Golden Parachutesand the Wealth of ShareholdersLucian Bebchuk (Harvard) Alma Cohen (Tel-Aviv, Harvard) Charles C.Y. Wang (Stanford, Harvard)
Yale SOM, November 2010
GP and the Wealth of Shareholders (Bebchuk, Cohen, Wang)
*MotivationGPs have attracted much debate and attention since the late 70s and early 80sCongress in 84 imposed substantial tax penalties on large GPs to discourage their useRise in shareholder precatory resolutions opposing GPs President Obama and Treasury Secretary Geithner aim to take the air out of golden parachutes2010 Dodd-Frank Act mandates shareholder advisory votes on all adoptions of GP by public firms.
We seek to inform this debate by investigating how GPs are associated with:Acquisition outcomes: likelihood, premiums, and expected premiums.The evolution of firm value over time.
*Main FindingsGPs and Acquisition Outcomes: GPs positively associated with likelihood of receiving acquisition bid and of being acquired GP negatively associated with acquisition premiaGPs positively associated with expected premia from an acquisition.
GPs and Evolution of Firm Value:Firms adopting GPs tend to have lower Tobins Q value already in the IRRC volume preceding the adoptionThe value of firms adopting GPs but their value continues to erode during the inter-volume period of adoption and continues to erode subsequently.
*Literature ReviewThere is substantial empirical literature on GPsEvent studies around GP adoptions, with mixed results(Lambert & Larcker 85; Born, Faria, & Trahan 93; Mogavero & Toyne 95; Hall & Anderson 97)Unlike these studies, we examine the evolution of value in a much longer window.
Evidence of negative correlation between GP and Q, but does not indicate timing when the negative correlation arises(Gompers, Metrick, Ishii 03; Bebchuk, Cohen, and Farrell 09)
Literature on the direct effects of GPs on acquisition likelihood and premia (but not on the expected premia) but with mixed results. (Machlin, Choe, and Miles 93; Born, Faria, &Trahan 93; Cotter and Zenner 94; Hall and Anderson 97; Lefanowicz, Robinson, and Smith 00; Fich, Tran, and Walking 09)
*Data DescriptionData on Golden ParachutesInvestor Responsibility Research Center (IRRC) 8 Volumes: 1990, 1993, 1995, 1998, 2000, 2002, 2004, 2006Tracks corporate governance provisions for 1400~1800 largest firms
Benefits of IRRCBroad coverage (> 90% of total U.S. market cap) Long time seriesData on other governance measures (poison pill, staggered board, etc)
Weaknesses of IRRCNo exact GP contract details and size of parachuteOnly has snap-shots every 2~3 years, dont have exact adoption dates
*Summary Statistics IStock of GPs in each IRRC volume rising over time
IRRC Volume# Firms in IRRC VolumeFirms w/ GP% of Firms w/ GP19901,46774050.4%19931,46378053.3%19951,49680253.6%19981,913106055.4%20001,886122364.9%20021,894128267.7%20041,982145573.4%20061,897147377.7%
*Summary Statistics IIAdoption of GPs in each IRRC volume averages to 22.4% of eligible adopters
YearsTotal FirmsFirms with no GP beginning of periodNum of Adopters% of Adopters1990~19931,27263910115.8%1993~19951,3446417912.3%1995~19981,21459414223.9%1998~20001,66776821427.9%2000~20021,41653316030.0%2002~20041,65452913124.8%2004~20061,65645510022.0%
*Summary Statistics IIIIncidence of acquisition positively associated with GPsBid (acquisition) incidence is43% (52%) greater for GP firms over Non-GP firms
% Receiving Initial Bid in the Next Calendar Year% Acquired in the Next Calendar YearNo GPGPDiffNo GPGPDiff19904.64%4.70%+2.48%2.35%-19912.71%3.63%+1.86%2.57%+19922.96%3.42%+2.79%3.11%+19933.24%4.58%+1.87%2.08%+19945.76%8.05%+1.92%5.46%+19953.97%7.45%+2.64%4.41%+19964.78%9.87%+3.92%8.56%+19978.41%9.08%+5.01%7.32%+19987.85%12.74%+6.25%10.24%+19996.17%9.68%+6.47%9.43%+20003.66%5.14%+3.66%5.57%+20011.94%2.64%+1.08%2.75%+20023.54%3.90%+2.29%2.57%+20033.21%4.75%+3.00%4.02%+20044.27%6.06%+1.76%4.58%+20056.98%8.08%+5.43%4.81%-20065.28%9.80%+5.59%8.16%+Mean4.7 % 6.7 %2.0 %***3.4 %5.2 %1.8 %***
*GP and Likelihood of Acquisitions GP associated with higher bid/acquisition likelihoodNote1: Marginal FX reported
* Note 1: Marginal FX reportedNote 2: Only interaction terms reported. Main effects and controls suppressed
Generality of the Association between GP & Acquisitions II
*Interpreting the Association between GP and Acquisitions IPositive association between GP and acquisition likelihood result from Incentive (Causality) EffectPrivate Information Effect (Lambert-Larcker, 85)
We test whether the effect is entirely driven by private information using the timing of GP adoption If managers adopt GP in anticipation of acquisition bid relationship with acquisition should be driven by newly-adopted GPs
* Diff = -0.003PVal= 0.324Note 1: Marginal FX reportedNote 2: Estimation using HHI to control for industry yields similar resultsInterpreting the Association between GP and Acquisitions II
GP and Acquisition Premium
*Interpreting Association between GP and Acquisition Premium IExplanations?GP decreases managers threshold, making manager more receptive to acquisitions* Weakens bargaining position in acquisitions that will take place regardless of a GP* Introduces additional (lower-value) acquisitions.
*Alternative Explanations? GP as a compensation-shifting tool (Choi 04)Shareholder shifts compensation burden to buyer in the event of acquisitionLowers shareholder return in acquisition, but benefits shareholder ex-ante by lowering managers non-acquisition compensationBut, model also predicts GPs decrease acquisition likelihood
Disloyal managers trading off premiums and private benefits (Hartzell, Ofek, and Yermack 04)Certain CEOs negotiate increased golden parachutes along with special cash bonuses during acquisition deals in exchange for lower premiumThe GPs we study in our data set are adopted ex ante
Interpreting Association between GP and Acquisition Premium II
GP and Expected Acquisition Premiums
*GP and Firm ValueEarlier literature has documented the negative association between Q and GP (GIM 03; BCF 09)However, the timing in the deterioration of firm value is unclear.
We investigate whether the negative association arisesPrior to adoption of GP?In period between IRRC volumes around the adoption of GP?After adoption of GP?
To answer these, use inter-volume changes in GP
*Adopters have low Q prior to adoption of GP Relative to non-adopters, future GP adopters Q 4~5% lower
Note:Future GP Adopter is an indicator where1: a firm that adopts GP by the next IRRC volume0 indicates firm that does not have GP in current and next volume
*Q continues to decrease around adoption I
Relative to non-adopters, future GP adopters experience volume-to-volume (over next 2~3 yrs) change in Q 4~5% lower
Note: Future GP Adopter is an indicator where1: firm adopts GP by the next IRRC volume0: firm does not have GP in current and next volume
*Q continues to decrease around adoption II
The long-term event window (2~3 years) surrounding GP adoption associated with a 4.5% decrease in Q
Note: This is a changes regression run on the full set of firms that show up in two consecutive volumes
*Q continues to drop for long-term adopters
Relative to LT non-adopters, LT GP adopters experience volume-to-volume (2~3 years) change in Q about 4~6% lower
Note: LT GP Adopter is an indicator where1: firm has GP in the preceding, current, and next IRRC volumes0: firm does not have GP in the preceding, current, and next volumes
*Stock returns decrease prior to adoption
On annualized basis VW: -6.85% EW: -4.12%
Note on portfolio formation: Long future adopters i.e., firms with no GP in current and next IRRC volume, adopts by 2 IRRC volume from nowShort long-term non-adoptersi.e., firms with no GP in current and subsequent 2 IRRC volumesRebalance monthly Update portfolio whenever new governance information from IRRC becomes available
*Stock returns decrease 2~3 years around adoption
On annualized basisVW: -4.35% EW: -2.37
Note on portfolio formationLong firms with no GP in current IRRC volume and adopts by the next IRRC volumeShort firms with no GP in current and subsequent IRRC volumesRebalance monthly Update portfolio whenever new governance information from IRRC becomes available
*Stock returns decrease after adoption
Note on portfolio formationLong firms with GP in current and subsequent IRRC volumesShort firms with no GP in current and subsequent IRRC volumesRebalance monthlyUpdate portfolio whenever new governance information from IRRC becomes available
On annualized basis VW: -4.35% EW: -3.31% On annualized basis VW: -3.77% EW: -2.84%
*Interpreting Results on GP and Firm ValueFirms have low Q and declining returns prior to adoption of GPConsistent with selection
Firms have declining Q and stock returns in the long-term event window (2~3 years between IRRC volumes) around GP adoption Consistent with selectionConsistent with managerial slack (Shleifer and Vishny 98; GIM 03; BCF 09)
Firms continue to experience decrease in stock returns (and Q) post-adoption, relative to non-adoptersConsistent with managerial slack(Shleifer and Vishny 98; GIM 03; BCF 09))Not consistent with GP inducing LT focus (Stein 98)
*ConclusionWe contribute to the empirical evidence on the long-term implications of GPs using IRRC dataGPs are positively associated with acquisition likelihood, negatively associated with premiums in the event of an acquisition, and positively associated with (unconditional) premia from an acquisition.
Firms adopting GPs have lower value to begin with but their value continues to erode during the inter-volume period of adoption and subsequently .
Congress enacted 280G and 4999 of the Internal Revenue Code
TOPIC OF GP REMAINS AN ACTIVE AND CONTROVERCIAL TOPIC
Late 70s and early 80s, during which period the use of GPs became popularized as a result of an unprecedented wave of corporate takeovers. In particular, a lot of debate over the ethics and legality of such a form of payment early on. Shareholders sued for illegal misappropriation of corporate funds Ousted management sued for refusal to pay GPSee Hankinson (2005) and Mullane (2009) on recent reviews of the legislative history. Precatory resolutions (unlike binding resolutions) are shareholder resolutions, or proposals submitted by shareholders for a vote at the companys annual meeting, that are non-binding in the sense the voting on these more closely resembles a poll than it does a (binding) referendum. Still, media coverage of voting on shareholder resolutions tends to focus on wheher the proposal received a majority of votes, which occurs in a very small but increasing proportion of cases. Note that shareholder resolutions have been important part of activist campaigns in a few cases. 4. For example, SEC in 84 required mandatory disclosure of GP adoption, and the adoption of Deficit Reduction Act of 84 (where the Internal Revenue Code changes were made. 5. House Bill (Barney Frank), titled Corporate and Financial Institution Compensation Fairness Act of 2009, has been referred to Senate Committee after being received from House, but not yet taken up. (Frank is chairman of the House Financial Services Committee, Congressman of Mass)
*Pervasive in all types of firms and not driven by a particular sub-type of firms that we examined.
CHECK TO SEE IF IT IS THE CASE THAT, GIVEN A BID, LIKELIHOOD OF SUCCESS IS HIGHER WHEN THERE IS GP
Make sure with Lucian that the INCENTIVE effect story is part of this. I dont think that we really test for this In unreported results, GIVEN THE PRESENCE OF A BIDDER (either current or next year), the presence of GP does NOT increase the likelihood of completion. This could be driven by the fact that *On identifying the announcement wealth effect: There is mixed evidence on the market reaction to GP announcements. But Narayanan (98) suggests that there are 3 reasons why this might be true, relating to the data:
Theres a lag between when GP is public knowledge (firms have to disclose info in the first proxy statement filed with the SEC after adoption) and when the information is reported in the financial press. (Papers differ on whether to use proxy filing date or financial press date)Very few GP adoptions are reported in financial pressUse of proxy statements raises confounding problem since in each proxy statement
The problem with the earlier studies on price response to adoption (as Machlin et al noted), is that stock return behavior around GP adoption does not provide information about the source of increase in shareholder wealth. For example, one source could be a greater likelihood of takeover and/or increase in premium (so, increase in expected premium). Another source could be aligning of managerial incentives.
The other problem with event studies, as noted by Gompers, Metrick, and Ishii (00), is that event-studies methodology face the difficulty that results are driven by contemporaneous events / conditions at the firm (e.g. adoption of GP may be driven by the change in corporate governance structure or provide a signal of managers private information about impending takeover bids).
Cotter and Zenner (1994) paper finds that only the gains on managers share ownership, not GP payments, have a significant effect on probability of acquisition, NOT GP!
There are also papers that find NO EFFECT on shareholder wealth, when you take out firms that are already in play at the time of GP adoption. (Born and Trahan 93) They conclude that this supports the hypothesis that GP SIGNALS increased probability of takeocer
Narayannan finds no evidence of value-destruction after the adoption of GP.
Note: I suspect that one of the reasons why the earlier papers did not find increases in takeovers is because they do not control for other governance / takeover readiness measures, like the presence of poison pills, etc *These data are derived from a variety of public sources including corporate bylaws and charters, proxy statements, annual reports, as well as 10-K and 10-Q documents filed with the SEC.
The IRRCs sample expanded by several hundred firms in 1998 through additions of some smaller firms and firms with high institutional-ownership levels.
We divide them into five groups: tactics for delaying hostile bidders (Delay); voting rights(Voting); director/officer protection (Protection); other takeover defenses (Other); and state laws (State).*GPs are prevalent and have become increasingly prevalent, at least among the large firms. % of Firms in the S&P 1500 with GP has steady increased.
Note: The IRRCs sample expanded by several hundred firms in 1998 through additions of some smaller firms and firms with high institutional-ownership levels.
*Remember, these numbers are not exactly comparable, since they are over the next 2~3 years.
We find the percentage of firms, covered by IRRC in two consecutive volumes, th...