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©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1 - - - - - - - - Chapter 20 - - - - - - - - Corporate Governance.

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Presentation on theme: "©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1 - - - - - - - - Chapter 20 - - - - - - - - Corporate Governance."— Presentation transcript:

1 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston Chapter Corporate Governance and Performance

2 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 2 Corporate Governance Systems in the United States Diffuse stock ownership –Limited liability public corporation –Diffuse ownership of voting equity shares –Large number of individual share owners

3 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 3 Requires little direct monitoring of individual firms by investors –Limited liability of investors –Diversification allows investors to ignore idiosyncratic risks of individual companies –Equity ownership shares actively traded Commercial banks and insurance companies limited in their ability to hold large equity positions in individual companies

4 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 4 Contractual theory of the firm –Firm as network of actual and implicit contracts Contracts specify roles of stakeholders and define their rights, obligations, and payoffs Potential conflicts –Contracts unable to envisage many changes in conditions that develop –Participants may have personal goals –Separation of ownership and control Operations of firm are conducted and controlled by managers without major stock ownerships Conflicts of interest arise between owners and managers

5 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 5 –Jensen and Meckling (1976) Agency problem — divergence of interests between owners (the principal) and management (their agent) Fractional firm ownership by managers can lead managers to work less and to consume excessive perquisites Additional monitoring expenditures (agency costs) are required –Auditing systems –Bonding assurances –Organization systems

6 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 6 Divergent interests of stakeholders –Business firms must recognize wide range of expectations of diverse stakeholders –Business firms must recognize external influences — job safety, product safety, environmental impacts –Business firms must recognize wide range of stakeholders and external influences to achieve long-run value maximization

7 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 7 Internal Control Mechanisms Shareholders elect board of directors to represent their interests Problems of how all stakeholders can obtain representation of their views and interests have not been resolved Public expectations look to board of directors to balance interests of all stakeholders

8 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 8 Campbell, Gillan, and Niden (1999) –Analyzed how shareholders used proxy mechanism in 1997 proxy season –Shareholder-proposal rules (Rule 14a-8) allow shareholders to include proposal and 500-word supporting statement in proxy materials –Sample of 287 social policy proposals and 582 corporate governance proposals at 394 companies –43.3% of all proposals were considered for vote Corporate governance proposals — 49.2% were voted on and 35.2% were either omitted or withdrawn Social policy proposals — 31.4% were voted on and 61.6% were either omitted or withdrawn –Rule 14a-8 remains an important avenue for shareholders

9 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 9 Role of the Board of Directors Views of role of monitoring board –Pro: In theory, monitoring by board of directors can deal with problems of corporate governance –Con: Boards have been ineffective Board fails to recognize problems of firm Board does not stand up to top officers External control devices such as hostile takeovers have multiplied because of failure of boards

10 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 10 Composition of the board –Role of outside directors Outside directors — directors who neither work for the corporation nor have extensive dealings with company Outside directors play larger role in monitoring management than inside directors –Fama (1980) Outside directors enhance viability of board in achieving low-cost internal transfers of control Lower probability of collusion with top management –Fama and Jensen (1983a) — outside directors have incentives to protect and develop reputation as experts in decision control

11 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 11 –Weisbach (1988) Tested hypothesis that inside and outside directors behave differently in monitoring top management Outsider-dominated boards more likely to remove CEO Replacement of CEO –Statistically significant inverse relation between firm's market-adjusted share performance in a year and likelihood of subsequent change in CEO –For outsider-dominated boards, responsiveness of removal decision to stock market performance is three times larger than for other board types –Replacement decision takes place relatively quickly

12 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 12 –Rosenstein and Wyatt (1990) — CAR for total sample was significantly positive when company appointed outside directors –Borokhovich, Parrino, and Trapani (1996) Positive relation between proportion of outside directors and likelihood that outsider is appointed CEO Market views appointment of outsider to CEO position more favorably than appointment of insider

13 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 13 Compensation of board members –Well-structured compensation systems may motivate directors Director stock ownership better aligns director interests with stockholders –Stock ownership requirements for directors and/or payment of part or all of directors' annual retainer in stock and stock options –Finance directors' retirements with stock Studies find directors of top-performing companies hold greater number of shares than do counterparts at poor-performing firms –Critics argue that compensation should not be motivating factor

14 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 14 Evaluating a board of directors –Business Week (11/25/96) Rated boards by how close they came to meeting these recommendations: –Evaluate CEO performance annually –Link CEO pay to clear performance criteria –Review and evaluate strategic and operating plans –Require significant stock ownership and compensate directors in stock –No more than three insiders –Require election each year and mandatory retirement at 70

15 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 15 –Key committees should be composed of outside directors –Limits on number of boards and ban on interlocking directorships –Disqualify (from board) anyone receiving fees from company Some pension funds and mutual funds judge boards by stock market performance of their companies — a "blinkered view" –Millstein and MacAvoy (1998) Better board rating (based on either board independence or performance) associated with higher spread of return on invested capital (ROIC) over cost of capital (WACC)

16 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 16 Ownership Concentration Equity ownership by managers must balance –Convergence or alignment of interests –Entrenchment considerations — managerial ownership and control of voting rights may allow pursuit of self-interest

17 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 17 Ownership and performance –Stulz (1988) Model in which at low levels of management ownership, increased equity holdings improve convergence — enhance firm value At higher levels of insider ownership, managerial entrenchment prevents takeovers — decrease firm value

18 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 18 –Morck, Schleifer, and Vishny (MSV) (1988) Study based on 1980 data Performance (measured by q-ratio) related to management or insider ownership percentages –Ownership concentration increased from 0 to 5% Performance improved Alignment-of-interest effect Direction of causality may be reversed — high performance firms more likely to give managers stock bonuses High performance firms may have substantial intangible assets that require greater ownership concentrations to induce proper use of these assets

19 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 19 –Ownership concentration in range 5% to 25% Performance deteriorated Management entrenchment dampens performance –Ownership concentration above 25% Performance improved but slowly Incremental entrenchment effects attenuated

20 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 20 –McConnell and Servaes (MS) (1990) Replicate MSV study using 1976 and 1986 data –For 1976, relationship between ownership concentration and performance relatively flat with moderate convergence of interest effect up to 50%, after which curve flattens and then declines moderately –For 1986, relationship curve rises relatively sharply to 40%, after which it is relatively flat to 50% followed by sharp decline Leverage, institutional ownership, R&D expenditures, and advertising expenditures do not change initial findings

21 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 21 –Cho (1998) Replicates MSV patterns using ordinary least square regressions and 1991 data Tests for endogenous ownership structure Finds that corporate value affects ownership structure, but not reverse –Bristow (1998) Sample of consistently derived insider holdings on 4,000 firms during Relationship between management ownership and performance varies for each of the ten years

22 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 22 Economic variables influence ownership- performance relationship –Relative growth rates of industries –Differences in demand-supply relationships among industries –Relative value change patterns among industries and firms within them –Stock price movements Interpretations of diverse data patterns –May reflect economic identification problem discussed by Cho –True relationship may be Demsetz-Lehn theory of no relationship between ownership level and performance

23 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 23 –Holderness, Kroszner, and Sheehan (1999) Percentage of managerial equity ownership –Mean increased from 12.9% in 1935 to 21.1% in 1995 –Median increased from 6.5% in 1935 to 14.4% in 1995 Doubling of managerial ownership may imply improvement in corporate governance in U.S.

24 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 24 Managerial ownership and bond returns — Bagnani, Milonas, Saunders, and Travlos (1994) –No relation between bond returns and managerial ownership below 5% –Positive relation for managerial ownership between 5% and 25% Increased incentives for managers to act in shareholders' interest, taking risks that are potentially harmful to bondholders Rational bondholders required higher returns

25 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 25 –Weak negative relation for ownership above 25% Managers become more risk averse Managers have high stake in firm — greater incentives to protect their private benefits and objectives Managers' interest more aligned with bondholders — lower bond premia

26 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 26 Financial policy and ownership concentration –Share repurchases financed by debt Insider group does not tender its shares in repurchases — percentage equity shares increased Increased convergence of interest effect –Incentive effects of high management ownership percentages performed positive role in LBOs and MBOs

27 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 27 –Safieddine and Titman (1999) Sample of 573 firms that successfully resisted takeover attempts during Effects on leverage –Increased leverage is one form of defensive strategy –In 207 firms, median leverage ratio increased from 60% to 71.5% Corporate restructuring activity –Turnover of top management during three-year window 30% for low leverage increasing group 37% for higher leverage increasing firms –Turnover of top management after takeover attempts 44% replaced in hostile takeover attempts 29% replaced in friendly takeover attempts

28 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 28 Operating performance improves and long-run post-termination performance of leverage- increasing targets superior to benchmark –Returns grow by about 55% after five years –Level of returns same as what would have been realized by accepting takeover offer Manager's behavior of leverage-increasing target firms consistent with long-term interest of their shareholders –Strong long-term abnormal stock price performance despite initial drop at takeover termination announcement –Associated productivity improvements

29 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 29 –Amihud, Lev, and Travlos (1990) Sample of firms that made cash acquisitions of over $10 million of other firms during Cash acquisitions are associated with significantly larger insider ownership levels than stock financed acquisitions

30 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 30 Executive Compensation Conflict of interest between owners and managers reduced if executive compensation plans more tightly related pay to performance

31 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 31 Executive compensation and changes in value of firm –Jensen and Murphy (1990) Executive pay changes only $3 for $1,000 change in firm wealth — elasticity of 0.3% Low elasticity indicates executive pay is not closely linked to performance But low elasticity partially explained by large value of firm in relation to executive compensation

32 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 32 –Haubrich (1994) — derived Jensen-Murphy results using principal-agent theory models –Schleifer and Vishny (1995) — Jensen- Murphy relationship would generate large swings in executive wealth and would require considerable risk tolerance for executives

33 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 33 Executive compensation and firm's corporate governance — Core, Holthausen, and Larcker (1999) –Sample of 495 observations for 205 publicly traded U.S. firms during –Board of director characteristics and ownership structure significantly related to CEO compensation CEO compensation higher –CEO was also board chair –Board was larger –Greater percentage of outside directors appointed by CEO –More outside directors considered 'gray' –Outside directors older and served on more than three other boards

34 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 34 CEO compensation lower –Greater percentage of inside directors in board –Lower CEO's ownership stake –Existence of non-CEO internal board members or external blockholders who owned at least 5% of equity –Significant negative relationship between compensation predicted by board and ownership variables and subsequent firm operating and market performance Board and ownership variables are proxies for effectiveness of firm's governance structure CEOs of firms with greater agency problems were able to obtain higher compensation Firms with greater agency problems perform worse

35 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 35 Executive compensation and performance measures –Criticism that compensation had been based on accounting measures rather than stock market-based performance measures –Rappaport (1986) Early executive compensation performance plans were market based In 1970s, performance measures for granting options shifted to accounting-based measures In recent years, performance is moving to market- based measures

36 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 36 Other proposals for improved pay- performance policies –Limit base salaries of top executives –Bonus and stock option plans based on stock appreciation –Stock appreciation benchmarks should consider Close competitors Wider peer group Broader stock market indexes

37 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 37 –Stock options based on premium of 10-20% over current market and should not be repriced –Company loan programs should enable top executives to buy substantial amounts of firm's stock –Directors should be paid mainly in stock with minimum specified holding periods

38 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 38 Outside Control Mechanisms Stock prices and top management changes –Warner, Watts, and Wruck (1988) Poor stock price performance likely to result in increased rate of management turnover Evidence of several internal control mechanisms — monitoring by large blockholders, competition from other managers, discipline by board

39 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 39 –Denis and Denis (1995) Announcement of changes in management –Forced resignations: Positive 1.5% (significant) –Normal retirements: Insignificant effects Forced top management changes –Preceded by significantly large operating performance declines and followed by significant improvements –Associated with significant downsizing measured by declines in employment, capital expenditures, total assets –Improvements did not result from effective board monitoring

40 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 40 –13% of 853 sample were forced changes Two-thirds of forced resignations associated with blockholder pressure, financial distress, shareholder lawsuits, and takeover attempts 56% of firms with forced changes became target of corporate control activity –Internal control mechanisms were inadequate; required pressure from external corporate control markets

41 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 41 –Role of stock market Schleifer and Vishny (1997) survey does not develop potential role of stock market and security price movements in disciplining managers Security price movements provide scorecard measuring management performance Bad scores on stock market increase likelihood of managerial turnover

42 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 42 Public pension funds –Public pension funds have ability and size to become significant factors in corporate governance California Public Employees' Retirement System (CALPERS) publicly announced names of companies that failed to negotiate adoption of corporate reforms World’s largest pension plan, TIAA-CREF, encourages companies to have independent, diverse boards

43 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 43 –Carleton, Nelson, and Weisbach (1998) Described negotiation process between TIAA- CREF and target firms on governance issues All firms agreed to institute confidential voting Most firms contacted added women or minorities to board Most firms that were asked to limit use of blank check preferred stock as antitakeover defense complied

44 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 44 –Wahal (1996) Nine activist pension funds in period Activist proposals shifted from takeover-related proxy proposals in late 1980s to governance- related proposals in 1990s –Takeover-related proxy proposals — poison pills, greenmail, antitakeover provisions –Governance-related targeting — golden parachutes, board composition, compensation

45 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 45 Abnormal returns –Zero average abnormal returns for shareholder proposals –Small positive abnormal returns for attempts to influence target firms in using shareholder proposals (nonproxy targeting) –No significant long-term improvement in either stock price movements or accounting measures in post- targeting period

46 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 46 –Strickland, Wiles, and Zenner (1996) Studied United Shareholders Association (USA) from 1986 to 1993 USA developed a Target 50 list of firms USA successfully negotiated corporate governance changes in 53 proposals before inclusion in proxy statements Abnormal return to target firm = 0.9% at announcement of negotiated agreements — wealth increase of $1.3 billion USA effective when target firm was poor performer with high institutional ownership

47 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 47 Multiple Control Mechanisms (Agrawal and Knoeber, 1996) Sample of 400 largest firms Consider seven control mechanisms –Insider shareholdings –Outside representation on board –Debt policy –Activity in corporate control market

48 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 48 –Institutional shareholdings –Shareholdings of large blockholders –Managerial labor market Firm performance measured by Tobin's q Results –Considering influence of each control mechanism separately — first four control mechanisms statistically related to firm performance –Considering all mechanisms together, but not within simultaneous equation system — influence of insider shareholdings drops out

49 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 49 –Considering all mechanisms together and using simultaneous equation system — only negative effect on firm performance from outside representation remains –Concluded that control mechanisms chosen optimally except for use of outsiders on boards (most other studies find positive benefits from use of outsiders)

50 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 50 Proxy Contests Background –Definition: Attempts by dissident groups of shareholders to obtain representation on board of directors –Success of proxy contests Most fail to get majority representation Better measure of success: Whether dissident group gains at least two members on board — one to make motion, another to second it

51 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 51 –Proxy reform rules Under old rules: Any shareholder who wanted to communicate with more than ten other shareholders required to submit comments for SEC approval prior to circulation Under new rules of October 1992: Ease requirements for shareholders not seeking control to communicate with one another –Focus of empirical studies Disciplinary value of proxy contests in managerial labor market Relationship between proxy contests and other forms of takeover activity Value of vote

52 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 52 Wealth effects — Earlier studies –Dodd and Warner (1983) 96 proxy contests over period Dissidents won majority on board in only 20% of cases Returns to target shareholder positive and significant = 6.2% from 39 days before announcement through outcome Hypothesis to explain positive returns –Even minority board representation allows dissident group to have positive impact on corporate policy –Challenge alone (even if no seats change hands) may lead incumbents to improve policy

53 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 53 No evidence of stock price declines when contests fail –Possibilities of increased efficiency exposed during contests –Negative abnormal returns at contest outcome announcement for contests in which dissidents failed to win any seat at all (-1.4%), not large enough or significant to offset earlier gains

54 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 54 Information leakage –Inevitable due to mechanics of waging proxy contest –Significant abnormal returns of 11.9% over period starting 60 days before announcement through announcement itself –Returns not attributable to merger activity — results are similar regardless of whether or not dissident group included another firm –No unexpectedly higher earnings in preannouncement period to explain runup –Conclude proxy contest is source of positive returns

55 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 55 –DeAngelo and DeAngelo (1989) 60 proxy contests during Dissidents successful in one-third of contests Returns to shareholders –40 days before contest through outcome announcement = 6.02% significant –40 days preceding any public indication of dissident activity = 18.76% significant –Gains not dependent on contest outcome

56 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 56 Negative returns at outcome when dissidents won no seats –Two-day outcome announcement period = -5.45% –When incumbents prevailed in shareholder vote — insignificant negative return (-1.73%) –When dissidents defeated by other means — significant negative return (-7.19%); include: Expenditure of corporate assets to buy off dissidents White knight acquisition of target Court approval of validity of incumbent's defense causing dissidents to withdraw

57 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 57 Strong link between proxy contests and takeover activity –Follow-up on targets for three years after contest Only 20% remained independent public firms under same management In 20 of 39 firms in which dissidents failed to win majority, there were 38 resignations of CEO, president, or chairman of board 25% (15 cases) were sold or liquidated –Most of the gains to proxy contest activity are closely related to merger and acquisition activity Initial precontest gains (about 20%) reflected increased likelihood of eventual sale of firm at premium after proxy contest

58 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 58 –Split sample results Firms eventually sold/liquidated — abnormal returns over full contest period = 15.16% Firms not sold/liquidated — less significant abnormal return = 2.9% Initial runup for both classes revised as more information becomes available about likelihood of sale –Goal of proxy contests — get representation on board to persuade rest of board to sell or liquidate

59 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 59 –Sridharan and Reinganum (1995) 79 hostile tender offers and 38 proxy contests Proxy contest more likely to take place –Target firm performance is relatively poor as measured by return on assets and stock returns –Managerial inefficiency –When shareholdings of management are high Tender offers more likely when –Firm fails to pursue new and profitable investment opportunities –Tender offer targets tend to be less leveraged than firms experiencing proxy fights

60 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 60 Wealth effects — Later studies –Borstadt and Zwirlein (1992) 142 firms involved in proxy contests during Sample divided into two groups –Full-control sample — Dissident success rate = 42% –Partial-control sample — Dissident success rate = 60% Turnover rate of top management after proxy contest higher than average Positive abnormal return of 11.4% (significant) during proxy contest period (60 days prior to announcement of contest through contest resolution announcement)

61 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 61 –Ikenberry and Lakonishok (IL) (1993) 97 election contests during period Test hypothesis that proxy contest represented referendum on management's ability to operate firm and can act as disciplinary mechanism –Contest targets underperformed control firms by 39.3% (significant) over five-year period prior to announcement of election contest –Proxy contest appears to be stimulated by poor performance Return to shareholders –For period from month -60 to month -5 relative to announcement of contest, CAR of proxy contest targets = -34.4% (significant)

62 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 62 –Incumbent board members retain all their seats: CAR not significantly different from zero for five-year period following contest –Dissidents gain at least one board seat: CAR from month +3 to +24 = -32.4% (significant) –Dissidents gain control of board: CAR from month +3 to +24 = -48% (significant); negative return due to Overoptimistic expectations of improved performance Dissidents' discovery that company faced more serious problems than anticipated Negative returns different from positive returns found in earlier studies

63 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 63 –Mulherin and Poulsen (1998) Sample of 270 proxy contests for board seats during Returns to shareholders –Day 0 = date of contest initiation; Day R = contest resolution date –Initiation period [-20,+5]; CAR = +8.04% (significant) –Post-initiation period [+6,R]; CAR = -2.82% (not significant) –Full-contest period [-20,R]; CAR = +5.35% (significant) –Post-contest period of one year following contest resolution; CAR = -3.43% (borderline significant)

64 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 64 Results contradict substantial decline in post- contest period reported by IL –Performance measurements sensitive to survivorship bias arising from minimum data requirements –IL's requirement that firm be listed in Compustat in period around contest led to downward bias in estimated wealth changes –Compustat requirement excluded sizeable number of firms that were acquired in period surrounding proxy contest

65 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 65 Management turnover and shareholder returns –Management turnover should be integral part of interpretations of changes in shareholders wealth in post-contest period –IL reported wealth decline, whether dissidents attained seats or not, but failed to observe that wealth changes following proxy contests were positive when there was management turnover

66 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 66 The M&A Market for Control Market for corporate control most widely recognized form of external pressure Empirical metrics demonstrate M&As do impact business firms –Mitchell and Mulherin (1996) 1,064 firms listed in Value Line Investment Survey at end of % of these firms had been either a takeover target or had engaged in defensive asset restructuring

67 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 67 –Schwert (1996) Comment's M&A proprietary database of all NYSE- and AMEX-listed target firms from ,814 target firms, a substantial percentage of total listed firms MBOs represented 11.4% of main sample of 1,523 firms –Mergerstat Review Many M&A announcements in recent years –3,510 in 1995 –9,278 in 1999

68 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 68 M&A market is major source of external control mechanisms — indicates at least some degree of failure of internal control mechanisms

69 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 69 Alternative Governance Systems Summary of U.S. governance system –Managerial stock ownership has increased over time –Large and small shareholders protected by well-developed systems of laws, court decisions, and financial market that facilitate Efficient transaction of securities Protect minority rights Enable shareholders to sue directors for violations of fiduciary duty

70 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 70 –Changes in stock market prices quickly penalize companies for poor performance and reward them for excellence –Vigilant stock market may cause managers to emphasize short-term results –Bankruptcy laws are highly protective of managers; after entering into bankruptcy Management remains in possession of company Provision is made for automatic stay Interest continues to accrue only on fully secured debt New financing is facilitated since it has priority status

71 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 71 Shleifer and Vishny (1997) –German governance system Creditors have stronger rights than in U.S. Shareholder rights are weaker than in U.S. Large shareholders, often major banks and financial groups, exercise control over large firms as permanent investors and lenders Small investors have virtually no participation in stock market

72 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 72 –Japanese governance system Degree of protection to shareholder and creditor rights fall between U.S. and Germany Powerful banks and long-term shareholders in Japan not as powerful as in Germany; anecdotal evidence questions this conclusion –Japanese companies have financed in U.S. during earlier periods of time when Japan supposedly had lower financing costs than rest of world –Japanese firms sought to avoid strong controls that came with financing from Japanese banks

73 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 73 Industrial firms own shares in one another and groups of firms become tied together by cross- shareholdings (Kaplan, 1994) Governance system has facilitated participation by small investors in stock market

74 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 74 –U.S., Germany, and Japan have in common well-articulated set of rules that provide effective legal protection for at "least some type of investors" and are enforced by courts and regulatory agencies

75 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 75 –Governance systems in other countries Italy –Predominantly family controlled –Difficulty raising outside funds –Investment mainly financed internally –Bank financing mainly by state banks for state firms Rest of world –Similar to Italy –Absence of system of laws, regulations, and courts to protect minority investors and creditors –Rules of game are deficient –Large firms, mostly family controlled, rely on internal financing, or obtain help from government controlled banks

76 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 76 Economist (1994) –German and Japanese corporate governance differ from U.S. Stronger role of banks and financial groups In theory, large ownership position of owners- lenders lead to effective monitoring –Critique of German and Japanese corporate governance model Banks have not monitored closely firms to which they provide both equity and debt capital; banks become active only when client firms experience difficulties

77 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 77 German and Japanese models appear good only because of earlier favorable economic environment — all parties have same long-term interests and goals As economic growth slows, conflicts of interest among different stakeholders arise Supervisory boards (in Germany particularly) did not seem to meet often enough and acted slowly –Incompetent managers permitted to complete standard 5-year contract –Chairman of board often leader of executive board –Supervisory boards not adequately informed Large banking corporations have their own governance problems

78 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 78 Conclusion: American-British systems of shareholder control works better –Market-based –Increased activism of pension funds –Active market for corporate control in form of M&A activity –Increased M&A activity in Japan and Germany after 1999 Consistent with deficiencies of internal control mechanisms Outside market for corporate control was needed to improve corporate performance


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