One of the most striking empirical regularities in finance is that many acquirer shareholders earn negative abnormal returns (Andrade et al. 2001, Bouwman et al. 2009), and that the losses from the worst performing deals are very large (Moeller et al. 2005). Why is this the case?
The finance literature has pointed to two non-mutually exclusive explanations. First, in line with the traditional ‘separation of ownership and control’ problem, managers who control widely held corporations may have private goals – such as empire building – that conflict with those of shareholders, particularly in the case of acquisitions (Morck et al. 1990). According to this view, managers know what they are doing and deliberately take excessive risks. Second, managers may be overconfident or suffer from ‘hubris’, thereby paying too much relative to rational managers (Roll 1986, Malmendier and Tate 2008).
Can shareholders address these issues and prevent negative abnormal returns in acquisitions from materialising in the future? In principle, shareholder voting can provide a potential solution in both of the cases described above. Rational shareholders can veto actions driven by overconfidence, while vigilant or active shareholders can halt transactions motivated solely by empire building or private benefit purposes. If shareholder voting is effective in deterring CEOs’ behavior, CEOs will not overpay relative to the median shareholder and will not propose projects the shareholders are unlikely to support. As a result, in equilibrium all acquisition proposals will be approved.
Shareholder voting in acquisitions is left to managerial discretion in the US
Previous research has examined voting on acquisitions in the US by comparing the announcement returns for acquisitions that were subject to a shareholder vote with those that were not (Hsieh and Wang 2008, Ouyang 2015, Kamar 2006). This evidence is inconclusive because shareholder voting on acquisitions in the US is discretionary for management.
Some share deals (those with new share issuance above 20%) need shareholder approval but cash deals do not. Management chooses the funding method and thereby determine if shareholders get a vote or not. Acquirer CEOs who want to make aggressive offers they expect to fail shareholder scrutiny would simply fund them with cash or debt. Therefore, shareholder voting on corporate acquisitions in the United States imposes no binding constraint.
On average acquirer shareholders of US acquirers lose money when the deal is announced, both when the target is relatively small compared to the acquirer and when it is relatively large (Figure 1).
Figure 1 Average abnormal value returns for acquisitions in the US and the UK in 2011 dollars, 1992-2010
Notes: Abnormal dollar returns are calculated by multiplying the market capitalisation of the acquiring firm the day before the announcement by the cumulative abnormal returns in the three days around the announcement. The US returns are split into two groups by relative size (the deal value divided by market capitalisation of the acquirer larger and smaller than 25%) and both groups contain a mixture of deals with and without shareholder approval. The UK returns are split over Class 1 and Class 2 transactions. Only Class 1 deals require shareholder approval.
Evidence from the UK where shareholder voting is mandatory
In a forthcoming paper, we address these issues by focusing on the UK case, in which shareholder voting on large acquisitions is mandatory and imposed exogenously via a series of threshold tests (Becht et al. 2016). At the threshold, assignment is potentially as good as random and we can apply a regression discontinuity design (RDD).
UK listing rules require a vote if the company buys an asset that is large relative to the acquirer, according to some ‘class tests’. Each test employs a different measure of relative size. The ratio of gross assets, gross capital, profits and the ratio between the consideration offered and the market capitalisation of the acquirer. Deals that exceed 25% in at least one of the four tests are called Class 1 transactions and require a mandatory shareholder vote. In contrast, transactions below 25% do not require a vote.
In our study, based on the acquisitions made by UK listed companies between 1992 and 2010, all Class 1 resolutions were approved at the general meeting. We find that in the UK shareholders gain 8 cents per dollar upon announcement with mandatory voting, or $13.6 billion over 1992-2010 in aggregate (+$41 million on average). Without voting, UK shareholders lost $3 billion in aggregate (see Figure 1).
Based on the RDD, comparing Class 1 and Class 2 deals on the two sides of the multivariate thresholds confirm the over-performance of deals subject to mandatory voting, and indicate that mandatory shareholder voting causes higher returns.
Why do Class 1 transactions have higher returns?
We also examine the economic channels through which mandatory voting might cause higher acquirer returns. Because ex post shareholders always vote with management, the effect of mandatory voting has to be on changing incentives ex ante by imposing a binding constraint on acquirer CEOs.
Consistently, we find that takeover premiums are smaller for publicly listed targets in completed Class 1 deals, particularly around the threshold. This interpretation is further corroborated by the fact that Class 1 acquirer returns are larger in deals with multiple bidders, which the previous literature has often associated with an increased likelihood of overpayment (e.g. Hietala et al. 2002). We also find that when there is an auction among several bidders, the UK Class 1 acquirers often lose against unconstrained bidders, often from the US. These findings suggest that mandatory voting is a governance mechanism that imposes a price constraint on acquirer managers, which is beneficial for acquirer shareholders.
Given the above results, why is mandatory voting on relatively large acquisitions not adopted more widely among issuers? Acquirer shareholders could be better off by writing a mandatory voting provision into the corporate charter. In some jurisdictions this might be difficult because the board and the management can get in the way and want to guard their autonomy. Under Delaware law in the US, for example, shareholders could potentially make the necessary charter amendment but this would require the approval of the board. The same frictions that explain the large value destruction in acquisitions - self-dealing and overconfidence - might explain why we do not see such charter amendments. In other countries company law and listing rules simply do not foresee the possibility of mandatory voting on acquisitions. Acquirer shareholders would have to lobby more effectively to get the tools that would allow them to protect their wealth.
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Becht, M, A Polo, and S Rossi (2016), “Does Mandatory Shareholder Voting Prevent Bad Acquisitions?”, Review of Financial Studies, forthcoming
Bouwman, C H S, K Fuller, and A S Nain (2009), “Market valuation and acquisition quality: Empirical evidence”, Review of Financial Studies 22, 633-679
Hietala, P, S N Kaplan, and D T Robinson (2002), “What is the price of hubris? Using takeover battles to infer overpayments and synergies”, Financial Management 32, 5-31
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