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Free Cash Flow, Golden Parachutes, and the Discipline of Takeover Activity
Abstract
We conjecture that golden parachutes are initiated when the agency cost of free cash flow is most severe. We examine the relation between golden parachutes and investment levels in firms that have been successfully acquired. Our results support these three conclusions. First, target firms overinvest prior to an acquisition when golden parachutes are present. Second, the acquirers of targets with golden parachutes reduce investment subsequent to the takeover. Third, the reversal in capital investment by the combined firm is correlated with the magnitude of the target's pre-acquisition overinvestment. The latter findings indicate the takeover acts as a disciplining mechanism with the acquirer reversing the target overinvestment subsequent to the acquisition Copyright Blackwell Publishers Ltd 2000.
... The empirical evidence on corporate control depicted that the takeover threat is an important mechanism for creating the discipline factor among managers (Manne, 1965). It has been argued that a takeover market is likely to enhance the allocation of resources, such as improving efficiency (Subramaniam and Daley, 2000). This increment in the insulation further leads to a rise in discretionary behavior among the managers. ...
Accounting Conservatism, Takeover Threat, Corporate Governance and Default Risk.
... Additionally, we controlled for the existence of golden parachutes (GOLD_PAR) as a mechanism for controlling free cash flow problems in the firm. According to Subramaniam and Daley (2000), golden parachutes are contracts that guarantee the continuation of managers' compensation if a change in the firm control occurs. Firms with free cash flow problems (usually from higher cash holdings) tend to sign such contracts with their executives. ...
The scope of this study is to examine the impact of board gender diversity on corporate
cash-holding decisions within the European sport and leisure sector. A sample of 125 unique firms was selected for the period from 2008 to 2019, and analysis was performed using panel fixed-effects regressions. Empirical evidence documented that the higher the number of women serving on the board of directors, the higher the level of cash the firm holds. This result is attributed to the critical mass theory of governance, suggesting that boards having at least two women directors are associated with higher cash holdings compared to firms with one or no women directors. Additionally, gender diversity leads to increased cash holdings for firms with lower governance quality, suggesting that women on boards perform a monitoring role within those firms with the most severe agency problems. The results remain robust after several sensitivity tests controlling for potential endogeneity among the variables and the model’s functional form.
... A company in which the management have great power often has cash-flow problems, as the management are in a position to spend cash, which may lead to overinvestment. Under such circumstances, management feel the need to seek protection, and this may take the form of demanding GPs (Subramaniam & Daley, 2000). ...
The paper examines the motivation and consequences of Golden Parachute (GP) contracts in the context of TBEA, a Chinese company whose GP payment was 1,000 times executive annual salary and which rescinded its GP provision in 2019. We find that for TBEA, whose ownership is dispersed, anti-takeover was the main motivation for the adoption of GPs, and that managerial power was the key factor in designing GPs with payment of high monetary value. We also find that such GPs may induce higher excess executive compensation, lower shareholder participation, and reduce firm value, and that market reaction to the rescinding of GPs is positive. These results show that emerging capital markets should beware of the negative effect of GPs on firm value.
... Machlin, Choe and Miles (1993) find that parachutes increase the odds of an acquisition, and Lambert and Larcker (1985) find a positive stock price reaction to the adoption of parachutes. Narayanan and Sundaram (1998) find that managers of firms that adopt parachutes do not thereafter reduce firm value in the hope of attracting an acquisition, and Knoeber (1986) finds that the presence of a parachute is inversely related to manager ownership, whereas Daley and Subramaniam (1995) present evidence that entrenched managers get parachutes to shield themselves from market discipline. Lefanowicz, Robinson and Smith (2000) study a sample of deals from 1980-1995, and find that (conditional on a deal), deal-induced changes in manager wealth overall (including those relating to salary, stock holdings, and parachutes) increase target stock returns, that the presence of parachutes reduces this effect for a given level of manager incentives, and that the level of parachute payments has no effect on target stock returns. ...
... The golden parachute payment (GP ) from shareholders to the manager is chosen at 1% of the firm market value. This is consistent with Lambert and Larcker (1985), Hall and Anderson (1987), Subramaniam and Daley (2000). ...
This paper develops a model that analyzes the impact of manager-stockholder conflicts and control challenge threats on leverage, firm value and debt restructuring frequency in a contingent claims framework. This is the first theoretical study to merge several lines of research - market for corporate control, manager-shareholder conflict, dynamic capital structure, and the effect of compensation policy on managerial decisions - in one framework. This richness of the model allows to reconcile some of the on-going controversy in the corporate finance literature regarding the leverage-profitability relationship - namely, empirical support for the pecking order theory (e.g. Fama and French, 2002), and theoretical appeal of the trade-off theory (e.g. Jensen, 1986). Another implication of this paper is that control change threats are relatively ineffective for high free cash flow firms, in which case shareholders need to resort to compensation policy.
... The golden parachute frequency in our paper is substantially higher than that found in other studies (Cotter and Zenner, 1994; Subramaniam and Daley, 2000; and Lefanowicz, Robinson, and Smith, 2000). ...
This paper investigates the impact of the target chief executive officer’s (CEO) postmerger position on the purchase premium and target shareholders’ abnormal returns around the announcement of the deal in a sample of bank mergers during the period 1990–2004. We find evidence that the target shareholders’ returns are negatively related to the postmerger position of their CEO. However, these lower returns are not matched by higher returns to the acquirer’s shareholders, suggesting little or no wealth transfers. Additionally, our evidence suggests that the target CEO becoming a senior officer of the combined firm does not boost the overall value of the merger transaction.
We examine the impact of the threat of takeovers on default risk. Using a sample of 50,189 firm year observations for US firms over the period 1990–2015, we find that the threat of takeovers has a negative relation with default risk. We use difference‐in‐difference analysis to address potential endogeneity concerns and propensity score matching to control for self‐selection bias. The results are robust to alternative measures of default risk and exclusion of the dot com and financial crisis periods. Our results also hold after controlling for G‐index and E‐index. We identify improvement in performance and earnings quality in response to the threat of takeovers as channels underlying our main result. The effect of the threat of takeovers on default risk is more pronounced for firms with opaque information environment and low institutional ownership. Our findings provide important insights for the market for corporate control as a disciplining mechanism in reducing default risk. This article is protected by copyright. All rights reserved
We investigate the relationship between Chief Executive Officer (CEO) compensation and firm innovation and find that long‐term incentives in the form of options, especially unvested options, and protection from managerial termination in the form of golden parachutes are positively related to corporate innovation, and particularly to high‐impact, exploratory (new knowledge creation) invention. Conversely, non‐equity pay has a detrimental effect on the input, output and impact of innovation. Tests using the passage of an option expensing regulation (FAS 123R) as an exogenous shock to option compensation suggest a causal interpretation for the link between long‐term pay incentives, patents and citations. Furthermore, we find that the decline in option pay following the implementation of FAS 123R has led to a significant reduction in exploratory innovation and therefore had a detrimental effect on innovation output. Overall, our findings support the idea that compensation contracts that protect from early project failure and incentivize long‐term commitment are more suitable for inducing high‐impact corporate innovation.
The (M, B, Q)Financial Models
Javier M. Huarca Ochoa1
School of Accounting and Finance, USMP, Perú.
The financial disasters that have occurred in the past will continue to occur if managers do not develop methodological tools to address them. This shows that there is no remedy to control the complexity of the
volatile behavior of the economic financial systems nor with the rapid development of technology.
Here, we propose the (M ,B,Q) (financial, mathematical, quantum-physic (FMQ)) models to alert,
prevent, pacify these random phenomenons. This financial model gives birth a family of triadic models of order (p,q,r) when p,q, r + ∈ < ∞. In particular, we apply the (6,6,6) model in the capital markets andwe give financial interpretations to its results.
See complete details in page 73.
The purpose of this paper is to review the existing empirical evidence and provide an integrative framework for the growing body of literature that is situated at the intersection of two highly debated topics: merger and acquisition (M&A) activities and executive compensation. The proposed framework structures the literature along two dimensions, such as M&A phases and firm's role in a M&A deal, allowing us to identify three main streams of research and five different conceptualizations of causal relationships between M&A transactions and executive compensation. Making a comprehensive review of empirical studies conducted to date we aim at shedding more light on the current and emerging knowledge in this field of investigation, discussing the inconsistencies encountered within each stream of research and suggesting promising directions for further exploration.
This study investigates how the implementation of special attributes of CEO compensation contracts is determined by both the acquisition and the acquirer features for a set of M&A deals undertaken by Canadian acquiring firms. Our findings reveal that when agency problems are higher, manifested by larger control premiums and poor firm performance, boards of directors tend to implement stronger mechanisms of incentive alignment around M&A transactions. Relying on multiple interdisciplinary logics that are activated to explain directors' ability to effectively perform their monitoring function, we show that boards are reactive rather than proactive in dealing with agency problems. Data are further interpreted in light of the unique aspects of the Canadian institutional context. Based on asymmetric risk properties of two different groups of executive compensation modes examined in this study, testing the substitution effects between alternative governance mechanisms is proposed as an interesting avenue for future research. Copyright © 2009 John Wiley & Sons, Ltd.
We investigate the extent to which managerial incentives, including golden parachute (GP) payments, have influenced target acquisition gains over the past two decades. We find that the use and scope of GP contracts expanded dramatically for a large sample of firms acquired from 1980 through 1995. To investigate the effect of managerial incentives on target acquisition gains, we estimate a regression of abnormal stock returns for acquisitions on variables including managerial incentives, the value of GP payments, and the interaction between GPs and management incentives. The regression results indicate that management incentives are positively associated with target acquisition returns and that GP payments serve to mitigate this influence. We do not, however, detect any direct association between the level of GP payments and target gains.
Purpose
The purpose of this paper is to examine the effects of golden parachutes on shareholders' wealth when the measure is used as a compensation device instead of a takeover defense. The results show that the adoption of the measure has a negative influence on shareholders' wealth. These negative results are more prevalent for firms with an operating performance above their industry peers and are significantly influenced by the previous performance of the firm and the size of the golden parachute.
Design/methodology/approach
Event study and regression analysis.
Findings
The results show that the adoption of the measure has a negative influence on shareholders' wealth. These negative results are more prevalent for firms with an operating performance above their industry peers and are significantly influenced by the previous performance of the firm and the size of the golden parachute.
Practical implications
Investors will have more information about the reaction of stock markets at the announcement of golden parachutes.
Originality/value
The paper presents a new evaluation of the adoption of golden parachutes on shareholders' wealth when the measure is used as a compensation device instead of a takeover defense.
We incorporate managerial risk aversion and stochasticity of takeover synergy gains into Harris' (Harris, E.G. 1990. Antitakeover measures, golden parachutes, and target firm shareholder welfare. Rand Journal of Economics 21, no. 4: 614-25. bargaining model for the coexistence of antitakeover defenses and golden parachutes in corporate charters. We show that: (i) it is not always optimal that the target-firm shareholders adopt antitakeover defenses, (ii) the size of the golden parachute is proportional to the riskiness of the synergistic gains, and (iii) the target-firm shareholders are unequivocally better-off with golden parachutes than takeover-contingent stock options.
Two models that attempt to explain the adoption of golden parachutes are examined. The first model views golden parachutes as an optimal contracting response to a takeover, the other perceives them as an outgrowth of severe managerial entrenchment that results in contracts for the benefit of managers. Using a sample of 169 successful acquisitions of NYSE targets from 1981 through 1989, I document that targets that have adopted golden parachutes experience significantly higher excess returns around the announcement of a takeover than targets without these contracts. I find similar increased excess returns for the bidder/target portfolios. In addition, bidder excess return is independent of the existence of golden parachutes in targets. Additional results suggest that golden parachutes do not reduce managerial resistance to takeovers. The results are consistent with the managerial entrenchment hypothesis and inconsistent with the optimal contracting hypothesis. Sensitivity tests confirm these results. Copyright Blackwell Publishers Ltd 2001.
"Golden Parachutes" have become an increasingly controversial management perquisite. This article looks at the existence of GPs in the 1981 Fortune 500 firms, the content of those GPs, and the arguments for and against GPs. The authors conclude that although GPs may be legal, they are ethically unjustifiable.
Using an agency theory framework and data on 89 Fortune 500 firms, we assess whether the granting of golden parachutes to chief executive officers is the result of an economically rational process or determined by the social influence of the CEO. While increased takeover risk is associated with a higher incidence of GPs, as predicted by economic theory, CEOs who are able to appoint more outsiders to their board are also more likely to have GPs. These results suggest that both economic and social influence perspectives have merit and that the importance of each may depend on the ownership structure of the firm.
I investigate changes in operating performance after 58 management buyouts of public companies completed during 1977–1986. Operating returns increase significantly from the year before to the year after buyouts as measured by operating cash flows (before interest and taxes) per employee and per dollar of operating assets. Subsequent changes in operating returns suggest that this increase is sustained. Adjustments in the management of working capital contribute to the increase in operating returns. The increase is not, however, the result of layoffs or reductions in expenditures for advertising, maintenance and repairs, research and development, or property, plant, and equipment.
This paper presents evidence on changes in operating results for a sample of 76 large management buyouts of public companies completed between 1980 and 1986. In the three years after the buyout, these companies experience increases in operating income (before depreciation), decreases in capital expenditures, and increases in net cash flow. Consistent with the operating changes, the mean and median increases in market value (adjusted for market returns) are 96% and 77% from two months before the buyout announcement to the post-buyout sale. The evidence suggests the operating changes are due to improved incentives rather than layoffs or managerial exploitation of shareholders through inside information.
This paper examines the disciplining function of hostile takeovers in the U.K. in 1985 and 1986. We report evidence of high board turnover and significant levels of post-takeover restructuring. Large gains are anticipated in hostile bids as reflected in high bid premiums. However, there is little evidence of poor performance prior to bids, suggesting that the high board turnover does not derive from past managerial failure. Hostile takeovers do not therefore perform a disciplining function. Instead, rejection of bids appears to derive from opposition to post-takeover redeployment of assets and renegotiation over the terms of bids.
We examine post-acquisition performance for the 50 largest U.S. mergers between 1979 and mid-1984. Merged firms show significant improvements in asset productivity relative to their industries, leading to higher operating cash flow returns. This performance improvement is particularly strong for firms with highly overlapping businesses. Mergers do not lead to cuts in long-term capital and R&D investments. There is a strong positive relation between postmerger increases in operating cash flows and abnormal stock returns at merger announcements, indicating that expectations of economic improvements underlie the equity revaluations of the merging firms.
This paper examines whether golden parachute adoptions in the banking industry during the eighties aligned the interests of CEOs with those of regulators and or shareholders. Our results provide evidence supporting concerns expressed by regulators: that boards of directors behaved opportunistically by adopting golden parachutes prior to large bank failures in order to exploit the FDIC guarantee. Parachute adoption was correlated with poor performance ex ante and ex post. Moreover, adoption of parachutes virtually ceased when the FDIC guarantee was withdrawn by FDICIA.
This paper presents a parameter covariance matrix estimator which is consistent even when the disturbances of a linear regression model are heteroskedastic. This estimator does not depend on a formal model of the structure of the heteroskedasticity. By comparing the elements of the new estimator to those of the usual covariance estimator, one obtains a direct test for heteroskedasticity, since in the absence of heteroskedasticity, the two estimators will be approximately equal, but will generally diverge otherwise. The test has an appealing least squares interpretation.
Existing research finds little evidence of overinvestment by successfully acquired targets. This paper shows how samples drawn from completed takeovers are biased against finding overinvestment and documents evidence of overinvestment in targets that use a highly leveraged transaction to avoid a takeover. The evidence also suggests that these restructurings create value by mitigating the targets' overinvestment problems.
In this paper we investigate the effect of golden parachute (GP) adoptions on shareholder wealth. We control for the potential effect a GP adoption has on the probability that a firm will receive a takeover bid by investigating the wealth effects for firms that are in play when the GP is adopted. We find that announcements are wealth neutral when firms are in play and wealth increasing when firms are not in play when a GP is adopted. The results suggest that GPs have no influence on the success of a tender offer, refuting the hypotheses that they either align manager and shareholder interests or that they entrench inefficient managers. The difference in the results for in-play and not-in-play firms is consistent with the hypothesis that GPs signal an increased likelihood that a firm will receive a takeover bid.
The abstract for this document is available on CSA Illumina.To view the Abstract, click the Abstract button above the document title.
Adopting antitakeover measures can enable the shareholders of a target firm to increase their share of any synergy gains expected to result from combining their firm with a bidder. Adopting such measures enhances the bargaining power of the target's manager, who will be a tougher bargainer than the nonmanagerial shareholders will, owing to his expected loss of his job following the target's acquisition. If the manager's expected loss of utility is very large, target firm shareholders may maximize their takeover-related gain by both adopting antitakeover measures and awarding the manager a golden parachute of the optimal size.
We develop a model of the acquisition market in which the acquirer has a choice between two takeover mechanisms: mergers and
tender offers. A merger is modeled as a bargaining game between the acquiring and target firms; whereas a tender offer is
modeled as an auction in which bidders arrive sequentially and compete for the target. At any stage of the bargaining game
the acquiring firm can stop negotiating and make a tender offer. In equilibrium, there is a unique level of synergy gains
below which the acquiring firm makes only a merger attempt as it expects to lose in the competition resulting from a tender
offer. For synergy gains above this level, tender offers can occur. However, to get tender offers, target shareholders must
give their managers golden parachutes that give higher payoffs in tender offers than in mergers.
The investment decisions of firms over a five-year period immediately prior to being taken private are examined. The results indicate that announcements of new investments made by going-private candidates are characterized by significant negative median abnormal returns. These findings appear to be driven largely by the subsample of contested transactions. For this subsample and its control group, the likelihood of becoming a buyout candidate is significantly inversely related to the wealth effects of the firm's investment decisions. Overall, the results suggest that one source of value in going-private transactions, particularly contested transactions, is the reduction of agency costs observed in the form of poor investment decisions.
This study seeks to determine whether stockholders experience increases in wealth due to a company's adoption of a golden parachute and resulting increased takeover bid probability. Market reaction to golden parachute adoption is examined by employing event analysis, logit analysis and metric regression. Our findings indicate that the adoption of a golden parachute does not signify an increased probability of a takeover bid, and stockholders experience a decrease in wealth. Copyright Blackwell Publishers Ltd 1997.
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