THE DISCIPLINARY ROLE OF FAILED TAKEOVER ATTEMPTS

• Date: 01 March 2016
• DOI: http://doi.org/10.1111/jfir.12088
• Published date: 01 March 2016
• Author: Baixiao Liu

THE DISCIPLINARY ROLE OF FAILED TAKEOVER ATTEMPTS

Baixiao Liu

Florida State University

Abstract

Ifind that the CEO turnover in target firms following failed takeover attempts is 21%

greater than matched nontarget firms and negatively correlated with stock returns both

before and during the attempt. Target firms are 14% more likely than matched nontarget

firms to initiate corporate restructurings during the failed attempt. Restructured firms

have more positive stock returns during this period and are less likely to experience

subsequent CEO turnover. When restructurings do not occur, active outside

blockholders are more likely to emerge and facilitate CEO turnover. These findings

indicate that failed takeover attempts can play a disciplinary role.

JEL Classification: G31, G32, G34

I. Introduction

In the finance literature, the corporate takeover market has long been thought of as a

“court of last resort”that imposes discipline on underperforming managers of target

firms in which internal control is ineffective (Manne 1965; Jensen 1986). Consistent with

this view, prior studies of successful takeover attempts report that more than 40% of

CEOs in target firms are replaced within two years of the completion of takeover

attempts, and that such turnover is significantly correlated with target firms’pretakeover

performance (Martin and McConnell 1991; Kini, Kracaw, and Mian 1995, 2004).

But this is only part of the story. Prior studies of failed takeover attempts report

that more than 30% of target firms’CEOs are also replaced within two years of the

termination of failed takeover attempts (Franks and Mayer 1996; Denis and Serrano

1996; Safieddine and Titman 1999). This turnover rate is almost double the “normal”

CEO turnover rate, suggesting that there exist alternative governance mechanisms that

impose discipline on the CEOs of target firms even when the court of last resort fails.

1

However, these studies also find that CEO turnover in target firms following failed

takeover attempts is not significantly related to performance.

In this article, I reexamine this relation using a sample of 389 target firms

following failed takeover attempts that occurred in the United States from 1985 to 2008,

I thank the editors and an anonymous referee for helpful suggestions. I also thank John McConnell, Mara

Faccio, David Denis, Byoung-Hyoun Hwang, Seoyoung Kim, Justin Tobias, Jin Xu, and participants at workshops

at Florida State University, Miami University, Purdue University, and Texas Tech University for helpful comments

and suggestions.

1

For normal rate of CEO turnover, see, for example, Denis and Denis (1995), who report a 17% average CEO

turnover rate in their study of 1,689 firms covered by the Value Line Investment Survey.

The Journal of Financial Research Vol. XXXIX, No. 1 Pages 63–85 Spring 2016

63

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RAWLS COLLEGE OF BUSINESS, TEXAS TECH UNIVERSITY

PUBLISHED FOR THE SOUTHERN AND SOUTHWESTERN

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together with 389 nontarget firms matched on the basis of industry, past stock returns,

size, and market-to-book ratio.

Consistent with prior studies, I find that an abnormally large fraction of CEOs in

target firms (41%) are replaced within two years following the resolution of these failed

takeover attempts. The 18% annualized CEO turnover rate following these attempts is

more than double the 8.8% annualized turnover rate of the sample target firms over the

five years before the failed attempt. I also find that the likelihood of CEO turnover in

target firms within two years following the failed takeover attempts is 21% greater than

nontarget firms during the same period.

In a departure from prior studies, I pay particular attention to the association

between the target firms’stock returns during the period from the day after the takeover

initiation through its resolution (henceforth, the failed takeover attempt period) and CEO

turnover in the target firm followingthe failed attempt. I do so because a target firm’sstock

returns during the failed takeover attempt period are likely to incorporate actions taken

by target managersduring this period: target managers may voluntarilyinitiate potentially

value-increasing corporate policy changes that commit them to making improvements

that would otherwise have been undertaken by a potential acquirer. The potentially

value-increasing changes initiated by target managers during the failed takeover attempt

period may improve investors’perceptions of the target firms’managerial performance.

Indeed, I find that the likelihood of CEO turnover in target firms following

failed takeover attempts is negatively correlated with the target firm’s stock returns

during the failed takeover attempt period. Estimates of logit regressions show that a

one-standard-deviation increase in the target firm’s cumulative abnormal stock returns

during the failed takeover attempt period (FTA-CAR) reduces the likelihood of CEO

turnover by 10.5%. Contrary to prior studies, I also find that CEOs in target firms

following failed takeover attempts are more likely to be replaced if their firms

have underperformed before the failed takeover attempts. For example, a one-standard-

deviation decrease in the target firm’s market-adjusted buy-and-hold returns during the

two-year period before the takeover attempt (BHR(2)) increases the likelihood of CEO

turnover by 9.8%.

Furthermore, I find that 23.7% of target firms announce corporate restructurings

during the failed takeover attempt period. In contrast, during the same period, 9.5% of

nontarget firms initiate restructurings. Target firms that initiate restructurings have

higher stock returns during this period and significant posttakeover attempt improve-

ments in operating performance than their counterparts that do not announce such

corporate restructuring programs. In addition, target firms that undertake restructurings

during the failed takeover attempt period are 17% less likely to experience CEO turnover

following the failed attempt.

Finally, I find that an active outside blockholder is 29% more likely to emerge in

target firms following the failed takeover attempt period than nontarget firms during the

same period.

2

Active outside blockholders are also more likely to emerge in target firms

2

Active outside blockholder is defined as any outside investor, other than the initial acquirer, that acquires

more than 5% of the target firm’s shares or that already has more than 5% of the target firm’s shares and increases its

ownership in the firm during the failed takeover attempt period or in the following two years.

64 The Journal of Financial Research