Viceroys or Emperors? An Institution‐Based Perspective on Merger and Acquisition Prevalence and Shareholder Value

• Author: Taco H. Reus,P. P. M. A. R. (Pursey) Heugens,A. J. J. (Ron) Maas
• Published date: 01 January 2019
• Date: 01 January 2019
• DOI: http://doi.org/10.1111/joms.12335

Viceroys or Emperors? An Institution-Based

Perspective on Merger and Acquisition Prevalence and

Shareholder Value

A. J. J. (Ron) Maas, P. P. M. A. R. (Pursey) Heugens and

Taco H. Reus

Erasmus University

ABSTRACT We study how cross-country variance in institutions that aim to address core

agency problems influences consequential strategic decisions of firms around the world.

Scholars frequently argue that the interests of minority shareholders are threatened by merger

and acquisitions (M&As) due to principal-agency problems. Rather than acting in

shareholders’ best interests, managers potentially act as viceroys, using M&As to cushion

themselves from risk and extract more pay. Yet equally salient is the issue of principal-

principal agency, where controlling shareholders can behave as emperors who use M&As to

siphon off assets and profits, and appropriate wealth of shareholders with fewer control rights.

Taking an institution-based perspective on these ‘viceroy’ and ‘emperor’ problems, we

conjecture that institutions aimed to address these agency problems can generate the desired

outcome regarding M&A prevalence, but may also produce unintentional negative

consequences for shareholder value as a side-effect. Empirical evidence covering M&As from

73 countries supports our hypotheses.

Keywords: comparative institutional research, institution-based view, mergers and

acquisitions, meta-analytic regression analysis, principal-agency theory, principal-principal

agency theory

INTRODUCTION

Management scholars have found that the environment places a great deal of constraint

on the strategic options open to firms (for summaries, see Heugens and Lander, 2009;

Scott, 1987; Tolbert and Zucker, 1999). Particularly when they restrain or drive conse-

quential strategic decision-making, such as mergers and acquisitions (M&As),

Address for reprints: Taco H. Reus, Department of Strategic Management & Entrepreneurship, Rotterdam

School of Management, Erasmus University, Burgemeester Oudlaan 50, 3062 PA Rotterdam, the Neth-

erlands (treus@rsm.nl).

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doi: 10.1111/joms.12335

Journal of Management Studies 5 :6 1 January 2019

environmental characteristics can greatly impinge upon the strategic expansion and per-

formance of firms. Scholars have therefore generated important insights about how the

environment – for example, in terms of environmental uncertainty (e.g., Schilling and

Steensma, 2002), network and resource dependencies (e.g., Pfeffer and Salancik, 1978),

and cross-national differences in institutions (e.g., Dikova et al., 2010) – influences M&A

prevalence and performance.

Although the influence of the environment has been widely recognized, little system-

atic research has built on institutional theory to explain how institutions that aim to

address a central conundrum in M&As – i.e., whether M&As are a vehicle for maximiz-

ing shareholder value or for serving the self-interests of managers at the shareholders’

expense (Haleblian et al., 2009) – influence the prevalence and value of M&As. In fact,

scholars recently observed that ‘institutional theory has been remarkably absent from

M&A research’ (Ferreira et al., 2014, p. 2556). As a result, we still have limited under-

standing of whether institutions serve to assure that M&As increase shareholder value –

for example by effectuating gains in efficiency and market power, optimizing asset rede-

ployment or disciplining management (e.g., Capron et al., 1998; Jensen, 1986) – or,

whether institutions allow executives and other stakeholders to engage in M&A activity

for self-serving reasons (e.g., Agrawal and Walkling, 1994; Deutsch et al., 2007). This is

surprising, because prior research indicates that countries vary widely in the extent to

which they have institutions in place to address such concerns (Rossi and Volpin, 2004).

We therefore seek to understand how different forms of institutional constraint that aim

to address two types of agency problems affect M&A prevalence and shareholder value.

The principal-agent problem is central to our understanding of firms’ M&A behav-

iour and performance (e.g., Desai et al., 2003; Jensen, 1986; Parvinen and Tikkanen,

2007). Bounded by fiduciary duties, managers are expected to act as stewards of the

firm’s shareholders, and run it in their absence while striving for maximum shareholder

value (Davis et al., 1997; Donaldson, 1990). As part of their duties, these stewards are

expected to seek out M&A targets that provide synergies with the acquirer and lead to

wealth gains. Yet, management scholars frequently emphasize that managers often

engage in M&As for self-serving reasons (Devers et al., 2013; Eisenhardt, 1989; Sanders,

2001; Shapiro, 2005), for example to increase the size of the firm, which is strongly

related to managerial compensation (Tosi and Gomez-Mejia, 1989; Wright et al.,

2002), or to diversify cash flows, which reduces the risk of dismissal due to exceptionally

weak performance (Amihud and Lev, 1981).The extent of the principal-agent problem

depends on the accountability of managers towards shareholders (Jiraporn et al., 2006),

and the existence of legal institutions that govern this accountability by shifting power

from managers to shareholders (Guillen and Capron, 2015). These institutions, com-

monly conceptualized as anti-director rights (ADR) (Spamann, 2009), serve to empower

shareholders, for example by facilitating the voting process for new director appoint-

ments, or reducing the percentage of votes required to call for an extraordinary general

meeting of shareholders (La Porta et al., 1998). Prior research in corporate governance

has emphasized that the presence of these control mechanisms is necessary to prevent

managers from engaging in self-benefitting behaviour. Yet, the antecedents for these

control mechanisms are institutionally derived, and as such differ across jurisdictions

(Aguilera and Jackson, 2003; Young et al., 2008). In countries where these institutional

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regulations are absent, shareholders therefore run greater risk that they see their

appointed stewards develop into viceroys who rule the firm as a personal fiefdom, and

use it to extract above-market wages and other perquisites (Devers et al., 2013). We

metaphorically refer to this issue as the viceroy problem.

However, while the classic principal-agent problem has received much attention in

the M&A literature, the viceroys are frequently no more than vassals, subordinate to

controlling shareholders that form the ulterior ruling party. Reigning as emperors over

the organization, the influence of controlling shareholders can lead to a different type of

agency problem: i.e., the principal-principal problem. This problem emerges when con-

trolling shareholders (e.g., wealthy entrepreneurs or founding families) extract private ben-

efits of control from the firm, defined as pecuniary gains that do not accrue to minority

shareholders (Bethel et al., 2009; Dharwadkar et al., 2000; Dyck and Zingales, 2004;

Young et al., 2008). For example, controlling shareholders can resort to tunnelling,

whereby assets are sold from the focal firm to another firm under their control at prices

below market value (Bae et al., 2002; Shleifer and Vishny, 1997). Or, controlling share-

holders can pay significant premiums for targets in which they enjoy greater cash flow

rights, thereby directly transferring wealth from minority shareholders to themselves

(Albuquerque and Schroth, 2010; Dyck and Zingales, 2004).

Besides running the risk of being expropriated by viceroys, smaller shareholders may

therefore also fall victim to larger shareholders, especially when large controlling block

holders emerge as the result of an acquisition (Holderness, 2003). Controlling block holders

can then act as emperors, using their controlling share of the voting rights to siphon off the

firm’s assets and profits without regard for the interests of non-controlling parties. We

metaphorically call this the emperor problem. The severity of this problem is contingent on the

accountability that majority shareholders have towards minority shareholders (Dharwadkar

et al., 2000). Similar to the viceroy problem, governments regulate the emperor problem

through legal institutions, also known as anti-self-dealing laws (ASD), as conceptualized by

Djankov et al. (2008). Examples of the institutions that address principal-principal problems

include laws that govern the disclosure of self-dealing transactions and minimally required

levels of approval for M&A deals from minority shareholders.

While both agency problems are important, we know little about the legal conditions

that determine their influence on M&A activity and how they affect post-M&A abnor-

mal returns to shareholders. Since countries vary widely in terms of the development of

dedicated institutions for governing and structuring M&A activity, we expect that the

global M&A context will be far from universal. Instead, jurisdictions differ in the extent

to which they have developed institutions that address managerial empire building (i.e.,

the viceroy problem) and minority shareholder expropriation by controlling sharehold-

ers (i.e., the emperor problem). However, the two problems do not always coincide, and

institutions that target one problem might neglect the other (Dyck and Zingales, 2004;

La Porta et al., 1997). In this paper, we therefore set out to develop an institution-based

perspective on M&As, and argue that the prevalence and performance of M&As is con-

tingent on the presence of institutions that accost the viceroy and emperor problems.

More specifically, we suggest that the institutional context influences variance in

M&A prevalence across markets in different ways, depending on the extent to which

institutions address the viceroy and emperor problems. Institutions that constrain the

236 A. J. J. (Ron) Maas et al.

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