Why Defer to Managers? A Strong-Form Efficiency Model

58 Pages Posted: 20 Sep 2005  

Richard E. Kihlstrom

University of Pennsylvania - Finance Department

Michael L. Wachter

University of Pennsylvania Law School - Institute for Law and Economics

Date Written: July 2005

Abstract

We compare the efficiency with which management discretion and shareholder choice regulate hostile tender offers. This is the first paper in a long running debate that rigorously compares these legal rules to analyze both the critical informational assumptions and the interplay of those assumptions with principles of financial market efficiency. A critical innovation of our model is its focus on an informed management's choice among alternative corporate policies under the protection of the business judgment rule, but where agency costs exist. We assume that corporate assets and reinvestment opportunities are efficiently priced by financial markets, but that markets never learn the value of foregone investments. In this case, shareholder choice may create an agency problem whereby managers forego positive net present value investments that increase the risk of a hostile bid. We are able to determine analytic conditions under which the expected cost of this agency problem exceeds that of the standard agency problem usually identified with management discretion.

Keywords: corporate takeovers, corporate governance, management discretion, shareholder choice, market efficiency

JEL Classification: G34

Suggested Citation

Kihlstrom, Richard E. and Wachter, Michael L., Why Defer to Managers? A Strong-Form Efficiency Model (July 2005). U of Penn, Inst for Law & Econ Research Paper 05-19. Available at SSRN: https://ssrn.com/abstract=803564 or http://dx.doi.org/10.2139/ssrn.803564

Richard E. Kihlstrom

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

Michael L. Wachter (Contact Author)

University of Pennsylvania Law School - Institute for Law and Economics ( email )

3501 Sansom Street
Philadelphia, PA 19104
United States
215-898-7852 (Phone)
215-573-2025 (Fax)

Paper statistics

Downloads
239
Rank
103,027
Abstract Views
1,858