Do Takeover Laws Matter? Evidence from Five Decades of Hostile Takeovers
U.S. Securities and Exchange Commission
University of Oregon – Department of Finance
Steven Davidoff Solomon
University of California, Berkeley – School of Law; University of California, Berkeley – Berkeley Center for Law, Business and the Econom
Abstract:
This study evaluates the relation between 16 U.S. takeover laws and hostile takeover activity from 1965 to 2013. Using a hand-collected dataset of largely exogenous legal changes covering 198,845 firm years, we find that certain takeover laws, such as poison pill laws, have had an effect on takeover activity running counter to their original intent, in some instances actually correlating with increased hostile activity. We also provide evidence that our Takeover Index, constructed from the full array of takeover laws, provides a better measure of firms’ governance environment than prior studies that have focused almost exclusively on business combination statutes. We conclude by examining the relation between the Takeover Index, firm value, and takeover premiums, and find a non-linear effect across time vintages.
Do Takeover Laws Matter? Evidence from Five Decades of Hostile Takeovers – Introduction
The takeover battle for Erie Railroad is legend. In 1868, Cornelius Vanderbilt, the railroad baron, began to build an undisclosed equity position in Erie. When the group controlling Erie discovered this, they quickly acted to their own advantage, issuing a substantial number of additional shares of Erie stock for Vanderbilt to purchase. One of the managers, James Fisk, purportedly said at the time that “if this printing press don’t break down, I’ll be damned if I don’t give the old hog all he wants of Erie.” The parties then arranged for their own bought judges to issue dueling injunctions prohibiting the other from taking action at Erie. The battle climaxed when Erie’s management fled to New Jersey with over $7 million in Erie’s funds. By the time the dust settled, they were still in control and Vanderbilt was out over $1 million.1
The Erie story is apocryphal, but informative for any attempt to measure the effect of takeover laws. Takeover laws are enacted to regulate takeover activity, and they often take the form of anti-takeover laws intended to thwart hostile takeovers. However, these laws can have the opposite effect of their intended purpose. Although they provide protection to targets, they also implicitly rule out certain defensive tactics and therefore provide protection and increased certainty for prospective hostile bidders (Kahan and Rock, 2002). In the case of Erie, it is the bidder that may have benefited from more legal structure, not the target.
The varying effect of takeover laws also has implications for the theory that the takeover market is an external disciplinary mechanism for corporate governance (Manne, 1965). Numerous studies have used variation in specific takeover defenses or anti-takeover laws as a proxy for changes in firm corporate governance.2 The use of an external influence, such as takeover laws, has come into favor to sidestep the endogeneity problem that arises when measuring takeover defenses at the firm level (Core, Guay, and Rusticus, 2006). But while specific studies have focused on individual or selected anti-takeover statutes, none have examined the full array of takeover laws, and it remains unexplored how the full spectrum of the legal environment actually impacts hostile takeover activity, either encouraging or discouraging such activity over an extended period of time. Moreover, Coates (2000) criticizes many studies of anti-takeover provisions for failing to have a longitudinal time frame sufficient to account for changes in legal regimes and markets. Our study addresses these gaps in the literature.
This study uses a hand-collected dataset of 16 different takeover laws and court decisions from 1965 through 2013 to measure the variation in takeover laws and their long-term impact on hostile activity through time. We also utilize a novel hand-collected dataset of M&A hostility back to 1965. We find that the general susceptibility to a hostile takeover peaked in 1973 and has decreased substantially since 1987. As a proportion of total M&A equal-weighted volume, hostile activity peaked immediately prior to the passage of the Williams Act in 1967 at 40% and has since declined to about 5% in 2013. Although hostile activity is less common than it once was, it has certainly not disappeared.
Bertrand and Mullainathan (1999) use variation in the timing and adoption of business combination (BC) laws by states to proxy for corporate governance quality of firms incorporated in each state. Numerous studies conducted since then rely on business combination laws as a plausibly exogenous proxy for governance quality (Karpoff and Wittry, 2014). However, the relation between these laws and actual levels of hostile takeover activity remains questionable, with Comment and Schwert (1995) concluding that the passage of business combination laws had no discernible deterrence effect on takeover rates. In contrast, by examining the full spectrum of takeover laws over a longer sample horizon we find that the passage of business combination laws was followed by a significant decline in the likelihood of firms being successfully taken over through hostile means. However, we also note that the value-weighted proportion of firms covered by these laws jumped from 0% pre-1985 to over 95% by 1990. Thus, it is unclear whether BC laws provide sufficient cross-sectional variation in coverage to comprise a valid measure of external pressures on firms’ corporate governance.
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