Employment Protection And Takeovers
University of Toronto – Rotman School of Management
University of Toronto – Rotman School of Management
Paolo F. Volpin
City University London – Faculty of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)
July 6, 2015
Abstract:
We show that labor restructuring is a key driver of corporate takeovers around the world. In a difference-in-differences setting, major increases in employment protection result in reduced takeover activity. Consistent with workforce restructuring being a prime source of synergies, tighter employment protection more than halves the combined firm gains and reduces takeover premiums by a third. In line with the labor channel behind these effects, the reforms do impede layoffs, and triple difference effects within affected country-years show a greater reduction in synergies in deals with greater potential for workforce restructuring. Bidders fail to adjust offer prices enough and exhibit lower returns.
Employment Protection And Takeovers – Introduction
Cost reductions in the pursuit of economies of scale and scope are commonly believed to be a major driver – and a key source of synergies – in corporate takeovers (see, e.g., Houston, James, and Ryngaert (2001) and Devos, Kadapakkam, and Krishnamurthy (2009)). Restructuring the workforce (in particular, in the form of laying off redundant white- and blue-collar workers at the target firm) is presumed to be one of the primary channels through which such cost reductions are obtained. In fact, employment considerations are a contentious issue in many takeovers and mergers. For example, when the U.S. pharmaceutical firm Pfizer made a takeover bid for its British-based rival AstraZeneca in 2014, the deal fell through in part due to the U.K. government’s opposition based on concerns that the acquisition would result in a significant reduction in the firm’s research and development personnel in the U.K.
While labor force issues are widely viewed as central to mergers and acquisitions (M&A), there is no systematic empirical evidence on the importance of labor restructuring as a driver of the market for corporate control and as a source of merger synergies. This is partly because labor regulations are largely uniform within countries, and any cross-country variation comes with a host of other pertinent differences. However, understanding the drivers of the market for corporate control is important because takeovers effect massive reallocations of resources both within and across industries and countries. For instance, the year 2014 alone has seen $3.5 trillion worth of M&A activity globally, amounting to almost 5% of the world gross domestic product (GDP).2 Our paper fills this void and provides the first systematic evidence on the link between labor regulation and takeovers.
Intuitively, restrictions to labor force restructuring are expected to affect takeover dynamics in several ways. First, if workforce restructuring represents an important consideration in takeovers, then fewer takeover attempts are likely to materialize when employment is highly protected and redundancies are costlier. Second, where bids are made, the rigidity of labor regulation is expected to reduce the synergy gains from mergers and acquisitions, and bidders are expected to pay lower premiums (assuming rational behavior on their part). Finally, there may be further distributional effects on bidder performance depending on the offer price adjustment. If offer prices do not fully adjust for the lower expected synergies (e.g. price-insensitive empire-builders), rational bidders may be crowded out from the market, resulting in more overpayment, lower average bidder returns, and potentially a dead-weight loss in efficiency.
In this paper, we exploit the cross-country and time-series variation in employment protection to identify the causal impact of labor market rigidity on takeover activity and related economic outcomes. As a prequel to our main analysis, we begin with a simple cross-country test and show that the national level of employment protection explains a large part of cross-country differences in M&A activity and takeover premiums. We then turn to a difference-in-differences research design exploiting major employment protection reforms across a panel of 21 developed economies and show that employment protection changes have statistically significant and economically large effects on the market for corporate control. We begin by showing that the number of takeover deals drops by almost 15% in response to major employment protection increases. Similarly, deal volume drops by almost 30%. These effects are consistent with workforce restructuring being a major driver of corporate mergers and acquisitions, in line with the neoclassical, efficiency-seeking motive of takeovers (Gort (1969), Jensen (1993), Mitchell and Mulherin (1996), Andrade, Mitchell, and Stafford (2001)).
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