The Sources of Value Destruction in Acquisitions by Entrenched Managers
53 Pages Posted: 21 Oct 2010 Last revised: 17 Oct 2011
Date Written: October 20, 2010
Prior work has established that entrenched managers make value-decreasing acquisitions. In this study, we ask how exactly they destroy that value. We hypothesize that rising equity values loosen financial constraints, much like free cash flow does, allowing entrenched managers to pursue more acquisitions in the first place. We further test whether entrenched managers simply overpay for good targets or actually choose targets with lower synergies. We find support for the latter. Overall, we find that value destruction by entrenched managers comes from a combination of factors. First, they disproportionately avoid private targets, which have been shown to be generally associated with value creation. Second, when they do buy private targets, they tend to use cash instead of equity, avoiding the creation of a valuable blockholder. Third, they are particularly active during times of high equity valuation, even though their own equity is not as highly valued as other bidders’ equity. Finally, they choose targets with low synergies, as shown by combined announcement returns and post-merger operating performance.
Keywords: Corporate Governance, Mergers, Entrenchment, Overvalued Equity, Overpayment
JEL Classification: G34, G32
Suggested Citation: Suggested Citation