Does the Market for Corporate Control Influence Executive Risk-Taking Incentives? Evidence From Takeover Vulnerability
32 Pages Posted: 18 Nov 2020
Date Written: October 1, 2020
Abstract
Purpose: We investigate the role of the market for corporate control as an external governance mechanism and its effect on executive risk-taking incentives. Managers tend to be risk-averse as they are more exposed to idiosyncratic risk, resulting in sub-optimal risk-taking that does not maximize shareholders’ wealth. The takeover market alleviates this problem, inducing managers to take more risk. Therefore, risk-taking incentives inside the firm are less powerful when the outside takeover market is more active.
Design/Methodology: Exploiting a novel measure of takeover vulnerability recently constructed by Cain, McKeown, and Solomon (2017), we explore how takeover vulnerability influences executive risk-taking incentives. Using a large sample of U.S. firms, we employ fixed-effects regressions, propensity score matching, and instrumental variable analysis
Findings: Consistent with our hypothesis, a more active takeover market results in less powerful risk-taking incentives. Specifically, a rise in takeover vulnerability by one standard deviation diminishes executive risk-taking incentives by 22.39%, an economically meaningful magnitude.
Originality/Value: Our study is the first to explore the effect of the takeover market on managerial risk-taking incentives, using a novel measure of takeover susceptibility. Our measure of takeover vulnerability is considerably less susceptible to endogeneity, enabling us to draw causal inferences with more confidence.
Keywords: Corporate Governance, Takeover Market, Risk-Taking Incentives, Vega, Market for Corporate Control
JEL Classification: G32, G34
Suggested Citation: Suggested Citation