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The Sources of Value Destruction in Acquisitions by Entrenched Managers

53 Pages Posted: 21 Oct 2010 Last revised: 17 Oct 2011

Ronan Powell

University College Dublin (UCD) - Michael Smurfit Graduate School of Business

Jarrad Harford

University of Washington

Mark Humphery-Jenner

UNSW Business School; Financial Research Network (FIRN)

Date Written: October 20, 2010

Abstract

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

Powell, Ronan and Harford, Jarrad and Humphery-Jenner, Mark, The Sources of Value Destruction in Acquisitions by Entrenched Managers (October 20, 2010). Paris December 2010 Finance Meeting EUROFIDAI - AFFI. Available at SSRN: https://ssrn.com/abstract=1695058

Ronan G. Powell (Contact Author)

University College Dublin (UCD) - Michael Smurfit Graduate School of Business ( email )

Blackrock, Co. Dublin
Ireland

Jarrad Harford

University of Washington ( email )

Box 353226
Seattle, WA 98195-3226
United States
206-543-4796 (Phone)
206-543-7472 (Fax)

HOME PAGE: http://faculty.washington.edu/jarrad/

Mark Humphery-Jenner

UNSW Business School ( email )

Sydney, NSW 2052
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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