Academic journal article Journal of Economics and Finance

Returns to Acquiring Firms: The Role of Managerial Ownership, Managerial Wealth, and outside Owners

Academic journal article Journal of Economics and Finance

Returns to Acquiring Firms: The Role of Managerial Ownership, Managerial Wealth, and outside Owners

Article excerpt


Since merger and acquisition activity does not unambiguously benefit the shareholders of acquiring firms, the motivation of managers who undertake such actions is unclear. The present study investigates the extent to which the wealth effects of acquisition activity undertaken by firms in one industry-communications and publishing-are related to (1) the ownership and wealth characteristics of both the executives and the board of directors of these firms and (2) the ownership concentration of large outside shareholders. The motivating hypothesis, supported by empirical results, is that these factors contribute to the alignment of executive and shareholder interests. (JEL G340)


A long-standing proposition in the economic theory of organization holds that corporate managers, isolated from owners and shielded from the vagaries of the marketplace, pursue goals which may be inconsistent with the profit-maximizing interests of the firm's shareholders. The conflict of interest between owners and managers, characterized as the separation of ownership from control by Berle and Means (1932), is usually couched in a value-enhancing context: the competing goals of owners and managers misalign corporate interests and may result in less than optimal share price performance. Solutions to the problem focus on aligning these competing interests, so that the value-enhancing interests of stockholders are satisfied when managers undertake actions which affect firm value.

The present study focuses on the potential conflict between the managers and owners of corporations which acquire other firms. Since acquisitions usually affect the stock price of the acquiring firm, the following question is posed: to what extent are the share price changes experienced by corporations which acquire other firms related to any of several institutional arrangements which might serve to narrow the gap between the wealth-maximizing interests of owners and the utility-maximizing interests of managers? The analysis focuses on a variety of factors which (it is hypothesized) help align the interests of executives and shareholders of acquiring firms, including firm-specific executive share ownership, executive wealth, and whether the board of directors and/or outside owners with significant share holdings play a role in monitoring the actions of the bidding firm's management.

Returns to Shareholders and Managerialism

While there is little doubt that target firm shareholders benefit from merger activity, the evidence supporting the assertion that bidding firm shareholders gain from takeover activity is mixed (Jarrell, Brickley, and Netter 1988). It is often somewhat cavalierly assumed that large gains for targets plus little or no gain for bidders by definition imply profitability; as Caves puts it, "A bundle for the target's shareholders plus zero for the bidders still sums to a bundle" (1989, p. 153). However, large gains for target firm shareholders by no means negate losses suffered by bidders, and it is acquiring firms that are the focus of the present study. Firms which succeed in acquiring or merging with other firms on average realize at best slightly positive (and usually insignificant) gains. Addressing the often deleterious effects of takeovers on the share price performance of acquiring firms, Jensen and Ruback note that "post-outcome negative abnormal returns [associated with merger activity] are unsettling because they are inconsistent with market efficiency and suggest that changes in stock price during takeovers overestimate the future efficiency gains from mergers" (1983, p. 20).

Left unsettled is the question of the motivation of managers undertaking these acquisitions. The "hubris" hypothesis posed by Roll (1986) asserts that managers overestimate their ability to put to better use the resources of a firm viewed as a potential takeover target. The source of this belief may be a pre-acquisition period of above-average performance by their own firm; Jensen's free cash-flow theory (1986, 1988) predicts that "many acquirers will tend to perform exceptionally well prior to acquisition," at which point acquiring firms may employ the proceeds of profitable firm activity in the takeover market (1988, p. …

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