Theme 1: M&A theories

Theme 2: Mergers Empirical Evidence

Theme 3: Valuation of Mergers and LBO

Theme 4: Corporate Restructuring & Divestitures

Theme 5: Corporate Governance and Control

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Theme 1: M&A theories

 

There are 06 typical tools to acquire a company:

-       Proxy contest

-       Acquisition

-       LBO

-       MBO

-       Merger

-       Tender offer

Proxy contest: a strategy that may accompany a hostile takeover. A proxy contest occurs when the acquiring company attempts to convince shareholders to use their proxy votes to install new management that is open to the takeover. The technique allows the acquired to avoid paying a premium for the target, also called proxy fight.

Acquisition: a corporate action in which a company buys most, if not all, of the target company’s ownership stakes in order to assume control of the target firm. Acquisitions are often made as part of a company’s growth strategy whereby it is more beneficial to take over an existing firm’s operations and niche compared to expanding on its own. Acquisitions are often paid in cash, the acquiring company’s stock or a combination of both.

LBO (Leveraged Buy-Out): the acquisition of another company using a significant amount of borrowed money to meet the cost of acquisition. Often, the assets of the company being acquired are used as collateral for the loans in addition to the assets of the acquiring company. In an LBO, there is usually a ratio of 90% debt to 10% equity. Because of this high debt/equity ratio, the bonds usually are not investment grade and are referred to as junk bonds. Leveraged buyouts have had a notorious history, especially in the 1980s when several prominent buyouts led to the eventual bankruptcy of the acquired companies. This was mainly due to the fact that the leverage ratio was nearly 100% and the interest payments were so large that the company's operating cash flows were unable to meet the obligation.

MBO (Management Buy-Out): when managers or executives of a company purchase controlling interest in a company from existing shareholders. In most cases, the management will buy out all the outstanding shareholders and then take the company private because it feels it has the expertise to grow the business better if it controls the ownership. Quite often, management will team up with a venture capitalist to acquire the business because it's a complicated process that requires significant capital.

Merger: the combining of two or more firms into one, through a purchase acquisition or a pooling of interests. It differs from a consolidation in that no new entity is created from a merger. This decision is usually mutual between both firms. There are some types of a merger:

-       Horizontal mergers: between firms in the same sector; rationale; government regulation due to potential anti-competitive effect;

-       Vertical mergers: combination between firms at different stages. Goal is information and transaction efficiency.

-       Conglomerate mergers: between firms in unrelated sectors.

Tender offer: an offer to purchase some or all shareholders’ shares in a firm. The price offered is usually at a premium to the market price. Tender offers may be either friendly or unfriendly. It is hostile when the offer is made without approval of the board.

Common characteristics of merger movements:

-       Various environment factors may contribute to merger movements: periods of high economic growth, favorable stock prices and financial conditions, technological change, input price volatility, legal and regulatory changes, financing innovations etc.

Theoretical explanation for merger waves:

-       Business environment shocks;

-       Agency problem and corporate governance;

-       Managerial hubris and herding;

-       Market timing.

Sensible reasons for mergers:

-       Combining complementary resources;

-       Economies of vertical integration;

-       Size and returns to scale: benefits of size are usual sources of synergies;

-       The whole is worth more than the sum of the parts;

-       Some mergers create synergies because the firm can either cut costs or use the combined assets more effectively;

-       Examine whether the synergies create enough benefits to justify the cost.

-       Economies of scale;

-       Improve capacity utilization;

-       Economies of scope;

-       Transaction costs;

-       Merger as a use for surplus funds.

Dubious reasons for mergers:

-       Diversification: investors should not pay a premium for diversification since they can do it themselves;

-       The bootstrap game;

Value effects of M&A:

Value increasing theories:

-       Transaction costs;

-       Mergers create synergies: economies of scale, economies of scope, improved management, complementary resources, improved production techniques;

-       Takeovers are disciplinary;

Value reducing theories:

-       Agency costs of free cash flow

+ Free cash flow is a source of value reducing merger;

+ Firms with FCF are those where internal funds exceed investment required for positive NPV projects;

-       Managerial entrenchment;

+ Managers hesitate to distribute cash to shareholders;

+ Investments may be in form of acquisition where managers over pay but reduce likelihood of their own replacement.

Value neutral theories:

-       Merger bids result from managerial hubris. Managers are prone to excessive self confidence;

-       Winner’s curse;

-       Mergers can occur even when no value effects: target sells when bid is higher than target value.

Takeover defenses

-       White knight: friendly potential acquirer sought by a target company threatened by an unwelcome suitor.

-       Shark repellent: amendments to a company’s charter made to forestall takeover attempts.

-       Poison pill: measure taken by a target firm to avoid acquisition; for example, the right for existing shareholders to buy additional shares at an attractive price if a bidder acquires a large holding.

-       Golden parachute: lucrative compensation package guaranteed to a firm’s senior managers in the event that a firm is taken over and the managers are let go.

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Theme 2: Mergers Empirical Evidence

 

It is useful to assess the effects of an event (announcement of a tender offer, share repurchase, etc) on stock prices. We can calculate the difference (abnormal return) between expected price and real market price of a stock by three methods. However, we first need to take steps as follows:

1. Define an event period:

-       Usually, this is centered on the announcement date, which is day 0 in event time.

-       The purpose of the event period is to capture all the effects on stock price of the event. Longer periods will ensure that all effects are captured but the estimate is subject to more noise in the data.

-       A period from 40 days prior to 40 days after the announcement of an event is often chosen to study (from -40 to +40).

-       Day 0 is the date the announcement is made for a particular firm. Thus, it will denote different calendar dates for different firms. 

2. Calculate a predicted return

-       The next step is to calculate a predicted return (or normal return), for each day t in the event period for each firm j.

-       Predicted return is the return that would be expected if no event happens.

-       There are 03 basic methods that can be used to calculate this predicted return:

+ The mean adjusted return method;

+ The market model method;

+ The market adjusted return method.

For most cases, the three methods yield similar results.

3. Calculate the residual return

-       Next, the residual return is calculated for each day for each firm.

-       The residual is the actual return for that day for the firm minus the predicted return.

-       The residual represents the abnormal return, that is the part of the return not predicted, and is, therefore, an estimate of the change in firm value on that day, which is caused by the event.

4. For each day in event time, the residuals are averaged across firms to produce the average residual for that day, ARt,(abnormal return).

5. Calculate the cumulative average residual:

Three methods to calculate the predicted return:

1. The Mean Adjusted Return Method

-       In the Mean Adjusted Return method, a “clean period” is chosen and the average daily return for the firm is estimated for this period.

-       The “clean period” can be before the event or after or both but never includes the event period.

-       The “clean period” includes days on which no information about the event is released, for example days -240 to -41.

-       The predicted return for each day in the event period for a firm is just the mean daily return for the clean period for the firm:

-       This predicted return is then used to calculate the residuals, average residuals and cumulative average residual as explained above.

2. The Market Model Method (most widely used)

-       In this method, a “clean period” is also chosen, and the market model is estimated by running a regression for the days in this period.

3. The Market Adjusted Return Method

-       The predicted return for a firm for a day in the event period is the market on the market index for that day.

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Theme 3: Valuation of Mergers and LBO

Methods of valuation:

-       DCF

-       Transaction multiples

-       Trading multiples

-       Valuation option method

Comparables approaches: trading multiples and transaction multiples

Advantages of comparables:

-       Common sense approach;

-       Marketplace transactions are used;

-       Widely used in legal case, fairness evaluation;

-       Allow evaluation of private firms.

Limitations of comparables:

-       May be difficult to find companies comparable by key criteria;

-       Ratios might differ widely for comparables;

-       Different ratios may give widely different results.

1. Transaction multiples

This method is based on companies involved in similar merger transactions. We take into account key ratios of each firm like total paid/ sales or total paid/ book, total paid/ net income and calculate the average ratios.

After that, we use the same financial indicators line LTM sales or EBITDA to multiple with those ratios, taking average to generate the estimated market value of the firm.

2. Trading multiples

Based on this method, we use companies comparable in size and products as well as recent trends and future prospects.

First, we calculate the enterprise market value of each company, using the following formula:

EV =

common equity at market value

+ debt at market value

+ minority interest at market value (if any)

- associate company at market value (if any)

+ preferred equity at market value

- cash and cash-equivalents.

Then, we calculate several ratios such as TEV/ Revenue, TEV/ EBITDA, TEV/ FCF, TEV/ Sales and take average of them.

After that, we multiply the same financial indicator of the targeted firm with those ratios, taking average of all the results. We have the total market value of the targeted firm.

3. Valuation option method (Real options)

We regard the targeted firm’s equity as a call option on the firm’s assets. If the intrinsic value is positive, the firm can exercise the option by paying off the debt. If negative, the firm can let the option expire and turn the firm over to the bondholders. Then, we determine other factors as follows:

Current share price (total) = …

Strike price = …

Then, we calculate the historical volatility of the firm based on stock prices. To do this, we calculate log price changes of shares within 01 year. After that, we calculate the standard deviations, which are historical volatilities of the shares.

We take an average of those volatilities. Finally, we put all data in Numa Option Calculator to calculate the total market price of the targeted firm.

4. DCF

Using DCF, the firm’s value is calculated by discounting the estimated free cash flows. These present values are summed up to arrive at an NPV.

Advantages:

-       DCF allows great flexibility in projections;

-       Express calculations in recognizable financial statements.

Disadvantages:

-       Projected numbers may create the illusion that they are actual numbers;

-       May have a disconnect between business logic and projections;

-       Complexity of spreadsheets may obscure important driving factors.

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Theme 4: Corporate Restructuring & Divestitures

 

The business environment changes on a continuous basis. This requires firms to adapt. Managers have other options other than taking part in M&A. Of those, corporate restructuring should occur with the framework of the firm’s overall strategy.

Types of restructuring: key methods of reorganizing assets and ownership:

  • Asset sales: sales of division or other assets to another firm, usually for cash.
  • Equity carve-out: public offering of partial interest in subsidiary creating new firm with at least some autonomy. Sometimes known as a partial spinoff, a carve-out occurs when a parent company sells a minority (usually 20% or less) stake in a subsidiary for an IPO or rights offering. Also when an established brick-and-mortar company hooks up with venture investors and a new management team to launch an internet spinoff. In most cases, the parent company will spin off the remaining interests to existing shareholders at a later date when the stock price is much higher.
  • Spinoff: the creation of an independent company through the sale or distribution of new shares of an existing business/division of a parent company. A spinoff is a type of divestiture. Businesses wishing to streamline their operations often sell less productive or unrelated subsidiary businesses as spinoff. The spun-off companies are expected to be worth more as independent entities that as part of a larger business.
  • Split-up: separation of one firm into two or more firms, often via spin-off. Shares of the original company are exchanged for shared in the new companies, with the exact distribution of shares depending on each situation. This is an effective way to break up a company into several independent companies. A company can split up for many reasons but it typically happens for strategic reasons or the government mandates it. Some companies have a broad range of business lines, often completely unrelated. This can make it difficult for a single management team to maximize the profitability of each line. It can be much more beneficial to shareholders to split up the companies into several independent companies, so that each line can be managed individually to maximize profits. The government can also force the splitting up of a company, usually due to concerns over monopolistic practices. In this situation, it is mandatory that each division of the company that is split up be completely independent from the others, effectively ending the monopoly.
  • Tracking stock: creation of a new class of stock with value based on cash flow of a division. When a parent company issues a tracking stock, all revenues and expenses of the applicable division are separated from the parent’s company financial statements and bound to the tracking stock. This is often done to separate a subsidiary’s high-growth division from a larger parent company that is presenting losses. However, the parent company and its shareholders still control the operation of the subsidiary.
  • Exchange offer: distribution giving shareholders choice between parent and subsidiary stock; creating separate public firms. An exchange offer occurs when a company offers to exchange securities that it provides for similar securities at less demanding terms. This is often done in an attempt to avoid bankruptcy.
Those methods are sometimes used in tandem or employed sequentially.

-       Equity carve-out can be first stage of a broader divestiture, preceding:

+ Sale of remaining interest of subsidiary to another firm;

+ Spin off remaining ownership to shareholders.

-       Split-ups employ a variety of methods, usually spinoffs.

-       Tracking stock may be first step of a spin-off or exchange offer.

Motives for divestitures:

-       Reducing agency problems:

+ Corporate control market corrects value-reducing diversification;

+ Private firms refocus at a lower rate than public firms;

-       Focus motives:

+ Divesting unrelated assets;

+ Greater portion of target is divested as value destruction in target increases.

+ Measuring relatedness;

+ Firms that combine units with different opportunity sets are most likely to spin-off or carve-out a unit;

+ Misallocation of investment funds increases as diversify in investment opportunities increases.

-       Financial constraint motives:

+ When a firm is in decline, it could divest its activities;

+ Management will sell assets if it is the cheapest way to provide them more funds.

-       Management capability motives:

+ Managers look for activities that fit their capabilities;

+ Any segment that performs worse than the industry is likely to be divested;

+ Segments where management has firm specific knowledge will be more productive and will also be larger.

Montgomery identifies 03 main theoretical perspectives to explain why a company might choose to diversify: agency theory, resource based view and market power.

1. Agency theory: managers diversify due to their own interest and at the expense of shareholders. They might diversify to:

-       Increase their compensation, power and prestige;

-       Entrench themselves in the firm by making investments requiring their particular skills via manager-specific investments;

-       Reduce the risk of their personal investment portfolio by reducing firm risk since they can’t reduce their own risks by diversifying their portfolio;

2. Resource-based perspective: when a firms possesses excessive resources and capabilities that are transferable across industries, it might want to leverage by diversify its activities and investments based on the economy of scope. For example, a firm can use the same distribution channel to distribute another product.

3. Market power: there are 03 anti-competitive motives for diversification:

-       The first uses the profits generated by the firm in one industry to support predatory pricing in another;

-       The second is that a firm might collude with other firms that compete with the firm simultaneously in multiple markets, or the mutual forbearance hypothesis of multi-market competition. \

-       Third, a firm might diversify to engage in reciprocal buying with other large firms in order to squeeze out smaller competitors.

Benefits of diversification:

-       A diversified firm can increase its debt capacity by the reduction in variance of future cash flows. To the extent that debt capacity adds value, diversification can be a source of added value.

-       The second benefit is that a diversified firm’s cash flows might provide a superior means of funding an internal capital market. This internal capital market helps funding the firm’s need for capital that creates a number of values for the firm’s owners. On the one hand, the internal capital market provides the firm with funds at lower costs than the external capital market. On the other hand, the firm’s owners have total control over their investments and projects selection instead of letting them to the hand of external investors. A diversified firm can shift funds from less-profitable units to more-profitable ones to create shareholders’ value.

-       The third benefit is the ability to mitigate failures in product, labor and financial markets.

Sources of wealth gains:

-       Asset sales: returns to buyer and seller likely represent efficient redeployment of assets;

-       Information and efficiency.

Choice of divestiture methods:

-       Spinoff and asset sales: choice depends on tax implications and financial constraints;

-       Spinoff and equity carve-out: firms choose carve-outs when subsidiaries have more opportunity growth.


Divestitures:

Merits of corporate diversification for:

-       Managers: reducing firm’s specific risks;

-       Creditors: reducing volatility of free cash flow;

-       Shareholders: not interested in divestiture because they may have a diversified investment portfolio.

Diversification: costs

-       Agency costs increase: free cash flows in diversified firm increase opportunities for overinvestment; power of stock options and grants is diminished.

-       Worse allocation of resources;

-       Information asymmetry between central management and management of the operating divisions.

Diversification: evidence of value destruction

-       Apply “chop-shop” approach:

+ Assumption that the stand-alone q of divisions of conglomerate firms is well approximated by the average q of specialized firms in the same industry;

+ Tobin’s q of a diversified firm is lower than the average q of similar stand-alone firm.

-       Tobin’s q is often estimated by the ratio of the market value to the book value.

-       Measure of firm performance.

-       Measure of investment opportunities.

-       Berger and Ofek:

+ Document a diversification discount between 13% and 15%;

+ Value is smaller in case of related diversification;

+ Value lost is created by overinvestment and cross-subsidization.

+ An imputed value is calculated, which is the value a firm would have if all its segments operated as stand-alone businesses;

+ Excess value is the natural log of the firm’s actual value to its imputed value.

+ Multiplier estimation of imputed value and excess value:

Diversification: Sources of value destruction

-       Capital misallocation;

-       Overinvestment;

-       Corporate governance;

-       Lower efficiency;

 

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Theme 5: Corporate Governance & Control

 

  • Corporate governance in the US

Diffuse stock ownership:

-       Diffuse ownership of voting equity shares with many individual share owners;

-       Require little direct monitoring of firms by investors;

-       Commercial banks and insurance companies limited in their ability to hold large equity positions in individual companies.

Contractual theory of the firm:

-       Contracts specify roles of stakeholders and define their roles, obligations and payoffs;

-       Separation between ownership and control may cause conflict between owners and managers.

-       Lower ownership by managers requires additional monitoring expenditure.

Divergent interests of stakeholders require the firm to recognize and their expectations and external influences like job safety and environment etc.

  • Internal control mechanism

-       Shareholders elect a Board of Directors to represent their interests;

-       However, it is difficult to response to all views and interests.

  • Roles of the Board of Directors:

-       In theory, monitoring of BoD can address issues of corporate governance;

-       However, BoD sometimes fails to recognize problems of the firm;

-       Board does not stand up to top officers;

-       Failure of BoD may lead to hostile takeovers;

-       Composition of the BoD:

+ Outside directors enhance viability of the firm, reducing collusion;

+ Outsider dominated boards are more likely to remove CEO;

-       CAR is likely to be positive when a firm appoints outside directors;

-       Market views appointment of outsider to CEO position more favorable than insider-boards with outsider directors are more likely to appoint outsider CEO;

-       Compensation of board members: stock ownership for directors help align their interests with stock holders;

-       Evaluating a BOD:

+ Numerous possibilities for board rating: CEO performance, strategic plans, outside directors, firm performance, etc.

+ Scandals expose possible improvement: more power to shareholders, director votes disclose;

+ Spinoffs are often associated with better internal governance and control practices.

  • Ownership concentration:

-       Ownership of managers must balance alignment of interest and entrenchment considerations;

-       Ownership and performance: value affects ownership, not reverse;

-       Effect of large shareholders: active participation in monitoring and management;

-       Financial policy and ownership concentration:

+ Share repurchases financed by debt: insider groups retain shares and increase concentration;

+ Incentive effects of high manager ownership percentages performed positive roles in LBO;

+ Leverage increasing firms improved performance – associated with alignment of managers’ behaviors with long-term shareholder interest;

+ Cash acquisitions are associated with larger insider ownership levels than stock acquisitions.

  • Executive compensation:

-       Conflicts between owners and managers reduce if executive compensation is tightly related to performance;

-       Board characteristics and ownership structure affect the level of CEO compensation.

-       In some cases, it is criticize that compensation is based on accounting measures rather than market-based performance measures.

-       Proposals to improve pay-performance policies:

+ Limit base salaries of top executives;

+ Bonuses and options are based on stock appreciation;

+ Options based on premium of 10-20% over market and should not be repriced;

+ Company loan programs should enable top executives to buy large amounts of firm’s stock;

+ Stock appreciation benchmarks should consider.

  • Outside control mechanisms:

-       Stock prices and top management changes: poor stock price performance, higher rate of management turnover; forced changes of top management have positive event returns;

-       Institutional investors: public pension funds have ability to become factors in corporate governance;

-       Shareholders’ proposals also have impacts on corporate governance.

 

  • Multiple control mechanism:
  • Proxy contests:

-       A proxy contest is a contest by dissident shareholders, often in case of poor performance. This is often in form of proposals to represent of board, changing strategies or replacing the CEO, etc.

-       Studies prove that proxy contests lead to negative returns for the firm.

  • M&A market for control:

-       This market is a widely recognized form of external pressure;

-       M&A market is a major source of external control mechanism, indicating some degrees of internal control mechanisms;

-       M&As do impact firms.

 

Corporate governance: best practices

Corporate governance plays an important role in a company’s performance that can help increase shareholders’ values. A company with good governance is able to outperform peers in different aspects.

The composition and structure of the management board has been instrumental in determining a company’s reaction in case of difficulties, affecting the process of CEO succession, the pursuit of acquisition opportunities and responding to takeover bids.

The independence of the audit, nomination and compensation committees has great impact on a company’s performance.

Executive ownership in the form of common stock or stock option increases the effectiveness of decision making and values of shareholders in most instances.

Stock option has increasingly become a part of director compensation and this trend has had a positive effect on a company performance.

Shareholder activists have frequently challenges anti-takeover provisions. However, these provisions do not necessarily reduce shareholders value.


Should the board be composed of a majority of independent directors?

-       Shareholders benefit when a board of directors is externally dominated.

-       It is more likely to replace poor performing CEO and appoint an outside CEO.

-       In this case, the company can make better acquisition.

-       This also leads to better bargaining when the company is a takeover target.

Lack of relation between board independence and performance:

-       Board composition itself is affected by performance;

-       Operating performance is less affected by the composition of board;

Who qualifies as an independent director?

Studies have proved that independent directors play an important role in enhancing shareholders’ value. However, it depends on the degree of their affiliation with the management board. The types of affiliation that have been identified as creating the potential for conflicts include:

-       Past employment with the company as an executive;

-       Any consulting or contractual agreement with the company from which a director may derive a pecuniary benefit, for example, executives of suppliers or customers;

-       Relatives of the top management team;

-       Commercial bankers, investment bankers or lawyers even if no business ties currently exist because of the potential for conflict of interest and the possibility that business ties may be sought;

-       Outside directors with interlocked directorship (one that serves the two companies reciprocally);

-       Representatives of large shareholders may have positive impacts on corporate governance.

Should the CEO be the only insider?

-       One of the biggest challenges is having the CEO as the primary conduit of information presented to the board. By having one or two non-CEO executives on the board, it is likely that a more comprehensive view of the company is presented to the outside board members. Adding the CFO might give board members a better view of firm activities;

-       If more than one insider is on the board, outside directors have a better view of the capabilities of the potential successors;

-       Outside directors with financial expertise (affiliated directors) can add value in some cases.

Should the Chairman be separated from the CEO?

-       If the two positions are convergent to one person, he will have the superior power in decision making. In practice, it only happens if a CEO outperforms his peers. Then, he is inaugurated the Chairman position as a reward;

-       However, if this happens, it would be more difficult for the board to replace the CEO in case of bad performance;

-       Amongst large industrial companies, those with non-CEO Chairmen traded at higher price-to-book multiples;

-       In a study of banks, those with separation between CEO and Chairman have better ROAs and cost efficiency ratios.

How should Board Committees be structured?

-       Audit committee: although studies have not identified any direct link between company performance and audit committee independence, equity investors tend to rely on earnings release of an independent audit committee;

-       Nominating committee: CEO involvement in the director nomination process has great impact on the type of directors to be appointed to boards. When the CEO takes part in this process, the company tends to appoint fewer outside independent directors and there emerge conflicts of interest with more affiliated outside directors;

-       The stock market reacts more positively when the CEO does not involve in the nomination process.

-       When the CEO sits on the nominating committee, the audit committee is less likely to have a majority of independent directors;

-       The CEO tends to receive more cash compensation in his remuneration package if he sits on the nominating committee;

-       Compensation committee: there is no evidence that a CEO sitting on the compensation committee leads to weaker governance. However, in fact, there are very few CEOs actually serving on this.

How many boards should a director sit on?

-       Directors with multiple board seats are likely to be individuals with strong reputations whose services are in demand by many boards;

-       Firms in which many directors hold many board seats are less likely to be the target of a hostile bid, extract higher takeover premiums, less likely to be sued for financial statement fraud;

-       However, presence of “busy” directors is correlated with excessive CEO compensation;

-       Market reacts negatively to the appointment of an outside director who is full-time executive at another firm and holds 3 or more other board seats. It would be time-constrained for them.

Should top executives hold more stock?

-       The more executive ownership, the more shareholders’ value and the better decision making;

-       Firm valuation multiples are higher when executives own more stocks and executive stock options;

-       Acquisition decisions are received more positively by the market when executives have larger ownership stakes;

-       CEOs are less likely to receive tender offers to their companies when executives own more stock.

This implies a positive correlation between managerial ownership and firm value. Therefore, compensation committees should make CEO stock ownership a key component of their compensation decisions.

Does option compensation create values for shareholders?

-       Stock option is a tool to encourage executives to make better investment decisions because it will affect their direct benefits in the future;

-       Firms with cash flow shortfall or poor access to capital markets also use options more frequently.

These findings suggest that firms use stock option quite effectively. However, whether this leads to abuses or not? In some cases:

-       Large option awards tend to be granted prior to favorable news releases and stock price appreciation, raising the possibility that in some instances, option awards may be “timed” in advance of favorable events;

-       Gold mining companies hedge price risk more if stock ownership is large, but less if stock option ownership is large. Stockholders may prefer lower risk, while option holders may prefer more volatility because of their asymmetric payoff.

-       After stock option grant initiations, companies have reduced their dividend payouts.

Option re-pricings are criticized because they appear to provide executives with a downside safety net that shareholders do not have. But if poor performance is not caused by poor executive decisions, re-pricing may be needed to provide incentives. Do re-pricings hurt shareholder value?

-       Companies that re-price options have largely been poor performers with low equity ownership prior to the re-pricing (Chance, et al. 2000). After the re-pricing, their performance stabilizes. The evidence does not, however, conclusively suggest that re-pricings hurt shareholders.

How should Directors be compensated?

-       Increasing compensation of board members with stock options;

-       Align managers’ interests with shareholders’ ones;

-       Boards react more quickly to poor performance by replacing the CEO when directors are compensated in stock and the board is independent. This result suggests that directors who receive incentive pay may oversee management more actively.

Do anti-takeover measures destroy shareholders’ values?

Institutional shareholders are often opposed to poison pills or any other anti-takeover mechanism. However, studies prove that anti-takeover mechanisms really help in certain situations:

-       Early studies show that, on average, the announcement of poison pill adoption led to a decline in the company’s stock price;

-       Firms with anti-takeover provision provisions such as poison pills were more likely to seek additional protection from state anti-takeover laws.

-       When the board is independent, the announcement of a poison pill adoption is not viewed negatively by equity investors;

-       Poison pills do not reduce the likelihood of being a successful takeover target;

-       Poison pill removals do not lead to stock price appreciation;

-       When companies mention that they reincorporate to have better takeover defenses, their stock price drops, on average.

In summary, the evidence suggests that while antitakeover provisions may help entrench managers in some cases, they can also benefits share holders by giving independent boards increased bargaining power.

 
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