Guiding Seminar 4 (2020) Flashcards
“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)
What has been concluded in the previous literature about the relationship between the power protection of shareholder rights and PBOC?
If protection of shareholder rights is STRONG –> PBOC is LOW -> shareholders can expect to get a proper financial return
If protection of shareholder rights is WEAK –> PBOC is HIGH -> shareholders will get less money
“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)
What is an anti-takeover provision?
Anti-takeover provisions (aka takeover defenses) are actions taken by a firm’s management to prevent unwanted takeovers.
(Unwanted takeover - acquisition of one company by another that is accomplished by:
- -going directly to the company’s shareholders OR;
- -fighting to replace management to put in a new management that will be more likely to get the acquisition approved.
Key characteristic of an unwanted takeover - target company’s management does not want the deal to go through, so it will defend against takeovers by using several strategies)
MORE takeover defense means LESS rights for the shareholders.
“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)
What has been concluded about anti-takeover defense influence on the firm’s value in the previous literature?
Higher antitakeover defenses—>
- –> managers who run firms inefficiently cannot be thrown out
- –> decrease in firm’s value through lower operating performance.
“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)
Please name all types of takeover defenses that you know!
- Charter amendments
- Golden parachute
- Poison pills
- Pac man defense
“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)
What is a charter amendment and what is another name for it?
Charter amendment OR Shark Repellent (anti-takeover technique)
Imposing conditions in a firm’s charter (“a legal document that formally establishes a corporate entity”) on control transfer.
Ex: requiring over 2/3 shareholder vote to approve a merger/acquisition.
(how to remember the name: “when a shark attacks, shark repellent can send the shark away from its place of attack” - so charter amendment a company’s way on HOW to send away the sharks)
“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)
What is a golden parachute?
Golden parachute:
Substantial benefits (compensation) that is guaranteed to a firm’s senior management if the firm is taken over and the managers are let go.
“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)
What is a poison pill?
Poison pills:
Strategy to make the company’s stocks seem less attractive to the acquirer. Accomplished by making the company’s stock more costly to acquire.
Ex1: Allowing existing shareholders to buy more stock at a discount which increases the number of shares that the acquirer will have to buy.
Ex2: Creating employee stock option plan that shows up only when the company is taken over which makes it more difficult to retain key employees after a takeover.
“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)
What is a pac-man defense?
Pac-man defense:
Company trying to acquire the acquirer in an attempt to scare off them (Tinder buying Bumble, Bumble threatening to buy Tinder - not irl)
During the takeover phase, the acquirer may begin a large-scale purchase of the target company’s stocks to gain control of the target company. As a counter-strategy, the target company may begin buying back its shares and purchasing shares of the acquiring company.
“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)
What is the main motivation of this paper?
The authors argue that the existence of dual-class stocks in a company ALSO can be an anti-takeover strategy (it has apparently been forgotten). Authors look at how being dual-class company in the US influences the firm’s value.
Background info:
Dual-class company has two types of shares:
1. Superior shares with more votes per share
2. Inferior class, with one vote per share
Superior class of shares is usually owned by company insiders which provide insiders with a majority of votes. Thus, insiders of dual-class firms have effective control over all corporate decisions which makes them virtually immune to hostile takeovers. Additionally, inferior shareholders have less control and thus can be more easily expropriated, leading to a worse performance of the firm.
“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)
What are the main characteristics of a publicly listed dual-class company in the US?
- The insiders (the ones who hold superior shares) of own a majority of the voting rights (~60%)
- The insiders own a minority of the cash flow rights (~40%), meaning that they bear considerably smaller financial consequences for their decisions.
- Dual-class firms are BIGGER than one-class firms on median terms of firm value
- Dual-class firms are MORE LEVERED, possibly due to their reluctance to engage in equity offerings not to lose ownership (If I issue more stock, my control gets weaker)
- Dual-class firms are OLDER, possibly due to less possibility of being acquired.
“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)
What predicts larger size of PBOC and, thus, a dual-class status?
- Name (A company named after a founder indicates a more “personal” stake involved);
- Media (Control of a media company provides opportunities for self-advertising, manipulating the public opinion);
- Activity of the founder (PBOC and also dual-class structure is more likely if the firm is young and the founder is still active);
- Firms in the area & Sales of the area (the less firms there are in firm’s area, the more likely the firm is a major employer in town which entails private benefits for insiders with dual-class shares - additionally, firms with an important local presence may use dual-class status as a promise to local authorities that the firm will resist takeovers in order to honor implicit contracts with local governments and other stakeholders).
“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)
Why are empirical studies of firm valuation and insider ownership criticized?
Endogeneity/Loop of Causality– it is not only that ownership structure determines firm’s value, but it can also be that the firm’s value influences the ownership structure
“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)
What are the main findings of the paper (despite the endogeneity issues)?
Nevertheless, the paper finds that:
1. Firm’s value is positively associated with insiders’ cash-flow rights. (insiders have more cash flow rights - (possibly) more incentivized to make good decisions because of monetary risk - firm’s performance, and, thus, value increases)
- Firm value is negatively associated with insider voting rights (more insider voting rights decreases the firm’s value)
- Firm value is negatively associated with the wedge between the two (insider voting rights – insider cash flow rights). - The more imbalanced they are, the more negative firm’s value is.
“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)
Why a negative trend on firm’s value can sometimes not seem important to a majority owner of a company?
- If majority owner deems establishing PBOC more important that maintaining firm value, he will rationally choose to sacrifice some of firm value to maintain PBOC.
- PBOC from controlling a newspaper, news agency or brand identity can outweigh financial losses of the firm.
“The bonding hypothesis of takeover defenses: Evidence from IPO firms” - (W. C. Johnson, J. M. Karpoff,
S. Yi)
What is the main motivation for this paper?
Although a general academic understanding deems that large PBOC decreases firm’s returns, this paper tries to prove the opposite through bonding hypothesis.
“The bonding hypothesis of takeover defenses: Evidence from IPO firms” - (W. C. Johnson, J. M. Karpoff, S. Yi)
What is a bonding hypothesis in regards to takeover defenses?
When 2 (or more) firms create a prearranged business strategy whose reversal is complicated and costly, it works as a takeover defense between the companies because this ensures that the companies will not act opportunistically and expropriate each other, but will encourage partnership to make relation-specific investments.
Paper creates a hypothesis that bonding of firms in regards to takeover defense allows the companies to gain favorable contract terms with its partners which increases firm value.
“The bonding hypothesis of takeover defenses: Evidence from IPO firms” - (W. C. Johnson, J. M. Karpoff,
S. Yi)
What is the hold-up problem?
Hold-up problem is a situation where two parties may be able to work most efficiently by cooperating but refrain from doing so because of concerns (usually, company profit).
Ex1: Company A makes ice blades and Company B makes ice skates. Company B cannot work properly without Company A. Company B can either push up the cost of the blades, making their profit bigger (because they know A cannot exist without them), BUT hinder their relationship in the LR or they can cooperate with acceptable costs for both and create a great relationship in LR.
Ex2: A builder constructs a house on land it does not own, but only leases short term. However, after the initial land lease expires, the landowner can violate the intent of the contractual understanding by threatening to raise the land rent unless the builder agrees to buy the land at an exorbitant price. A hold-up occurs.
“The bonding hypothesis of takeover defenses: Evidence from IPO firms” - (W. C. Johnson, J. M. Karpoff,
S. Yi)
Please, provide an example of companies bonding in regards to takeover defense!
Pemstar Inc: engineering services provider (seller);
IBM: needs engineering services (buyer).
IBM invested heavily to the relationship with Pemstar, engaging in joint ventures and sharing knowledge of its production.
Pemstar could have exploited IBM’s reliance and demanded higher payments, payable by IBM in the short term, but hindering the relationship in the long run.(hold-up problem)
Why did not Pemstar exploit the opportunity?
Pemstar’s managers had personal connections and reputations that would be hurt if they “betrayed” IBM for a short term gain (Pemstar’s PBOC).
This would be of no value if Pemstar’s incumbents were replaced by new managers lacking such connections.
Pemstar defended from 5 takeover attempts to ensure
no new managers would come it to preserve the mutually beneficial relationship with IBM.
In turn, this motivated IBM to invest to the relationship further.
This is how takeover relationships can be valuable – they can be used to defend a mutually beneficial relationship.
“The bonding hypothesis of takeover defenses: Evidence from IPO firms” - (W. C. Johnson, J. M. Karpoff,
S. Yi)
What is the difference between an IPO and a seasoned offering?
IPO - when a company offers ownership shares to the public for the first time.
Seasoned offering - a company is already listed on stock exchanges and decides to release additional stock
“The bonding hypothesis of takeover defenses: Evidence from IPO firms” - (W. C. Johnson, J. M. Karpoff,
S. Yi)
Is an effect of bonding hypothesis more pronounced for IPOs or for seasoned offerings? Why?
Evidence and effects of bonding is more pronounced in IPOs.
Why?
1) Becoming an IPO poses a SUBSTANTIAL RISK for a hostile takeover. Risk up –> risk also up for firm’s counterparties, thus takeover defenses become more necessary and valuable.
2) IPO firms tend to be SMALL and valued based on HIGH DEPENDENCE on specific business partners, so the benefits of bonding are extremely valuable for such firms.
“The bonding hypothesis of takeover defenses: Evidence from IPO firms” - (W. C. Johnson, J. M. Karpoff,
S. Yi)
What is an IPO puzzle?
Firms adopting more takeover defenses after becoming IPO even though it is widely believed that more takeover defenses (more PBOC) lower firm value (seemingly irrational decision).
