The Effect of Takeover Protection in Quiet Life and Bonding Firms

Abstract

Antitakeover measures are controversial because the evidence on their net effect on shareholders is mixed. We propose that for many firms, the potential bonding benefits outweigh the agency costs of the quiet life, explaining the mixed results. We study business combination and poison pill laws as exogenous shocks to takeover vulnerability and use shareholder valuation of internal slack as an indicator of the net effect of takeover protection. We find that there is considerable heterogeneity in how the value of slack responds. Firms susceptible to quiet life agency problems exhibit a decrease in the market-assessed value of internal slack. Conversely, cash appreciates at companies where takeover protection helps bond commitments with major counterparties.

Keywords: Business combination laws; Poison pills; Quiet life; Bonding hypothesis; Cash value

JEL Classification: G30; G32; G34; K22; L14