Tutorial 4:How can employee equity ownership (EEO) influence agency conflicts between managers and shareholders during a merger?

Question 1

How can employee equity ownership (EEO) encourage managers to make value-
destroying acquisitions?

Answer 1

EEO can encourage managers to make empire-building & value-destroying acquisitions (harmful to shareholder value & returns):

1) EMPLOYEES W VOTING RIGHTS (ATTACHED TO THEIR SHARES) PROTECT MANAGERS FROM HOSTILE TAKEOVER ATTEMPTS (WHITE SQUIRE ROLE) BECAUSE MANAGERS REWARD EMPLOYEES HIGHLY FOR THEIR WORK –> if employees benefit from favourable
employment policies e.g. long-term contracts, high wages, generous benefits, & infrequent layoffs they have stronger incentives to form alliances with empire-building managers to secure their employment
status against adverse consequences of poor acquisitions –> incentivises managers to pursue
empire-building acquisitions w/o fear of mkt discipline –> alignment of interests between managers & employees can lead to mutually beneficial relationship where managers reward employees for their support but to detriment of shareholder value as managers may prioritise expanding business rather than max. shareholder value.

2) UNDIVERSIFIED EMPLOYEES & MANAGERS SHARE PREFERENCE FOR RISK-REDUCING & DIVERSIFYING ACQUISITIONS –> common preference for acquisitions that reduce firm risk & increase employees’ job security even if they do not max. shareholder value.

Question 2

How can employee equity ownership (EEO) discourage managers to make value- destroying acquisitions?

Answer 2

EEO can discourage managers to make empire-building and value-destroying acquisitions (beneficial for shareholder value & returns):

1) VALUE-DESTROYING ACQUISITIONS DECREASE EMPLOYEES’ SHARE VALUE & LEAD TO ADVERSE CONSEQUENCES FOR FIRM OPERATIONAL PERFORMANCE & EFFICIENCY –> e.g. firms can experience declines in employee morale, decreases in productivity, & increases in voluntary employee turnover –> can lower firms’ operating efficiency & performance –> hence managers may find employees more demanding at times of contract renewals & renegotiations –> worsening employer-worker relations can lead to temporary work stoppage or prolonged strikes & cause further operational disruption & make employees unwilling
to support incumbent managers in event of unsolicited takeover attempts –> managers may be discouraged from carrying out value-destroying acquisitions which decreases value of all shareholders & employee shareholders.

2) HOWEVER EMPLOYEES MAY STILL SUPPORT INCUMBENT MANAGERS IF BENEFITS OF LABOUR-FRIENDLY POLICIES OUTWEIGH LOSSES IN EMPLOYEES’ SHARE VALUE FROM ACQUISITION.

Question 3

What was the key finding (employee equity ownership encourages/discourages manager to make value-destroying acquisitions)?

Answer 3

Firms w large EEO more likely to engage in value-reducing acquisitions –> -ve relation between employee block ownership & acquirer shareholder returns:

1) MANAGERS MAY PRIORITISE REWARDING EMPLOYEES DESPITE -VE SHARE PRICE EFFECT OF ACQUISITIONS –> higher concentration of lower announcement date abnormal returns (evidence of value-destroying acquisitions) in firms w better employee treatment, more unionised workforces, abnormally high employee wages & diversifying acquisitions.

2) EMPIRE-BUILDING ACQUIRING MANAGERS LESS LIKELY TO BECOME TAKEOVER TARGETS FOLLOWING VALUE-DESTROYING ACQUISITION DUE TO EMPLOYEE BLOCK OWNERSHIP PROTECTION.