in popularity during the 1980’s (4th merger wave). Ruback (1988) organized defensive strategies into pre-bid en post-bid categories, the first incorporates defences that are protecting the firm and
managerial team in anticipation of a takeover bid, the latter can include pre-bid strategies but also new defensive mechanisms directed at specific bidders. Pre-offer defences are defences to discourage hostile bidders from attacking the firm and are rather the rule than an exception (Gorzala, 2010). The study of Brickley et al. (1994) found evidence that the stock market can assess the likelihood that the board will resist takeover offers. In the case of pre offer defences the market can already suspect management resistance, while post offer defences are less predictable. Thus, the market anticipation on the likelihood that the management will resist an offer is already the largest for pre offer defences. Hypothesis 4 predicts that these defences will benefit the target firm performance the most:
Hypothesis 4: Pre offer defences are expected to enhance target firm performance more than post offer defences.
11 Table 1a. An overview of pre-offer defensive strategies
Defensive strategy Description Impact Shareholder
approval Stock price effect Potential effectiveness Popularity
Anti-takeover charter amendments and bylaws Staggered board
(i.e. classified board)
Board is classified into three equal groups. Only one group is elected each year. 1
Bidder cannot obtain control of the target immediately after a majority of shares. 1
Required 1 -1% 1,2 Moderate 1 Unknown
Super majority For reaching an approval of a merger a high percentage of shares are required. Typically 80%.
An increase in the number of shares that is needed to obtain control of the target in hostile takeover situations. 1
Required 1 -5% 1,2 Mild 1 Medium 6
Fair price All shareholders must receive a uniform, fair price.
Prevents two-tier takeovers offers.
Required -1% Mild High 6
Dual class recapitalization
Distributes a new class of equity to
shareholders with superior voting rights but inferior dividends or marketability. Allows shareholders to exchange the new shares for ordinary common stock. 1
Allows incumbent managers to obtain a majority of votes without owning a majority of the common stock. 1
Required 1 2% 1,4 Severe 1 Medium 6
Restricted voting rights
Shareholders who own more than a specified stake in the target company have no voting rights, unless approved by the targets board. 7
It is more difficult to obtain a large stake in the target within a relative short period of time. 7
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Other shark repellents Poison pill (i.e. shareholder rights plan)
Flipover poison pill Flipin poison pill Poison put (i.e. backend poison pill)
Rights to preferred stock issued to
shareholders. Rights can be exercised after a tender offer or the accumulation of a large block of shares by an outside party. In flip-over plans exercised rights are repurchased by the issuing firm at a substantial premium. The bidding firm or large shareholder is excluded from the repurchase. 1
Makes hostile tender offer prohibitively expensive. 1
Not required 1 N/A 1,3 Severe 1,5 High 6,5
Golden parachute Compensation package arranged for the managerial team or select group of executives.
Makes hostile tender offer more expensive and requires higher cash payments
Not required (required by SEC as of
2011) 7
Negligible Low 5 Medium 5,6
1
SeeGorzala (2010) and Ruback (1988).
2
See DeAngelo and Rice (1983), Linn and McConnell (1983), and Jarrell and Poulsen (1987).
3
See Malatesta and Walkling (1988), Kidder, Peabody (1986), and Securities and Exchange Commission [SEC] (1986).
4
See Partch (1987).
5
See Pearce and Robinson (2004).
6
See Loh and Rathinasamy (1997).
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13 Table 1b. An overview of post-offer defensive strategies
Defensive strategy Description Impact Shareholder
approval Stock price effect Potential effectiveness Popularity Targeted repurchase Greenmail Leveraged recapitalization
Repurchase of block of shares held by a shareholder, usually at a premium. 1 Greenmail is repurchases of shares from bidder. In the case of leveraged
recapitalization huge debts are made to repurchase shares
Eliminates potential bidder. 1 Makes the target less
attractive.
Not required 1
-3% 1,2 Medium Medium 7
Standstill agreement Limits ownership by a given firm for a specified time period. May include an agreement with a large shareholder to vote holdings with the board. 1
Eliminates a potential bidder1 Not required 1
-4% 1,3 Low 6 Low 6,7
Litigation Suit filed against bidder for violating antitrust or securities laws. 1
Delays bidder 1 Not
required
0% 1,4 Low Medium
Asset restructuring Scorched earth / Crown jewel defence
Assets bought that a bidder does not want or that will create antitrust problems. Assets sold that the bidder wants 1 (crown jewel defence refers to selling an essential asset(s) or all valuable assets to a neutral third party.)
Makes the target less valuable
1
(and less attractive to the bidder)
Not required
14 Liability restructuring
White squire White knight
Shares issued to a friendly third party or number of shareholders increased. Shares repurchased at a premium from existing shareholders.1 (White squire buys significant minority share, while a white knight actually buys a majority interest)
Makes it more difficult to obtain the number of shares required for a hostile bidder to achieve control. 1 Leads to a better negotiated deal or a bidding war. White knights are friendly takeovers.
Required -2% 1,5 N/A N/A
Pac man defence Target firm makes a counteroffer to acquire the bidder.
Attempt to turn the tables. Required N/A N/A N/A
Suicide pill Extreme version of poison pill, targeted repurchases and assets restructuring
Might ruin the firm and makes it less valuable and attractive.
Not required 1
N/A N/A N/A
Lockup agreement Option granted by the target firm to a friendly buyer to purchase stock.
Delays bidder and reduces volatility of shares
Required N/A N/A N/A
1
SeeGorzala (2010) and Ruback (1988).
2
See Dann and DeAngelo (1983), Bradley and Wakeman (1983), and Mikkelson and Ruback (1985, 1991).
3
See Dann and DeAngelo (1983).
4
See Jarrell (1985).
5
See Dann and DeAngelo (1988).
6
See Pearce and Robinson (2004).
7
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3 Data, Sample and Methodology
3.1 Sample selectionTo test the hypotheses of defensive mechanisms on target firm performance; deal specific data is retrieved from the Thomson Financial SDC Merger and Acquisition database. The sample is obtained on the following conditions: (1) the deal is announced between 1 January 1977 and 1 June 2012; (2) the deal attitude is hostile or unsolicited; (3) the target firm status is public; (4) the target is located in the United States; (5) the target firm survives for the duration of the event window; (6) variables needed to run the analysis are not missing. The firm specific data was retrieved from DataStream; this includes data such as share prices, return index, market capitalization and the Tobin’s Q, but also the S&P500 composite market return index. The selection process produced 961 M&A observations.
3.2 Variable description 3.2.1 Independent variables
The following variables were used as independent variables to analyse the effect of defensive mechanisms:
Defended: A variable which flags whether the target firm resisted the takeover attempt (1= defended, 0=not defended).
Ranking: A count of the different defences employed by the target firm to fend off the acquirer.
Management Entrenchment: A variable which flags if the dominant board enacted behaviour is categorized as management entrenchment (=1, 0=not management entrenchment).
Shareholder Interests: A variable which flags if the dominant board enacted behaviour is categorized as shareholder interests (=1, 0=not shareholder interests).
Pre offer: A variable which flags if the dominant employed defences are categorized as pre offer defences (=1, 0=not pre offer or not defended).
Post offer: A variable which flags if the dominant employed defences are categorized as post offer defences (=1, 0=not post offer or not defended).
Dominance is determined by looking at the majority of defences; e.g. when the majority of employed defences are labelled as management entrenchment, the deal was categorized as management
16 Furthermore, the defensive mechanisms are included. Each of the following variables are used as individual dummy variables: (1) asset lockup; (2) backend poison pill; (3) flip-over poison pill; (4) greenmail; (5) target owns lockup; (6) lockup granted; (7) pac man; (8) poison pill (shareholder rights plan); (9) recapitalization; (10) targeted repurchases; (11) scorched earth; (12) self-tender; (13) stock lockup; (14) voting plan; (15) white knight; (16) white squire.
3.2.2 Dependent variables
Firm performance is expressed as a function of the share price reaction to the event, also known as the cumulative abnormal return (Dodd & Ruback, 1977). In this study the cumulative abnormal return (CAR) is used as the dependent variable. The CAR is based upon the return index to adjust the share price reaction for dividends and stock splits.
Modelling firm performance
The structure of the event study is based on the market model proposed by Fama (1976) and work of Brown & Warner (1985) on measuring excess returns. The bid announcement dates are identified as the event of interest (day 0) and the period over which security returns are examined are labelled as the estimation window and the event window. Figure 1 depicts both time periods. The event window is chosen to cover the market anticipation of defensive mechanisms. Additional event windows for robustness are added in the appendices. Only trading days are counted as days in both windows.
Figure 1. Time line of Cumulative Abnormal Returns
The share price reaction and firm performance are measured, on a number of assumptions discussed in the next subchapter (3.3.1. Testing linear regression assumptions), using the market model. The share price effect is a cumulative calculation of the abnormal returns (AR), which is defined as the difference between the actual realized (R) and the expected returns (ER).
(1)
For i being firms security and t being the time period. The expected returns are calculated with the Fama-French model by employing an ordinary least squares (OLS) regression:
̂ ̂ ̂ (2)
Announcement Date
0
-250 days -60 days -10 days +10 days
Event Window Estimation
17 Where Ri,t is the return on the firm i’s securities in time period t, Rm,t is the market return in the time
period t. The term ̂ is the intercept coefficient for firm i’s securities, ̂ is the slope coefficient, a measure of systematic risk of i’s securities and ̂ is firm i’s error term. The market return is based on the S&P500 composite index and serves as a benchmark. With these OLS values from the estimation period, the abnormal returns for the event period can be calculated.
– ̂ – ̂ (3)
The time period used in this OLS regression is the event window, returning the abnormal return (AR) for firm i. Where is Ri,t is the actual return for firm i in period t, and Rm,t is the market return in t. The
total share price reaction to an event can be obtained by cumulating the abnormal return per firm. ∑
(4)
Where t1 is the start (-10 days) and t2 the end (+10 days) of the event window. The cumulative abnormal returns provide a measurement of the firm’s performance. Although informative the CAR is not sufficient for hypotheses testing.
3.2.3 Control variables
The literature study shows that firm and deal specific variables affect M&A behaviour and M&A performance (Coates, 2000; Sudarsanam, 1995). In the context of anti-takeover defences, the following control variables are included:
Tobin’s Q: The Tobin’s Q is calculated with the following formula: (Equity Market Value + Liabilities Book Value) / (Equity Book Value + Liabilities Book Value). Each element is made available and defined by DataStream. Servaes (1991) found that, in general, the shareholders of low q targets benefit more from takeovers than the shareholders of high q targets. Furthermore Lang et al. (1989) provided evidence that suggests that lower q firms are more likely to have entrenched management.
18
Relative size: See market capitalization. Relative size controls for the relative size, calculated as: Transaction Value / Market Capitalization, as defined by Moeller et al. (2004).
Relatedness: Datta and Puia (1995) argued that whether the acquisition is horizontal, vertical or conglomerate may impact the level of abnormal returns of the target.
Cross-border: In a study on US targets Wansley et al. (1983) found that targets gain more in cross-border than in domestic acquisitions. Additionally, Danbolt (2004) showed in an UK study that significant more gains are made with cross-border than domestic acquisitions during the months surrounding the bid. However, a study by Goergen and Renneboog (2004)
contradicts these results by showing that domestic acquisitions trigger higher wealth effects than cross-border ones.
Withdrawn: According to Parkinson and Dobbins (1993), target shareholder returns show substantial gains in successfully defended acquisitions. The study found evidence for abandoned targets retaining their bid-related returns, which conflicts with Wong and O’Sullivan (2001, 2003) and Fabozzi et al. (1988) stating that all bid-related returns of the target vanishes once the offer was cancelled suggesting that the market reacts quickly to failure.
3.3 Model specification
The market anticipation of defences is tested with OLS regressions. The flow of analysis is first to run univariate, then multivariate and finally interaction regressions. The general formula for univariate regression is:
(5)
Where INDEPENDENT can be replaced with any of the discussed independent variables. The general regression model for multivariate regression, which includes control variables, is:
(6)
This model allows the use of one or more of the discussed control variables. The general formula for interaction regressions is defined as follows:
19 The interaction model can be used as univariate regression for both univariate and multivariate
regressions. The interaction variable acts as an independent variable and additional control variables can be added to the model.
3.3.1 Testing linear regression assumptions Assumption 1: Normal Distribution
To test for normality the Shapiro-Wilk test is used. It tests if the dependent variable is normally distributed. The null hypothesis is that the data is normally distributed. The Shapiro-Wilk test of the cumulative abnormal return revealed a small probability (Prob>z of 0.00) rejecting the null hypothesis. A departure from normality compromises the reliability of the estimated coefficients; this effect will be taken into account in the results section.
Assumption 2: Homoscedasticity
To test for homoscedasticity the Breusch-Pagan / Cook-Weisberg test is used. It tests if the variance around the regression line is the same for all values of the independent variable. The null hypothesis is that data is homoscedastic. The tests determine if ordinary least squares estimates of the variance (and, thus, standard errors) are biased, giving too much weight to certain subsets. An unbiased estimate, H0
accepted, for the relationships between the CAR and these independent variables were found: (1) defence, (2) management entrenchment, (3) pre offer and (4) post offer. The variables (5) ranking and (6) shareholder interests showed little heteroscedasticity, Which can be explained by large differences among the number of observations in each subset. The model is adjusted to account for
heteroscedasticity. Heteroscedasticity-robust standard errors are used for the applicable variables. Fox (1997) and Mankiw (1990) describe the effect of heteroscedasticity as not dramatic and only worth fixing if it is severe.
Assumption 3: Errors are independent
20 were collected, this impacts the observed value. The calculated Durbin-Watson value equals 1.10. Values well below 1.0 indicate structural problems, while this value indicates room for improvement of the model. From the table in Gujarati (2004, p. 970) can be derived that anything below 1.748 falls into the rejection region, suggesting positive autocorrelation. But, since the data is not truly time-series, it was expected to be observed closer to zero than usual. A visual check, using a scatterplot of the residuals versus the time variable, showed linear fit with a straight horizontal line, which indicates independent errors.
Assumption 4: Relationships are linear
21
4 Empirical results
4.1 Descriptive and sample statistics
Table 2. Descriptive statistics and relationship between the event windows
Variable Observations Mean Std. Dev. Min Max
related 959 0.3868613 0.4872856 0 1 cross border 938 0.1257996 0.3318003 0 1 withdrawn 961 0.7346514 0.4417485 0 1 completed 961 0.1727367 0.3782163 0 1 hostile_unsolicited 961 0.4838710 0.5 0 1 defence 961 0.3402706 0.4740468 0 1 asset_lockup 961 0.0010406 0.0322581 0 1 back_end 961 0.0052029 0.0719808 0 1 flip_over 961 0.0530697 0.2242893 0 1 greenmail 961 0.0083247 0.0909063 0 1 target_lockup 961 0.0031217 0.0558144 0 1 lockup_flag 961 0.0208117 0.1428277 0 1 pacman 961 0.0052029 0.0719808 0 1 poison_pill 961 0.2996878 0.4583597 0 1 recap 961 0.0374610 0.1899874 0 1 repurchase 961 0.0405827 0.1974242 0 1 scorched_earth 961 0.0176899 0.1318904 0 1 self_tender 961 0.0468262 0.2113765 0 1 stock_lockup 961 0.0260146 0.1592614 0 1 voting_plan 961 0.0104058 0.1015297 0 1 white_knight 961 0.1488033 0.3560798 0 1 white_squire 961 0.0301769 0.1711629 0 1 ranking 961 0.7544225 1.2153720 0 7 mbigger 961 0.1893861 0.392019 0 1 sbigger 961 0.0582726 0.2343802 0 1 pre_bigger 961 0.1175858 0.3222848 0 1 post_bigger 961 0.1113424 0.3147194 0 1 tobinsq 734 1.4063130 1.0544480 0.334113 10.77584 market_capitalization 737 1,343,052 6,151,465 884 135,000,000 relative_size 688 2,651.104 21,351.96 4.744598 495,546.1 car2_21 961 0.1728665 0.2700127 -3.156865 2.546384 car10_10 961 0.2111041 0.2718066 -3.098699 2.979956 car2_2 961 0.171244 0.1966422 -0.9292495 1.816887 car1_1 961 0.164932 0.1856064 -0.6254905 1.316121
Pearson correlation CAR (-2,21) CAR (-10,10) CAR (-2,2) CAR (-1,1)
22 4.1.1 Sample statistics
Within the dataset each deal is uniquely identified, information on the target firm is included, deal specific information added and deals categorized. The sample contains 118 (12.3%) cross-border and 843 (87.7%) domestic M&A observations. Furthermore, 371 (38.6%) M&A observations are in the same industry SIC group, and 590 observations (61.4%) unrelated. In terms of bid attitude, 465 (48.4%) observations are hostile and 496 (51.6%) unsolicited. A total of 327 (34%) observations are defended and 643 (66.9%) observations undefended .Of all the M&A observations 166 (17.3%) deals are fully completed, 706 (73.5%) deals withdrawn and 89 (9.3%) deals have partial or unknown status. 4.1.2 Descriptive statistics
Table 2 shows the descriptive statistics of the variables employed in the study. The high variance in market capitalization and relative size stand out. Furthermore, table 2 reports on the Pearson correlation and significance of the various CAR windows. The four event windows show high correlation with each other. Event window -10, +10 is used for testing the hypotheses, and the remaining windows are, for robustness, added in the appendices. The regressed variables where also checked for multicollinearity, which was not found in the models.
Table 3 shows the percentages of defended versus undefended deals per deal outcome. Despite defensive mechanisms the relative number of completed deals is highest for defended hostile deals. This result contradicts findings in the literature; Holl and Kyriazis (1996) found that the probability of a completed takeover bid drops once the bid is opposed by target management. Deal attitude might explain the departure of existing theories, this study only observed unsolicited and hostile deals while in other studies friendly deals also were included.
Table 3. Descriptive results deal categories and status
Completed Withdrawn Defended 21.1%** (69) 78.9% (258) Undefended 15.3%** (97) 84.7% (537) Cross-border 25.4%** (30) 74.6%* (88) Domestic 16.6%** (136) 83.4%* (684) Related 20.2%* (75) 79.8% (296) Unrelated 15.3%* (90) 84.7% (498) ** significant at α=0.05 level * significant at α=0.1 level
23 provides some suggestive evidence for the use of both variables as control variables in the following hypotheses.
4.2 Hypothesis One: On probability of takeover completion
Hypothesis 1a suggests that takeover attempts which are defended are in general less likely to succeed than undefended takeover attempts. This hypothesis is tested by looking at the percentage of
completed and withdrawn deals per deal category. Table 3 shows the results of the logistic univariate regression. The probability of a completed takeover for defended firms (21.1%) is higher than that of undefended firms (15.3%). The odds for defended takeovers are 1.48 times larger than the odds for an undefended takeover, the ratio is significant at α=0.05 level. In other words, an odds ratio above 1 suggests that defended hostile takeovers are more likely to be completed. The H0 of hypothesis 1a
Defended takeover attempts are less likely to be completed than undefended takeover attempts is therefore rejected. The findings of Holl and Kyriazis (1996) on a decreasing probability of a
completed takeover when a bid is opposed, does not hold when only hostile and unsolicited deals are considered.
The relationship between defences and the probability of takeover completion is further investigated by looking at the odds ratios per different count of defences. Hypothesis 1b suggests that probability for a completed takeover decreases with the number of defences employed. The initial test is to look at the general odds ratio of ranking (the number of defences employed), which is 1.17 and significant at α=0.02 level. To further investigate the hypothesis, the Wald test for the likelihood ratio is used and results are shown below.
Table 4. Odds ratio per number of defences employed
Ranking Exp(Ranking) 0 0.183197 1 0.214423 2 0.250972 3 0.293751 4 0.343821 5 0.402425 7 0.551305 χ2 prob > χ2 5.88 0.0153*** *** significant at α=0.02 level
Table 4 reports the odds ratios per different level of the variable ranking. The p-value (prob > χ2)
24 shows that with the number of defences (ranking) the odds of a completed takeover increases.
Following this observation it can be concluded that the Ho of hypothesis 1b: The probability of a
completed takeover is lower for extensively defended firms than for lightly defended firms is rejected, and the opposite seems to be true. However, with an increase in ranking also comes a significant increase in variance.
4.3 Hypothesis Two: On target firm performance
The second hypothesis suggests that, because an acquirer withdraws a by the target resisted bid, the target firm will retain bid-related excess returns. Any premiums the bidders will have to pay for control are anticipated by the market, this provides the target with the benefit of increasing value. Furthermore, the hypothesis infers that the market anticipates that these value increasing effects of the takeover process are sustained after withdrawal. The hypothesis is tested by running a univeriate regression. As table 5 shows, there is a statistically significant linear relationship between defence and the firm performance at α=0.02 level. In other words, whether or not the deal is opposed affects the targets performance. When investigating the relationship between firm performance and
successful/unsuccessful defended target firms, a significant relationship (at α=0.02 level) is found for both categories. The model shows that respectively 6.39% and 5.14% of the variation in the
performance (CAR) can be explained by the deal outcome. Furthermore, it reports a positive β of 0.1805 for unsuccessful defended deals and a negative β of -0.1530. This infers the size of the effect; for every one unit increase in defended firms, the performance (CAR) changes with β. Table 5 clearly shows that resisted and withdrawn bids have a negative effect on the performance of the firm and completed and defended deals have a positive effect. With the Wald test for comparing coefficients across groups is determined that the β coefficients are statistically different from each other, thus rejecting the H0 of hypothesis 2: Target firm performance is more likely to increase for successful
defended firms than for unsuccessful defended target firms.
Table 5. Defences and target firm performance
25 4.4 Hypothesis Three: On shareholder approval and enhancing value
The third hypothesis divides defensive mechanisms in two categories, based on whether they require shareholder approval or not. The hypothesis suggests that managerial entrenchment defences which do not require shareholder approval destroy value, because of the costs associated with defensive actions. On the other hand, defences categorized as shareholder interests allow negotiation power and
investments which suggests value creation. This hypothesis is tested by looking at the coefficient of both categories in an OLS regression. Table 6 reports the univariate, multivariate and interaction results for both categories. Management entrenchment shows a significant relationship with
performance in various models (1-4,6-9) with a positive price reaction, while ‘shareholder interests’ is mostly insignificant, suggesting a stronger effect for ‘management entrenchment’ on performance than ‘shareholder interests’. Significance, at α=0.1 level, was found for both categories by applying an interaction model (9), which regresses the interaction term of the category by cross-border. The interaction term of ‘management entrenchment’ has a β of 0.09769 and a model fit of 0.29%. The category ‘shareholder interests’ has an interaction term with an OLS β of 0.16664 and a model fit of 0.35%. The explained variance in the performance of both models is significant but small, and the coefficient shows in both cases a positive direction, the β-coefficient of ‘shareholders interests’ is a factor 1.7 larger, suggesting higher performance for firms in the ‘shareholders interests’ category. However it should be considered that this effect might be caused by departure from normality in the distribution. Furthermore the interaction model decreased the subset size of ‘management
entrenchment’ and ‘shareholder interests’ to respectively (n) 172 and 54 observations, which could create some bias in the estimates of the variance and the coefficients. The Wald test for comparing regressions coefficients shows a p-value of 0.4830, thus the coefficients are not statistically different from each other. The H0 of hypothesis 3: Defensive mechanisms that require shareholder approval
enhance more shareholder value than those which do not require shareholder approval will be rejected based on insignificant difference between the coefficients of both categories.
4.5 Hypothesis Four: On pre offer en post offer defences
26 different models (4, 7, 8 &10) and event windows (see appendix) show consistent results with positive and statistically significant β coefficients, and always a higher β coefficient for the ‘pre offer’
category. These findings provide some suggestive support for the hypothesis. However the Wald test shows no statistical difference between the β coefficients, and thus is the H0 of the last hypothesis: Pre
27 Table 6. OLS regressions on defences and categories
Event window (-10,10) Model 1 Related Model 2 Cross-border Model 3 Market capitalization Model 4 Tobin’sQ Model 5 Related + Cross-border Model 6 Withdrawn + Related + Tobin’sQ Model 7 Market capitalization + Related Model 8 #Cross-border Model 9 #Cross-border + Tobin’sQ Model 10
Univariate Multivariate Interaction
28 4.6 Drivers of performance
In the process of investigating the various categories high variances were observed between individual defensive mechanisms. The effect of each defensive mechanism on the target performance and deal outcome is tested with regression analysis. Previous studies suggest that on the level of individual defensive mechanisms the popularity and outcome may vary distinctively. Table 7 reports the results of correlation and regression analysis. The variables ‘asset_lockup’ and ‘target_lockup’ were omitted because the first predicted deal completion perfectly and the latter predict withdrawn perfectly. This excludes four observations. The presence of either ‘lockup_flag’ or ‘stock_lockup’ defences indicate a high significant probability of deal completion, further, when both are observed a probability of 70.62% is reported. Effective defences, in terms of successfully defended deals, are white squire, poison pill and flip over, which complies with previous studies. The effect on target firm performance is significant for flip over, lockup flag, poison pill and white knight defences, which largely overlaps with deal outcome. These defences have a relative high r-squared, providing around 1% explanation of the variance in the targets firm performance. The size of the effect, indicated by the β-coefficient, shows a positive significant relationship. These results by itself are not counter-intuitive, the most popular defences show the most significant positive relationships on both deal outcome and target firm performance.
Table 7. Individual defensive mechanisms
Defences Performance Completed
Pearson correlation p>|z| r2 β Probability p>|z|
29 The probability of a completed takeover can be influenced with certain defences, flip over and poison pill defences show respectively a 33.33% and 21.88% probability of completion, while ‘stock lock up’ and ‘lock up flag’ show a much higher, respectively 48% and 60%, probability of completion. The probability for a completed takeover is the smallest for takeovers that involve white squire defences (3.45%). Table 7 also reports on which defences generate a positive stock price effect; flip over defences are again very effective, but so are the ‘lock up’ defences. The latter may not proof to be effective in fending off the acquirer; it does show a positive stock price reaction. Intuitively, white knight defences also show an increase in performance; because an increased demand or a bidding contest often leads to a positive stock price reaction.
30
5 Discussion
The results of this study are largely aimed at determining when defensive mechanisms increase or decrease shareholder value. There is no single, consistent and right answer to that, it is a trade-off between deal outcome and performance limited by the availability of defensive mechanisms. The following key findings were found in the process:
1. Effectively defending the target firm depends on specific defence mechanisms.
Against expectations, defended takeovers did not lower the probability of being acquired, on the contrary, an increase in probability was observed. Effectively defending the target firm does not depend on how many and intensely defences are employed, it is determined by which defences are deployed. Results suggest that the acquirer becomes more determined to
complete the takeover when more defences are employed. These findings indicate a need to reconsider the way defences affect the probability of completion in hostile takeovers. 2. Successfully defended firms are likely to underperform compared to unsuccessful defended
firms.
The results rejected the hypothesis that target firm performance is more likely to increase for a successful defended firm than for unsuccessful defended target firms. Findings indicate that the market responds quickly to failure or that defences are costly and might blot out any gains from the bid process. A plot of the quadratic fit between the performance and the number of defences shows that with an increase in defences comes a significant increase in variance. This shows that employing defences decreases the predictability of performance.
Graph 1. Fit between performance and number of defences
31
3. Theory and studies on defensive mechanisms need to recognize the way defences interact. Categories introduced in this study did not provide evidence on when defences enhance shareholder value. However analysis on the level of individual defensive mechanisms and certain sets of defences, showed significant deviation in performance and outcome, indicating the importance of recognizing the way defences interact. This might explain why across theories and studies there is no consistent and strong evidence on defensive mechanisms. Further research on how defences interact will contribute to the understanding of mergers and acquisitions and when defensive mechanisms create value.
4.
The most popular defences are the most effective.Although these findings are not counter-intuitive, and do not only show why they are popular, they are worth noting. Because they indicate that the market is able to observe and anticipate these defensive mechanisms and their effects. This indicates the possibility to better predict and understand target firm performance and deal outcome.
The results and discussion stresses the importance of recognizing the way defences interact but also provides both direct and indirect evidence on when defensive mechanisms create value. This research thus contributes to the understanding of defensive mechanisms and why there are so many different and inconsistent findings on if defensive mechanisms create value and how they affect deal outcome.
5.1 Managerial implications 5.1.1 Target firms
In the context of hostile takeovers the results revealed some new insights that have an impact on target firm managerial decision making. First, the results imply that once the managerial team opts for resistance, the probability of a completed takeover not necessarily drops. Management should consider the consequences of employing defences, since they seem to increase the determination of the acquirer to complete the takeover. The completion of a takeover becomes more difficult to predict with each additional defence employed, and data showed that with the number of defences the odds of a completed takeover increases. Thus, effectively defending the target firm does not depend on the number of defences employed, merely; a successful defence is determined by a few specific defence mechanisms, such as the white squire, white knight, poison pill and flip over defences. However once the takeover process is initiated and the managerial team opts for resistance, the availability of
32 own position) and the performance of the firm. The latter aligns with prevailing academic views on defences: management should try to maximize shareholder value. Successfully defended firms tend to have, in general, a lower performance and bid related gains are not sustained, while on the other hand the firm remains independent. There will, of course, be exceptions to this trade-off, e.g. the flip over and white knight defence mechanisms tend to be value creating, also in successfully defended bids. Although the two categories reflecting management motives did not show significant different impacts on the performance, on a lower level of individual defensive mechanisms, significant differences in outcome were observed. In other words, it matters for effectiveness, impact and performance which defences are employed. When opting for resistance, managers are advised to seek the defensive mechanisms which comply with overall firm strategy, while considering the interaction between defences. One defence may render another ineffective or could change the value enhancement into value destruction.
5.1.2 Acquiring firms
The investigation into individual defences also provided implications for the acquiring firm. Prospects with certain characteristics are less attractive than prospects with other characteristics. Firms with anti-takeover charter amendments, bylaws and shareholder rights plans have a negative impact on the probability of takeover completion. Furthermore, third parties friendly to the target firm can purchase a significant block of shares (white squire and white knight defences) which makes it more difficult for the acquirer to obtain the required number of shares to achieve control. However, these defences can be exercised after bid announcement, and are thus hard to assess ex ante. The results on the stock price reaction to each defence also revealed that defences can make the bid process unsoughtly expensive. In exercitation of flip over defences, rights are repurchased by the target firm at substantial premiums increasing the stock price and thus making takeover bids costly for acquirers.
5.2 Limitations
33 any strong or consistent price reactions to defensive mechanisms, mainly because studies fail to recognize the way defences interact. This study indirectly identified some interactions, how defences influence each other, how some defences seem to be always effective and others only when certain defences are present and others absent. However, these interactions were a side track to this study, but are most definitely recommended for further studies on this subject. Recognizing the interactions between defences should improve studies on, and the understanding of, defensive mechanisms. These interactions should also allow the creation of new categorizations of defences and more consistent observations on the relationship between the adoptions of defensive mechanisms and firm
performance/deal outcome.
This study uses performance as dependent variable and is expressed as a function of the share price reaction to an event. The measure stock price reaction, could be reflecting stock market inflation (profiting from a short term increase in stock price) as well as a higher performance (market
34
6 Conclusion
The aim of this paper was to research the effects of defensive mechanisms on the performance of the target firm. The research started off with reviewing the literature on value creation by mergers and acquisitions, describing the various available defensive mechanisms and the two general theories on defensive behaviour; shareholder interests and management entrenchment. Then the thesis described the data sample selection, the methodology of an event study, the calculation of the cumulative abnormal returns and the methods required to investigate relationships between variables. Based on the research question and the literature review a number of hypotheses were formulated to test theories. The following findings were made:
1. a) Defended takeover attempts are more likely to succeed than undefended takeover attempts.
Analysis of completed and withdrawn hostile takeovers showed that are defended takeovers have an increased probability of being completed. Holl and Kyriazis (1996) found the opposite to be true, however they also included friendly deals. When only considering hostile and unsolicited takeovers, the probability of a completed takeover increases when bids are resisted.
b) Extensively defended firms are more likely to be taken over.
The more extensively defended the firm the higher the odds ratio for a completed takeover. Thus, effectively defending the firm’s independence does not depend on the number of defences employed to thwart a hostile or unsolicited takeover. Furthermore with an increase in number of defences employed comes an increase in variance making deal outcome less predictable.
2. Successfully defended firms show lower post-bid performance
This study found that gains obtained by the target firm due to negotiation power or bid – related gains are in general not sustained by successfully defended target firms, this supports the findings of Ruback (1988), who reported significant negative returns. It suggests the market responds to the failure of a takeover; withdrawn takeover bids have a negative effect on the performance of the target firm and completed takeovers a positive effect.
3. Value enhancing categories were not significant different from value destroying.
35
4. The way defences interact are important
Despite the grouping of defences into categories, no significant findings were made on if certain types of defences are more value creating than others. On the level of individual defensive mechanisms and certain combinations significant results were found. The most popular defences also had the largest effects on target performance and deal outcome. Furthermore, the way defences interact has a great impact on how each defensive
mechanisms influences performance or deal outcome. For example, the poison pill in itself is a good mechanism to fend off acquirers, but when combined with certain lock up agreements it loses most of its effectiveness. This is an important finding, given the current
inconsistency in studies and theories on defensive mechanisms, it underlines the importance of studying the way defences interact.
36
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