Employee Inside Debt and Acquirer Returns

Abstract

Underfunded corporate pension plans create inside debtholders out of employees. This paper examines the governance role of employee inside debt in the form of corporate pension deficits in mergers and acquisitions. We find that acquiring firms with larger pension deficits realize higher announcement returns, particularly when employees play a more important role in firm operations, when firms have poorer external governance, and when employees have stronger incentive and capability to monitor managers. These acquirers also realize higher synergistic gains, pay lower premiums to targets, engage in fewer diversifying acquisitions, and are less likely to divest target firms’ assets or become takeover targets in the post-acquisition period. Further analyses show that acquirers with larger pension deficits experience greater improvement in labor productivity and operating performance after acquisitions. Taken together, our findings suggest that employee inside debt pressures managers to make value-enhancing investment decisions to protect employees’ claims on firm value.

Keywords: Pension Deficit, Inside Debt, Merger and Acquisition, Announcement Return, Monitoring by Employees

JEL Classification: G32, G34