CRG L8 - 2019

Corporate Restructuring
& Governance
BUSI 3101
Lecture 8
Dr. Young Un Kim
2016 CRRC International Talent Development Programme

Announcements
• Ongoing seminars this week…

• Attend your designated seminar time
>> if you cannot, please email me before your
designated seminar time
You are required to:
– Read the article of Denis 1994 with various cases of
restructuring that is provided on Moodle under seminar 1.
– Prepare answers to the questions asked in the document
seminar 1 assignment on Moodle under seminar 1.
Copyright 2019 © Nottingham University Business School China. All Rights Reserved 2
Today’s Lecture
• The market for corporate control
• Takeovers and firm performance:
propositions
• Empirical evidence
Copyright 2019 © Nottingham University Business School China. All Rights Reserved
The Market for Corporate Control
What is it:
• Management teams compete for control of corporations
= takeover market
• Underperformers are under threat of replacement
(other management teams think they can generate
better results and improve performance)
• Takeovers are a form of natural selection where only
the better performing firms and managers prosper
• Takeovers are probably the most effective way of
replacing managers that do not maximise firm value
(Shleifer and Vishny, 1988)
Takeover market as external pressure
Separation Excessive Excess FCF Attractive

of managerial waste & restructuring
ownership discretion inefficiency target
& control
Monitoring Takeover
by board activity & /
or threat
Anti-t/over Friendly Hostile LBO /

devices merger takeover MBO
Source: Fox and Marcus, 1992, AMR

Friendly take-over
In 2014, Facebook acquired Whats
App for $19 billion in a friendly
takeover.
The target company was happy

with the transaction.
Hostile take-over
• Tender offer: acquirer makes offer directly to the
target shareholders at a stated price
• Proxy contest: the acquirer asks target
shareholders to elect a dissident slate of directors
to approve the deal
How does the market for corporate control work?
• MCC is the arena where management teams
compete for the rights to manage corporate
resources (Jensen & Rubeck, 1983; Jensen, 1988).
• Takeovers reconcile the interests of shareholders
and managers when internal governance
mechanisms fail (Jensen, 1986).
• Threat of takeover itself is a motivating factor
• Actual takeover event corrects for managerial
failure by displacing under-performing or
opportunistic managers and/or changing internal
governance mechanisms
Function of MCC
• Changing market conditions require major
restructuring of corporate assets
• Existing managers find it difficult to abandon
strategies
• Threat of takeover disciplines existing managers
and pushes managers to change
• Takeover event pushes managers out or
incentivizes/penalizes managers to make
changes. Easier for new managers to make these
changes
“The lower the stock price, relative to what it could
be with more efficient management, the more
attractive the takeover becomes to those who
believe that they can manage the company more
efficiently”
– Manne 1965
Theoretical Predictions
• Expect target firms to exhibit inferior performance
prior to the bid announcement
• Expect the post-takeover performance of
companies to improve
• Expect effects on managerial and employee
turnover
• Expect failed takeover attempts to improve
corporate efficiency
Think about case of Safeway and Kroger…

Theoretical predictions (2)
• Function not solely to correct agency problems
(replace underperforming managers; increase
alignment managers & shareholders).
• Resource based view: strategy to acquire resources
the company lacks (e.g. market-seeking, resource-seeking
(technology), natural-resource seeking)
– competences: Geely wants to take over Volvo: high quality
and high safety technology & manufacturing process
– Distribution channels: Geely wants access to European
market (similarly before Chinese companies bidding for Opel)
– Access to resources: Yanzhou coal recently took over
Australian miner Felix resources (access to coal resources)
Evidence - Why use an event study?
• Measure the effect of an event or announcement
e.g. takeover, M&A, profit announcement, issue of
new debt and/or equity
• In the case of takeovers (M&As) share price is the
appropriate measure of corporate gains and losses
because it reflects shareholders interests
 As a measure of performance it assumes that the stock
market is efficient
• Accounting based measures used to assess real
performance gains or losses
 Used to assess whether stock market performance reflects
economic performance
What is an event study?
Time line
t-time t=0 t+time
pre-event Event date post-event
• Share price studies tend to examine short
periods around the event using daily data
• Accounting data studies tend to examine longer
periods using annual data
• What is the event? Bid announcement date or
takeover date
 Stock markets incorporate new information, so bid announcement
should be used
 Accounting data studies use takeover date, the date from which
economic gains can be realised
Illustration of an Event Study:
Plots of Cumulative Residuals for Successful Bidding Firms
Cumulative Abnormal
Returns (CAR)
20
15
10
5
0
-5
-10
-15
-60 +60
0
Event Studies: Post-Bid Announcement
• Evidence extensive and consistent:
– large gains to target shareholders
– bidder s/holders returns less clear but
more evidence of negative returns
– overall bidder + target shareholder gains
positive
– “Bad bidders become good targets”
(Mitchell & Lehn, 1990)
Accounting data studies’ evidence
• ‘Real’ economic performance of firms should be reflected
in accounting measures of performance e.g. ROE, ROA
• Target
 Pre-takeover profitability of targets 0.97% below industry norm
and nine years after takeover it is 3.1% below industry norm
(Ravenscraft and Scherer, 1987)
 Threat of takeover declines with higher profitability (Dickerson et
al., 2002)
• Acquirer
 Most studies show post-acquisition performance declines
(O’Sullivan and Wong, 2005)
• Combined (target & acquirer) post-acquisition
performance
 Negative impact on profitability (Dickerson et al., 1997)
• Related acquisitions have a positive effect on profitability
(Conyon et al., 2004)
Effects on Managerial Turnover
• Managerial turnover more likely when:

– A company is targeted for takeover in hostile (as
opposed to friendly) bids
– When target is under-performing pre bid
– When bid is resisted by management
– With low outside representation on board
– With low levels of block shareholders
Takeover Failure
• How important is the threat of a takeover vis-à-
vis the actual event?
• Even if takeover doesn’t go through, target
shareholder can retain gains if:
– Target receives, or market expects them to receive,
further bids
– Corrective action taken
• the bid process can reveal new information
• company can be re-valued (issuing new profit
reports/forecasts)
Takeover Failure
• Managerial turnover often follows failed takeover
(ironically, successfully defending against a
takeover doesn’t secure managers jobs!)
• Denis and Serrano (1996) find that 34% of
companies (with takeover failure) experienced
top management turnover
Overall outcomes on takeovers
1. No clear evidence that firms that are taken
over show improved performance after
takeover
2. Evidence that takeovers impact managerial
turnover (managers likely to be replaced after
takeover)
3. Evidence that threat of takeover (failed
takeovers) has an effect on managerial
turnover. (increased replacement of CEO in 2
years after failed takeover).
Unanswered questions
• Given that on average bidders don’t gain, why do
they engage in takeovers?
– There are motives for takeovers other than the MCC such as
pursuit of synergies, acquisition of specific resources (e.g.
market entry); the benefits of which are not easily measured.
– Hubris / overconfidence by managers.
• Why aren’t the post-takeover performance effects
more promising?
– Measurement issues?
– Changes in strategic direction esp. in hostile takeovers.
– Average effects: Some takeovers may be successful – need to
understand when the benefits are reaped.
– There are factors that frustrate the effective functioning of the
MCC – for example takeover defences and transaction costs
Hubris / Overconfidence
• Roll’s (1986) hypothesis - managers overestimate
their abilities to add value in a target firm and,
hence, overpay.
• Some evidence :
 CEO hubris is associated with higher bid premiums and this
relationship is stronger when there is a weak board of directors
(Hayward and Hambrick, 1997)
 Greater CEO hubris associated with greater losses to acquiring
firms’ shareholders (Hayward and Hambrick, 1997)
 The odds of takeover are 65% higher if the CEO is classified as
over-confident (Malmendier and Tate, 2008)
 There is a more negative market reaction to takeover
announcements by overconfident CEOs (Malmendier and Tate,
2008)
Unanswered questions
• Why aren’t the post-takeover performance
effects more promising?
– Hostile takeovers are risky because the target company’s
management do not typically share any information that is
not already available for public view.
– Changes in strategic direction requires good
implementation skills
– Average effects: Some takeovers may be successful –
need to understand when the benefits are reaped.
– There are factors that frustrate the effective functioning of
the MCC – for example takeover defences and transaction
costs
Takeover Defences: tactics to make targets less
attractive
Next Lecture
• Focus on Takeover Defences
• Read articles relevant for lectures 9
• Key articles:
– Holl & Kyriazis (1997) Agency, Bid resistance and the
market for corporate control
– O’Sullivan and Wong (2005): The Governance Role of
Takeovers, Chapter 8 in Keasey et al., Corporate
Governance.
THANK YOU

CRG L8 - 2019

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Corporate Restructuring

Dr. Young Un Kim

2016 CRRC International Talent Development Programme

• Ongoing seminars this week…

Separation Excessive Excess FCF Attractive

Anti-t/over Friendly Hostile LBO /

Source: Fox and Marcus, 1992, AMR

The target company was happy

Think about case of Safeway and Kroger…

• Managerial turnover more likely when:

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