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Governance provisions and managerial entrenchment: evidence from CEO turnover of acquiring firms

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Abstract

Prior studies often assume that governance provisions restrict shareholders’ ability to replace managers. However, current literature provides no evidence that firms with a higher number of provisions are less likely to replace the Chief Executive Officer (CEO). This study examines CEO replacements following corporate acquisitions. It documents that CEOs of firms with a higher number of provisions make acquisitions that generate negative bidder returns; however, these CEOs are less likely to leave the firm within 5 years after the acquisition announcement. Some evidence suggests that governance provisions reduce the sensitivity of CEO turnover to bidder returns. The results are especially strong for the staggered board indicator. Acquiring CEOs of firms with staggered boards are less likely to leave the firms voluntarily; they are less likely to face internal discipline from the board of directors and external disciple from the takeover market. Thus, the deployment of governance provisions weakens internal and external discipline of acquiring CEOs.

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Notes

  1. Gompers et al. (2003) define governance provisions as firm-level charter and bylaw provisions and state antitakeover laws that restrict shareholder rights through takeover protection and limitations on voting power and other forms of shareholder activism. Gompers et al. combine 24 provisions into the Governance Index, also known as G, GIM Index, G-Index, or index of antitakeover provisions. High G-Index value represents weak shareholder (or strong managerial) power.

  2. When making acquisitions, managers can extract private benefits at the expense of shareholders through empire building, investing in manager-specific assets, and receiving lucrative compensation packages (see Harford and Li 2007; Jensen 1986; Moeller et al. 2005; Murphy 1985; Shih and Hsu 2009; Shleifer and Vishny 1989).

  3. Lehn and Zhao (2006) and Mitchell and Lehn (1990) document that CEOs frequently lose control of the firm following value-reducing acquisitions, but they do not analyze the effect of governance provisions on CEO replacement.

  4. There is also ample anecdotal evidence. For example, Carly Fiorina of Hewlett-Packard was fired in 2005, 3 years after the completion of a contentious merger between Hewlett-Packard and Compaq. More recently, Bank of America’s CEO Ken Lewis was forced to resign in 2009, a year after the controversial acquisition of Merrill Lynch.

  5. The sample period is extended for 5 years for CEO turnover analysis.

  6. The main results presented in the paper do not change when 1999–2000 “bubble” period is excluded from the analysis.

  7. For a summary of the merger announcement returns see Andrade et al. (2001).

  8. Firms with a G-Index value below six are categorized as “Democracies” (i.e., they have strong shareholder power), and firms with a G-Index value above 13 are categorized as “Dictatorships” (i.e., they have strong managerial power).

  9. E-Index includes six out of 24 G-Index components: staggered board, poison pill, supermajority voting requirement, limits to amend bylaws, limits to amend charters, and golden parachute. Bebchuk et al. (2009) show that this reduced index drives the negative relation between governance provisions and firm value.

  10. Bebchuk and Cohen (2005) and Faleye (2007) argue that staggered boards protect management from removal. In contrast, Koppes et al. (1999) and Wilcox (2002) suggest that staggered boards provide stability and continuity and encourage board independence. Zhao et al. (2009) document that firms with staggered boards are less likely to overstate earnings, providing the interpretation that firms with staggered boards have lower takeover threat, which mitigates managerial pressure to overstate earnings.

  11. Poison pill can be adopted any time, even after the takeover bid is announced.

  12. Following Lehn and Zhao (2006), only the first deals are included for CEOs who make several acquisitions during the sample period. The main results do not change when I examine the largest acquisitions made by each CEO during the sample period or the acquisitions with the highest negative bidder returns around the announcement date (results are unreported but available upon a request).

  13. For example, Parrino (1997) and Blackwell et al. (2007) examine board driven turnovers but do not analyze replacements by the market for corporate control. Lehn and Zhao (2006) and Kaplan and Minton (2006) are notable exceptions.

  14. Other studies that examine CEO turnover include Denis and Serrano (1996), Denis et al. (1997), Farrell and Whidbee (2002), Goyal and Park (2002), Huson et al. (2001), Huson et al. (2004), Murphy and Zimmerman (1993), and Weisbach (1988).

  15. It should be noted that very few turnovers in the sample are due to bankruptcy/delisting. Thus, I combine these firms with takeover turnovers and refer to them as “external” turnovers.

  16. See Lehn and Zhao (2006) for more details on the procedure of identifying forced CEO turnover for merged and bankrupt firms.

  17. I thank the anonymous referee for this suggestion.

  18. Very few announcements explicitly state that CEO replacement is due to a bad acquisition. Furthermore, while using 5-year benchmark is consistent with prior studies examining post-acquisition CEO turnover (e.g., Lehn and Zhao 2006), many things, besides acquisitions, can prompt the firing during 5-year time period. It should be noted that 68 % of all turnovers in this study occur within 3 years from the acquisition announcement date, and the average time to dismissal is 2.35 years, which is much shorter than the arbitrary chosen 5-year benchmark. Furthermore, buy-and-hold abnormal return during 1 year after the acquisition completion date is included in the regressions and, at least partially, captures the success or failure of a corporate resource allocation decision.

  19. Lehn and Zhao (2006) examine the acquisitions of public targets during 1990–1998 and use age 65 instead of 60 as the determining point for classifying forced CEO turnover. They document that 47 % of CEOs acquiring public firms during 1990–1998 are replaced involuntarily within 5 years. Restricting the sample to public targets only, I find that 32 % of the acquiring CEOs during 1993–2006 are replaced involuntarily.

  20. In any corporate governance study, there is always a concern that correlation with some unobservable factors might be driving the results. I address this issue in Sect. 5.3.

  21. Recent studies emphasize the difficulty in interpreting the interaction terms in nonlinear models (e.g., Ai and Norton 2003; Norton et al. 2004; Powers 2005). Buis (2010) explains that researchers face two alternative ways of dealing with interaction effects: interpreting them in terms of marginal effects (coefficient estimates) or in terms of multiplicative effects (odds ratios). The multiplicative effect (as opposed to additive marginal effect) provides information relative to the baseline odds, which is appropriate for this study. Thus, my interpretation of interaction effects follows Buis (2010).

  22. Any merger or acquisition requires an approval from the board of directors.

  23. In unreported analysis, I separate non-forced turnover into non-forced internal and non-forced external. The results are virtually the same as for the non-forced category that combines internal and external turnover mechanisms.

  24. The E-Index also does better that the G-Index in predicting the turnover probability. It is negative and significant in non-forced turnover and forced internal turnover, but not significant in forced external turnover. Results are not reported for the sake of brevity.

  25. Field and Karpoff (2002) document that firms typically adopt staggered boards when they go public.

  26. The results are quite similar for firm age and industry average G-Index; thus, only firm age results are reported for the sake of brevity.

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Acknowledgments

I am especially grateful to Laura Field for continuous comments and support on this paper. I would also like to thank William Kracaw, David Haushalter, Jean Helwege, Michelle Lowry, Lukas Roth, Sherrill Shaffer, and John Wald for helpful comments and suggestions. I extend special thanks to the anonymous referee and the editor, for their valuable suggestions and guidance in improving the paper.

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  1. Brock University, St. Catharines, ON, Canada

    Tatyana Sokolyk

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Appendix: Variable definitions

Appendix: Variable definitions

1.1 Measures of managerial power

All governance provisions’ variables are measured the year of or, if not available, the year prior to the acquisition announcement, and are from the IRRC Governance database.

G-Index is the index of 24 governance provisions constructed by Gompers et al. (2003).

E-Index is the index of six governance provisions: staggered board, poison pill, supermajority voting requirement, limits to amend bylaws, limits to amend charters, and golden parachute, constructed by Bebchuk et al. (2009).

Staggered Board is a dummy variable that equals one if only a portion of directors is elected each year and equals zero otherwise.

1.2 Deal and firm characteristics

Deal value is acquisition value, as reported by SDC.

Acquirer market value is bidder market capitalization (stock price × number of shares outstanding), measured on the 21st trading day prior to the acquisition announcement date.

Relative deal value is acquisition value reported by the SDC, divided by the acquirer’s market value, which is measured as stock price multiplied by the number of shares outstanding on the 21st trading day prior to the acquisition announcement.

Stock deal is a dummy variable that equals one if the deal is at least partially paid with stock and equals zero otherwise.

Public target is a dummy variable that equals one if the target is a public firm and equals zero otherwise.

CAR is the cumulative abnormal stock return, in percent, to the acquiring firm around merger or acquisition announcement date, measured over several event windows, with market model parameters estimated over a period of 220 through 21 trading days prior to the merger announcement using CRSP value-weighted index.

Pre-BHAR is market-adjusted (CRSP value-weighted) buy-and-hold return, in percent, measured over the 3 years prior through 21 trading days prior to the merger or acquisition announcement.

Post-BHAR is market-adjusted (CRSP value-weighted) buy-and-hold return, in percent, measured over 1 year after the completion of merger or acquisition for the sample of firms with no forced CEO turnover, and from the acquisition completion date to the CEO replacement date for firms with forced CEO turnover.

1.3 CEO and other governance characteristics

Data on CEO age, board and ownership characteristics are collected from the acquiring firm’s proxy statements. CEO tenure is recorded from either Execucomp or the firm’s proxy statements. Following Lehn and Zhao (2006), for firms that have the same CEO in the fifth year after the acquisition announcement, these variables are recorded from the proxy statements closest prior to the acquisition announcement date. For firms that experience forced CEO turnover, CEO age, board and ownership characteristics are measured prior to the CEO turnover date. For firms that are taken over or delisted, these variables are recorded from the firm’s last proxy statement.

CEO/Chairman is a dummy variable that equals one for firms where the CEO is also the chairman of the board and equals zero otherwise.

Board size is the number of directors.

Prop. independent is the proportion of the firm’s board consisting of independent directors, which are defined as directors who are not employees, relatives of employees, or former employees of the firm.

Insider ownership is the percentage of the firm’s common stock owned by executives and directors, as a group.

Block ownership is the ownership of at least 5 % of common stock by non-executives and non-directors of the firm.

CEO age and CEO tenure are in years.

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Sokolyk, T. Governance provisions and managerial entrenchment: evidence from CEO turnover of acquiring firms. Rev Quant Finan Acc 45, 305–335 (2015). https://doi.org/10.1007/s11156-014-0438-4

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