Murders and demolitions : how agency costs destroy wealth in hostile takeovers

Abstract

We address agency costs in the context of hostile takeovers. We argue that agency costs on both buy- and sell-side are represented by the overpayment that occurs between a transaction’s initiation and its conclusion; we call this agency-costs-associated overpayment a “hostile agency premium”. In our hypothesis, agency costs on the acquiring side are attributable to the managerial entrenchment that facilitates maximization of private benefits and satisfaction of empire-building ambitions, among other; in turn, agency costs on the target side are mostly due to target-firm managers’ unwillingness to have their employment terminated.

In order to test this hypothesis, we formulate an empirical model based on a number of factors that are either likely or proven to have an impact on agency costs. In doing that, we adopt a number of perspectives on the quantification of overpayment and, inherently, agency costs, including that of relative valuation.

First, we find a strong consistent positive relationship between the overpayment on hostile takeovers and their relative value. In fact, every 1% increase in the transaction multiple results in an additional overpayment of 0.2-0.4%. This suggests that hostile takeovers of “growth” targets and hostile takeovers in the ‘hot’ sectors are particularly value-destructive. An application of this finding shows that successful hostile takeovers cost their shareholders at least $76.2 billion in agency costs in 2016 only.

Second, our results show that successful takeovers result in the average agency premium increase of 0.26-0.93% in relative terms. In contrast, we find that unsuccessful hostile takeovers would not have been overpaid for had they been concluded at the latest bid, weakly suggesting that the managerial entrenchment on the acquiring side is heterogeneous.

Finally, our results emphasize the consistent disciplinary role of debt in hostile takeovers, albeit marginal in its impact when compared to other forces.