The Econometrics of Corporate Governance Studies

Abstract

A vast theoretical and empirical literature in corporate finance considers the inter-relationships between corporate governance, takeovers, management turnover, corporate performance, corporate capital structure, and corporate ownership structure. Most of the extant literature considers the relationship between two of these variables at a time - for example, the relationship between ownership and performance, or the relationship between corporate governance and takeovers. We argue that takeover defenses, takeovers, management turnover, corporate performance, capital structure and corporate ownership structure are interrelated. Hence, from an econometric viewpoint, the proper way to study the relationship between any two of these variables would be to set up a system of simultaneous equations that specifies the relationships between these six variables. However, specification and estimation of such a system of simultaneous equations is non-trivial. To illustrate the above problem in a meaningful manner we consider the following two questions that have received considerable attention in the literature and have significant policy implications: Do antitakeover measures prevent takeovers? Do antitakeover measures help managers enhance their job-tenure? In this research, we examine the impact of firm performance, ownership structure and corporate takeover defenses on takeover activity and managerial turnover. Our focus is the efficacy of corporate takeover defense. A vast literature suggests that takeovers and the managerial labor market serve to discipline poor performers in the managerial ranks, and also suggests that corporate takeover defenses are designed to shield incumbent managers from these forces. If this is in fact the case, and the belief that motivates the adoption of takeover defenses is rational, the presence of these defenses should be associated with a decline in takeover activity and extended job tenure for managers. The results presented here provide little support for this hypothesis. We find that antitakeover measures are not effective in preventing takeovers, nor are they effective in enhancing management's job-tenure. We do observe a negative correlation between takeover activity and takeover defense that is statistically significant. However, when we control for the financial performance of the company, we do not observe the negative relation between takeover activity and takeover defense. In a model that allows the relationship between performance and takeover activity to vary with takeover defense, we find that defensive activity is ineffective. In the case of management turnover, our results are even stronger. The frequency of CEO departures is uncorrelated with the status of takeover defenses at firms in our sample. This statement is consistent with both simple correlations, and with the estimates from probit models, where we find that turnover is related to performance. At firms with poison pill defenses, there is a statistically significant relationship between management turnover and performance. We stress that these results do not imply that defensive activity is costless to shareholders. It may well be the case that managers who are shielded by takeover defenses perform less well than they would have had the takeover defenses not been in place. This hypothesis is consistent with both the results reported here, and with indirect evidence from announcement returns. Our evidence does, however, suggest quite strongly that takeover defenses are not completely effective in insulating managers from the consequences of poor corporate financial performance.

JEL Classification: C30, C33, G31, G32, G34, K22, M40