CEO Preferences and Acquisitions

• Published date: 01 December 2015
• DOI: http://doi.org/10.1111/jofi.12283
• Author: KATHARINA LEWELLEN,DIRK JENTER
• Date: 01 December 2015

THE JOURNAL OF FINANCE •VOL. LXX, NO. 6 •DECEMBER 2015

CEO Preferences and Acquisitions

DIRK JENTER and KATHARINA LEWELLEN∗

ABSTRACT

This paper explores the impact of target CEOs’ retirement preferences on takeovers.

Using retirement age as a proxy for CEOs’ private merger costs, we find strong evi-

dence that target CEOs’ preferences affect merger activity.The likelihood of receiving

a successful takeover bid is sharply higher when target CEOs are close to age 65.

Takeover premiums and target announcement returns are similar for retirement-age

and younger CEOs, implying that retirement-age CEOs increase firm sales without

sacrificing premiums. Better corporate governance is associated with more acquisi-

tions of firms led by young CEOs, and with a smaller increase in deals at retirement

age.

FROM 1990 TO 2012, CLOSE TO 9,700 public U.S. firms were acquired. For the

6,418 target firms with available data, target shareholders received a median

premium of 36% over the pre-announcement share price, and the total value

increase for all target firms combined was about $1.7 trillion. These magnitudes

suggest that the takeover market has great potential to create shareholder

value. This paper provides evidence that the career concerns and retirement

preferences of target firms’ CEOs affect takeover decisions, leading to outcomes

that are unlikely to be in target shareholders’ best interest.

Target firm CEOs are arguably among the most important actors in the

takeover market. These CEOs play a key role in their firm’s decisions leading

up to a bid (e.g., the decision to seek out a buyer,or to initiate merger talks), and,

once a bid is made, lead their firm’s response to and negotiations with buyers

(Graham, Harvey, and Puri (2013)). Given this unique role, it is interesting to

∗Dirk Jenter is at the London School of Economics, Stanford University, and NBER. Katharina

Lewellen is at the Tuck School at Dartmouth. Weare grateful for comments and suggestions from

two anonymous referees, Kenneth Ahern, Jeffrey Coles, Jess Cornaggia, John Graham, Charles

Hadlock, Jarrad Harford, Simi Kedia, Kai Li, Kevin J. Murphy,Francisco Perez-Gonzalez, Adriano

Rampini, Myron Scholes, Geoffrey Tate,Ralph Walkling, Ivo Welch, Rebecca Zarutskie, and Jeffrey

Zwiebel, seminar participants at Arizona State University, Boston College, Brandeis University,

Duke University, Hong Kong University of Science and Technology, Indiana University, London

School of Economics, Michigan State University,Nanyang Technological University, National Uni-

versity of Singapore, Rice University, Singapore Management University, Stanford University,

Stockholm School of Economics, University of Alberta, University of Chicago, University of Illinois

at Urbana–Champaign, University of Michigan, University of Oklahoma, University of Oxford, and

University of Wisconsin, and conference participants at the 2011 Econometric Society Meeting, the

2011 Western Finance Association Meeting, the 2011 Duke-UNC Corporate Finance Conference,

the 2011 SFS Cavalcade, and the 2012 University of Washington Summer Finance Conference.

The authors do not have any conflicts of interest, as identified in the Disclosure Policy.

DOI: 10.1111/jofi.12283

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2814 The Journal of Finance R

note that target CEOs’ career concerns and retirement preferences are likely

to be at odds with shareholders’ objectives: target CEOs typically lose their

jobs during or shortly after a takeover, and in only a handful of cases does

the departing CEO find a new position in a public firm (see, for example,

Martin and McConnell (1991) and Agrawal and Walkling (1994)). This suggests

that mergers can represent serious setbacks to target CEOs’ careers. Though

most CEO compensation contracts recognize these costs by including golden

parachutes or bonuses conditional on mergers, the extent to which they succeed

at eliminating the inherent incentive problem is unclear.

In this paper, we test whether target CEOs’ retirement preferences affect

the incidence and pricing of takeovers. If mergers force target CEOs to retire

early, CEOs’ private merger costs are the forgone benefits of staying employed

until the planned retirement date. Though retirement plans differ across in-

dividuals, research in labor economics shows that a disproportional fraction of

workers retires at the age of 65. This effect cannot be fully explained by mone-

tary incentives, including Social Security benefits or Medicare, which suggests

behavioral explanations related to customs or social norms. If CEOs similarly

favor 65 as their retirement age, this preference should be reflected in their

private merger costs, and—provided these costs affect merger decisions—in ob-

served merger patterns. Specifically, one should observe an increase in merger

activity as CEOs approach 65 or a discrete jump around the age-65 threshold.

We find strong evidence that target CEOs’ retirement preferences affect

merger activity. In data on U.S. public firms from 1989–2007, the likelihood

of a firm being acquired increases sharply when its CEO reaches retirement

age. Controlling for CEO and firm characteristics and the 1997–1999 merger

wave, the implied probability that a firm receives a successful takeover bid is

close to 4.4% per year for CEOs just below retirement age, but increases to

5.8% for CEOs aged 64–66. This corresponds to a 32% increase in the odds of

a sale, with the increase statistically significant at the 1% level. (Henceforth,

we refer to the increase in takeover frequency for firms with CEOs aged 64–66

as the “age-65 effect,” and we refer to the 64–66 age bracket as “retirement

age.”) The increase in takeover activity appears abruptly at retirement age,

with only a small gradual increase as CEOs approach age 65. The effect is

similar if we include all bids instead of focusing only on successful bids, and

it remains significant when CEO age and age squared are included separately

as controls. These results show that bidders are more likely to target firms

with retirement-age CEOs, possibly due to these CEOs’ greater willingness to

accept takeover bids.

The increase in takeover activity at retirement age is not uniform across

types of firms or over time. First, during the merger wave of the late 1990s,

the peak in takeover activity shifted from the retirement-age group (64–66)

to the age group immediately before it. This shift may have been caused by

target CEOs responding to the increased benefits from merging that fueled the

merger wave by selling their firms at a younger age.

Second, the age-65 effect on takeover frequencies is significantly weaker

among better governed firms. Our empirical measures of governance quality

CEO Preferences and Acquisitions 2815

are stock ownership by the CEO, blockholders, and directors; board size; board

independence; and CEO-chairman duality. Five out of the six governance mea-

sures reduce the spike in takeover activity at retirement age. When the six

measures are combined into a governance index, a one standard deviation in-

crease in the index around its mean reduces the effect of retirement age on

takeover frequency from 2.4% to 0.7% (t=2.45). This result points towards

agency conflicts between shareholders and target CEOs as the explanation for

the age-65 effect. The result also underscores the importance of governance in

aligning CEOs’ interests with those of shareholders.

We next explore how target shareholders’ gains from acquisitions change

around retirement age. One might expect that, because of their lower per-

sonal costs, retirement-age CEOs would be willing to accept less valuable deals

and thus would experience lower average shareholder gains. However, em-

pirically, we find that takeover premiums and target announcement returns

are slightly (but insignificantly) higher for retirement-age CEOs than younger

CEOs. This finding, combined with the takeover frequency results, suggests

that retirement-age CEOs are able to increase the frequency of firm sales

by almost one-third without sacrificing premiums. One explanation, consistent

with the governance results described earlier, is that young CEOs are reluctant

to sell their firms, and that weak boards allow them to reject value-increasing

deals. More broadly,the evidence suggests that managerial self-interest causes

the overall frequency of takeovers to be lower than optimal for target share-

holders.

Interestingly, acquirer announcement returns appear unrelated tothe age of

the target CEO. Hence, there is no evidence that the increase in firm sales at

retirement age is associated with weaker bargaining by targets or with larger

gains for acquirers.

Finally, we evaluate different explanations for the increase in takeovers as

target CEOs reach retirement age. Because merger activity is elevated in a

narrow window around age 65, it is difficult to come up with explanations un-

related to CEO retirement. However, there is more than one channel through

which CEOs’ preference to retire at 65 might affect takeover activity. We find

little support for the alternative hypotheses in the data. First, retirement-age

CEOs appear to be no more frequent targets of disciplinary takeovers than

younger CEOs. Second, there is no evidence that the more frequent takeovers

of firms with retirement-age CEOs are due to CEOs’ desire to cash out their

illiquid stock holdings. Third, it is possible that retirement-age CEOs sell their

firms more frequently to solve succession problems. However, we find no evi-

dence that the retirement-age effect on takeovers is larger in firms or industries

in which we expect succession problems to be more severe.

This paper has a number of implications. A growing literature in corporate

finance examines the effects of executives’ personal attributes—including risk

aversion, overconfidence, or life experience—on corporate finance decisions.1

1See, among others, Bertrand and Schoar (2003), Malmendier and Tate (2005,2008),

Malmendier, Tate,and Yan (2011), and Schoar and Zuo (2011).