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A test of the free cash flow hypothesis: The case of bidder returns
Abstract
We develop a measure of free cash flow using Tobin's q to distinguish between firms that have good investment opportunities and those that do not. In a sample of successful tender offers, bidder returns are significantly negatively related to cash flow for low q bidders but not for high q bidders; further, the relation between cash flow and bidder returns differs significantly for low q and high q bidders. This result holds for several cash flow measures suggested in the literature and also in multivariate regressions controlling for bidder and contest-specific characteristics.
... Second, we control for acquirer firm characteristics that potentially influence acquisition returns, including CSR performance (Hussain and Shams, 2022), leverage (Lang et al., 1991), firm size (Moeller and Schlingemann, 2004; Tunyi, 2019), Tobin's q (Lang et al., 1991), profitability (Tunyi, 2021), book to market (Masulis et al., 2007), sales growth (Tunyi, 2021), liquidity (Cornett et al., 2011), cash flow (Martynova and Renneboog, 2008), and bidder industry. The underlying reasons for the inclusion of these control variables are as follows: ...
... Second, we control for acquirer firm characteristics that potentially influence acquisition returns, including CSR performance (Hussain and Shams, 2022), leverage (Lang et al., 1991), firm size (Moeller and Schlingemann, 2004; Tunyi, 2019), Tobin's q (Lang et al., 1991), profitability (Tunyi, 2021), book to market (Masulis et al., 2007), sales growth (Tunyi, 2021), liquidity (Cornett et al., 2011), cash flow (Martynova and Renneboog, 2008), and bidder industry. The underlying reasons for the inclusion of these control variables are as follows: ...
... Prior research suggests that bidders with better CSR practices earn higher returns because they make value-enhancing deals, and the stock market positively reacts to such deals (Deng et al., 2013). A high level of leverage limits managerial discretion (Lang et al., 1991), provides incentives for managers to enhance organizational performance (Gilson, 1990) and positively affects bidder returns (Wang and Xie, 2009). The overvalued firms (captured by high values of Tobin's q) can acquire less overvalued targets using their stock as a cheap currency (Danbolt et al., 2016;Dong et al., 2006). ...
Drawing from the resource-based view (RBV), we examine the effect of environmental innovation on mergers and acquisitions (M&As) announcement returns. Using an international sample of M&As for the period 2003 to 2021 and an event study methodology , we document that acquirers with higher environmental innovation-innovative acquirers-earn average deal announcement abnormal returns that are 0.10 to 0.50 percentage points higher than those earned by their non-innovative counterparts. These results are consistent across three important forms of environmental innovation (i.e., product, process and organizational innovation) and are partly explained by the transfer of environmental innovation from the acquirer to the target. We further find that environmentally innovative acquirers are more likely to engage in majority control and cross-border acquisitions, thus emphasizing the transfer effect. Overall, we contribute to RBV by providing evidence that environmental innovation is a distinctive resource or dynamic capability that is transferable from bidders to targets in the takeover market.
... The decision to hold cash, like other corporate choices, is guided by a marginal benefit-marginal cost analysis (Saunders et al. 2021). However, some previous studies suggest that a firm's cash holding decisions may deviate from the optimal level suggested by the marginal benefit-marginal cost approach (Jensen 1986;Lang et al. 1991). Given the importance of liquid asset management in corporate finance, it is unsurprising that numerous studies have investigated the determinants of corporate cash holdings, aiming to identify factors that could significantly influence a firm's motivation to maintain a certain amount of cash, as well as the value implications of the size of corporate cash reserves (Opler et al. 1999;Han and Qiu 2007;Acharya et al. 2012;Harford et al. 2014;Marwick et al. 2020). ...
... Jensen (1986) develops this idea and proposes the agency costs of free cash flow hypothesis. This hypothesis suggests that when managers possess excess cash beyond what is required for funding positive NPV projects (i.e., free cash flow), they may have an incentive to squander it on unprofitable investments like acquisitions which increases their private benefits (Lang et al. 1991). Furthermore, ample free cash flow may reduce the pressure on management to achieve specific performance goals, thereby also exacerbating the managerial moral hazard problem 3 . ...
... Furthermore, ample free cash flow may reduce the pressure on management to achieve specific performance goals, thereby also exacerbating the managerial moral hazard problem 3 . Several prior studies have supported the free cash flow hypothesis by reporting empirical findings that confirm a negative relationship between the size of free cash flow, when interacting with CEO moral hazard incentives, and firm value (Lang et al. 1996;Lang et al. 1991). Among various corporate governance mechanisms, outside directors, who are independent of CEO influence and possess a stronger incentive to monitor and, if necessary, discipline the CEO, tend to enhance the value contributions of corporate cash (Hsu et al. 2015). ...
Our study investigates how CEO-friendly boards influence the value and utilization of cash resources. In this paper, we analyze two conflicting views on CEO-friendly boards and their impact on corporate cash holdings: one view posits that such boards might be too lenient, fostering managerial moral hazard problem, while the other contends that they encourage CEOs to share information, despite CEOs knowing that better-informed boards could enforce stricter oversight. By measuring board friendliness through CEO-board social ties, we find that firms with a friendly board tend to maintain lower cash reserves but their excess cash is valued higher by the market compared to firms without such a board. Moreover, these boards deploy excess cash in ways that significantly enhance firm value. The results remain robust even after controlling for various governance variables and CEO characteristics. Our findings offer crucial insights for corporate practitioners and policymakers, highlighting the importance of appointing and retaining CEO-friendly directors to foster effective information exchange, especially in firms with substantial CEO-board information asymmetry in capital budgeting.
... Finally, section 5 discusses the implications and offers conclusions. Langetieg (1978) 1950-69 149 NS Lang and al. (1991) 1968-86 101 NS Frank et al. (1991 1975-84 399 S Charlety- Lepers and Sassenou (1994) 1985-88 80 NS Maquieira and al. (1998) 1963-96 55 S Fuller and al. (2002 1990-00 456 S Bradley and Sundaram (2004) 1990-00 12476 NS Masulis and al. (2005) 1990-03 3333 S Walters and al. (2007) 1997-01 100 NS Campa and Hernando (2008) 1998-02 244 S Sbai (2010) 1998-03 48 S Sbai (2013) 1996-2010 74 S Asquith and al. (1983) 1963-79 211 S Dumontier and Humbert (1996) 1977-92 47 NS Maquieira and al. (1998 1963-96 47 S Bessière (1999) 1991-97 41 S Eckbo and Thorburn (2000) 1964-83 1846 NS Pécherot (2000) 1977-93 80 NS Phèlizon (2001) 1991-97 49 S Kohers and Kohers (2001) 1987-96 3268 S Moeller and al. (2004) 1980-01 12023 S Hamza (2007) 1997-05 58 S Masulis and al. (2007) 1990-03 3333 S Ben Amar and al. (2007) 1998-02 273 S Dutta and Jog (2009) 1993-2002 1300 S ...
... Prior studies find that an acquirer's Tobin's q has an ambiguous effect on CAR. Lang and al. (1991) and Servaes (1991) document a positive relation with the acquirer's Tobin's q, respectively, while Moeller and al. (2004) find a negative relation in a comprehensive sample of acquisitions. ...
... Jensen (1986) free cash flow hypothesis argues that managers realize large personal gains from empire building and predicts that firm with abundant cash flows but few profitable investment opportunities are more likely to make value-destroying acquisitions than to return the excess cash flows to shareholders. Lang and al. (1991) test this hypothesis and report supportive evidence. Morck and al. (1990) identify several types of acquisitions (including diversifying acquisitions and acquisitions of high growth targets) that can yield substantial benefits to managers, while at the same time hurting shareholders. ...
This paper analyse bidder short-term returns of 86 takeovers bids that occur between 1997 and 2002 on the French market. Furthermore, the determinants of this performance are examined to improve understanding of the sources of value creation or destruction arising from M&A. The event study methodology is used to estimate bidder value creation. Two findings are shown in this study. First, we find strong evidence that the announcement of a takeover bid destructed of value for the bidder. Second, these results show that the relative size of the target and the announcement period transaction is associated with value destruction for the bidder.
... As a result, businesses are equipped to take advantage of available investment opportunities and address underinvestment problems. The agency view, on the other hand, contends that managers may misuse the free cash flows, leading to overinvestment (Chen et al., 2014), which is the main cause of investment inefficiency (Lang et al., 1991). They might act out of self-interest and select projects to maximize their own welfare (Jensen & Meckling, 1976). ...
... Furthermore, a predominant cause of investment inefficiency is agency problems, as managers may end up over-investing available free cash flows (Lang et al., 1991). Agency problems are caused by a misalignment of management's and shareholders' interests, which are exacerbated by the availability of free cash flows since managers may select projects for personal gains rather than what is best for the shareholders (Jensen & Meckling, 1976). ...
Driven by the dynamic corporate social responsibility (CSR) environment, which is encouraging movement from self-regulation to co-regulation, this study empirically investigates the impact of CSR on the efficiency of capital investments of firms in India, given its remarkable legislation that mandates firms surpassing a threshold to invest 2 per cent of their profits in CSR activities. The study is based on firms listed on NSE 500 from the year 2008 to 2019, and the results suggest that CSR significantly improves investment efficiency in the post-mandate regime. There exists an optimal CSR level that instigates an inverse U-shaped relationship. We also investigate the impact of CSR on the speed of adjustment of capital investments towards the target in case of deviations. High-CSR firms are found to adjust swiftly to their targets since such firms tend to deviate less and incur low adjustment costs. Only the governance dimension of CSR seems to affect the firms’ speed of adjustment in the current context. The positive association between CSR and adjustment speed is pronounced only in the post-mandate period. Also, CSR seems to affect the speed of adjustment only when firms are operating above the target.
... The independent variables we use in our analysis are: . This is a proxy for Tobin's Q and has been used by Jung et al. (1996) and Lang et al. (1991), among others. Low Q Firm: We define a firm as a Low Q if the its Tobin's Q is in the lowest quartile of the sample. ...
This study examines the role of growth opportunities on stock buybacks and provides evidence on the importance of signaling and agency theories in explaining stock buybacks. Both theories are required to fully explain stock buybacks. As per the signaling theory, we find that the announcement period returns are positive for stock buybacks, which indicates that the buyback firms’ stock is undervalued. Furthermore, consistent with agency theory, we also find that the announcement period returns are higher for firms with low growth opportunities and high free cash flow. We also examine buyback firms' long-run stock price performance for 12 months, 24 months, and 36 months following the buyback. We use the Fama–French five-factor model to study the long-run stock performance of buyback firms because of its better explanatory power than the three-factor model. Low growth-high free cash flow firms tend to outperform their benchmark portfolios during this period. Recent regulations such as the Stock Buyback Tax can discourage low growth firms from conducting stock buybacks, which could increase agency costs.
... This ratio is used second and is the positive moderating variable between open innovation and SRI. The bidder's abnormal return is negatively related to firms' cash flow with poor investment opportunities and unrelated to firms' cash flow with good investment opportunities (Lang et al., 1991). However, the sales growth for firms with FCF is less profitable than the growth for firms without FCF (Brush et al., 2000). ...
The study aims to explore how to measure firms' open innovation from financial statements. So, our research question is as follows: How can we determine firms' open innovation signals directly or indirectly from financial statements? This study used data from the US financial statements and patent registration database from 2016 to 2018 to answer this research question. Three manifest signals of open innovation in financial data were found. First, subsidiary or related firm investment in financial data may have a negative relationship with open innovation because open innovation (i.e., the co-application of patents) could decrease subsidiary or related firm investment. But there are differences between the top and bottom twenty firms. Second, internal R&D investment (I R&D) in financial data may have a positive relationship with open innovation because I R&D could trigger inward open innovation. If I R&D combines with an open innovation strategy, it increases the size of subsidiary or related firm investment as a kind of inward open innovation. Third, free cash flow (FCF) in financial data may have a positive relationship with open innovation because high FCF could support outward open innovation.
... Despite the event window selected, the aggregate results indicate little returns for the shareholders of the acquiring company. Studies conducted in the UK and the US show either no discernible difference between acquirer returns or noticeably negative acquirer returns surrounding the bid announcement (Lang et al., 1991;Walker, 2000). Based on a sample of large international acquisitions made by UK companies between 1985 and 1994, Gregory and Mc Corriston (2005) suggest that regardless of the acquisition's location, short-run returns are insignificantly different from zero. ...
... Despite the event window selected, the aggregate results indicate little returns for the shareholders of the acquiring company. Studies conducted in the UK and the US show either no discernible difference between acquirer returns or noticeably negative acquirer returns surrounding the bid announcement (Lang et al., 1991;Walker, 2000). Based on a sample of large international acquisitions made by UK companies between 1985 and 1994, Gregory and Mc Corriston (2005) suggest that Value of the Acquiring Company and the Success of M&A Transaction in the Automotive Sector 704 regardless of the acquisition's location, short-run returns are insignificantly different from zero. ...
... ROE was included to control for the influence of profitability, and SG was incorporated due to its potential effect on firm value. Companies with a higher ratio of cash included in earnings are generally considered to have higherquality earnings; hence, the operating cash flow ratio (CFO) was also included [36,37]. A higher ownership stake (Ownerrate) by the largest controlling shareholder can expedite major investment decisions, such as those related to facility investments, and enhance firm value. ...
This study analyzes the influence of CEO types on corporate governance, focusing on de facto (substantial) CEOs. We examine how substantial CEOs impact environmental, social, and governance (ESG) activities (Hypothesis 1) and corporate value (Hypothesis 2). Data were collected from KIS-VALUE and DART (Electronic Disclosure System) from the Financial Supervisory Service, defining substantial CEOs as the highest remuneration recipients who exceed the pay of the company’s representative director. The results support Hypothesis 1, showing that companies with substantial CEOs are more likely to engage in ESG activities, potentially to improve public image while concealing self-serving behaviors. Hypothesis 2 is validated, indicating lower corporate value in companies with substantial CEOs, owing to the prioritization of personal interests over long-term profit maximization. Despite the limitations of exploring governance relationships beyond remuneration data, this study offers key contributions. It expands the research on corporate governance and ESG activities by identifying substantial CEOs through objective remuneration data. Additionally, it highlights the importance of an independent board for transparent governance and positive corporate value. Lastly, the empirical evidence shows the negative impact of misdirected ESG activities on corporate value. Using remuneration as an indicator, this study illuminates substantial CEOs’ influences on corporate value and ESG activities, providing insights for future research in this area.
... Moeller, Schlingemann, and Stulz (2004) asserted that managers of large corporations are likely to be entrenched and make destructive acquisition decisions. Similarly, evidence suggests that acquisitions are likely destructive when acquirers have a low Tobin's q (Lang, Stulz, and Walkling 1991), whereas those with a high Tobin's q may perform well (Harford, Humphery-Jenner, and Powell 2012). Maloney, McCormick, and Mitchell (1993) reported that debtholders' monitoring may cause managers to make good acquisition decisions. ...
SYNOPSIS
We empirically examine the relevance of the disclosure of internal control weaknesses (ICWs) by target firms for acquirers in making their merger-and-acquisition (M&A) decisions. We find that acquirers offer lower premiums for targets that disclose ICWs (ICW targets) before acquisition in comparison with targets that disclose effective internal controls (non-ICW targets). We also find that acquirers offer less cash (versus stock) for ICW targets in comparison with non-ICW targets. Overall, results indicate that ICW disclosure by targets is informative to acquirers. Practically, we contribute to the literature by identifying the relevance of ICW disclosure as a reliable public source of information that can help mitigate the negative impact on acquirers acquiring target firms with poor financial reporting quality.
Data Availability: Data are available from the public sources cited in the text.
JEL Classifications: G34; D81; M41; M4.
... Overconfidence is also associated with lower shareholder returns (Gervais 2010). Lang, Stulz, and Walkling (1991) and Malmendier and Tate (2008) find that market responses to acquisitions are more negative for acquiring firms led by overconfident CEOs. ...
For a broad sample of firms, we use structural equations modeling to construct latent variables for real-action aggressiveness and reporting policy aggressiveness. We estimate the association between the latent variables and the associations of each latent variable with shareholder payoffs (returns) and CEO payoffs (annual compensation to the CEO position). Results show the two types of aggressiveness are positively correlated but have different associations with the payoffs we consider. Greater policy-choice aggressiveness is associated with higher returns and compensation; the opposite is true for greater real-action aggressiveness. We find a positive association between policy-choice aggressiveness and restatement likelihood. Compared with nonrestatement firms, abnormal returns of restatement firms with aggressive policy choices are larger in the pre-restatement period and lower in the post-restatement period. Negative returns at the restatement announcement do not, on average, eliminate long-run (multi-year) positive returns of the pre-restatement period or of the period whose results are restated.
JEL Classifications: M40; M41.
... Sales growth is controlled for in the model because it is an essential variable determining the choice between an IPO and a takeover and a firm's valuation (Bayar & Chemmanur, 2012a). EBITDA and free cash flow are also controlled because profitability can affect a deal price, and free cash flow may reflect a firm's value (Lang et al., 1991;Masulis et al., 2007). Industry differences are also controlled. ...
This study investigates whether the retention of founders has a greater impact on deal prices and acquirer benefits compared with the retention of family successors or CEOs when private firms pursue a merger exit strategy. The results demonstrate that higher prices and returns can be achieved when founders remain postmerger. These findings hold up even when considering the acquirer’s long-term operating and market performance, indicating the robustness of the results. Additionally, the study reveals that the effect of founder retention is larger than that of CEO retention, and the effect of founder-CEO retention is the largest. Furthermore, the study examines multistage investments and exits, revealing that venture capitalists can trade off the benefits of founder maturity and firm growth. This implies that founder premiums vary with the enterprise life cycle. Finally, the study investigates the mechanism behind these results, finding that venture capital backing, high-tech industry, earnouts and stock-for-stock deals as moderators can significantly enhance the founder-retention effect on acquirer benefits. This study proposes that the specific human capital and entrepreneurial spirit of founders, transcending ownership, emerge as driving forces behind this effect. Founder heterogeneity also suggests that acquirers can benefit more from founder retention when founders are innovative talents or serial entrepreneurs.
... 10 See Asquith et al. (1983), Jensen and Ruback (1983), Lubatkin (1983), Jensen (1986), Travlos (1987), Bradley et al. (1988), Franks and Harris (1989), Lang et al. (1989Lang et al. ( , 1991, Morck et al. (1990), Maloney et al. (1993), Harford (1999), Ang and Kohers (2001), Moeller et al. (2004), Henry (2005), Capron and Shen (2007), and Humphery-Jenner and Powell (2011), among others. (1)- (3), (4)-(6) and (7)- (9), respectively. ...
We investigate the influence of gender diversity on the acquisition choices of bidding firms and find that firms with greater gender diversity are more likely to acquire nonlisted targets, use cash as the method of payment, and purchase firms in similar industries. Results show that these preferences are significantly influenced by female directors' financial expertise, target industry experience, mergers and acquisitions (M&A) experience, academic and professional qualifications, and networks. The percentage of female directors on boards is positively correlated with the market response to the announcement of acquisition choices preferred by female directors. Furthermore, bidders improve efficiency and accumulate long‐term value gains through the contributions made by their female directors to these acquisition choices.
... There have been a number of studies regarding firm value as one of the major factors affecting the cash holding level. Firm value creation also can represent the growth opportunities of firms (Lang et al., 1991;and Han and Qiu, 2007). The more growth opportunities firms have, the higher the cash reserves they maintain in order to capture all opportunities. ...
... Pre-M&A free cash flow of the acquirers firm has a positive impact on post-M&A performance, and the impact is statistically significant at 1% level for all measures of performance except for EBITROE post , as shown in Table 7. Our results contrast with Jensen's (1986) free cash flow hypothesis and other studies in the developed markets (Doukas, 1995;Gregory, 2005;Lang et al., 1991). This study's findings suggest that the free cash flow hypothesis is less relevant in the emerging markets of SAARC and ASEAN regions due to high ownership concentration, which reduces agency issues. ...
The purpose of the study is to examine the impact of agency issues such as free cash flow, empire-building, managerial risk aversion, and private benefit of control on post-merger financial performance in the context of emerging markets of SAARC and ASEAN regions. The sampling period for the study is from 2000 to 2017, limited to M&A deals where at least three years of pre- and post-merger data is available. A total of 184 M&A deals were analyzed from SAARC and ASEAN regions. Financial performance is measured through operating profit returns and cash returns, while the explanatory variables are free cash flow, firms’ size, industry relatedness, and block holding. Two-sample t-test is used for univariate analysis, and OLS regression is used for multivariate analysis. Results reveal that post-mergers and acquisition (M&A) financial performance declined as compared to pre-M&A financial performance over three (−3, +3) years window. Opposite to the free cash flow hypothesis, this study found that free cash flows are beneficial for acquirers in the context of emerging markets. Furthermore, acquirers’ size has either no impact or a significantly positive impact in robustness check on post-M&A performance, which rejects the empire-building motive. Unrelated mergers cause a decline in post-M&A performance, and large block holding enhances post-M&A performance. The findings of the study are helpful for managers, shareholders, and the board’s members to ensure that the free cash flow before the M&A transaction is positive and consistent also conscious of the nature of the target and avoid unrelated M&A deals.
... Therefore, they would retain and nonoptimally invest the free cash flows when external or internal corporate governance mechanisms fail. 4 Several empirical studies (e.g., Jensen, 1986;Matsusaka & Nanda, 2002;Lang, Stulz, & Walkling, 1991;Brush, Bromiley, & Hendrickx, 2000) have shown that due to the agency conflict at the headquarters level, the reinvestment of the free cash flows generally destroys rather than create value. Accordingly, the free cash flow hypothesis suggests that the headquarters may allocate resources inefficiently through suboptimal growth, i.e., by overinvesting in unprofitable old or new projects. ...
This chapter reviews the theoretical and empirical literature on the efficiency of resource allocation in multibusiness firms. The chapter proceeds by discussing the differences between resource allocation in markets vs. firm hierarchies in section 2. This discussion establishes the costs and benefits of internal resource allocation (i.e., allocation in multibusiness firms). Section 3 summarizes the process of resource allocation in multibusiness firms. Section 4 reviews both theoretical and empirical literature on the efficiency of resource allocation while section 5 discusses the role of managerial incentives and conduct in the process and outcomes of resource allocation in multibusiness firms. Section 6 concludes the chapter.
For various reasons, carbon-intensive firms in emerging markets are constrained to pursue cross-border acquisitions. This paper examines domestic mergers and acquisitions (M&As) as a carbon-offsetting strategy among carbon-intensive firms in China. We find that high carbon-emitting firms are more likely to engage in domestic M&As. Stricter environmental regulations amplify this effect. Additionally, these firms display higher risk profiles, characterized by elevated betas, idiosyncratic risks, cashflow volatility, and accounting return volatility due to the substantial transition risks associated with pollution control expenses. These firms opt for M&A activities to mitigate these risks, acquiring low-pollution or green innovation-focused targets. M&A announcements result in higher returns performance than low-carbon risk acquirers, indicating the value-enhancing impact of decarbonizing M&As. State-owned enterprises, financially stable firms, and those with stronger corporate governance tend to engage in M&A deals to address carbon risk.
Purpose
This paper aims to investigate the relationship between uncertainty and corporate cash holdings with the moderating role of political connections.
Design/methodology/approach
We employ fixed effects estimation on a panel dataset of 669 Vietnamese listed firms over the 2010–2020 period, with one- and two-way standard error clustering. We conduct various robustness tests, including two-stage least squares/instrumental variable and generalized method of moments regressions, alternative cash holding measure, and additional controls for macroeconomic conditions and ownership types.
Findings
The effect of uncertainty on cash holdings is weakened for firms with political connections relative to those without the connections. Although general firms depend on cash flows to adjust their cash holding behavior when uncertainty increases, our findings suggest that politically connected firms do not rely on internal cash flows to accumulate cash when confronted high uncertainty.
Practical implications
Our findings on the role of political connections in moderating the relationship between cash holding and economic policy uncertainty have practical implications for policymaking. Since political connections serve as a buffer for a firm’s liquidity, firms may want to seek those connections, which can, in turn, lead to increasing informal costs and unfair business environment.
Originality/value
This is the first study investigating the role of political connections to the nexus of cash, cash flow and uncertainty, providing novel evidence regarding the less dependence on internal cash flows to save cash by politically connected firms. Second, the paper enriches the literature on the motives of cash holdings by proposing a modified agency view in the context of weak investor protection. Therefore, our findings strengthen the explanation for the positive effect of uncertainty on firms’ cash holdings in emerging markets.
This study examines the association between Corporate Social Responsibility (CSR) activities measured by two of Taiwan’s leading publishers, the Commonwealth Magazine and the Global View Magazine, and the acquirer’s short- and long-term performances after the merger announcement in Taiwan. We use CEO compensation and the firm’s free cash flow as the proxies for CEO self-confidence. We find that the acquirer’s CSR engagement is positively associated with its long-term performance but not with its short-term performance. CEO compensation is positively associated with the acquirer’s performance, especially after the mandatory establishment of the remuneration committee for publicly traded firms. However, the acquirer’s free cash flow is found negatively associated with its performance, supporting Jensen’s (Agency costs of free cash flow, corporate finance, and takeovers. American Economic Review, 76, 323–329) free cash flow hypothesis or CEO hubris. These findings indicate that the CSR measurements of Commonwealth Magazine and Global View Magazine do provide valuable information for CSR activities and that CSR activities do enhance firm value in the long run. Furthermore, the requirement for the establishment of the remuneration committee does improve the effectiveness of CEO compensation for firm performance in Taiwan.
Studies have consistently demonstrated that both overinvestment and underinvestment exert adverse effects on the overall efficacy of business operations, showcasing the significance of understanding and addressing these phenomena in the realm of scholarly research. Therefore, in this study, we aim to develop an accurate machine-learning model to identify overinvestment in firms listed on the HSX and the HNX stock exchanges in Vietnam. We decided to conduct a comparison to identify the optimal model for classifying firms of overinvestment or not, including Logistic Regression, K-Nearest Neighbor (KNN), Naive Bayes (NB), Support Vector Machine (SVM), Decision Tree, and Random Forest. Using a sample of 658 non-financial listed companies in Vietnam between 2011 and 2021, our result shows that the most importance predictor variable is "FCF" (free cash flow), with an importance value of 0.14. Although both logistic regression and random forest (RD) algorithms demonstrate high accuracy in identifying firms with overinvestment, the Random Forest algorithm exhibits slightly higher precision and recall for class 1 (overinvestment firms) when compared to Logistic Regression. By contrast, the accuracy performance of the four models (NB, KNN, DT, and SVM) is low, ranging from 0.53 to 0.67. At the microeconomic level, this research can help businesses gain insights into their financial performance, identify areas for improvement, and take proactive measures to avoid financial distress and improve profitability by identifying potential cases of overinvestment. Overall, the study provides a valuable contribution to the field of financial analysis using machine learning techniques. We firmly believe that the findings of this research will serve as a significant scholarly reference for future investigations in the field and explore other importance predictors of overinvestment in Vietnam and other emerging markets.
This research employs a difference-in-differences framework to study the impact of major board reforms on the performance of mergers and acquisitions (M&As). Using an international sample of board reforms implemented in 61 countries from 1985 to 2021, we document a drastic redistribution of wealth from target shareholders to acquirer shareholders after the board reforms in target countries. This effect is most pronounced in M&A transactions that involve the sale of controlling shares, thereby supporting the hypothesis that corporate board reforms mitigate the private benefits of control in the target firm. Furthermore, these reforms increase expected deal synergies, in that deal-level announcement returns are higher after the implementation of the reforms. When country-level institutional quality and legal protection of shareholders are greater, it reinforces the reform effects. Overall M&A activity remains unchanged following the reforms, yet financial bidders complete fewer transactions, implying a reform-induced squeeze-out of financial bidders from the M&A market in the target country. Collectively, these international results are consistent with the predictions of the private benefits of control theory and underscore the role of institutional quality and investor protection in reinforcing the effects of board reforms worldwide.
Research question/issue
This study investigates whether local CEOs make more efficient investment decisions in labor.
Research findings/insights
We find that firms hiring local CEOs are associated with lower deviations of labor investment from the level justified by economic fundamentals, that is, higher labor investment efficiency. More importantly, we explore the role of information advantage, corporate governance, and CEO cultural background in shaping the relationship. We find the effect of CEO locality is more pronounced when firms have higher levels of local business integration, poorer corporate governance, and higher agency costs. Moreover, the impact of CEO locality is stronger when CEOs' hometowns have stronger unselfishness culture, patriotism culture, and Confucian culture. Our results are robust to a battery of endogeneity tests and robustness checks.
Theoretical/academic implications
Our study reveals that CEO locality, as one of the idiosyncratic top executive styles, can hinder managers from myopic behavior by investing more efficiently in labor, as a key factor of production and a major internal stakeholder, for a firm's success.
Practitioner/policy implications
Given human capital is considered the primary source of firms' competitive advantage, our study provides useful insights and managerial implications for firms to consider the impact of the idiosyncratic top executive styles as one of the noncontractual factors on firms' employment decisions.
Companies need cash to fund various business activities, such as purchasing inventories, paying bills, developing new products, acquiring assets, paying off debts, paying dividends, etc. A cash flow statement shows the movement of cash through the three main types of business activities (operating, investing, and financing) and cash balance for the financial period. However, cash balance is not free cash flow (FCF); it is a key variable in corporate valuation. None of the three financial statements (balance sheet, income statement, and cash flow statement) are designed to show free cash flows.
The financial crisis that began in 2008 and its lingering aftermath have caused many intellectuals and politicians to question the virtues of capitalist systems. This book analyzes both the strengths and weaknesses of capitalist systems. The volume opens with articles on the historical and legal origins of capitalism. These are followed by articles describing the nature, institutions, and advantages of capitalism: entrepreneurship, innovation, property rights, contracts, capital markets, and the modern corporation. The next set of articles discusses the problems that can arise in capitalist systems including monopoly, principal agent problems, financial bubbles, excessive managerial compensation, and empire building through wealth-destroying mergers. Two subsequent articles examine in detail the properties of the “Asian model” of capitalism as exemplified by Japan and South Korea, and capitalist systems where ownership and control are largely separated as in the United States and United Kingdom. The volume concludes with an article on capitalism in the twenty-first century by Nobel Prize winner Edmund Phelps.
This paper examines the effects of audit quality and firm growth on the relationship between corporate cash holdings and firm performance by using a sample of about 2500 unique non-financial Indian firms from 2000 to 2017, consisting of 51,388 firm-year observations. The results obtained by controlling for potential endogeneity using the dynamic panel generalised method of moment (GMM) approach show that cash holdings have an inverse U-shaped (concave) relationship with firm performance, which is stronger for firms with higher audit quality than firms with lower audit quality. Our findings also show that firm growth affects the cash holdings and firm performance relationship and the moderating effect of audit quality. Our study highlights the need for corporate managers to consider firm performance, audit quality and firm growth levels in policy decisions on cash holdings.
Research Question/Issue
We examine whether bond‐blockholders provide additional, distinct monitoring roles in merger and acquisition (M&A) processes beyond those of equity‐blockholders. Using a sample of 4309 M&A deals reported between 2001 and 2010, we shed new light on the monitoring spillover effects of bondholders to shareholders in the context of M&As.
Research Findings/Insights
Our findings demonstrate a positive relationship between the presence of bond‐blockholders (or a change in their position) and acquiring firms' abnormal return announcements, which supports the monitoring spillover effects from bondholders to shareholders in M&A processes. Our subsample analyses indicate that bond‐blockholders are better monitors of (1) overconfident CEOs engaging in M&As, (2) CEOs exhibiting risk‐taking behavior in M&As, and (3) entrenched managers participating in M&As. Moreover, we discover a positive association between the previous quarter's changes in “monitoring” bond‐blockholders' positions and the acquiring firms' 3‐day cumulative abnormal returns (CARs).
Theoretical/Academic Implications
In corporate finance literature, equity‐blockholders have long been recognized as effective monitors. Despite the importance of debt as most firms' primary funding source, the benefits of debt for monitoring the efficiency of managers and their organizations have been largely overlooked in the existing literature. Thus, this study provides evidence on the additional and distinct monitoring roles of bond‐blockholders beyond those of equity‐blockholders in M&A processes and the impact of bond‐blockholders on shareholders' wealth around M&A announcements.
Practitioner/Policy Implications
This study offers insights to policymakers interested in enhancing the legitimacy of corporate governance on the monitoring spillover effects of bondholders to shareholders in the context of M&As. In addition, our findings suggest that bondholders can have a long‐term perspective beyond the limited time horizon of bond maturity and influence M&A processes positively. Thus, this study has significant implications for managers and practitioners interested in which investors positively affect M&As.
Merger and acquisition is known as a market expansions strategy. This paper examines several factors associated with M&A namely bank size, intermediary role, modes of financing, bank-specific variables, and macro-economic variables on the operational performance and stability along with the mediation role of market structure for Islamic banks. This paper employs empirical research methods, namely POLS, panel data techniques and SEM to analyse a set of unbalanced panel samples of 10 Islamic banks during 2004Q1 to 2020Q4 from six countries, namely Qatar, Kuwait, Saudi Arabia, United Arab Emirates, Bahrain, and Pakistan. Stata package 14.2 is used to estimate M&A results (5 years pre and 5 years post). The results indicate that M&A improve Post-M&A performance of Islamic banks while stability does not improve. Interestingly, there is no mediation effects of market structure on the relationship between M&A, operational performance, and stability. Policymakers should take into consideration those factors taking M&A decisions considering the role of market structure.
This research looks into the impact of female directors on dividend payment policies. From 2016 to 2020, the study used a sample of 170 non-financial enterprises listed on the Borsa Istanbul (BIST). The study used the Board Female Membership (BFM). Meanwhile, control wedge ownership was used as a moderating variable. A control variable, including return on equity, was also employed (ROE). The study's dependent variable was the dividend per share, which represented the company's dividend payout policy. The female board membership was strongly linked with the dividend policy in the regression analysis. Furthermore, we add to the current research on the link between dividend payments and firm ownership by demonstrating that for control-ownership wedge companies, female directors have a greater influence on dividend payouts.
This study examines the impact of the Latin American Integrated Market (MILA for its Spanish acronym) on investment efficiency from 2003 to 2020. Our research suggests that MILA affects the efficiency of investment decisions by reducing information asymmetry and the agency problem. We present compelling empirical evidence that the impact of MILA on enhancing investment efficiency is especially pronounced in the over-investment problem. Furthermore, the mediation analysis reveals that firms listed on MILA stock exchanges have increased the efficiency of their investments, a result attributable partly to enhanced financial reporting quality. We employ difference-in-difference analysis to address the possibility of endogeneity. Our findings are validated by the fact that, compared with control firms, treatment firms improve their investment efficiency and mitigate the over-investment problem, thereby validating our findings.
"August 1990." Includes bibliographical references (p. 31-32). Supported by the Division of Research, Graduate School of Business Administration. Paul Asquith, Robert F. Bruner, David W. Mullins, Jr.
This paper reviews much of the scientific literature on the market for corporate control. The evidence indicates that corporate takeovers generate positive gains, that target firm shareholders benefit, and that bidding firm shareholders do not lose. The gains created by corporate takeovers do not appear to come from the creation of market power. With the exception of actions that exclude potential bidders, it is difficult to find managerial actions related to corporate control that harm shareholders. Finally, we argue the market for corporate control is best viewed as an arena in which managerial teams compete for the rights to manage corporate resources.
Four statistics which may be used to test the equality of population means are com-pared with respect to their robustness under heteroscedasticity, their power, and the overlap of their critical regions. The four are: the ANOVA F-statistic; a modified F which has the same numerator as the ANOVA but an altered denominator; and two similar statistics proposed by Welch and James which differ primarily in their approximations for their critical values.The critical values proposed by Welch are a better approximation for small sample sizes than that proposed by James. Both Welch's statistic and the modified F are robust under the inequality of variances. The choice between them depends upon the magnitude of the means and their standard errors. When the population variances are equal, the critical region of the modified F more closely approximates that of the ANOVA than does Welch's.
This study supports the proposition that managerial welfare affects merger decisions. The abnormal stock returns experienced by bidder firms, from the time of the announcement of a merger bid through the stockholder approval date, are positively related to the percentage of own-company stock held by the senior management of the bidder. The results suggest that substantial amounts of own-company share ownership help align the interests of stockholders and management.
For a sample of successful tender offers, we find that the shareholders of high q bidders gain significantly more than the shareholders of low q bidders. In general, the shareholders of low q targets benefit more from takeovers than the shareholders of high q targets. Typical bidders have persistently low q ratios prior to the acquisition announcement while target q ratios decline significantly over the five years before the tender offer. Our results are consistent with the view that takeovers of poorly managed targets by well-managed bidders have higher bidder, target, and total gains.
I analyze financing policies in a firm owned by atomistic shareholders who observe neither cash flows nor management's investment decisions. Management derives perquisites from investment and invests as much as possible. Since it always claims that cash flow is too low fund all positive net present value projects, its claim is not credible when cash flow is truly low. Consequently, management is forced to invest too little when cash flow is low and chooses to invest too much when it is high. Financing policies, by influencing the resources under management's control, can reduce the costs of over- and underinvestment.
This paper documents that a successful tender offer increases the combined value of the target and acquiring firms by an average of 7.4%. We also provide a theoretical analysis of the process of competition for control of the target and empirical evidence that competition among bidding firms increases the returns to targets and decreases the returns to acquirers, that the supply of target shares is positively sloped, and that changes in the legal/institutional environment of tender offers have had no impact on the total (percentage) synergistic gains created but have significantly affected their division between the stockholders of the target and acquiring firms.
This paper considers a firm that must issue common stock to raise cash to undertake a valuable investment opportunity. Management is assumed to know more about the firm's value than potential investors. Investors interpret the firm's actions rationally. An equilibrium model of the issue-invest decision is developed under these assumptions. The model shows that firms may refuse to issue stock, and therefore may pass up valuable investment opportunities. The model suggests explanations for several aspects of corporate financing behavior, including the tendency to rely on internal sources of funds, and to prefer debt to equity if external financing is required. Extensions and applications of the model are discussed.
In a sample of 326 U.S. acquisitions between 1975 and 1987, three types of acquisitions have systematically lower and predominantly negative announcement period returns to bidding firms. The returns to bidding shareholders are lower when their firm diversifies, when it buys a rapidly growing target, and when its managers performed poorly before the acquisition. These results suggest that managerial objectives may drive acquisitions that reduce bidding firms' values. Copyright 1990 by American Finance Association.
In the 1980s, the market for corporate control has been increasingly active, and the quantity of output of academic researchers studying corporate control questions has mirrored the market activity. This review examines the returns to bidders and targets, and the effects of defending against hostile takeovers.
This study explores the role of the method of payment in explaining common stock returns of bidding firms at the announcement of takeover bids. The results reveal significant differences in the abnormal returns between common stock exchanges a nd cash offers. The results are independent of the type of takeover b id, i.e., merger or tender offer, and of bid outcomes. These findings supported by analysis of nonconvertible bonds, are attributed mainl y to signaling effects and imply that the inconclusive evidence of ea rlier studies on takeovers may be due to their failure to control for the method of payment. Copyright 1987 by American Finance Association.
This paper analyzes the relation between takeover gains and the q rations of targets and bidders for a sample of 704 mergers and tender offers over the period 1972-87. Target, bidder, and total returns are larger when targets have low q ratios and bidders have high q ratios. The relation is strengthened after controlling for the characteristics of the offer and the contest. This evidence confirms the results of the work by L. Lang, R. Stulz, and R. A. Walkling (1989) and shows that their findings also hold for mergers and after controlling for other determinants of takeover gains. Copyright 1991 by American Finance Association.
The interests and incentives of managers and shareholders conflict over such issues as the optimal size of the firm and the payment of cash to shareholders. These conflicts are especially severe in firms with large free cash flows--more cash than profitable investment opportunities. The theory developed here explains 1) the benefits of debt in reducing agency costs of free cash flows, 2) how debt can substitute for dividends, 3) why diversification programs are more likely to generate losses than takeovers or expansion in the same line of business or liquidation-motivated takeovers, 4) why the factors generating takeover activity in such diverse activities as broadcasting and tobacco are similar to those in oil, and 5) why bidders and some targets tend to perform abnormally well prior to takeover.
Tobin's q, agency costs and corporate control: An empirical analysis of firm-specific parameters
- Servaes
Servaes, Henri, 1991, Tobin's 4, agency costs and corporate control: An empirical analysis of firm-specific parameters, Journal of Finance 16. 409-419.
Do managerial objectives drive bad acquisitions?
- Morck
Corporate control and the choice of investment financing: The case of corporate acquisition
- Amihud