Thursday, 21 July 2016

How mandatory shareholder voting prevents bad corporate acquisitions

In a new column at Marco Becht, Andrea Polo and Stefano Rossi argue that many corporate acquirers impose losses on their shareholders. Conflicted or overconfident CEOs and boards embark on acquisitions that are not in the best interest of the owners of the firm. They go onto argue that the governance tool of shareholder voting can represent a potential solution. Their column shows that in the UK, where bids for relatively large targets require mandatory shareholder approval, shareholders gain when the transaction is conditional on a vote and lose when it is not. The evidence suggests that the vote puts a constraint on the amount the CEO can offer for the target.

This does raise the question that if this is true, why do we not see more shareholder activism on this issue? Also if this is true and activism is low, ie "voice" is not used, then why do we not see more "exit" occurring? That is, why do we not see disgruntled shareholders selling their shares?

Becht, Polo and Rossi write,
One of the most striking empirical regularities in finance is that many acquirer shareholders earn negative abnormal returns (Andrade et al. 2001, Bouwman et al. 2009), and that the losses from the worst performing deals are very large (Moeller et al. 2005). Why is this the case?

The finance literature has pointed to two non-mutually exclusive explanations. First, in line with the traditional ‘separation of ownership and control’ problem, managers who control widely held corporations may have private goals – such as empire building – that conflict with those of shareholders, particularly in the case of acquisitions (Morck et al. 1990). According to this view, managers know what they are doing and deliberately take excessive risks. Second, managers may be overconfident or suffer from ‘hubris’, thereby paying too much relative to rational managers (Roll 1986, Malmendier and Tate 2008).

Can shareholders address these issues and prevent negative abnormal returns in acquisitions from materialising in the future? In principle, shareholder voting can provide a potential solution in both of the cases described above. Rational shareholders can veto actions driven by overconfidence, while vigilant or active shareholders can halt transactions motivated solely by empire building or private benefit purposes. If shareholder voting is effective in deterring CEOs’ behavior, CEOs will not overpay relative to the median shareholder and will not propose projects the shareholders are unlikely to support. As a result, in equilibrium all acquisition proposals will be approved.

In the conclusion Becht, Polo and Rossi ask, given the above results, why is mandatory voting on relatively large acquisitions not adopted more widely among issuers? In their answer to their own question they write,
Acquirer shareholders could be better off by writing a mandatory voting provision into the corporate charter. In some jurisdictions this might be difficult because the board and the management can get in the way and want to guard their autonomy. Under Delaware law in the US, for example, shareholders could potentially make the necessary charter amendment but this would require the approval of the board. The same frictions that explain the large value destruction in acquisitions - self-dealing and overconfidence - might explain why we do not see such charter amendments. In other countries company law and listing rules simply do not foresee the possibility of mandatory voting on acquisitions. Acquirer shareholders would have to lobby more effectively to get the tools that would allow them to protect their wealth.

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