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The takeover market’seffect on
managerial ownership: evidence
from hostile takeover susceptibility
Pattanaporn Chatjuthamard
Center of Excellence in Management Research for Corporate Governance and
Behavioral Finance, Sasin School of Management, Chulalongkorn University,
Bangkok, Thailand
Ploypailin Kijkasiwat
Faculty of Business Administration and Accountancy, Khon Kaen University,
Khon Kaen, Thailand
Pornsit Jiraporn
Great Valley School of Graduate Professional Studies,
Pennsylvania State University, Malvern, Pennsylvania, USA, and
Ali Uyar
Finance Department, Excelia Business School, La Rochelle, France
Abstract
Purpose –Capitalizing on a unique measure of takeover susceptibility principally based on the staggered
implementation of state laws, this study aims to explore the takeover market’s effect on managerial
ownership. The market for corporate control, often known as the takeover market, is an important
external governance mechanism, whereas managerial ownership is a vital internal governance instrument.
Managerial ownership brings into convergence the interests of shareholders andmanagers. The originality of
this study arises from the usage of state-level anti-takeover legislations as a measure which is beyond the
control of firms and plausibly exogenous to firm-specific characteristics.
Design/methodology/approach –In addition to the standard regression analysis, this study also
executes a variety of robustness checks to minimize endogeneity, i.e. propensity score matching, entropy
balancing, instrumental–variable analysis, Lewbel’s (2012) heteroscedastic identification and Oster’s (2019)
testing for coefficient stability.
Findings –Based on a large sample of US firms, the results show that more hostile takeover threats bring
about significantly lower managerial ownership. The results reinforce the prediction of the substitution
hypothesis. The disciplinary function of the takeover market reduces agency conflict to the point where
managerial ownership is less necessary as a governance mechanism. Specifically, a rise in takeover
susceptibility by onestandard deviation diminishes managerial ownership by 7.22%.
Originality/value –`To the best of the authors’knowledge, this study is the first to shed light on the impact of
the takeover market on managerial ownership using a novel measure mainly based on the staggered adoption of
state laws, which are plausibly exogenous to individual firms’characteristics. Consequently, unlike prior research,
this study is more likely to indicate a causal effect, rather than merely a correlation.
Keywords Hostile takeovers, Takeover vulnerability, Takeover susceptibility, Managerial ownership,
Corporate governance, Agency theory
Paper type Research paper
JEL classification –G32, G34
Takeover
market’seffect
Received 5 March2022
Revised 26 May 2022
21 August 2022
Accepted 9 October2022
Management Research Review
© Emerald Publishing Limited
2040-8269
DOI 10.1108/MRR-03-2022-0164
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/2040-8269.htm
1. Introduction
According to agency theory, the separation of ownership and control leads to agency
conflicts. Managerial ownership is crucially important, as it helps align the interests of
shareholders and managers (Fama and Jensen, 1983;Jensen and Meckling, 1976). Managers
who own a greater percentage of the firm’s equity are subject to the same motivations as
shareholders and so are less likely to make decisions that are damaging to shareholders. In
this regard, managerial ownership is considered a governance mechanism, as it helps
alleviate agency problems. Prior research has extensively investigated the role of
managerial ownership as a governance instrument (Morck et al.,1988;McConnell and
Servaes,1990, 1995;Kole, 1995). However, one area that has received scant attention in the
literature is how managerial ownership is influenced by the takeover market which is an
external governance mechanism. We address this important void in the literature.
Exploiting a distinctive measure of takeover vulnerability principally based on the
staggered adoption of state legislations, we examine how the discipline of the takeover
market influences managerial ownership. Thus, we aim to assess the substitution or
complementarity between internal (i.e. managerial ownership) and external (i.e. takeover
market) governance mechanisms. Our research question is whether there exists substitution
or complementarity between managerial ownership and the takeover market. The answer to
the research question is of particular importance to various stakeholders including
regulators, shareholders and creditors. They may find the empirical results useful and
integrate them into their decision-making.
The market for corporate control (i.e. takeover market) has long been viewed as one of the
most significant external governance mechanisms (Manne, 1965;Fama, 1980;Fama and
Jensen, 1983;Lel and Miller, 2015;Cain et al., 2017;Ongsakul et al.,2022;Ongsakul, et al.,
2020); Chatjuthamard et al.,2021). Not surprisingly, considerable research has been
conducted on the takeover market’sinfluence on a wide variety of corporate policies,
strategies and outcomes such as managerial preferences (Bertrand and Mullainathan, 2003),
firm risk (Low, 2009), capital structure (Garvey and Hanka, 1999), ownership structure
(Cheng et al.,2005), innovation efficiency (Ongsakul et al., 2022), executive risk-taking
incentives (Ongsakul et al., 2020) and board gender diversity (Chatjuthamard et al.,2021).
Undoubtedly, this is a substantial and critical area of research in the literature.
Managerial ownership has also generated an academic debate in the past literature, as it
is likely to influence firm decision-making and outcomes such as firm performance
(Himmelberg et al.,1999;Short and Keasey, 1999;Zhou, 2001;Benson and Davidson, 2009;
Florackis et al., 2009), accounting conservatism (Lafond and Roychowdhury, 2008), board
structure (Lasfer, 2006), earnings management (Yang et al., 2008), audit quality (Kane and
Velury, 2005) and executive compensation (Janakiraman et al.,2010). As seen from the cited
literature, most managerial ownership studies focus on firm outputs among which firm
performance is the dominant focus. Thus, unlike our study, they do not consider the
interaction of managerial ownership with exogenous factors.
Endogeneity is a serious challenge that has prevented researchers from making causal
inferences. It is exceedingly difficult to identify exogenous variations in takeover
susceptibility. To address this issue, Cain et al. (2017) rely on the staggered implementation
of anti-takeover state laws to generate exogenous changes in takeover vulnerability. State-
level legislations are obviously beyond the control of any one firm and are plausibly
exogenous to firm-specific characteristics. Exploiting this novel measure recently developed
by Cain et al. (2017),wefind that a stronger level of takeover vulnerability results in much
lower managerial ownership. In particular, onestandard deviation of an increase in takeover
MRR
vulnerability lowers managerial ownership by 7.22%. Therefore, the effect of hostile
takeover threats is not only statistically significant but is also economically substantive.
Our findings corroborate the prediction of the substitution hypothesis. Acting as an
important external governance instrument, the takeover market helps alleviate agency
conflicts to the point where managerial ownership is less necessary. Thus, firms with more
takeover exposure exhibit significantly lower managerial ownership. Notably, our findings
are consistent with those of Cain et al. (2017), who document that more takeover
vulnerability significantly raises firm value, implying that the takeover market plays a
crucial role in reducing agency problems. The discipline brought about by the takeover
market keeps opportunistic managers in line, diminishing the role of managerial ownership
in aligning the interests of stockholders and managers. In other words, the takeover market
substitutes for managerial ownership in controlling agency problems.
As we rely on plausibly exogenous changes in takeover vulnerability mainly based on
the staggered enactment of state laws, our findings likely imply a causal effect, rather than
just a correlation. We also execute a variety of robustness checks to further ensure that our
conclusion is not sullied by endogeneity, i.e. propensity score matching (PSM), entropy
balancing, instrumental–variable analysis, Lewbel’s (2012) heteroscedastic identification
and Oster’s (2019) method for testing coefficient stability. All the robustness checks strongly
validate the conclusion. Finally, we show that our results are robust even when we account
for internal governance by considering board characteristics. Moreover, we find that the
substitution effect between the takeover market and managerial ownership is significantly
less pronounced when the degree of board independence is high.
The results of our study extend the literature in several important ways. First, our
findings contribute to the body of knowledge in the corporate governance literature. Prior
research has established that the market for corporate control hasan effect on a wide variety
of corporate policies and outcomes (Bertrand and Mullainathan, 2003;Low, 2009;Garvey
and Hanka, 1999;Cheng et al., 2005;Ongsakul et al., 2020;Chatjuthamard et al., 2021;
Ongsakul et al., 2022). Hence, our study aims to advance current research on how internal
and external governance mechanisms interact, which may have implications for
compensation packages that typically include equity ownership for executives.
Second, several previous studies have investigated managerial ownership as a
governance mechanism. However, most prior studies focus on managerial ownership’s
effect on corporate outcomes such as firm performance (Morck et al., 1988;McConnell and
Servaes, 1990;Zhou, 2001;Benson and Davidson, 2009;Florackis et al.,2009), board
structure (Lasfer, 2006), earnings management (Yang et al.,2008), accounting conservatism
(Lafond and Roychowdhury (2008), audit quality (Kane and Velury, 2005) and executive
compensation (Janakiraman et al., 2010). Surprisingly, however, scant attention has been
given to how managerial ownership is affected by external governance.
Furthermore, we provide new evidence concerning the relationship between internal and
external governance using a novel measure. Prior research that uses indirect methods finds
inconsistent results on the interactions between external and internal governance
instruments (Mikkelson and Partch, 1997;Huson et al., 2001;Cremers and Nair, 2005;Gillan
et al.,2011;Guo et al.,2015). By using a distinctive measure of takeover susceptibility, which
is plausibly exogenous, we show that managerial ownership drops considerably in response
to an increase in hostile takeover threats, suggesting a substitution effect. This substitution
effect might guide firms in formulating managerial ownership structure contingent upon the
takeover market and not only on internal factors.
Finally, we contribute to an expanding corpus of research that uses the hostile
takeover index as an exogenous proxy for takeover susceptibility (Cain et al., 2017;
Takeover
market’seffect
Ongsakul et al.,2020;Chatjuthamard et al.,2021;Ongsakul et al.,2022;Chatjuthamard et al.,
2022). While this area of research is still in its infancy, it is an intriguing one that, given the
paucity of exogenous changes in takeover exposure, will most likely generate substantial
research in the future.
The paper is organized as follows. Section 2 of the paper reviews the relevant prior
literature and develops the hypotheses. Section 3 describes the sample selection and data,
followed by Section 4 reporting the results along with the robustness tests. Finally, Section 5
discusses the findings, suggests implicationsand outlines future research avenues.
2. Pertinent research and hypothesis development
2.1 Managerial ownership
The concept that managers’equity ownership helps align shareholders’and managers’
interests is widely established in the literature (Jensen and Meckling, 1976). The
convergence of interest hypothesis of Jensen and Meckling (1976) asserts that, as managerial
ownership in a corporation grows, the firm’s performance improves, since managers are less
likely to divert resources away from value maximization (Short and Keasey, 1999). This
notion is supported by the fact that most companies encourage their managers to own at
least some equity in the firm. Demsetz (1983) and Fama and Jensen (1983) argue, on the other
hand, that market discipline will compel managers to pursue value maximization at
extremely low levels of ownership. However, at some levels of equity ownership, managers’
consumption of perquisites, such as an attractive compensation, may offset the loss they
incur from the firm’s diminished value (Short and Keasey, 1999). Morck et al. (1988) believe
that high levels of management ownership may result in entrenchment, as external
shareholders struggle to exert control over such managers’conduct.
2.2 Corporate governance and the takeover market
The market for corporate control, frequently known as the takeover market, is a critical
external disciplinary mechanism for corporate governance according to the literature
(Manne, 1965;Fama, 1980;Fama and Jensen, 1983;Lel and Miller, 2015;Cain et al.,2017;
Ongsakul et al.,2022;Ongsakul et al.,2020;Chatjuthamard et al.,2021). Several previous
studies have used variations in particular takeover defenses or anti-takeover laws to assess
changes in takeover vulnerability (Karpoff and Malatesta, 1989;Schwert, 2000;Bertrand
and Mullainathan, 2003). Nonetheless, a major flaw in previous research in this field has
been its exclusive focus on a single or a limited selection of anti-takeover legislations (Cain
et al.,2017).
Taking into account plausibly exogenous factors to address the concerns noted in earlier
studies, Cain et al. (2017) construct a hostile takeover index based on 17 takeover legislations
enacted between 1965 and 2014. They demonstrate that more takeover protection results in
worse company value using this novel measure of takeover susceptibility, corroborating the
managerial entrenchment and agency costs arguments. Their findings are remarkable not
just because they represent a substantial step toward tackling endogeneity but also because
they encompass the whole range of state laws.
2.3 Hypothesis development
Based on the literature, two competing hypotheses can be advanced, i.e. the complementary
hypothesis and the substitution hypothesis implying that different governance mechanisms
complement or substitute for each other. While complementarity necessitates interactions,
interdependencies, alignment and mutual enhancement (Aguilera et al.,2008;Misangyi and
Acharya, 2014), substitution refers to a replacement of different mechanisms with each other
MRR
(Misangyi and Acharya, 2014). First, the complementary hypothesis argues that the
marginal effect of one governance mechanism is increased by another governance
mechanism on firm outcomes in a synergetic way (Oh et al., 2018). In this vein, for example,
Hoskisson et al. (2009) posit that monitoring and compensation mechanisms act as
complements rather than substitutes. Confirming this argument, Yoshikawa et al. (2014)
demonstrate that outside directors’monitoring ability is reinforced by the interaction of a
bundle of governance structures. Supporting this argument, Schepker and Oh (2013) find
that stronger governance mechanisms lead to the rescission of anti-takeover provisions
which insulate managers from the active takeover market. In this line of argument, the
disciplinary function of the takeover market reduces agency costs and thus helps promote
stronger internal corporate governance. Greater managerial ownership better aligns the
interests of shareholders and managers, hence leading to lower agency costs. According to
this view, firms exposed to higher hostile takeover threats are expected to have a greater
rate of managerial ownership. Thus, we develop the following hypothesis:
H1a. The hostile takeover market is positively associated with managerial ownership.
By contrast, the substitution hypothesis proposes that the marginal effect of one governance
mechanism is decreased by another governance mechanism on firm outcomes (Oh et al.,
2018). For example, a weaker incentive mechanism triggers a stronger monitoring
mechanism and vice versa (Tosi, 2008). According to this perspective, it is also argued that
adopting diverse governance mechanisms is costly and hence multiple mechanisms could be
unnecessary (Schepker and Oh, 2013). Supporting this perspective, Oh et al. (2018) find that
alternative monitoring functions and incentive mechanisms act as substitutes in spurring
CSR engagement; the existence of larger blockholding does not necessitate a higher
proportion of outside directors in promoting CSR, and higher executive ownership renders
long-term executive incentive unnecessary in stimulating greater CSR involvement. In line
with this perspective, it may be suggested that more hostile takeover threats impose
stronger discipline on self-interested managers, making internal governance less necessary.
In other words, a stronger takeover market substitutes for higher managerial ownership. As
agency conflicts are already reduced by the discipline of the takeover market, it is less
necessary to rely on managerial ownership to align the interests of managers and
shareholders. There is a substitution effect between the takeover market and managerial
ownership. Based on this view, we develop the following hypothesis:
H1b. The hostile takeover market is negatively associated with managerial ownership.
3. Sample selection and data description
3.1 Sample selection
We construct our sample as follows. We start with the sample of Cain et al. (2017). The
hostile takeover index is available on Stephen McKeown’s website (http://pages.uoregon.
edu/smckeon). Then, we merge the sample into COMPUSTAT to obtain firm-specific
characteristics. In order to get the data on board attributes, we merge the sample into the
Institutional Shareholder Services. Finally, the data on managerial ownership is from the
EXECUCOMP database. We define managerial ownership as the total percentage of equity
ownership held by the top-five executives because the database reports the data for the top-
five executives. Because we take advantage of the staggered passage of takeover-related
laws across various states in the US to generate an exogenous shock in takeover exposure,
our sample is comprised of US firms only. Our sample firms come from a total of 60
Takeover
market’seffect
industries, as classified by the first two digits of the standard industry classification (SIC)
codes. The largest industry groups in our sample are electronics, chemical-related products,
news media and industrial and commercial machinery. The sample firms are all publicly
listed in the USA and thus tend to be large firms. The final sample consists of 23,613
observations from 1996 to 2014. We start the sample in 1996 because the data on board
characteristics are available beginning in 1996. Our sample ends in 2014 because the data on
the hostile takeover index from Cain et al. (2017) is available until 2014.
3.2 Hostile takeover index
In accordance with previous research (Cain et al.,2017;Chatjuthamard et al., 2021;Ongsakul
et al.,2022;Chatjuthamard et al., 2022), we use the hostile takeover index to assess takeover
susceptibility. This metric has the considerable benefit of being based on variables that are
supposedly exogenous. The index is composed of three parts:
(1) legislative determinants (17 state takeover laws);
(2) macroeconomic determinants (capital liquidity); and
(3) a company-specific variable (firm age) that is not susceptible to firm choice.
A higher index score indicates that the firm is more exposed to a hostile takeover. This
measure is far less subject to endogeneity than any other previously used in the literature.
Cain et al. (2017) use logistic regression analysis to build a firm-level takeover
index. Cain et al. (2017) discuss the approach used to create the takeover index in
further detail. In recent research, the hostile takeover index has received considerable
adoption (Ongsakul et al.,2020;Chatjuthamard et al., 2021;Ongsakul et al., 2022;
Chatjuthamard et al., 2022).
3.3 Other variables
Numerous elements that may affect managerial ownership are included in the regression
analysis. We consider firm size (Ln of total assets), profitability (earnings before interest
and taxes/total assets), leverage (total debt/total assets), capital investments (capital
expenditures/total assets), intangible assets (R&D/total assets and advertising expense/
total assets), discretionary spending (selling, general, and administrative expense/total
assets), cash holdings (cash holdings/total assets), dividend payouts (total dividends/
total assets) and asset tangibility (fixed assets/total assets). Additionally, we incorporate
year, industry and state fixed effects to account for variations across time, industries and
states. The first two digits of the SIC code are used to classify industries. The variables’
descriptive statistics are shown in Table 1. A summary of the variable definitions is
displayed in the Appendix.
4. Results
4.1 Baseline results
Table 2 shows the regression results where the dependent variable is the percentage of
managerial ownership held by the top-five executives. The standard errors are clustered by
firm and state. The coefficients of the hostile takeover index are significantly negative in
both Model 1 and Model 2. A higher level of takeover susceptibility lowers managerial
ownership significantly. The evidence is in favor of the substitution hypothesis. As far as
economic significance is concerned, we estimate the economic magnitude of the effect as
follows. The coefficient of the takeover index in Model 2 is 4.771. The standard deviation
of the hostile takeover index is 0.098. Thus, a rise in takeover susceptibility by one standard
MRR
deviation decreases managerial ownership by 4.771 times 0.098, which is 0.468. As the
standard deviation of managerial ownership is 6.489, a drop by 0.468 represents a 7.22%
decline [1]. Thus, the result supports H1b concerning the negative association between the
hostile takeover market and managerial ownership.
Table 1.
Summary statistics
Mean SD 25th Median 75th
Managerial ownership
Managerial ownership (%) 3.237 6.489 0.000 0.593 2.700
Takeover susceptibility
Hostile takeover index 0.160 0.098 0.088 0.135 0.219
Firm-specific characteristics
Firm size 5763.119 25000.000 379.770 1038.025 3246.032
Leverage 0.215 0.204 0.031 0.191 0.327
Profitability 0.083 0.128 0.049 0.093 0.142
Capital investments 0.055 0.056 0.020 0.037 0.068
R&D intensity 0.039 0.076 0.000 0.004 0.049
Advertising intensity 0.012 0.028 0.000 0.000 0.009
Dividends 0.011 0.021 0.000 0.000 0.014
Asset tangibility 0.500 0.369 0.211 0.402 0.708
Discretionary spending 0.252 0.213 0.101 0.203 0.348
Cash Holdings 0.170 0.188 0.029 0.097 0.248
Notes: The hostile takeover index is constructed by Cain et al. (2017) with a higher value of the index
implying stronger takeover susceptibility. Managerial ownership is the total percentage of equity
ownership held by the top-five executives
Table 2.
Hostile takeover
market’s effect on
managerial
ownership
(1) (2)
Managerial ownership Managerial ownership
Hostile takeover index 9.061*** (7.842) 4.771*** (3.502)
Firm size 0.669*** (6.657)
Leverage 1.928*** (4.506)
Profitability 0.866 (1.172)
Capital investments 5.924** (2.530)
R&D intensity 6.261*** (4.048)
Advertising intensity 9.626 (1.628)
Dividends 3.468 (0.700)
Asset tangibility 0.500 (1.150)
Discretionary spending 0.161 (0.319)
Cash holdings 1.517* (1.823)
Constant 4.700*** (25.365) 8.884*** (10.701)
State fixed effects Yes Yes
Industry fixed effects Yes Yes
Year fixed effects Yes Yes
Observations 23,613 23,613
Adjusted R-squared 0.086 0.117
Notes: The hostile takeover index is constructed by Cain et al. (2017) with a higher value of the index implying
stronger takeover susceptibility. Managerial ownership is the total percentage of equity ownership held by the top-
five executives; Robust t-statistics in parentheses; ***p<0.01, **p<0.05, *p<0.1
Takeover
market’seffect
Notably, our results are consistent with those in Glendening et al. (2016). Using an
international sample, Glendening et al. (2016) report a marked decline in dividend payouts
after M&A laws raise takeover susceptibility. So, when M&A laws strengthen the takeover
market, it is less necessary for firms to rely on dividends to mitigate agency problems.
Dividends function as a governance mechanism by reducing the free cash flow that could
otherwise be exploited by opportunistic managers and by making the firms raise capital
more often in the capital markets and being subject to more scrutiny by external parties
(Grossman and Hart, 1980;DeAngelo et al., 2006). Their results imply that the takeover
market substitutes for dividends in reducing agency costs. Our results are similar as we
show that the takeover market substitutes for managerial ownership, which is an internal
governance instrument like dividends [2].
4.2 Propensity score matching
Although our findings are already much less prone to endogeneity as our measure of
takeover susceptibility is based mostly on the staggered enactment of state laws, we
nonetheless validate the results using PSM to further minimize endogeneity (Rosenbaum
and Rubin, 1983;Lennox et al., 2011). The sample is split into quartiles based on the hostile
takeover index. The treatment group consists of observations that fall inside the
distribution’s top quartile (highest takeover vulnerability). Then, based on nine firm
characteristics, we select the most comparable observation from the remainder of the sample
for each observation in the treatment group (i.e. using the nine control variables included in
the regression analysis). Except for their susceptibility to hostile takeovers, our treatment
and control firms are almost identical in every observable aspect.
To ensure the correctness of our matching, we conduct diagnostic testing. Table 3 Panel
A summarizes the findings. Model 1 specifies a logistic regression including a binary
dependent variable which is equal to one if the company is in the treatment group (most
vulnerable to a hostile takeover) and zero otherwise. Model 1 includes the entire sample (pre-
match). The result shows that the treatment firms differ considerably from the rest of the
sample in a variety of areas. In particular, the treatment firms are larger and less leveraged
and have less capital investments, invest less in R&D, pay larger dividends, hold more fixed
assets and hold less cash. We attempt to account for these material differences by using
PSM. Model 2 specifies a logistic regression based on the propensity-score matched sample
(post-match). Model 2 has no statistically significant coefficients. As a consequence, our
treatment and control firms have statistically similar observable properties. To the extent
that takeover vulnerability is irrelevant, the degree of management ownership in our
treatment and control firms should be similar.
Table 3 Panel B displays the regression result for the propensity-score matched sample.
The coefficient of the takeover index is significantly negative, showing that when takeover
susceptibility is higher, management shareholdings fall dramatically. The substitution
hypothesis is once again validated. Endogeneity is unlikely to play a role in our findings
because our results are consistent even after utilizing PSM.
4.3 Entropy balancing
To address endogeneity further, we employ a novel method known as entropy balancing to
more effectively minimize inequalities in observable characteristics across the treatment and
the control groups. This technique is gaining interest in the social sciences as a means of
addressing issues with standard PSM (McMullin and Schonberger, 2020;Hainmueller, 2012).
According to Gaver and Utke (2019), entropy balancing eliminates covariate imbalance and
boosts testing power because no observations are lost nor random matches created (Hossain
MRR
et al.,2021). This novel matching method has been widely used in recent research (McMullin
and Schonberger, 2020;Wilde, 2017;Neuenkirch and Tillmann, 2016;Chatjuthamard et al.,
2022;Chatjuthamard et al.,2021).
The following describes our method for entropy balancing. We choose companies in the
top quartile of takeover vulnerability as our treatment group. The rest of the sample is
known as the control group. Then, using entropy balancing, we verify that the mean,
skewness and variance of the observations in the two groups are comparable. The
Table 3.
Propensity score
matching
(1) (2)
Prematch treatment (high
takeover susceptibility)
Postmatch treatment (high
takeover susceptibility)
Panel A: Diagnostic testing
Firm size 0.261*** (11.937) 0.020 (0.789)
Leverage 0.479*** (3.301) 0.127 (0.683)
Profitability 0.077 (0.368) 0.233 (0.793)
Capital investments 3.537*** (6.696) 0.162 (0.226)
R&D intensity 1.006* (1.696) 1.019 (1.162)
Advertising intensity 1.301 (1.216) 1.698 (1.183)
Dividends 8.915*** (7.921) 1.750 (1.642)
Asset tangibility 0.465*** (5.272) 0.022 (0.197)
Discretionary spending 0.211 (1.186) 0.028 (0.130)
Cash holdings 0.963*** (4.888) 0.038 (0.148)
Constant 2.501*** (12.812) 0.170 (0.715)
State fixed effects Yes Yes
Industry fixed effects Yes Yes
Year fixed effects Yes Yes
Pseudo R-squared 0.142 0.003
Observations 23,710 11,846
Panel B: The effect of hostile takeover threats on managerial ownership
(1)
Managerial Ownership
Hostile takeover index 4.028*** (3.559)
Firm size 0.637*** (7.240)
Leverage 1.347** (2.310)
Profitability 1.645 (1.436)
Capital investments 4.192 (0.838)
R&D intensity 6.766** (2.201)
Advertising intensity 9.569* (1.785)
Dividends 5.191 (0.706)
Asset tangibility 0.208 (0.309)
Discretionary spending 1.371 (1.635)
Cash holdings 3.722*** (3.529)
Constant 8.466*** (10.450)
State fixed effects Yes
Industry fixed effects Yes
Year fixed effects Yes
Observations 11,737
R-squared 0.149
Notes: The hostile takeover index is constructed by Cain et al. (2017) with a higher value of the index
implying stronger takeover susceptibility. Managerial ownership is the total percentage of equity
ownership held by the top-five executives; Robust z-statistics in parentheses; Robust t-statistics in
parentheses; ***p<0.01, **p<0.05, *p<0.1
Takeover
market’seffect
regression results for the entropy-balanced sample are shown in Table 4. The coefficient of
the hostile takeover index remains negative and significant, confirming the prediction of the
substitution hypothesis once more.
4.4 Instrumental–variable analysis
Notably, our findings are unlikely to be tainted by endogeneity, as the hostile takeover index
is generated utilizing the staggered passage of state legislations, which are plausibly
exogenous to firm-specific factors (Cain et al., 2017). An instrumental variable (IV) analysis
is performed to further minimize endogeneity. To prevent reverse causality, we adopt the
value of the hostile index from each firm’s earliest year as our instrumental variable. The
assumption is that the index in the initial year could not have been determined by the degree
of managerial ownership in subsequent years, hence minimizing reverse causality.
Table 5 displays the IV results. Model 1 is the first-stage regression in which the dependent
variable is the takeover index. As expected, the coefficient of the takeover index is significantly
positive in the earliest year. Model 2 is the second-stage regression using managerial ownership
as the dependent variable. The coefficient of the takeover index instrumented from the first
stageisnegativeandsignificant, confirming the substitution hypothesis once more.
One objection that may be levied at this technique is that the takeover index is sticky,
changing only slowly over time. As a result, the value in the initial year may be fairly comparable
to the value in any subsequent year. To address this concern, we calculate the standard deviation
of the takeover index for each firm over time. Then, for all observations with a standard deviation
larger than the median, we perform a regression analysis. In essence, we focus primarily on those
with a more volatile takeover index over time. Model 3 shows the regression result for the
subsample with high variance in the takeover index. Again, the coefficient of the takeover index
Table 4.
Entropy balancing
(1)
Managerial ownership
Hostile takeover index 3.219*** (2.877)
Firm size 0.629*** (8.831)
Leverage 1.850*** (3.252)
Profitability 0.270 (0.281)
Capital investments 5.496 (1.526)
R&D intensity 11.272*** (3.798)
Advertising intensity 7.933 (1.085)
Dividends 2.736 (0.436)
Asset tangibility 0.259 (0.712)
Discretionary spending 0.146 (0.236)
Cash holdings 2.882*** (2.963)
Constant 8.090*** (12.385)
State fixed effects Yes
Industry fixed effects Yes
Year fixed effects Yes
Observations 23,613
Adjusted R-squared 0.134
Notes: The hostile takeover index is constructed by Cain et al. (2017) with a higher value of the index
implying stronger takeover susceptibility. Managerial ownership is the total percentage of equity
ownership held by the top-five executives; Robust t-statistics in parentheses; ***p<0.01, **p<0.05,
*p<0.1
MRR
remains significantly negative. So, even when we focus on those observations where the takeover
index changes relatively quickly over time, the result is still similar.
Additionally, we employ a distinct instrumental variable based on geography to
increase robustness. We use the average hostile takeover index of all firms within a
three-digit zip code in particular. Companies in close proximity are often subject to the
same economic circumstances. The location of the firm’s headquarters is frequently
determined in the distant past, during the early stages of the firm’s existence, and it
very seldom changes throughout time (Pirinsky and Wang, 2006). As a result, the
headquarters location is probably exogenous to contemporaneous firm characteristics.
Furthermore, zip codes are given to optimize mail delivery efficiency and are not
supposed to be associated with corporate policies or outcomes, making zip code
assignments plausibly exogenous. This strategy, which is based on geographic
identification, has lately gained traction in the literature (Jiraporn et al., 2014;
Chintrakarn et al.,2017;Chintrakarn et al.,2015).
The results are shown in Table 6.Model1isthefirst-stage regression with the
takeover index as the dependent variable. To prevent any mechanical relationship, we
include only those zip codes with at least five firms. The coefficient of the average
takeover index in the same three-digit zip code is significantly positive, as predicted.
Model 2 is the second-stage regression where managerial ownership is the dependent
variable. The coefficient of the takeover index instrumented from the first stage is
significantly negative, once again reinforcing the prediction of the substitution
hypothesis. All of the IV results are consistent, implying that endogeneity is unlikely
and that our results probably reflect a causal influence, rather than merely an
association.
Table 5.
Instrumental–
variable analysis
based on the earliest
value of the takeover
index
(1) (2) (3)
Full sample Full sample High variance sample
First-stage Second-stage Second-stage
Hostile takeover index Managerial ownership Managerial ownership
Hostile takeover index (earliest) 0.770*** (45.663)
Hostile takeover index
(instrumented) 4.542*** (8.019) 2.603*** (3.451)
Firm size 0.003*** (4.560) 0.674*** (19.990) 0.609*** (13.204)
Leverage 0.009*** (2.906) 1.923*** (8.377) 1.827*** (5.827)
Profitability 0.004 (1.189) 0.877** (2.299) 0.469 (0.927)
Capital investments 0.074*** (6.795) 5.984*** (5.821) 4.779*** (3.378)
R&D intensity 0.011 (1.190) 6.243*** (8.121) 3.960*** (3.949)
Advertising intensity 0.021 (0.891) 9.638*** (5.646) 12.718*** (5.506)
Dividends 0.073** (2.355) 3.317 (1.532) 8.583*** (2.742)
Asset Tangibility 0.014*** (4.640) 0.510*** (3.006) 0.463** (2.048)
Discretionary Spending 0.006 (1.597) 0.169 (0.645) 1.391*** (3.784)
Cash Holdings 0.005 (1.327) 1.525*** (5.128) 2.796*** (7.254)
Constant 0.009 (0.578) 14.591*** (13.210) 14.685*** (13.031)
Observations 23,613 23,613 11,839
Adjusted R-squared 0.835 0.117 0.152
Notes: The hostile takeover index is constructed by Cain et al. (2017) with a higher value of the index
implying stronger takeover susceptibility. Managerial ownership is the total percentage of equity
ownership held by the top-five executives; Robust t-statistics in parentheses; ***p<0.01, **p<0.05,
*p<0.1
Takeover
market’seffect
4.5 Lewbel’s (2021) heteroscedastic identification
In addition, we perform a regression analysis using Lewbel’s (2012) heteroscedastic
identification to increase robustness. This method does not rely on the exclusion condition
and does not necessitate the use of an external instrumental variable. What this strategy
does is make use of the heteroscedasticity of the variables and is effective in situations
where it is difficult to find an acceptable instrumental variable. This method is discussed in
more depth in Lewbel (2012).Table 7 shows the regression results using this estimation
approach. Again, the takeover index carries a negative and significant coefficient.
4.6. Oster’s (2019) technique for testing coefficient stability
Further, to ensure that our findings are not compromised by the omitted-variable bias, we
apply Oster’s(2019)insight and calculate the magnitude of the effect of the unobservables
necessary to outweigh the effect of the observables, hence rendering our conclusions less
valid (Chintrakarn et al.,2020). By applying Oster’s (2019) technique to our regressions in
Table 2,wefind that the unobservables’effect would have to be greater than 1.43–5.93 times
that of the observables in order for our results to be doubtful. By and large, the literature
deems the results robust when the ratio exceeds one. As a result, our results do not appear to
be driven by the omitted-variable bias. Oster’s(2019)method for assessing coefficient
stability is explained in further detail in Oster (2019).
4.7 Controlling for internal governance and exploring an interaction effect
For further robustness, we control for internal governance by accounting for board
characteristics. We did not include board characteristics in our earlier tests because the data
Table 6.
Instrumental–
variable based on
geography
(1) (2)
First stage Second stage
Hostile takeover index Managerial ownership
Hostile takeover index (Average 3-digit Zip Code) 0.750*** (30.036)
Hostile takeover index (Instrumented) 9.908*** (3.938)
Firm size 0.020*** (40.067) 0.503*** (7.783)
Leverage 0.012*** (3.139) 1.667*** (5.974)
Profitability 0.031*** (5.301) 1.647*** (3.680)
Capital investments 0.227*** (13.872) 2.148 (1.547)
R&D intensity 0.042*** (3.539) 5.312*** (5.887)
Advertising intensity 0.005 (0.171) 0.121 (0.059)
Dividends 0.547*** (16.161) 5.914** (2.020)
Asset tangibility 0.035*** (13.020) 0.035 (0.155)
Discretionary spending 0.025*** (5.988) 0.596* (1.831)
Cash holdings 0.024*** (5.134) 1.481*** (4.130)
Constant 0.085** (2.383) 18.837*** (7.047)
State fixed effects Yes Yes
Industry fixed effects Yes Yes
Year fixed effects Yes Yes
Observations 15,468 15,468
Adjusted R-squared 0.352 0.111
Notes: The hostile takeover index is constructed by Cain et al. (2017) with a higher value of the index
implying stronger takeover susceptibility. Managerial ownership is the total percentage of equity
ownership held by the top-five executives; t-statistics in parentheses; ***p<0.01, **p<0.05, *p<0.1
MRR
for board characteristics are available only for a subsample of firms. Specifically, the data on
board attributes are available for only about 60% of the observations. So, we include them
here as a robustness check instead. We include three important board attributes that have
been frequently investigated in the literature, i.e. board independence (% independent
directors), the board size and board gender diversity (% female directors). In general, it has
been documented in the literature that boards that are more independent, smaller and more
gender-diverse tend to be more effective (Rosenstein and Wyatt, 1990;Cotter et al.,1997;
Nguyen and Nielsen, 2010;Jenwittayaroje and Jiraporn, 2019;Yermack, 1996;Adams and
Ferreira, 2009;Arun et al., 2015;Campbell and Mínguez-Vera, 2008).
The regression results are displayed in Table 8. Model 1 includes three board
characteristics as control variables. Importantly, the coefficient of the takeover index
remains significantly negative. So, even after controlling for internal governance, the effect
of the takeover market remains robust. To gain further insights, we explore a possible
interaction effect between board independence and the takeover market. We construct an
interaction term between board independence and the hostile takeover index. The coefficient
of this interaction variable captures the takeover market’s effect on managerial ownership at
different levels of board independence. The regression result is in Model 2. The coefficient of
the interaction term is significantly positive, implying that the takeover market reduces
managerial ownership to a lesser extent when board independence is stronger. The
substitution effectis less pronounced when agency problems are less severe.
5. Discussion and conclusion
Agency conflicts arise as a result of the separation of ownership and control, according to
agency theory. Managerial ownership is critical because it enables shareholders and
managers to align their interests (Fama and Jensen, 1983;Jensen and Meckling, 1976). In this
aspect, managerial ownership is seen as a governance mechanism since it aids in the
Table 7.
Lewbel’s (2012)
Heteroscedastic
identification
(1)
Managerial ownership
Hostile takeover index 2.292*** (2.965)
Firm size 0.725*** (20.274)
Leverage 1.874*** (8.148)
Profitability 0.982** (2.568)
Capital investments 6.573*** (6.334)
R&D intensity 6.069*** (7.879)
Advertising intensity 9.750*** (5.708)
Dividends 1.839 (0.838)
Asset tangibility 0.602*** (3.520)
Discretionary spending 0.254 (0.962)
Cash holdings 1.598*** (5.362)
Constant 14.550*** (13.166)
State fixed effects Yes
Industry fixed effects Yes
Year fixed effects Yes
Observations 23,613
Adjusted R-squared 0.116
Notes: The hostile takeover index is constructed by Cain et al. (2017) with a higher value of the index
implying stronger takeover susceptibility. Managerial ownership is the total percentage of equity
ownership held by the top-five executives; z-statistics in parentheses; ***p<0.01, **p<0.05, *p<0.1
Takeover
market’seffect
resolution of agency issues. Despite the existence of so much research on managerial
ownership, how managerial ownership is shaped by external corporate governance has
garnered sparse attention. We fill this void in the literature by exploring how the takeover
market, which is a crucial external governance mechanism, influences managerial ownership.
Endogeneity makes it notoriously difficult to investigate the takeover market’s effect on
managerial ownership. We address this issue by utilizing a unique measure of takeover
susceptibility principally based on the staggered passage of state laws, which are plausibly
exogenous to an individual firm’s characteristics. Our results show that a stronger level of
takeover vulnerability leads to significantly less managerial ownership, consistent with the
prediction of the substitution hypothesis. The disciplinary function of the takeover market
helps alleviate agency conflicts, thereby lessening the need for managerial ownership as a
governance mechanism. A variety of robustness checks are executed, i.e. PSM, entropy
balancing, instrumental–variable analysis, Lewbel’s (2012) heteroscedastic identification
and Oster’s (2019) testing for coefficient stability. The conclusion is strongly reinforced by
all the robustness checks.
Hence, based on the two competing perspectives of complementary and substitution
hypotheses, we provide evidence for the substitution hypothesis implying that an active
takeover market substitutes for managerial ownership, which is an internal governance
mechanism. While the findings support the notion that the external governance mechanism
replaces the internal governance mechanism (Misangyi and Acharya, 2014), it rejects the
two governance mechanisms’interactions, interdependencies, alignment and mutual
enhancement (Aguilera et al., 2008;Misangyi and Acharya, 2014). Although this conclusion
Table 8.
Controlling for
internal governance
and investigating an
interaction effect
(1) (2)
Managerial ownership Managerial ownership
(%) Independent directors Hostile takeover index 0.184** (2.531)
Hostile takeover index 4.742*** (3.352) 18.431*** (3.117)
(%) Independent directors 0.097*** (12.627) 0.127*** (9.925)
Ln (Board size) 1.968*** (2.873) 1.941*** (2.853)
(%) Female directors 0.011 (0.721) 0.012 (0.780)
Firm size 0.233** (2.017) 0.241** (2.102)
Leverage 2.735*** (5.555) 2.770*** (5.537)
Profitability 1.247 (1.338) 1.250 (1.341)
Capital investments 4.769 (1.633) 4.628 (1.585)
R&D intensity 6.869*** (3.270) 7.152*** (3.454)
Advertising intensity 14.536** (2.179) 14.345** (2.158)
Dividends 6.258 (0.909) 5.981 (0.862)
Asset tangibility 0.211 (0.466) 0.280 (0.614)
Discretionary spending 1.222 (1.272) 1.290 (1.345)
Cash holdings 1.237 (1.291) 1.294 (1.345)
Constant 16.720*** (10.117) 18.929*** (11.046)
State fixed effects Yes Yes
Industry fixed effects Yes Yes
Year fixed effects Yes Yes
Observations 14,206 14,206
Adjusted R-squared 0.205 0.207
Notes: The hostile takeover index is constructed by Cain et al. (2017) with a higher value of the index
implying stronger takeover susceptibility. Managerial ownership is the total percentage of equity
ownership held by the top-five executives; Robust t-statistics in parentheses; ***p<0.01, **p<0.05,
*p<0.1
MRR
is contradictory to the findings of some studies supporting complementary hypothesis
(Schepker and Oh, 2013;Yoshikawa et al., 2014), it is in line with those in several studies
(Oh et al., 2018;Ruiz-Barbadillo and Martínez-Ferrero, 2020) which find that alternative
monitoring mechanisms function as substitutes in spurring CSR engagement. The evidence
for the substitution hypothesis could be due to the fact that adopting diverse governance
mechanisms may be costly or unnecessary (Schepker and Oh, 2013).
Our findings have several implications of practical value. First, shareholders benefit
from our findings as they design compensation packages that typically include equity
ownership for executives. They should take into account the effect of the market for
corporate control as we show that it is one of the most crucial determinants of managerial
ownership. Second, regulators who contemplate regulations on mergers and acquisitions
also learn from our findings. As they consider regulations that facilitate or impede corporate
takeovers, they should keep in mind the consequences of such regulations on internal
governance for we demonstrate that external governance has a palpable effect on internal
governance. Third, shareholder activists who campaign to strengthen internal governance
should find our results useful. It is clear that the interactions between external and internal
governance instruments cannot be ignored. Furthermore, our study provides evidence that
firm practices are affected by the external environment which has implications for both
researchers and practitioners. Researchers should integrate external and institutional
factors into research design as those factors may have direct (i.e. regulations) or indirect
effects through stakeholders. Similarly, practitioners are advised to consider the
institutional external environment’s effect on firm governance and ownership structures as
they do not operate in isolation from the market forces.
Our sample period is limited by the availability of the data provided by Cain et al. (2017).
However, there have been far fewer state laws related to takeovers since 2014 than there
were in our sample period. So, we exploit the variations generated by most of the takeover-
related state laws in the past twenty years, while acknowledging that one of the possible
weaknesses of our study is the fact that our sample ends in 2014. Our study provides
insights into the complementary and substitution relationships of an internal and an
external governance mechanism. Even after combining our results/evidence with the
findings of prior studies, there is still room for further exploration of the topic. In this
respect, future studies could deepen the investigation by focusing on other dimensions of
internal and external governance mechanisms and their interactions. While it is important to
explore whether they complement or substitute for each other, it would be also insightful to
examine how different governance mechanisms alter firm decision-making and outcomes
such as financial and non-financial performance, accountability and transparency or
financial reporting quality for example. While designing future studies, consideration of
internal and external factors’interactions as well as internal factors’interdependencies
among themselves could reveal additional implications.
Notes
1. It may be suggested that firm fixed effects should be included as they help control for time-
invariant firm-specific characteristics that may be unobservable. Although that is generally true,
afixed-effects may not be appropriate in our context as our variables of interest tend to change
only slowly over time. To show that this is the case, we calculate the standard deviations of both
the takeover index and managerial ownership and find that the cross-sectional variations in both
variables are much larger than the intertemporal variations. For instance, the cross-sectional
variation of the hostile takeover index is more than three times more than the variation over time.
Takeover
market’seffect
2. It could be argued that the direction of causality might be reversed, i.e. managerial ownership
might affect the probability of the firm being acquired. While that is true, it would be exceedingly
difficult to test that hypothesis due to a lack of exogenous changes in managerial ownership,
which is notoriously endogenous. Rather, our research design relies on exogenous changes in
takeover susceptibility, which allows us to explore the takeover market’seffect on managerial
ownership.
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Takeover
market’seffect
Appendix
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Ploypailin Kijkasiwat can be contacted at: ploypailin@kku.ac.th
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Table A1.
Variable definitions
Variable Definition
Managerial Ownership
Managerial Ownership (%) The total percentage of equity ownership
held by the top-five executives
Takeover Susceptibility
Hostile Takeover Index The index developed by Cain et al. (2017)
A higher index value indicates higher takeover susceptibility
Firm-specific Attributes
Firm Size Natural logarithm of total assets
Leverage Total debt/total assets
Profitability EBIT/total assets
Capital Investments Capital expenditures/total assets
R&D Intensity R&D expense/total assets
Advertising Intensity Advertising expense/total assets
Dividends Dividends/total assets
Asset Tangibility Fixed Assets/total assets
Discretionary Spending SG&A expense/total assets
Cash Holdings Cash Holdings/total assets
MRR
