Large Shareholders and the Value of Takeover Defenses

Abstract:     
Takeover defenses are generally viewed as a tool used by entrenched managers to prevent raiders from taking over the firm. As a consequence, activist groups interested in governance reform have recently been arguing for the elimination of such defenses. In this paper we analyze the value impact of takeover defenses when looking at the takeover market as one component of the overall governance system of the firm. We demonstrate that governance reform that attempts to eliminate takeover defenses is not necessarily optimal for shareholders. The key insight of the model is that a company may be monitored by two distinct entities: an "active" outside raider and a large (institutional) shareholder. The paper finds that an ex-ante commitment to a more aggressive takeover defense strategy will result in both a decrease in the incentive of potential raiders to search for a value-increasing takeover as well as an increase in the incentive of the large institutional shareholder to monitor current management. Thus, the model offers a motivation as to why takeover defenses may increase the ex-ante value of the firm. An analysis of the resulting equilibrium generates several empirical predictions with respect to the conditions under which this is the case.

Number of Pages in PDF File: 30

Keywords: Takeover defenses, large shareholders, monitoring

JEL Classification: G30, G34

working papers series