Faculty Working Paper 91-0154

An Empirical Investigation of the Effect of Corporate Charter Antitakeover Amendments

on Stockholder Wealth

James M. Mahoney Joseph T. Mahoney

Wbarton School of Business Department of Business Administration

University of Pennsylvania University of Illinois

>

Bureau of Economic and Business Research

College of Commerce and Business Administration

University of Illinois at Urbana-Champaign

BEBR

FACULTY WORKING PAPER NO. 91-0154

College of Commerce and Business Administration

University of Illinois at Urbana-Champaign

July 1991

An Empirical Investigation of the Effect

of Corporate Charter Antitakeover Amendments

on Stockholder Wealth

James M. Mahoney

Wharton School of Business

University of Pennsylvania

Joseph T. Mahoney

Department of Business Administration

University of Illinois at Urbana-Champaign

Business Policy and Planning Division of the Academy of Management meeting in Miami, August, 1991. Please direct all comments to Joseph T. Mahoney.

Digitized by the Internet Archive

in 2011 with funding from

University of Illinois Urbana-Champaign

http://www.archive.org/details/empiricalinvesti91154maho

An Empirical Investigation of the Effect

of Corporate Charter Antitakeover Amendments

on Stockholder Wealth

James M. Mahoney

Doctoral Candidate in Finance

Wharton School of Business

University of Pennsylvania

Philadelphia, Pennsylvania 19104

(215) 898-6333

and

Joseph T. Mahoney

Assistant Professor of Business Administration

University of Illinois-Urbana-Champaign

1206 South Sixth Street

Champaign, Illinois 61820

(217) 244-8257

>

Business Policy and Planning Division of the Academy of Management meeting in Miami, August, 1991. Please direct all comments to Joseph T. Mahoney.

An Empirical Investigation of the Effect

of Corporate Charter Antitakeover Amendments

on Stockholder Wealth

Abstract

This paper tests competing theoretical explanations for the passage of corporate charter antitakeover amendments. The managerial entrenchment theory suggests that antitakeover amendments are adopted by incumbent management to obtain job security at stockholders' expense. The alternative hypothesis is that antitakeover amendments benefit stockholders by extracting a larger share of synergistic gains between the bidder and target firm. Our event study from a sample of 409 firms that adopted antitakeover amendments in the 1974-1988 period indicates a strongly negative effect on stockholder wealth in support of the managerial entrenchment hypothesis that antitakeover amendments are adopted by managers at the expense of stockholders.

An Empirical Investigation of the Effect

of Corporate Charter Antitakeover Amendments

on Stockholder Wealth

Several mechanisms that influence the transfer of managerial control are now a research focus of finance and business scholars. These mechanisms include greenmail (Bradley & Wakeman, 1983; Dann & DeAngelo, 1983; Shleifer & Vishny, 1986b; Kosnik, 1987, 1990), golden parachutes (Cochran, Wood & Jones, 1985; Knoeber, 1986; Lambert & Larcker, 1985; Singh & Harianto, 1989a, 1989b), poison pills (Davis, 1990; Malatesta & Walkling, 1988; Ryngaert, 1988) and antitakeover amendments (Jarrell & Poulsen, 1987; Sundaramurthy, 1990; Walsh & Seward, 1990). This study concentrates on corporate charter antitakeover amendments and is motivated by the considerable controversy that surrounds the use of antitakeover amendments by United States' corporations at the federal, state, and individual firm level. Antitakeover amendments are often the most debated issues on the agendas of annual stockholder meetings (Pound, 1985).

Antitakeover amendments are intended to restrict the transfer of managerial control (Easterbrook & Fischel, 1981). The study of the effect of antitakeover amendments on stockholder wealth has produced mixed empirical evidence. DeAngelo and Rice (1983) found essentially no effect of antitakeover amendments on stock price (stockholder wealth). Linn and McConnell (1983) found a weak positive effect of antitakeover amendments on stockholder wealth. Jarrell and Poulsen (1987), however, found a strong negative effect of antitakeover amendments on stock price. The considerable debate concerning the stockholder wealth effects of antitakeover amendments motivates our empirical research.

We consider competing theoretical explanations for the passage of antitakeover amendments i derived from the agency theory literature (Alchian & Demsetz, 1972; Eisenhardt, 1989). The

managerial entrenchment hypothesis posits risk averse managers who desire a reduction in

employment risk (Amihud & Lev, 1981). Managerial preferences diverge from stockholders' preferences, and antitakeover amendments are viewed as protecting inefficient and/or opportunistic managers at the stockholders' expense. An alternative stockholder interests hypothesis suggests that antitakeover amendments serve stockholders by strengthening the position of incumbent management in dealing with corporate acquirers whose primary objective is to acquire the assets of the target firm at an unreasonably low price.

The issue of whether the announcement of new information related to the proposal of antitakeover amendments results in an increase or decrease in the wealth of stockholders is our empirical focus. In particular, we concentrate on the stockholder wealth effects of supermajority amendments and classified boards. Supermajority amendments and classified boards are nonoperating defensive measures1 and require stockholder approval (Walsh & Seward, 1990) (see Table 1). These corporate charter amendments involve no direct effect on share price paid by potential acquirers (as do fair price amendments) and involve no obvious direct wealth transfers to other stakeholders (as do "poison pills").

Insert Table 1 about here

In addition to a direct transfer of wealth from stockholders to management, a possible signaling effect may have an additional stock price impact (Szewczyk & Tsetsekos, 1990). If the market interprets the antitakeover amendment as an indication of a management which is overly concerned with protecting its own employment position, stock prices may reflect an extrapolation of current actions indicative of opportunistic managers. If the market interprets the antitakeover amendment as

A nonoperating defensive measure does not necessarily directly affect the asset and/or liability structure of the firm (i.e., the balance sheet), but nevertheless affects the probability of a successful takeover attempt (Walsh & Seward, 1990).

managerial behavior consistent with the long-term interests of the firm, the stock price may reflect an additional positive impact of indications of a responsible management.

Supermajority and classified board provisions almost always require the approval of a majority vote by stockholders2. Supermajority merger approval provisions typically stipulate stockholder approval percentages in the 66 percent to 80 percent range. Various supermajority stockholder approval requirements may block a bidder from implementing a merger even when the bidder controls the target's board of directors. Supermajority amendments also typically include escape clauses. For example, they are usually not applicable to mergers with a firm's subsidiary. If the board is able to determine when and if the supermajority provisions will be in effect, the amendment is said to have a board-out clause.

Classified board provisions segment (or stagger) the board of directors into classes with one class standing for election each year. Typically, with a classified board provision, one-third of the board is elected each year for a three-year term. With a classified board, a new majority stockholder would have to wait for two annual meetings to attain majority representation on the board before being guaranteed a successful proposal of a merger for stockholder vote. Amendments to classify the board are often accompanied by an amendment specifying that supermajority approval by stockholders is necessary to change the number of directors. The supermajority provision inhibits a bidder from expanding the board and thus taking control of the board by electing candidates to the newly created positions. Now let us consider these two corporate charter amendments in relation to the agency literature.

2 An interesting question is put forth by Cary (1969): May a mere majority of the stockholders institute a supermajority requirement?

The Managerial Entrenchment Hypothesis

According to the managerial entrenchment view, the separation of ownership and control allows entrenched managers a wide range of discretion (Berle & Means, 1932) including shirking (Jensen & Meckling, 1976), top management featherbedding (Myers, 1983), taking fewer investment risks (Morck, Shleifer & Vishny, 1989) and maintaining short time horizons that result in a present-value loss for the firm (Hayes & Wheelwright, 1984; Jensen & Meckling, 1979). The managerial entrenchment hypothesis suggests that managers propose and support antitakeover amendments as a pre-tender offer defensive tactic to reduce employment risk and to insulate themselves from competition in the takeover market (Kesner & Dalton, 1985).

To be sure, many "institutions of capitalism" (Williamson, 1985) mitigate the agency problem of the separation of ownership and control including: (1) the market for corporate control (Jensen & Ruback, 1983; Marine, 1965); (2) competitive forces in the product market (Williamson, 1964); (3) outside boards of directors who effectively monitor top management and limit its opportunism (Baysinger & Butler, 1985; Baysinger & Hoskisson, 1990; Fama & Jensen, 1983a, 1983b; Friedman & Singh, 1989; Mizruchi, 1983); (4) compensation plans based on performance (Coughlan & Schmidt, 1985; Eaton & Rosen, 1983; Eisenhardt, 1989; Murphy, 1985; Walkling & Long, 1984);

(5) equity ownership by management (Jensen & Meckling, 1976; Knoeber, 1986; McWilliams, 1990);

(6) the external managerial labor market and the so-called "ex post settling-up mechanism" (Fama, 1980); (7) internal labor markets and the multidivisional internal capital market (Williamson, 1970);

(8) concentrated ownership (Demsetz & Lehn, 1985; Hill & Snell, 1989; Shleifer & Vishny, 1986a);

(9) increased monitoring by institutional investors (Brickley, Lease & Smith, 1988; Graves & Waddock, 1990; Oviatt, 1988); and (10) corporate culture (Barney, 1986).

Those who hold the managerial discretion view do not deny that mechanisms have evolved which lessen the problem of the separation of ownership and control (Walsh & Seward, 1990). The major

claims which are made by supporters of the managerial entrenchment hypothesis are the following: (1) all of the institutions of capitalism listed above attenuate but do not eliminate managerial discretion (Williamson, 1964, 1985); (2) reducing the effectiveness of the market for corporate control would exacerbate the agency problem of the separation of ownership and control (Easterbrook & Fischel, 1981); and (3) uninformed stockholders may be in the majority, in which case stockholders may vote to establish amendments which are not in their best interest (Jarrell & Poulsen, 1987)3.

Thus, managers are posited as exercising managerial discretion at the expense of stockholders since disciplinary mechanisms are not perfect. The organization's managers are able to balance commitments to various "stakeholders", to buffer the organization by maintaining slack resources, and to serve the interests of the organization as a "going concern" (Commons, 1934) even if it comes at the expense of stockholder wealth (March & Simon, 1958; Pfeffer & Salancik, 1978; Thompson, 1967).

The Stockholder Interests Hypothesis

The stockholder interests hypothesis posits that the adoption of antitakeover provisions increases current stockholder wealth (Berkovitch & Khanna, 1990). Antitakeover amendments, by giving target managements additional negotiating leverage or veto power, enable managements to negotiate better deals on average for their stockholders.

In the full information case where the gains of merger are attainable through merger with a potentially large number of bidding firms, antitakeover amendments are superfluous. The target firm will already be able to appropriate the full gains between the bidding firm and target firm in the

3 Stockholders in widely held corporations do not have an economic incentive to closely study every decision which is put to a stockholder vote. If, on average, the management's recommendations lead to an increase in stockholder wealth then the stockholder with small holdings has little incentive to monitor individual managerial decisions.

bidding process without additional safeguards such as antitakeover amendments (Bradley, 1980). Thus, the stockholder interests hypothesis implicitly posits asymmetric information and/or a private synergy between the target firm and bidding firm (Barney, 1988).

First, consider the case of asymmetric information. Suppose the current stock price, P^ ($80), is common knowledge, but only the bidding firm knows the true ex post price of the target firm PHIGH ($90). Suppose further that the target stockholders have a knowledge of the distribution of the possible ex post stock price. In this case, a particular bid (say, PBID = $85) will induce a certain percentage of the stockholders to tender their shares. We expect, of course, that the percentage of stockholders that tender their shares to increase with PBID (i.e., the supply curve of tendered shares is upward sloping in price).

In this case of asymmetric information, a supermajority amendment which requires 80 percent stockholder approval rather that a simple majority of 51 percent will result in a higher PBID (say, $89) for a successful takeover. The maximum share price that the bidding firm would offer is PHIGH ($90). A successful takeover will surely make the target firm's stockholder better off under a supermajority scenario relative to a simple majority, given that a takeover occurs. However, the supermajority amendment also increases the likelihood that the takeover will not take place and the target firm's shares will continue to sell for PL0W-

Next, consider the case of a private synergy between the bidding firm and the target firm due to economies of scope in production (Baumol, Panzar & Willig, 1982), market power (Eckbo, 1983) or informational economies (Bradley, Desai & Kim, 1983, 1988) which cannot be readily achieved by contractual exchange (Williamson, 1975). A private synergy obtains when the value of the target firm to the bidding firm is greater than the value of the target firm to any other bidder. The target firm wants to extract as much of the synergistic gain as possible in this bilateral monopoly situation with the bidding firm. However, the individual stockholders find that acting as a cartel is difficult

due to the incentive to cheat. As DeAngelo & Rice (1983) point out, in the case of a widely held firm, property rights (Alchian, 1965) are not perfectly defined since any coalition of 51 percent of the target stockholders can transfer voting control to the bidder. An inefficient 'rush' (from the target stockholders' point of view) by individual stockholders to tender at the currently offered control premium may result. A possibly effective way to counteract this inefficiency is to force the bidding firm to deal directly with the board of directors of the target firm. The target firm's board should be able to collude more effectively and at a lower cost than individual stockholders. Thus, antitakeover amendments such as classified board provisions force the bidding firm to deal with a small, cohesive group which may result in the extraction from the bidding firm of a larger percentage of the bilateral monopoly gains.

The private synergistic value is analogous to the Klein-Crawford-Alchian (1978) notion of quasi- rent. The target firm, of course, wants to appropriate as much of the quasi-rent as possible in this bilateral monopoly case. Antitakeover amendments may serve the rent-appropriation objective for the target firm (Grossman & Hart, 1980). The target stockholders potentially benefit from contractual mechanisms which enforce a "stockholder cartel" in which the individual stockholder is encouraged to hold-out for a higher tender price, approaching the bidder's maximum valuation of the target (DeAngelo & Rice, 1983). The antitakeover amendment is viewed as an institutional response to a free-rider problem associated with tender bids. Thus, antitakeover amendments which enable the target firm's stockholders to appropriate a greater share of the synergistic gains can be viewed as a special case of the insights of Schelling (1960) and Jensen & Meckling (1976) that voluntarily agreed upon constraints can often benefit the constrained in corporate contracting.

Supermajority provisions, as illustrated above, increase the number of shares needed for stockholder approval of a merger proposal. Supermajority provisions reduce the probability of losing the control premium (the difference between the tender offer price and the expected share value of the

target firm following a successful offer) and therefore increase the incentives of the individual stockholder to hold out for a higher offer. Antitakeover amendments help to force once-diffuse target stockholders to respond in unison to takeover bids, and thereby to capture a larger share of the economic gains from the perspective merger.

The stockholder interests hypothesis predicts that antitakeover amendments are adopted because they benefit stockholders on net. Thus, the value to stockholders of an increased ability to extract quasi-rents from bidders outweighs any additional costs which may include a lower probability of merger or increased transaction costs such as legal fees to effect a merger.

Empirical Analysis

The efficient capital market theory provides a framework for the empirical testing of our competing hypotheses (Bettis, 1983). We study stock price changes at the publication of news items relating to antitakeover amendments. Methodologies based on the OLS market model and using standard parametric tests are well-specified under a variety of conditions for daily stock return data (Brown & Warner, 1980, 1985) and are utilized here.

The managerial entrenchment and stockholder interests hypotheses differ in the predicted stock price impact of an antitakeover provision. The managerial entrenchment hypothesis suggests a negative impact as wealth is diverted from stockholders to management as opportunistic and/or less efficient managers protect their jobs. In contrast, the stockholder interests hypothesis suggests that equity value will increase to capitalize the larger expected quasi-rent from the idiosyncratic synergy gains. The managerial entrenchment and stockholder interests theories are empirically tested by considering the equity value impact at the time of the antitakeover amendment proposal. The proxy statement mailing date is utilized as the best available estimate of the date of the first public announcement of antitakeover amendment consideration.

8

Our sample of firms proposing antitakeover amendments is derived from several sources: (1) DeAngelo and Rice (1983); (2) the Security and Exchange Commission (1985); and (3) the Investor Responsibility Research Center (Rosenbaum, 1987, 1989). Our sample includes 409 firms adopting supermajority and classified board amendments for the 1974-1988 period. This large sample should reduce the level of statistical noise in measuring stock returns. The security market rates of return utilized in testing were taken from the CRSP (Center for Research in Security Prices, University of Chicago) daily file for firms listed in the New York Stock Exchange, the American Stock Exchange and the National Association of Security Dealers.

We expect any resulting changes in stock prices, due to the perceived effect of antitakeover amendments, to occur immediately around the proxy mailing date. We chose an event window of 50 days before the proxy mailing date (-50) to 10 days following the proxy mailing date (+ 10). An average of 27 trading days (and a median of 24) separates the board meeting date (when an amendment is passed) from the proxy mailing date (Linn & McConnell, 1983). Although it is against SEC rules to actively solicit votes before the proxy mailing date, the possibility remains that the board decision to adopt antitakeover amendments is leaked to some market participants. The market returns in the -40 to -20 interval roughly surround the board meeting date. We chose 50 days before the proxy mailing date to ensure the inclusion of the board meeting date. We chose 10 days after the proxy mailing date as a sufficient time period for the market to fully react to the antitakeover amendment provisions.

The statistical tests presented below consider the estimation of the market-price impact associated with public announcement of proposed antitakeover amendments. We utilize capital market residual analysis techniques (Fama, Fisher, Jensen & Roll, 1969). If we assume that security returns have a multivariate normal distribution, a single factor model consistent with the capital asset pricing model (Lintner, 1965; Sharpe 1964) can be formulated for time-event studies. Therefore, the statistical tests

described below entail a joint hypothesis of market efficiency, the capital asset pricing model, and the effects of antitakeover amendments.

Specifically, it is assumed that the market model is a valid representation of the stochastic process which generates returns for security j in time period t.

% = (% + %%«+% (1) where

Rp = stochastic return on security j over time period t

Rmt = stochastic return on a market portfolio of common stocks over time period t, and

ejt = disturbance term for security j at time period t which is assumed to be normally distributed with zero mean, serially uncorrected and has constant variance over time.

According to the market model, each security's period t return is expressed as a linear function of the corresponding time period's return on the market portfolio plus a random error term which reflects security specific effects.

The market model is implemented by computing ex-post abnormal returns for each security as ARjt = Rjt - (Sj + % Rmt ) (2)

where Rjt and Rmt are the observed returns for security j and the market portfolio, respectively, in time period t relative to the event date of interest.

The security specific parameters a} and @-} are estimated over a period of 1 10 days (-160 to -51)

preceding the event date (Linn & McConnell, 1983). To reduce the impact of random estimation

errors, portfolios were formed in event time such that each daily abnormal return is an equally

weighted average of individual securities' abnormal returns for that common event date,

N

AR, = E ARjt / N, j = l

10

where N is the number of securities in the portfolio on event date t. Cumulative average abnormal

returns are computed as:

t __ m CAR, = L AR,, , k= -50

where t = -50 through +10.

To determine the statistical significance of the average abnormal returns, we employed a

parametric mean test as described in Linn & McConnell (1983). The statistic used to test the null

hypothesis is computed as:

2=^/5 (AR), (3)

where ARt = 1/N ( E AR^ )

j = l

l/:

S (AR) = ( T-2/ (N (T - 4)) )

and AR^t = ARjt / St(ARj )

where

T _

St (ARj ) = ( Sj2 (1 + 1/T + 0C - RJ2 / E (Rmt - RJ2 ) )1/2

t=l

and

Sj2 = residual variance from the ordinary least squares estimation of the market model for security j

R^ = average return on the market portfolio computed over the same event period used to estimate the market model for security j

T = total number of days in the interval used to estimate the market model, and

N = number of securities in the portfolio of interest.

11

The Z-statistic in (3) is distributed approximately unit normal for large N.

The test statistic of the null hypothesis that the cumulative average residual (CAR) is equal to zero is computed as:

Zt = CAR, / S (AR), (4)

where

N ^

CAR, = (1/N E CARj ) j = l

A T a

CARj =(SARj, ) / (T)1/2 t=l

The Z-statistic in (4) is distributed approximately unit normal for large N.

Table 2 presents sample average and cumulative average abnormal rates of return for the event- time surrounding the proxy mailing date for antitakeover amendments. For the event window (-50, + 10) the cumulative average abnormal return (CAR) over the 61 day period decreased by 1.6 percent. The decrease in the CAR is significantly different from zero at the 0.05 level (see Figure 1). The result is consistent with the managerial entrenchment hypothesis.4

Insert Table 2 about here

Several methodological issues concerning event studies must be addressed (Brown & Warner, 1985). First, a pre-event period was chosen to estimate the parameters a and /5 in the market model. These parameters may change due to the event, thus yielding potentially biased and inefficient estimates for the market model. Changes in the parameter values are generally not a major concern

4 Formally, the hypotheses which we are testing are:

H0 : CAR10 = 0 Null hypothesis of no stockholder wealth effect

H1A : CAR,0 > 0 Supports the stockholder wealth hypothesis

H1B : CAR10 < 0 Supports the managerial entrenchment hypothesis

12

when events are nonoperating, that is, when the events do not change the asset structure (business risk) or the capital structure (financial risk) of a firm. We replicated our event study test using a post-event estimation period (+ 1 1 to + 120) in place of our pre-event estimation period (-160 to -51) to estimate a. and fi, and still found significantly negative CAR's, as expected.

Second, correlation among securities due to clustering of events in calendar time violates the OLS assumption of contemporaneously uncorrected error terms. In this study, cross-correlation is not viewed as a problem since the event dates are scattered through the years which we study. In addition, the problem of non-synchronous trading (Scholes & Williams, 1977) was not considered a major problem since the firms proposing antitakeover amendments are in general large, heavily traded corporations.

Third, a consistent choice of market index is needed in order to properly interpret the results (Brown & Warner, 1985). Thus, the equally-weighted market index was used in order to be consistent with the equal weighting of the firms in the event-study portfolio.

Finally, we tested for increased variance around the event date which would violate the OLS assumption of constant variance and would not allow standard interpretations of the t-tests for significance. We could not reject the hypothesis that the residuals from the OLS regression (1) above had the same variance before and after the event date, implying that constant variance is a reasonable assumption.

The apparent robustness of our results raises questions about the conflicting empirical results referred to in the introduction of this paper. We can reconcile these results if we look at the time frames of these studies. Linn & McConnell (1983) included amendments from 1960 through 1980 and found marginally significant positive CAR's. DeAngelo & Rice (1983) studied the period 1974 through 1979 and found no significant impact of antitakeover amendment proposals on stockholder wealth. Finally, Jarrell & Poulsen's (1987) study included amendments from 1980 to 1985 and found

13

significantly negative CAR's. This apparent negative trend over time prompted us to break our sample down by time period as well as by type of amendment.

Table 3 shows the results of the event-study methodology applied to various breakdowns of our 409 firm sample. Table 3A contrasts the pre-1980 results with the post-1980 results. Before 1980, no (statistically or economically) significant returns were associated with the passage of antitakeover amendments. After 1980, the antitakeover amendments were associated with significant negative returns. These results, when viewed in light of previous research, imply that early amendment passages (pre- 1975) generally induced positive cumulative average abnormal residuals, mid-period amendment proposals (1975-1979) had no general impact on stock prices, and more recent amendments (since 1980) have had significantly negative impacts on stockholder wealth. One can conjecture reasons for the negative trend over time in the effect of antitakeover amendments. Possible explanations include learning over time by stockholders (i.e., stockholders may update their expectations of the effects of an antitakeover amendment after seeing the effects on firms which have already passed them), changes in the structure of the takeover market5 (e.g., a more competitive takeover market would decrease the overall benefits of antitakeover amendments), and changes in the types of management which propose antitakeover amendments (e.g., perhaps early antitakeover amendments were proposed by responsible managers who acted in the best interests of stockholders but more recent amendments have been proposed by self-interested managers who propose the amendments despite the negative share price effect).

Table 3B shows the breakdown of post-1980 antitakeover amendments by type, supermajority or classified board. Each amendment shows similarly negative stock price effects (CAR's of

5 Many changes in the takeover market may have caused antitakeover amendments to have a relatively larger effect on stockholder wealth in the 1980s relative to the 1970s. For example, state antitakeover laws have been largely invalidated since 1982, and antitrust impediments have been reduced for the merger of large firms and between competitors since 1980 (Jarrell & Poulsen, 1987).

14

approximately -2 percent), but only the results of the classified board provisions are significantly negative due to the smaller sample size and large sample variance estimate of the supermajority provisions.

Conclusions

Our empirical findings support the position of the U.S. Securities and Exchanges Commission (SEC) and legal scholars such as Easterbrook and Fischel (1981). Antitakeover amendments are in general contrary to the best interests of the stockholders of the firms that adopt them. Protective responses while serving the interests of incumbent managements are dysfunctional from the standpoint of the system as a whole (Williamson, 1975: 160-161).

Our results are particularly strong since the tests are biased against the managerial entrenchment hypothesis. The proposal of antitakeover amendments may provide information, signaling an increased probability that the firm may currently be a takeover target. The signal of a potential bidder to the target stockholders empirically leads to an increase in the stock price. Thus, the significant decline in the stock price around the event date of the antitakeover amendments, despite the positive signaling effect, strengthens our interpretation of the evidence in support of the managerial entrenchment hypothesis.

The observed stock-price reaction to antitakeover amendments has at least three components: a negative component associated with the reduced probability of a successful offer, a positive component associated with a lowering of the costs of negotiating higher-valued offers, and a positive component associated with additional information about managers' expectations of a takeover. Our empirical results indicate that the negative component outweighs the positive components. Moreover, the negative stockholder reaction to corporate charter antitakeover amendments appears to have increased over time.

15

Thus, we reject the notion that takeovers play only a minor role in disciplining managers and that efficient labor markets are sufficient to solve the problem of the separation of ownership and control. The market reacts negatively when disciplining mechanisms placed on managers are circumvented by those same managers.

We find unpersuasive the argument that since stockholders freely choose to vote in favor of antitakeover amendments that they must be perceived as positive by stockholders. Jarrell and Poulsen (1987) show that firms passing supermajority amendments have relatively low institutional stockholdings (averaging 19 percent) and high insider holdings (averaging 18 percent), which we interpret as helping to explain how these amendments received voting approval despite their harmful wealth effects. Although higher insider holdings suggest greater financial interests to protect, managers also have employment concerns as well. Thus, inside holders may trade-off wealth accumulation for greater corporate control (Fortier, 1989).

Finally, it is important to note that although we found a negative average impact, this does not preclude the possibility that some firms' antitakeover amendments actually benefit stockholders. Our test is properly interpreted as providing evidence concerning the average effect of antitakeover amendment proposals on stockholder wealth. With this important caveat clearly in mind, we have been persuaded by the empirical evidence that antitakeover amendments are generally detrimental to stockholders.

Tender offers and hostile takeovers are primary market mechanisms which encourage efficient management and competitive firms. Antitakeover amendments subvert competition in the market for corporate control.

16

TABLE 1

Operating

Nonoperating

Stockholder

Approval

Required

No Stockholder

Approval

Required

1 Example: Dual-class recapitalizations	3 1. Supermajority amendments 2. Classified board amendments
2 Example: Poison pills	4 Example: Golden parachutes

Mechanisms intended to restrict transfer of managerial control (adapted from Walsh & Seward, 1990, p. 438). This paper focuses on amendments in box 3.

>

TABLE 2

Daily abnormal returns surrounding the event date for the proxy mailing for classified board and supermajority provisions. (N=409)

Event	Average	CAR		Event	Average	CAR
date	residual			date	residual
-50	-0.0014	-0.0014		-15	-0.0016	-0.0161	**
-40	-0.0014	-0.0031		-14	0.0000	-0.0161	**
-39	-0.0003	-0.0034		-13	0.0008	-0.0153	**
-38	-0.0007	-0.0041		-12	0.0011	-0.0142	**
-37	-0.0018	-0.0059	*	-11	0.0015	-0.0127	**
-36	-0.0014	-0.0074	*	-10	0.0010	-0.0117	*
-35	-0.0005	-0.0079	**	-09	0.0000	-0.0117	*
-34	-0.0015	-0.0094	**	-08	-0.0004	-0.0121	*
-33	-0.0006	-0.0100	**	-07	-0.0007	-0.0128	*
-32	0.0019	-0.0081	* *	-06	-0.0001	-0.0129	*
-31	-0.0014	-0.0095	**	-05	-0.0001	-0.0130	*
-30	-0.0001	-0.0096	**	-04	-0.0012	-0.0141	*
-29	-0.0001	-0.0097	* *	-03	0.0013	-0.0129	*
-28	0.0012	-0.0084	* *	-02	-0.0012	-0.0141	*
-27	0.0000	-0.0084	* *	-01	-0.0007	-0.0147	*
-26	-0.0022 *	-0.0106	**	00	-0.0012	-0.0159	*
-25	-0.0010	-0.0116	* *	+01	-0.0010	-0.0170	*
-24	-0.0002	-0.0118	**	+02	-0.0013	-0.0183	**
-23	-0.0012	-0.0130	**	+03	0.0010	-0.0173	*
-22	-0.0017	-0.0147	* *	+04	0.0018	-0.0155	*
-21	0.0003	-0.0144	**	+05	0.0000	-0.0155	*
-20	0.0002	-0.0142	**	+06	-0.0014	-0.0170	*
-19	-0.0004	-0.0146	* *	+07	-0.0013	-0.0183	*
-18	-0.0003	-0.0150	**	+08	-0.0006	-0.0188	*
-17	0.0018	-0.0131	**	+09	0.0012	-0.0176	*
-16	-0.0014	-0.0145	* *	+ 10	0.0016	-0.0160	*

* indicates that the average of the standardized residuals is significantly different from zero at the 5% level of significance using a two-tailed test.

** indicates that the average of the standardized residuals is significantly different from zero at the 1% level of significance using a two-tailed test.

TABLE 3

Cumulative Average Abnormal Residuals 10 days after the event date (CAR10) for Classified Board and Supermajority provisions broken down by time period and by amendment.

Table 3A	PROVISIONS BY TIME PERIOD
	1974-1979		1980-1988
Sample size (N	) 93		316
CARio	-0.0032		-0.0197
t(CAR10)	-0.3746		-2.1738

Table 3B	PROVISIONS BY TYPE
	Classified Board 1980-1988	Supermajority Provision 1980-1988
Sample size (N	} 192	118
CAR10	-0.0196	-0.0237
t(CARl0)	-2.333	-0.7206

>

Figure 1

a

< o

Cumulative Average Abnormal Residual

0.02 0.015	Supermajority & Classified Boards
-
0.01
0.005	^_-—--v— -^/v /-—"Significantly positive
0 -0.005
	V"^^^-^ ^-xSignficantly negative
-0.01	Mean CAR for sample\ » / — v /0\
-0.015 -nn?	i i i i i

-50

-30 -10

Time relative to event day

10

REFERENCES

Alchian, A. A. 1965. Corporate management and property rights. In H. G. Manne (Ed.) Economic policy and the regulation of corporate securities (pp. 337-360). Washington, D.C.: American Enterprise Institute.

Alchian, A. A., & Demsetz, H. 1972. Production, information costs and economic organization. American Economic Review, 62: 777-795.

Amihud, Y., & Lev, B. 1981. Risk reduction as a managerial motive for conglomerate mergers. Bell Journal of Economics, 12: 650-657.

Barney, J. 1986. Organizational culture: Can it be a source of sustained competitive advantage? Academy of Management Review, 11: 656-665.

Barney, J. 1988. Returns to bidding firms in mergers and acquisitions: Reconsidering the relatedness hypothesis. Strategic Management Journal, 9 (Summer): 71-78.

Baumol, W. J., Panzar, J. C, & Willig, R. D. 1982. Contestable markets and the theory of industry structure. New York: Harcourt Brace Jovanovich.

Baysinger, B. D., & Butler, H.D. 1985. Corporate governance and the board of directors: Performance effects of changes in board composition. Journal of Law, Economics, and Organization, 1: 101-124.

Baysinger, B. D., & Hoskisson, R. E. 1990. The composition of boards of directors and strategic control: Effects on corporate strategy. Academy of Management Review, 15: 72-87.

Berkovitch, E., & Khanna, N. 1990. How target shareholders benefit from value-reducing defensive strategies in takeovers. Journal of Finance, 45: 137-156.

Berle, A., & Means, G. C. 1932. The modern corporation and private property. New York: Macmillan.

Bettis, R. A. 1983. Modern financial theory, corporate strategy and public policy: Three conundrums. Academy of Management Review, 8: 406-415.

Bradley, M. 1980. Interfirm tender offers and the market for corporate control. Journal of Business, 53: 345-376.

Bradley, M., Desai, A., & Kim, E. H. 1983. The rationale behind interfirm tender offers: Information or synergy? Journal of Financial Economics, 11: 183-206.

Bradley, M., Desai, A., & Kim, E. H. 1988. Synergistic gains from corporate acquisitions and their division between the stockholders of target and acquiring firms. Journal of Financial Economics, 21: 3-40.

Bradley, M., & Wakeman, L. M. 1983. The wealth effects of targeted share repurchases. Journal of Financial Economics, 11: 301-328.

Brickley, J. A., Lease, R. C, & Smith, C. W. 1988. Ownership structure and voting on antitakeover amendments. Journal of Financial Economics, 20: 267-291.

Brown, S., & Warner, J. 1980. Measuring security price performance. Journal of Financial Economics, 8: 205-258.

Brown, S., & Warner, J. 1985. Using daily stock returns: The case of event studies. Journal of Financial Economics, 14: 3-31.

Cary, W. 1969. Corporate devices used to insulate managers from attack. Antitrust Law Journal, 39: 318-324.

Cochran, P. L., Wood, R. A., & Jones, T. B. 1985. The composition of boards of directors and the incidence of golden parachutes. Academy of Management Journal, 28: 664-671.

Commons, J. R. 1934. Institutional economics. Madison: University of Wisconsin Press.

Coughlan, A. T., & Schmidt, R. M. 1985. Executive compensation, managerial turnover, and firm performance: An empirical investigation. Journal of Accounting and Economics, 7: 43-66.

Dann, L. Y., & DeAngelo, H. 1983. Standstill agreements, privately negotiated stock repurchases, and the market for corporate control. Journal of Financial Economics, 11: 275-300.

Davis, G. F. 1990. Agents without principles? The spread of the poison pill through the intercorporate network. Working paper, Evanston, IL: Kellogg Graduate School of Management.

DeAngelo, H., & Rice, E. M. 1983. Antitakeover charter amendments and stockholder wealth. Journal of Financial Economics 11: 329-360.

Demsetz, H., & Lehn, K. 1985. The structure of corporate ownership: Causes and consequences. Journal of Political Economy, 93: 1155-1177.

Easterbrook, F. H., & Fischel, D. R. 1981. The proper role of a target's management in responding to a tender offer. Harvard Law Review, 94: 1161-1204.

Eaton, J., & Rosen, H. 1983. Agency, delayed compensation, and the structure of executive remuneration. Journal of Finance, 3: 1489-1505.

Eckbo, B. E. 1983. Horizontal mergers, collusion, and stockholder wealth. Journal of Financial Economics, 11: 241-273.

Eisenhardt, K. M. 1989. Agency theory: An assessment and review. Academy of Management Review, 14: 57-74.

Fama, E. 1980. Agency problems and the theory of the firm. Journal of Political Economy, 88: 288-307.

Fama, E., & Jensen, M. C. 1983a. Agency problems and the theory of the firm. Journal of Law and Economics, 26: 327-349.

Fama, E., & Jensen, M. C. 1983b. Separation of ownership and control. Journal of Law and Economics, 26: 301-325.

Fama, E., Fisher, L., Jensen, M., & Roll, R. 1969. The adjustment of stock prices to new information. International Economic Review, 10: 1-21.

Fortier, D. 1989. Hostile takeovers and the market for corporate control. Economic Perspectives, 13 (1): 2-16.

Friedman, S. D., & Singh, H. 1989. CEO succession and stockholder reaction: The influence of organizational context and event content. Academy of Management Journal, 32: 718-744.

Graves, S. B., & Waddock, S. A. 1990. Institutional ownership and control: Implications for long- term corporate strategy. Academy of Management Executive, 4: 75-83.

Grossman, S., & Hart, 0. 1980. Takeover bids, the free-rider problem, and the theory of the corporation. Bell Journal of Economics, 11: 42-64.

Hayes, R. H., & Wheelwright, S. C. 1984. Restoring our competitive edge. New York: John Wiley & Sons.

Hill, C. W. L., & Snell, S. A. 1989. Effects of ownership structure and control on corporate productivity. Academy of Management Journal, 32: 25-46.

Jarrell, G. A., & Poulsen, A. B. 1987. Shark repellents and stock prices: The effects of antitakeover amendments since 1980. Journal of Financial Economics, 19: 127-168.

Jensen, M., & Meckling, W. 1976. Theory of the firm: Managerial behavior, agency costs, and ownership structure. Journal of Financial Economics, 3: 305-360.

Jensen, M., & Meckling, W. 1979. Rights and production functions: An application to labor- managed firms and codetermination. Journal of Business, 52: 469-506.

Jensen, M., & Ruback, R. S. 1983. The market for corporate control: The scientific evidence. Journal of Financial Economics, 11: 5-50.

Kesner, I. F., & Dalton, D. R. 1985. Antitakeover tactics: Management 42, Stockholders 0. Business Horizons, 17-25.

Klein, B., Crawford, R., & Alchian, A. 1978. Vertical integration, appropriable rents, and the competitive contracting process. Journal of Law and Economics, 21: 297-326.

Knoeber, C. R. 1986. Golden parachutes, shark repellents, and hostile tender offers. American Economic Review, 76: 155-167.

Kosnik, R. D. 1987. Greenmail: A study of board performance in corporate governance. Administrative Science Quarterly, 32: 163-185.

Kosnik, R. D. 1990. Effects of board demography and directors' incentives on corporate greenmail decisions. Academy of Management Journal, 33: 129-150.

Lambert, R. A., & Larcker, D. F. 1985. Golden parachutes, executive decision making, and shareholder wealth. Journal of Accounting and Economics, 7: 179-203.

Linn, S. C, & McConnell, J. J. 1983. An empirical investigation of the impact of 'antitakeover' amendments on common stock prices. Journal of Financial Economics, 11: 361-399.

Lintner, J. 1965. The valuation of risky assets and the selection of risky investments in stock portfolios and capital budgets. Review of Economics and Statistics, 47: 13-37.

Malatesta, P. H., & Walkling, R. A. 1988. Poison pill securities: Stockholder wealth, profitability, and ownership structure. Journal of Financial Economics, 20: 347-376.

Manne, H. 1965. Mergers and the market for corporate control. Journal of Political Economy, 73: 110-120.

March, J. G., & Simon, H. A. 1958. Organizations. New York: Wiley.

McWilliams, V. B. 1990. Managerial share ownership and the stock price effects of antitakeover amendment proposals. Journal of Finance, 45: 1627-1640.

Mizruchi, M. S. 1983. Who controls whom? An examination of the relation between management and boards of directors in large American corporations. Academy of Management Review, 8: 426- 435.

Morck, R., Shleifer, A., & Vishny, R. W. 1989. Alternative mechanisms for corporate control. American Economic Review, 79: 842-852.

Murphy, K. J. 1985. Corporate performance and management remuneration: An empirical analysis. Journal of Accounting and Economics, 7: 1-32.

Myers, C. A. 1983. Top management featherbedding? Sloan Management Review, 24 (4): 55-58.

Oviatt, B. M. 1988. Agency and transaction cost perspectives on the manager-shareholder relationship: Incentives for congruent interests. Academy of Management Review, 13: 214-225.

Pfeffer, J., & Salancik, G. R. 1978. The external control of organizations: A resource dependence perspective. New York: Harper & Row Publishers.

Pound, J. 1985. The impact of antitakeover charter amendments on contests for corporate control. Washington, D.C.: Investor Responsibility Research Center, Inc..

Rosenbaum, V. K. 1987, 1989. Takeover defenses: Profiles of the Fortune 500. Washington D. C: Investor Responsibility Research Center, Inc..

Ryngaert, M. 1988. The effect of poison pill securities on shareholder wealth. Journal of Financial Economics, 20: 377-417.

Schelling, T. 1960. The strategy of conflict. Cambridge, Mass.: Harvard University Press.

Scholes, M., & Williams, J. 1977. Estimating betas from nonsynchronous data. Journal of Financial Economics, 5: 309-328.

Securities & Exchange Commission, 1985. Shark repellents and stock prices: The effects of antitakeover amendments. Office of the Chief Economist.

Sharpe, W. F. 1964. Capital asset prices: A theory of market equilibrium under conditions of risk. Journal of Finance, 19: 425-442.

Shleifer, A., & Vishny, R. W. 1986a. Large shareholders and corporate control. Journal of Political Economy, 94: 461-488.

Shleifer, A., & Vishny, R. W. 1986b. Greenmail, white knights, and shareholder's interest. Rand Journal of Economics, 17: 293-309.

Singh, H., & Harianto, F. 1989a. Management-board relationships, takeover risk and the adoption of golden parachutes. Academy of Management Journal, 32: 7-24.

Singh, H., & Harianto, F. 1989b. Top management tenure, corporate ownership structure and the magnitude of golden parachutes. Strategic Management Journal, 10 (Summer), 143-156.

Sundaramurthy, C. 1990. Corporate governance and strategic action within the context of anti- takeover charter amendments. Dissertation proposal, University of Illinois - Urb ana-Champaign.

Szewczyk, S., & Tsetsekos, G. P., 1990. State intervention in the market for corporate control: The case of Pennsylvania Senate Bill 1310. Working paper, Philadelphia: Drexel University.

Thompson,. J. D. 1967. Organizations in action. New York: McGraw-Hill.

Walkling, R. A., & Long, M. S. 1984. Agency theory, managerial welfare and takeover by resistance. Rand Journal of Economics, 15: 54-68.

Walsh, J. P., & Seward, J. K. 1990. On the efficiency of internal and external corporate control mechanisms. Academy of Management Review, 15: 421-458.

Williamson, O. E. 1964. The economics of discretionary behavior: Managerial objectives in a theory of the firm. Englewood Cliffs, N.J.: Prentice-Hall.

Williamson, O. E. 1970. Corporate control and business behavior. Englewood Cliffs, N.J.: Prentice-Hall.

Williamson, O. E. 1975. Markets and hierarchies: Analysis and antitrust implications. New York: The Free Press.

Williamson, O. E. 1985. The economic institutions of capitalism: Firms, markets, relational contracting. New York: The Free Press.