Corporate Governance and Firm Survival

• Author: Rabih Moussawi,M. Sinan Goktan,Robert Kieschnick
• Date: 01 May 2018
• Published date: 01 May 2018
• DOI: http://doi.org/10.1111/fire.12161

The Financial Review 53 (2018) 209–253

Corporate Governance and Firm Survival

M. Sinan Goktan

California State University – East Bay

Robert Kieschnick

University of Texasat Dallas

Rabih Moussawi∗

Villanova University

Abstract

We explore how various aspects of corporate governance influence the likelihood of a

public corporation surviving as a separate public entity,after addressing potential endogeneity

that arises from competing corporate exit outcomes: acquisitions, going-private transactions,

and bankruptcies. We find that some corporate governancefeatures are more important deter-

minants of the form of a firm’s exitthan many economic factors that have figured prominently

in prior research. We also find evidencethat outsider-dominated boards and lower restrictions

on internal governance play major roles in the way firmsexit public markets, particularly when

a firm’s industry suffersa negative shock. Overall, our results suggest that failure to recognize

competing risks produces biased estimates, resulting in faulty inferences.

Keywords: corporate governance, acquisitions, going private, bankruptcy, corporate restruc-

turing

JEL Classifications: M40, M48, G33, G34

∗Corresponding author: Villanova University, Villanova School of Business, 800 Lancaster Avenue,

Villanova,PA 19085; E-mail: rabih.moussawi@villanova.edu.

The authors wish to thank the anonymous referee, the Editor Srini Krishnamurthy and participants in

the SEC Financial Reporting Conference, the Southern and Eastern Financial Association meetings, the

Financial Management Association meetings and seminars at the University of Texas at Dallas and at

University of Texasat San Antonio for helpful comments. Goktan gratefully acknowledges the support of

the Jack and Susan Acosta Professorship at California State University – East Bay.

C2018 The Eastern Finance Association 209

210 M. S. Goktan et al./The Financial Review 53 (2018) 209–253

1. Introduction

Corporations with publicly traded stock exit these markets by either being ac-

quired by another operating company, being acquired by a private equity firm, or

going bankrupt. All prior published studies of the effect of corporate governance on

the likelihood of a firm exiting public equity markets in one of these three ways has

failed to address two issues that raise concerns about their findings. First, these studies

fail to recognize that these outcomes are competing risks. Second, these studies fail

to address the possibility that the corporate governance measures that they use might

be endogenous variables in their regression models. The purpose of this study is to

address both of these issues and so add to the literature an enriched understanding of

how corporate governance influences the likelihood of these outcomes.

The fact that these three forms of corporate exits are competing risks should be

clear to anyone that reads the business press. For example, one finds news stories of

firms receiving competing bids from other operating companies and private equity

firms. As a result, some prior research (e.g., Halpern, Kieschnick and Rotenberg,

1999) has examined what factors significantly influence the likelihood of a firm

going private rather than being acquired by another operating company. On a different

note, even though Stiglitz (1972) points out that being acquired by another operating

company and going bankrupt, are alternatives for one another, less research attention

has been given to this choice.1Yet this choice occurs frequently enough to raise inter-

esting regulatory issues2as pointed out by Heyer and Kimmel (2009). The key point

is that these outcomes are competing risks, and according to the statistics literature

on competing risks (e.g., Crowder, 1991), the failure to recognize them as such in

probability models produces parameter and standard error estimates that are biased.

Separate from the above issue, our review of prior research on the determinants

of each of these outcomes reveals that they ignore the possibility that the corporate

governance measures they use might be endogenous variables in their estimated

choice models (see Appendices A, B, and C for reviews of each of this research). The

failure to address this issue in prior research raises questions about the conclusions

drawn from such research since it is quite possible that the corporate governance

features that they consider are correlated with omitted variables (managerial quality,

etc.) that influences how their firms exit public equity markets.

Consequently, the focus of this study is on examining how corporate gover-

nance influences the likelihood of a corporation being acquired by another operating

1Notable exceptions to this lack of empirical attention are Pastena and Ruland (1986) and Meier and

Servaes (2014).

2For firms facing serious financial distress, once financing becomes more readily available to potential

acquirers we might expect an increase in both the number and share of mergers where at least one of

the parties is having difficulty staying afloat independently.The merger then becomes an anticompetitive

merger where the target that could have a chance to float independently failsafter the merger, leading to a

reduction in market competition.

M. S. Goktan et al./The Financial Review 53 (2018) 209–253 211

company,going private, or going bankrupt while both recognizing that these are com-

peting risks and recognizing the potential endogeneity of their governance features

to these outcomes. Further, we address whether firms change their corporate gover-

nance features in expectation of a possible form of exit. Alternatively, we examine

whether certain corporate governance features are correlated with omitted variables

that influence the form of exit (e.g., CEO ability). To the best of our knowledge, our

study is the only study to explore these issues.

To conduct our analysis, we use all U.S. corporations from 1997 through 2004

with sufficient data on the variables of interest. Based on these data, we findevidence

for severalmajor conclusions. First, consistent with the statistics literature, we provide

evidence that probability models for the likelihood of a firmbeing acquired by another

firm, or going private, or going bankrupt that ignore the competing risks produces

different estimates of their parameters and standard errors from a probability model

that recognizes the existence of such competing risks.

Second, we find evidence that severalcorporate governance features are endoge-

nous variables in regression models that estimate the probability of a corporation

going private, or being acquired, or going bankrupt. We identified 50 studies that

examine the various factors on the likelihood of a firm being acquired, going private,

or going bankrupt, yet none considers this possibility. Based on an analysis of gover-

nance changes prior to these events, it is unlikely that these endogeneity concerns are

raised by changes in their governance features prior to these events. Rather,it is more

likely that these concerns arise because of their correlation with omitted factors. The

most obvious omitted variables are associated with the quality of the firm’s CEO or

its management team. Regardless, by comparing evidence from probability models

that account for such endogeneity to those that do not, we demonstrate the importance

of addressing endogeneity in these regression models.

Third, after accounting for endogeneity concerns, we find that firms with rel-

atively less independent boards and management teams with a larger share of their

firms’ stock are more likely to go private. This link between insider control and the

higher likelihood of going private is inconsistent with Bharath and Dittmar (2010) but

is supportive of the evidence in Halpern, Kieschnick and Rotenberg (1999) for U.S.

firms and Weir, Laing and Wright (2005a) for U.K. firms. To confirm our findings,

we examine the impact of various governance features in detail and find that firms

with limits on amending their corporate charter with confidential voting, unequal

voting, an anti-greenmail provision, directors’ duties provision, pension parachute,

and silver parachute provision are less likely to go private. Interestingly, the presence

of shareholder restrictions in the corporate charter and/or bylaws makes going-private

transactions less likely. Together these pieces of evidence suggest that control and the

ability to exercise it without outside shareholder influence are critical to why these

firms go private.

Fourth, after accounting for endogeneity concerns, we find a number of different

results on how corporate governance influences the likelihood of a firm being ac-

quired. For example, we find that the stock ownership of insiders is not a significant