Intra-Industry Effects of Control Threats on Investment, Financing, and Financial Reporting Quality
London Business School; Centre for Economic Policy Research (CEPR)
London School of Economics & Political Science (LSE)
May 13, 2009
This paper studies how industry peers respond when another firm in the industry is the subject of a hostile takeover attempt. We document two major responses. First, the industry peers cut their capital spending, free cash flows, and cash holdings, and increase their leverage and payouts to shareholders. Second, they increase the quality of financial reporting: after the control threat, there is evidence of less earnings management, more timely loss recognition, and more value relevance of accounting earnings. We also find that the stock price reaction upon announcement of the takeover is larger for peer firms with higher capital spending, less debt, fewer takeover defenses in place, and lower insider ownership. These findings are consistent with Jensen's (1986, 1993) and Shleifer and Vishny's (1988) observation that agency costs often manifest themselves at the industry level, and with Bushman and Smith's (2001) conjecture that changes in takeover pressure can alter managerial incentives to distort firms' accounting numbers. Our results also highlight the relation between financial reporting quality and financing and investment policies.
Number of Pages in PDF File: 55
Keywords: Hostile takeover, agency costs, investment decisions, capital structure financial reporting quality
JEL Classification: G31, G32, G34, G35, M41, M43, D82working papers series
Date posted: February 13, 2008 ; Last revised: May 14, 2009
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