In-Depth Notes on Hostile Takeovers and Corporate Governance

Introduction

  • Hostile takeovers play a significant role in the market for corporate control.
  • Jensen's view: alternative management teams compete for the ability to manage corporate assets owned by shareholders.
  • Hostile takeovers serve two functions:
    • Mechanism for downsizing (creative destruction)
    • Governance mechanism to curb managerial slack and opportunism.

Hostile Takeovers as a Governance Mechanism

  • Study examines the implications of hostile takeovers concerning:
    • Downsizing vs. governance improvements.
    • Historical literature often concludes that underperforming firms become targets of hostile takeovers.
  • Findings indicate underperformance might not be a significant factor, challenging existing consensus and suggesting a possible mis-specified empirical model in literature.
  • Previous studies aggregated hostile takeovers and internal governance mechanisms as substitutes without distinction.

UK Corporate Governance Context

  • UK corporate governance presents a unique environment for hostile takeovers;
  • Compared to the USA:
    • Higher incidence of hostile takeovers as a percentage of total takeovers.
    • More dispersed ownership structure.
  • Research highlights the importance of evaluating board effectiveness in changeovers in management as hostile takeovers are more contested in the UK.

Market Dynamics and Ownership Structure

  • By 1993, UK market capitalization was disproportionately larger compared to the USA (120% vs. 66% of GDP).
  • Wider share ownership in the UK encourages changes in ownership, reinforcing separation of ownership from control.
  • Empirical analysis suggests hostile takeovers in the UK impose fewer defenses compared to the USA (e.g. poison pills, charter amendments).

Methodology

  • Utilizes a matched sample of firms subject to hostile takeover bids compared to matched firms not subjected to bids.
  • Panel data techniques control for industry effects and omitted variable bias, providing robust estimates of hostile takeover likelihood.
  • The logit model is employed due to the problematic issue of unequal sampling rates in firms.

Evaluation of Hypotheses

Hypothesis 1: Financial Performance
  • Expectation: Poor financial performance increases likelihood of a hostile takeover.
  • Data suggests that this holds for cross-sectional analysis, but fails to show significance in panel data estimates.
Hypothesis 2: Effectiveness of Governance Structures
  • Expectation: Ineffective internal governance mechanisms correlate with hostile takeover bids.
  • Panel data estimates provide mixed results showing slight governance effectiveness variance; a closer examination shows limited support for hypothesis, suggesting that internal governance mechanisms remain important regardless of hostile bids.

Results Summary

  • Study supports Weisbach (1993) propositions regarding hostile takeovers.
  • Key findings:
    • Financial performance (multiple indicators) does not uniformly predict takeover likelihood.
    • Governance structure impacts can vary based on whether firms are subject to bids.
    • Institutional ownership shows a positive, significant impact on the likelihood of takeover bids in some analyses.
  • Results highlight that hostile takeovers may not always align with poor firm performance indicators.

Sensitivity Analysis

  • Sensitivity and robustness tests suggest that no significant multicollinearity exists among independent variables.
  • Further analysis on the functional forms and interaction between ownership and performance provides additional insight into firm-specific performance effectiveness.