Mergers and Acquisitions and Executive Compensation 2015007648, 9781138802001, 9781315754505

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Mergers and Acquisitions and Executive Compensation “This book provides an excellent review of a crucial, contemporary issue in M&As and corporate governance, namely, are CEOs motivated to transact M&A deals just to maximize their own compensation, or act purely in shareholders’ best interests. With billions of dollars at stake for companies and economies, the motivation of CEOs to do these deals matters. This book provides clear insights into how value may be created and destroyed through CEO compensation.” —Dr. Duncan Angwin, Professor and M&A Specialist, Oxford Brookes University, UK “In today’s fast-moving business world, M&As are common options for business expansion. Boards are reviewing compensation systems to reward the right behavior and encourage executives to achieve corporate objectives without incurring higher risk than the board approves. The relationship between M&As and CEO remuneration is an important area of research that can add a lot of value to governance scholars and practitioners. I highly recommend reading this book.” —Dr. Ashraf Gamal, CEO, Hawkamah, The Institute for Corporate Governance, UAE “A skillfully written, informative book and a remarkable up-to-date contribution to existing literature worldwide. Bodolica and Spraggon have succeeded in providing a compelling argument for an advanced, combined analysis of two recently growing and impactful trends—M&As and executive compensation. The book is a must read that should be recommended to researchers interested in examining the strategic value of the CEO pay-setting processes around M&A transactions.” —Dr. Alex Kostyuk, Director, Virtus Global Center for Corporate Governance & International Center for Banking and Corporate Governance, Ukraine Over the past decades, the total value of executive compensation packages has been rising dramatically, contributing to a wider pay gap between the chief executive officer and the average worker. In the midst of the financial turmoil that brought about a massive wave of corporate failures, the lavish executive compensation package has come under an intense spotlight. Public pressure has mounted to revise the levels and the structure of executive pay in a way that will more closely tie the executive wealth to that of shareholders. Merger and acquisition (M&A) activities represent an opportune setting for gauging whether shareholder value creation or managerial opportunism guides executive compensation. M&As constitute major examples of high-profile events prompted by managers who typically conceive them as a means for achieving higher levels of pay, even though they are frequently associated with disappointing returns to acquiring shareholders. Mergers and Acquisitions and Executive Compensation reviews the existing empirical evidence and provides an integrative framework for the growing body of literature that is situated at the intersection of two highly debated topics: M&A activities and executive compensation. The proposed framework structures the literature along two dimensions, M&A phases and firm’s role in a M&A deal, allowing the identification of three main themes, five streams, and six topics of inquiry that represent different conceptualizations of causal relationships between M&A transactions and executive compensation. The book makes a comprehensive review of empirical studies conducted to date, aiming to shed more light on the current and emerging knowledge in this field of investigation, to discuss the inconsistencies encountered within each stream of research, and to suggest promising directions for further exploration. This book will appeal to researchers and students alike in the fields of strategic management and corporate governance as well as accounting and accountability. Virginia Bodolica is Associate Professor of Management at American University of Sharjah, School of Business Administration, UAE. Martin Spraggon is Associate Professor of Management at American University of Sharjah, School of Business Administration, UAE.

Routledge Studies in Corporate Governance

1 Corporate Governance Around the World Ahmed Naciri

5 Internal and External Aspects of Corporate Governance Ahmed Naciri

2 Behaviour and Rationality in Corporate Governance Oliver Marnet

6 Green Business, Green Values, and Sustainability Edited by Christos N. Pitelis, Jack Keenan and Vicky Pryce

3 The Value Creating Board Corporate governance and organizational behaviour Edited by Morten Huse

7 Credit Rating Governance Global credit gatekeepers Ahmed Naciri

4 Corporate Governance and Resource Security in China The transformation of China’s global resources companies Xinting Jia and Roman Tomasic

8 Mergers and Acquisitions and Executive Compensation Virginia Bodolica and Martin Spraggon

Mergers and Acquisitions and Executive Compensation Virginia Bodolica and Martin Spraggon

First published 2015 by Routledge 711 Third Avenue, New York, NY 10017 and by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN Routledge is an imprint of the Taylor & Francis Group, an informa business © 2015 Taylor & Francis The right of Virginia Bodolica and Martin Spraggon to be identified as authors of this work has been asserted by them in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. Library of Congress Cataloging-in-Publication Data Bodolica, Virginia, 1976–   Mergers and acquisitions and executive compensation / by Virginia Bodolica and Martin Spraggon.    pages cm. — (Routledge studies in corporate governance ; 8)   Includes bibliographical references and index.   1.  Consolidation and merger of corporations.  2.  Executives—Salaries, etc. I.  Spraggon, Martin, 1973–  II.  Title.   HD2746.5.B63 2015  338.8'3—dc23   2015007648 ISBN: 978-1-138-80200-1 (hbk) ISBN: 978-1-315-75450-5 (ebk) Typeset in Sabon by Apex CoVantage, LLC

First and foremost, I want to dedicate this book to my father, who is and has always been such a powerful source of inspiration since the very beginning of my academic career. And to my mother for her care, love, and constant attempts to remove all the bumps on my road so that my ride could be effortless and pleasant. I would also like to thank my sister and niece for their encouragement and motivation throughout the whole process. And my soul mate, who does really know all it takes to engage in a bumpy and adventurous road like this one. This book would not have been possible without your loving support, confidence, and understanding. Virginia Bodolica To my life partner. Martin Spraggon

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Contents

List of Figures List of Tables List of Abbreviations Preface

ix xi xiii xv

PART I Overview of M&As and Executive Compensation

1

1  M&A Activities: Global Portrait and Merger Motives

3

2  Incentive Design of Executive Compensation Packages

25

3 Conceptual Framework Linking M&As With Executive Compensation

48

PART II Bidders’ Executive Compensation Before the Deal

69

4 Impact of Bidding Executive Compensation on Bidder-Specific M&A Occurrence 4.1 Impact of Bidding Executive Compensation on Risk Taking and Corporate Diversification 4.2 Impact of Bidding Executive Compensation on M&A Decisions and Abnormal AnnouncementRelated Returns 5 Impact of Bidding Executive Compensation on M&A Characteristics

71 71 84 102

viii  Contents

PART III Targets’ Executive Compensation Before the Deal

115

  6 Impact of Target-Specific M&A Occurrence (Threat of Takeover) on Target Executive Compensation

117

  7 Impact of Target Executive Compensation on M&A Characteristics 7.1. Impact of Target Executive Compensation on Target Management Attitude 7.2. Impact of Target Executive Compensation on Acquisition Premium

PART IV Acquirers’ Executive Compensation After the Deal   8 Impact of M&A Characteristics on Executive Compensation of Acquiring Firms 8.1 Impact of M&A Performance and Growth in Corporate Size on Executive Compensation of Acquiring Firms 8.2 Impact of Acquisition Premium and Mode of Payment on Executive Compensation of Acquiring Firms

126 126 135

145

147 147 165

PART V Discussion and Priorities for Future Research

175

  9 Discussion of Extant Knowledge on M&As and Executive Compensation

177

10  Priorities for Future Research Endeavors in the Field

199

About the Authors Index

219 221

Figures

1.1 Distinctive characteristics of the different merger waves 3.1 Conceptual framework for structuring empirical studies on M&A deals and executive compensation 3.2 Typology of causal relationships tested between M&A deals and executive compensation 3.3 Conceptual linkages among various themes, streams, and topics of inquiry identified and covered in different chapters of the book

5 62 63

65

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Tables

2.1 Distinctive features of compensation protection devices and LTIPs 2.2 Asymmetric properties of stock option pay and stock ownership 3.1 Post–2000 review articles of the M&A literature, the executive pay literature, and the executive pay around M&As literature 4.1 Review matrix of studies analyzing the impact of bidders’ executive compensation on risk taking and corporate diversification—Topic A1, Stream A, Theme I 4.2 Review matrix of studies analyzing the impact of bidders’ executive compensation on corporate M&A decisions and abnormal announcement-related returns—Topic A2, Stream A, Theme I 5.1 Review matrix of studies analyzing the impact of bidders’ executive compensation on mode of payment and acquisition premium—Stream B, Theme I 6.1 Review matrix of studies analyzing the impact of the threat of takeover on target executive compensation—Stream C, Theme II 7.1 Review matrix of studies analyzing the impact of target executive compensation on target management attitude—Topic D1, Stream D, Theme II 7.2 Review matrix of studies analyzing the impact of target executive compensation on acquisition premium—Topic D2, Stream D, Theme II 8.1 Review matrix of studies analyzing the impact of M&A performance on executive compensation of acquiring firms—Topic E1, Stream E, Theme III 8.2 Evolving nature of the agency problem around M&A deals and implications for boards’ pay-related decisions

37 39

49

77

93

110

122

133

140

158 168

xii  Tables 8.3 Review matrix of studies analyzing the impact of acquisition premium and mode of payment on executive compensation of acquiring firms—Topic E2, Stream E, Theme III 9.1 Quantitative and qualitative summary of studies across different themes, streams, and topics of inquiry

170 178

Abbreviations

CEOs—chief executive officers CFOs—chief finance officers EBC—equity-based compensation EU—European Union LTIPs—long-term incentive plans M&As—mergers and acquisitions OLS—ordinary least-squares SEC—Securities and Exchange Commission S&P—Standard & Poor’s UK—United Kingdom US—United States USA—United States of America 2SLS—two-stage least-squares

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Preface

BOOK’S AIM AND DESCRIPTION Over the past decades, the total value of executive compensation packages has been rising dramatically, contributing to a wider pay gap between the chief executive officer and the average worker. In the midst of the financial turmoil that brought about a massive wave of corporate failures, the lavish executive compensation package has come under an intense spotlight. Public pressure has mounted to revise the levels and the structure of executive pay in a way that will more closely tie the executive wealth to that of shareholders. Merger and acquisition (M&A) activities represent an opportune setting for gauging whether shareholder value creation or managerial opportunism guides executive compensation. M&As constitute major examples of high-profile events prompted by managers who typically conceive them as a means for achieving higher levels of pay, even though they are frequently associated with disappointing returns to acquiring shareholders. Mergers and Acquisitions and Executive Compensation reviews the existing empirical evidence and provides an integrative framework for the growing body of research that is situated at the intersection of two highly debated topics: M&A activities and executive compensation. The proposed framework structures the literature along two dimensions, M&A phases and firm’s role in a M&A deal, allowing the identification of three main themes, five streams, and six topics of inquiry that represent different conceptualizations of causal relationships between M&A deals and executive pay. The book makes a comprehensive review of empirical studies conducted to date, aiming to shed more light on the current and emerging knowledge in this field of investigation, to discuss the inconsistencies encountered within each theme of research, and to suggest promising directions for further exploration. BOOK’S AUDIENCE This book is addressed to those who are interested in researching and understanding phenomena associated with the effectiveness of various governance arrangements in today’s corporate world. Since Mergers and Acquisitions

xvi  Preface and Executive Compensation is a research-oriented book, it is of particular interest to scholars who are positioning their studies at the intersection of external and internal governance mechanisms, namely M&A transactions and executive compensation. Corporate governance practitioners and members of boards of directors, who approve M&A deals and are responsible for determining the incentive design of executive pay packages, may find the book informative for enhancing the efficacy of their decision making processes. This book will also appeal to doctoral students who are seeking to familiarize themselves with the progress made to date in the field of executive compensation around M&A transactions and to identify a promising topic of further inquiry. The book does not assume a substantial amount of specialist knowledge, introducing and discussing its contents with a sufficient degree of detail to be accessible to the lower-level student clientele. Considering the book’s specific emphasis on executive compensation in the context of active markets for corporate control, university professors could use it as a supplementary reading in an advanced undergraduate or master’s-level course in corporate governance, mergers and acquisitions, or strategic management of compensation systems. The subject area of Mergers and Acquisitions and Executive Compensation is researched by scholars from different disciplines such as strategic management, corporate governance, compensation management, corporate finance, financial economics, accounting, and business ethics and accountability. The discussed topics have an international appeal because the reviewed studies are not grounded within a given geographical space but rather employ empirical data originating from several countries around the world. Comparative cross-study analyses performed in this book highlight samples’ nationality to account for the peculiarities of national corporate governance regimes.

OVERVIEW OF THE CONTENTS The five parts and 10 chapters of Mergers and Acquisitions and Executive Compensation provide comprehensive information and research-driven discussions with respect to the following areas:

Part I. Overview of M&As and Executive Compensation (Chapters 1–3): • Recent M&A activity (number and value of deals): global and regional trends • M&A waves and their distinctive logics and characteristics

Preface  xvii • Various motives for conducting M&As transactions • Theoretical tension (agency theory versus political perspective): shareholder wealth maximization versus managerial entrenchment rationales • Recent advancements and current debates in the field of executive compensation • Incentive design of executive compensation packages: structure and components • Method for conducting the review: articles’ selection and analysis • Conceptual framework with different themes, streams, and topics of inquiry that highlight various causal relationships between M&As and executive compensation

Part II. Bidders’ Executive Compensation Before the Deal (Chapters 4–5): • Debate on the relationship between bidders’ managerial ownership levels and diversifying M&As • Conflicting results regarding the impact of bidding executive compensation on risk taking and diversification • Effect of managers’ incentives on their propensity to undertake M&As and the abnormal returns to bidding firms from M&A announcements • Empirical evidence on the effect of bidding executive pay on the mode of payment used to finance M&As • Impact of bidding executive compensation on the magnitude of acquisition premium

Part III. Targets’ Executive Compensation Before the Deal (Chapters 6–7): • Relationship between the threat of takeover and the incidence of golden parachutes in target firms • Determination of changes in the monetary magnitude of different compensation components of target executives prior to M&As • Impact of target executive compensation on target management attitude • Different approaches to target management pay: model of normal compensation, structure of compensation packages, and changes in target management wealth • Impact of various measures of target executive compensation on the magnitude of acquisition premium • Inconsistencies in empirical findings across studies on target executive pay

xviii  Preface

Part IV. Acquirers’ Executive Compensation After the Deal (Chapter 8): • Impact of postacquisition performance and growth in corporate size on executive compensation of acquiring firms • Pay–performance association in acquiring firms, weaknesses in corporate governance structures, and managerial entrenchment hypothesis • Impact of the mode of payment and control premium on the structural design and magnitude of executive compensation packages in acquiring firms • Compensation implications for acquiring executives for a suboptimal selection of acquisition terms

Part V. Discussion and Priorities for Future Research (Chapters 9–10): • Summary of extant knowledge in each theme of inquiry • Methodological considerations: discussion of comparative research designs and endogeneity concerns • Reasons for inconsistency in cross-study findings and limitations in each theme • Contrasting corporate governance regimes in the USA, Canada, UK, and Australia • Priorities for further empirical research within each theme of inquiry and research opportunities for building analytical bridges across themes • Additional research considerations: treatment of acquisition-related performance in extant studies and implications for theory

Part I

Overview of M&As and Executive Compensation Part Contents: Chapter 1. M&A Activities: Global Portrait and Merger Motives Chapter 2. Incentive Design of Executive Compensation Packages Chapter 3.  Conceptual Framework Linking M&As With Executive Compensation

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1 M&A Activities Global Portrait and Merger Motives

UPDATED PORTRAIT OF GLOBAL M&A ACTIVITY

M&As as High-Profile Events Corporate restructuring strategies are presently at the center of a heated debate, and myriad leading topics related to mergers and acquisitions (M&As) figure prominently among central business policy issues. What continuously surprises the public is the unwavering popularity of M&As, as in 2007, organizations merged and acquired across the globe at an all-time record level of US$5.58 trillion (Zephyr, 2008), while the bulk of empirical studies show that many of these transactions fail to produce the expected benefits to the shareholders of acquiring companies (Girma, Thompson, & Wright, 2006). In the aftermath of the financial recession of 2008, the global M&A activity declined, registering a total of 72,356 and 67,183 deals valued at US$3.77 and US$3.38 trillion in the years 2009 and 2010, respectively (Zephyr, 2012). However, the number and value of M&A transactions soon started rising again due to the burgeoning signs of economic recovery and the increased investors’ confidence in many regional markets. According to the latest Zephyr Annual M&A Report, as many as 71,811 deals worth US$3.45 trillion were conducted in the world during 2013 (Zephyr, 2014a). Having emerged at the end of the 19th century, M&A deals became over the years an important and dramatic phenomenon that brings about numerous socioeconomic consequences in terms of financial worth, legal considerations, and number of affected stakeholders. These transactions may implicate direct competitors or acquisitions of a firm’s major supplier/ distributor (i.e., horizontal versus vertical deals), companies operating in the same or completely different industries (i.e., concentric versus conglomerate deals), and bidders and targets originating from the same or different countries (i.e., domestic versus cross-border deals). M&As currently represent a dominant growth strategy for many corporations due to the increasing globalization trend and particularly in an environment where opportunities for pursuing organic growth are scarce (Galpin  & Herndon, 2014). Some transactions are worth astronomical amounts of money, while others

4  Overview of M&As and Executive Compensation result in the creation of the largest corporate entities in their industries of operation. The top deal in global M&A history, which involved Vodafone AirTouch, a British telecommunication company, and Mannesmann, a German telephone and Internet firm, was valued at US$172 billion including debt when it was completed in 2000 (Rocco, 2013). Anheuser–Busch InBev, which ensued from the 2008 merger between the Belgian-Brazilian InBev and the American Anheuser–Busch, continues to be the largest beer company in the world (Kim, Nofsinger, & Mohr, 2010). M&As are high-profile and complex events that imply substantial wealth movements between the parties concerned, requiring the assistance of specialized professionals such as financial consultants (e.g., Goldman Sachs, Morgan Stanley, Bank of America Merrill Lynch) and legal advisors (e.g., Shearman & Sterling, Davis Polk & Wardell). The conduct of M&A deals is typically associated with multiple risks of a operational, strategic, financial, reputational, and cultural nature (Asimakopoulos & Athanasoglou, 2013). The target and acquiring firms may incur significant integration problems, which often result in high failure rates and a huge waste of organizational resources. For instance, America Online’s takeover of Time Warner is commonly viewed as one of the worst transactions ever concluded, leading to the official separation of the two companies nine years after the initial agreement (Rocco, 2013). Time Warner Cable Inc. is presently sought to be acquired by the American Comcast Corporation at an announced value of US$68.94  billion (Zephyr, 2014b). Nonetheless, despite the potential merger-induced hazards and difficulties occurring in integrating firms, M&As continue to occur at high levels, which may be conducive toward the attainment of new heights in terms of frequency and estimated value (Hammond, 2014).

The First Five Merger Waves It is generally agreed that M&A activity comes in waves as a result of a combination of economic, technological, and regulatory shocks that determine the rate and intensity of corporate acquisitive behavior (Andrade, Mitchell, & Stafford, 2001). Recent studies show that merger waves are caused by stock market booms (Polemis & Paleologos, 2014) and are diffused over the wider economy from industries that occupy a central position in customersupplier networks (Ahern & Harford, 2014). Scholars identify six merger waves (see Figure  1.1) that took place in the United States of America (USA), each of them being demarcated by a distinctive logic and featuring specific characteristics (Bodolica & Spraggon, 2009a; Gaughan, 2007). The statistical data on global M&A activities over the recent years, which are illustrated later in this chapter, may be indicative of another merger wave, but this contention has yet to be confirmed. The first wave recorded many horizontal transactions and consolidation of petroleum, chemicals, food, transportation equipment, and metal industries, resulting in a monopolistic

M&A Activities  5

Figure 1.1  Distinctive characteristics of the different merger waves Source: Adapted from Bodolica & Spraggon (2009a)

market structure. Reporting a value creation of 12 to 18 percent for bidding and target firms, Banerjee and Eckard (1998) posit that acquisitions from this wave were more consistent with efficiency rationales rather than monopoly power considerations. The consolidation trend continued into the second merger wave, creating an oligopolistic industry structure, with many horizontal and vertical deals being financed through the use of debt. According to Leeth and Borg (2000), the observed abnormal returns of zero and 15 percent to acquiring and target shareholders, respectively, were not driven by industry relatedness, acquisition mode, and method of payment. The conglomerate era demarcated the third wave as companies started to diversify their core businesses purchasing targets from different industries (Bodolica & Spraggon, 2009a). Bidders’ wealth benefits extracted from diversifying deals of the 1960s could be explained by expectations of internal capital markets’ efficiency and complementary expertise-related effects of merging firms, where the target provided operational information and the bidder contributed the financial capital (Hubbard & Palia, 1999). Because many conglomerates ultimately failed, American corporations started to look for greater specialization in the fourth merger wave, which is also characterized by higher levels of hostile takeovers and leveraged buyouts (Holmstrom & Kaplan, 2001). Hence, the first four merger waves spread over a period of 100 years to come to an end in 1989, evolving from consolidating and debt-financed acquisitions to more diversified and hostile deals (Bodolica, 2013). According to Weston and Chen (1994), this period has witnessed an important shift from an era of heavy leveraging as a mechanism to discourage takeover attempts to an entirely new epoch of financial restructuring and equitizing. Mergers from the fifth wave were undertaken for strategic reasons to expand into new markets or to take advantage of perceived synergies and were associated with greater use of equity mode of financing and antitakeover defenses (Moeller, Schlingemann,  & Stulz, 2005). Apart from these prevailing features, the whole period of the 1990s is labeled as the “mega-merger mania” decade, when all the records registered in the previous merger waves were beaten (Hitt, Harisson,  & Ireland, 2001). More than 10 transactions were taking place daily in the USA during 2000, the

6  Overview of M&As and Executive Compensation year that has also witnessed the largest deal (by announced value) ever not only in American history but also worldwide. This was the mega-merger between America Online (AOL) and Time Warner worth US$186 billion at the time the deal was announced (Bloomberg, 2013). The fifth merger wave came to its end in 2001 as the number of M&A deals declined significantly due to the collapse of the stock market and global downturn. The period of relative stagnancy in M&A activity that followed, particularly in the USA, can be explained by various events such as the 9/11 attacks, uncertainty over the war in Iraq, and higher risk aversion on the part of American executives in the wake of huge corporate failures (e.g., Enron, WorldCom) and new corporate governance reforms (i.e., Sarbanes-Oxley Act; Hansen, 2004). However, as statistical data show, this pause ended in 2004, when acquisitions started to occur again very frequently at a global scale, reaching unprecedented levels in 2007. About 73,000 deals took place in the world during 2007, with a total value exceeding US$5.5  trillion—numbers that are significantly higher than the 55,342 deals worth US$2.41  trillion registered in 2004 (Zephyr, 2008).

The Sixth Merger Wave The 2004 to 2007 period demarcated the sixth merger wave, which is unique not only in terms of record numbers and values of completed transactions but also in that M&As became a global phenomenon occurring more regularly outside the USA (Gregoriou  & Renneboog, 2007). The empirical evidence suggests that this wave featured a less competitive market for corporate control, higher availability of liquidity, lower rates of acquirers’ acquisitiveness, less overvaluation of acquiring firms relative to targets, smaller size of acquisition premiums, larger cash components in deals’ financing, and more rationality and cautiousness with regard to M&A–related decisions (Alexandridis, Mavrovitis, & Travlos, 2012). The European Union (EU) member states played a determinant role during the sixth wave, as M&As in Europe reached higher levels than those registered in the USA. The creation of the Euro Zone in 2002 and the enlargement of the EU in 2004 to include 10 new members from Central and Eastern Europe have been critical factors facilitating merger activities in this region (Campa, 2006). A total of 23,010 deals of a combined value of US$1.96 trillion were conducted in Europe in 2007 (29,699 deals and US$1.58 trillion in 2006), while these figures equaled 18,042 deals and US$1.84 trillion in the USA and Canada (Zephyr, 2008). During the 1995 to 2007 period, the European merger market revealed some distinctive characteristics such as the prevalence of domestic, private, and cash-financed transactions, an increase in intra-European deals, very low levels of hostility and competing bids, weaker role played by financial investors, a tendency toward national industry consolidation, and an insignificant influence of industry regulation on M&A completion (Moschieri & Campa, 2014).

M&A Activities  7 With a spectacular number of 18,802 deals completed in 2007 worth US$1.02 trillion (compared to the modest 2003 levels of 7,702 and US$279 billion, respectively), companies from the Asia Pacific region have also emerged as important players in the M&A landscape. Transactions that occurred in the rest of the world (including Latin America, Africa, the Middle East, and Russia) followed the same pattern, hitting the all-time high in 2007 with 12,359 deals of a total value of US$698 billion (against 5,176 deals and US$200 billion in 2003). In Russia alone, M&A deals during the year 2007 were concluded at a rate of one per day, with a total value of US$80 billion (Mergemarket, 2009). The significant increase in M&A activities in these less mature markets was possible due to the massive wave of privatization of state-owned enterprises that took place in the late 1990s, allowing the released-from-governmental-control companies to more freely pursue their own M&A strategies. Another prominent characteristic of the sixth merger wave is the appearance of the emerging market bidder (Gaughan, 2007). One example is the US$12 billion acquisition of British-owned Corus Group by Indian Tata Steel in January 2007, which is the largest Indian takeover of a foreign firm, making Tata Steel the fifth-largest steel maker in the world (IndiaPRwire, 2007). Another is Dubai Ports World’s US$6.8 billion takeover of Peninsular & Oriental Steam Navigation Co. completed in 2006, which turned the company into one of the world’s three largest ports operators (Goldstein, 2006). Although due to the recent financial crisis the global M&A numbers in 2008 (with 68,363 deals worth US$4.22 trillion) were brought down to levels not seen since 2004 (Zephyr, 2012), analysts suggest that emerging markets are and will continue to be the major drivers of M&A activity during these times of economic turmoil. Indeed, because of the prevalence of cash-rich privately owned firms in Middle East, this region outperformed global M&A trends in 2008, as its deal numbers and values grew by approximately 40 percent (Singh, 2009).

Most Recent Global M&A Data During the first half of 2014, a total of 35,429 transactions worth an estimated US$2.03 trillion took place across the globe (Zephyr, 2014b). Although the number of undertaken deals stood at comparable levels, their financial value was the highest recorded for the last nine half-year periods. According to Hammond (2014), the value of M&As reached US$2.66  trillion in the first three quarters of 2014, representing a 60  percent upsurge on the same period in the previous year. Fourteen high value deals each estimated at US$10  billion and more were registered worldwide during the first six months of 2014, involving American, Chinese, Irish, British, German, Spanish, Swiss, and Japanese acquirers and targets. The acquisitions of DirecTV LLC by AT&T Inc. (for US$67.1  billion), of Covidien plc by Medtronic Inc. (for US$42.9  billion), of Forest Laboratories Inc. by Actavis plc (for US$24.2 billion), of WhatsApp Inc. by Facebook Inc. (for US$19 billion), and of Biomet Inc. by Zimmer Holdings Inc. (for US$13.3 billion) are among the top 10 global transactions by the announced value (Zephyr, 2014b).

8  Overview of M&As and Executive Compensation Some of the distinctive features of this worldwide deal-making trend in 2014 is the general market resilience in terms of absorbing politico-financial risks and the industrywide pursuance of M&A activities for expansion purposes as a result of saturation in organic growth (Hammond, 2014). This period was led by strategic acquirers, companies with abundant cash reserves that were eager to take advantage of cheap available financing, to pursue an inversion strategy by acquiring overseas to decrease corporate taxes, and to temper target’s hostility when a higher value was expected from the deal (Kim  & Roumeliotis, 2014). In North America, the most active was the energy, mining, and utilities sector, where 179 transactions valued at US$383.2 billion took place, followed by the pharmaceutical, medical, and biotechnological sector, which registered more than 125 transactions worth US$106.8 billion (Josselyn, 2014). As far as the Western European market is concerned, the recent escalation in deals’ value, which hit a 5-year high, came at the expense of a declined deals volume, which stood at the lowest point over the past 4 years. During the first half of 2014, 9,870 deals worth US$553 billion were announced, compared to 12,154 deals worth US$464  billion over the last six months of 2013 (Zephyr, 2014b). The healthcare sector was a particularly active player in the M&A market, while the most popular targets from the region were located in the United Kingdom (UK). Similar trends can be observed in Asia and the Asia Pacific, where deal making slipped by 21 percent and M&A values remained stable, while Chinese firms were the most attractive for acquisition purposes. In the Middle East, the most recent deal volume was down to 136, while deal values were up to US$7.1 billion from 160 and US$3.5 billion, respectively, registered at the end of 2013 (Zephyr, 2014b). Many of the 20 highest-valued transactions in the region were minority stakes, and the most active country by total deal value was the United Arab Emirates, followed by Qatar. In an empirical investigation of M&A deals involving Qatari firms, Bodolica (2013) found that 2007 was the year that demarcated two merger-related periods: one of almost nonexistent M&A activity and the other of relatively high merger intensity. Despite the financial recession, which hit the Gulf region hardest at the beginning of 2009, M&A deals continued to happen at the same yearly frequency, indicating that the post-2007 period was the most active in the history of the Qatari market for corporate control. On the basis of these findings, Bodolica (2013) concluded that the credit crunch did in fact constitute a valuable opportunity for cash-rich Qatari acquirers to buy undervalued target companies. REASONS FOR UNDERTAKING M&A DEALS AND RELATED EXPLANATIONS Given the persistently escalating economic magnitude and frequency of acquisitions, business scholars have long been pursuing an answer to the question of why M&As take place. Different motives have been advanced in the specialized literature aiming to explain the incessant occurrence of these

M&A Activities  9 activities. Among the most often-cited reasons are expansion objectives and expectations to extract a higher value from the target company due to better management and more efficient decision making of the new executive team (Gaughan, 2007; Trautwein, 1990). Apart from this inefficient management hypothesis, the acquirer is also expected to pursue a deal when it estimates that the shares of the target are currently undervalued by the stock market—a view consistent with the information hypothesis (Asimakopoulos & Athanasoglou, 2013). Despite a broad variety of merger-related explanations that can be traced in the extant research in the field, the three most commonly explored hypotheses with regard to the conduct of M&A transactions are associated with synergy, hubris, and market for corporate control reasons. Yet the results of empirical studies are inconclusive about the prevalence of one hypothesis over the other. In a recent analysis of 627 successful deals that occurred over the 1990 to 2004 period, Goktan (2012) contrasted the implications of target valuation uncertainty in these three merger hypotheses to assess the distribution of financial gains between the target and the acquiring company. The author concluded that, under the condition of higher predictability of the target’s value, findings are more consistent with the synergy hypothesis, as both firms are able to benefit from the transaction even though the larger portion of gains is extracted by the target.

Synergy Hypothesis The vast majority of early studies have focused primarily on economic efficiency rationales, such as economies of scale and scope, monopoly power advantages, financial and operating synergistic gains, fiscal advantages, benefits achieved from attractive market valuations, wealth transfers from the target to the acquirer, and strategic responses to evolving realities in the business environment (Bradley, Desai,  & Kim, 1983; Hayn, 1989; Shleifer  & Vishny, 1991). The top managers’ expectation to extract potential synergies from the integration of target and acquiring companies, which may be achieved through efficient combinations of complementary resources, eliminations of redundancies, and improvements in value chain activities, justifies the payment of premiums to gain control of another firm (Chatterjee, 1992). Consistent with the synergy hypothesis of M&As, Dutordoir, Roosenboom, and Vasconcelos (2014) showed that the disclosure of forecasted synergy values in M&A announcements is beneficial for bidding companies because they experience higher stock market returns due to a better reception of the announced deal by the investment community. According to Galpin and Herndon (2014), the various strategic motives associated with the incidence of M&A transactions can be clustered into eight Cs. In particular, these Cs refer to costs (i.e., rationalize the current cost structure), channels (i.e., expand the distribution channels), content (i.e., extract benefits from new products or services), capabilities (i.e., develop additional skills and build strategic advantages), customers

10  Overview of M&As and Executive Compensation (i.e., diversify the extant customer base), countries (i.e., gain exposure to other geographical markets), capital (i.e., exploit new financial opportunities), and capacity (i.e., augment the size of business operations). From this strategic management standpoint, it is the shareholder wealth maximization that guides managerial action inducing organizations to involve in M&A deals.

Postacquisition Underperformance After years of systematic research, scholars started to recognize that the pursuit of economic efficiency and value creation is not the main reason for the conduct of M&A activities. If that were the case, the results of empirical works would have explicitly shown that M&As contribute positively to an acquiring firm’s performance, enhancing shareholders’ wealth. Yet many studies that focus on measuring the returns to acquiring stockholders are inconsistent with this view. Employing meta-analytic techniques to draw conclusions from 93 empirical papers, King, Dalton, Daily, and Covin (2004) found no evidence that acquisitions improve financial performance (i.e., abnormal returns and accounting performance) of acquiring firms, which is rather negatively affected to a modest extent. In a review of acquirers’ performance, Tuch and O’Sullivan (2007) showed that M&As have an insignificant impact on shareholder wealth in the short run but produce overwhelmingly negative returns in the long run. In an examination of 170 acquirers in the European banking sector from 1990 to 2004, Asimakopoulos and Athanasoglou (2013) demonstrated that the owners of these companies earned negative, although statistically insignificant, abnormal returns. Reporting an aggregate dollar loss of US $240 billion for acquirers’ shareholders, Moeller and colleagues (2005) concluded that M&A transactions performed over the 1998 to 2001 period are to be seen as mechanisms of “wealth destruction on a massive scale.” M&As undertaken during the sixth merger wave produced similar performance implications for acquiring stockholders who experienced negative abnormal returns of −9.1  percent over the 3-year window following the acquisition announcement (Alexandridis et al., 2012). When it comes to accounting measures of performance, the findings are mixed, with some studies reporting higher posttransaction operating cash flows (Andrade et al., 2001; Healy, Palepu, & Ruback, 1992) and others demonstrating that acquisitions generate negative industry-adjusted returns on assets and returns on equity (Lu, 2004). Some researchers suggest that these detrimental post–M&A effects are driven by the suboptimal selection of acquisition terms, such as the payment of exaggerated premiums in a transaction and the stock-based choice of deal financing (Song & Walkling, 2004; Varaiya & Ferris, 1987). Others argue that returns to acquiring shareholders are influenced by the conduct of cross-border versus domestic, multiple versus single, conglomerate versus related, merger-wave versus non–in-wave deals (Andonova, Rodriguez, & Sanchez, 2013; Nankervis & Singh, 2012; Uddin & Boateng, 2009). Selected

M&A Activities  11 studies on the relationship between various acquisition characteristics and postdeal performance are discussed next. Acquisition Premium and Performance According to Sirower (1998), the magnitude of the premium paid to the shareholders of target firms represents an important predictor of the amount of possible losses caused by the M&A deal, because any payment, even a small one, above the current market value of the target company can be considered as wealth destructive for acquiring shareholders (Hitt & Pisano, 2003). Sometimes corporations pay such an exorbitant sum of money to gain control of another firm that they cause their own bankruptcy (Haunschild, 1994). This was the case of Campeau, which declared bankruptcy one year after it paid a 124 percent premium to acquire Federated Department Stores because of the inability to meet its debt obligations (Kaplan, 1989). Relying primarily on US data, scholars predict a significantly negative relationship between the size of control premium and the acquirer’s postdeal performance (Datta, Pinches, & Narayanan, 1992; Lubatkin, 1983). Using a large sample of 354 mergers that took place in the second half of the 1980s, Hubbard and Palia (1995) showed that bidders’ negative announcement returns originated mainly from their overpayment for target companies. In a study of 174 US firms that initiated M&As between 1992 and 1998, Krishnan, Hitt, and Park (2007) found that premiums inversely affected acquirers’ returns on sales over a 2-year period following the acquisition date. Acquiring firms with stronger governance structures, such as board members with prior investment banking experience, are better positioned in the determination of more favorable acquisition terms, paying lower takeover premiums and experiencing superior levels of performance in the long run (Huang, Jiang, Lie, & Yang, 2014). However, the evidence gathered on other national settings indicates that the relationship between the size of control premiums and bidders’ returns may be curvilinear rather than unidirectional. For 49 European M&A deals from 1995 to 2004, Diaz, Azofra, and Gutierrez (2009) reported a premium threshold of 21 percent, which separated the effects of synergy from the overpayment hypothesis. Method of Payment and Performance When it comes to the method of deal financing, the empirical findings tend to converge toward the view that cash offers are value maximizing in both the short run (Dong, Hirshleifer, Richardson, & Teoh, 2005; Draper & Paudyal, 1999) and the long run (Linn & Switzer, 2001), while common stock exchange offers are detrimental for acquiring stockholders (Travlos, 1987; Tuch & O’Sullivan, 2007). Over the five-year period following acquisitions, Loughran and Vijh (1997) found positive abnormal returns of 61.7 percent for cash transactions but negative excess returns of −25 percent for stock deals. Ghosh’s (2001) research produced similar outcomes, indicating that

12  Overview of M&As and Executive Compensation acquiring firms’ total asset turnover improved for cash deals, whereas their cash flows declined in the case of stock-financed acquisitions. In a recent study of 1,300 cross-border M&As undertaken by Canadian acquirers, deals financed through equity exchanges significantly underperformed in the long run relative to their cash-based counterparts, despite showing initial promise due to a positive stock market reaction in the short run (Dutta, Saadi, & Zhu, 2013). Using a sample of 5,726 American acquisitions between 1985 and 2001, Song and Walkling (2004) reported negative announcement returns for equity bids and positive abnormal returns for bids where cash was used as a method of payment. Similarly, for a large database of 9,712 M&As, Moeller, Schlingemann, and Stulz (2004) showed that small acquirers gained 2.84  percent in cash-based transactions and lost 0.42  percent in stock-financed deals. This occurs because equity financing signals to the market that bidder’s stock is overvalued, calling for downward adjustments in stock price, whereas the tougher regulatory approvals with longer periods of time involved open the competition to other bidders and allow target management to install antitakeover protections, increasing the total costs for the acquiring company. According to Mitchell, Pulvino, and Stafford (2004), these findings can also be explained by the dilution of bidder’s share price ensuing from the stock payment where the number of shares outstanding increases while the acquirer value remains unchanged. Other M&A Features and Performance Relying on a sample of 373 cross-border transactions, Uddin and Boateng (2009) examined how specific M&A features influence the short-term performance of British acquirers. Their study demonstrated that unrelated deals and acquisitions of targets that are publicly traded and originate from European rather than North American locations lead to lower firm performance in the short run. This empirical evidence regarding the association between acquirers’ returns and targets’ private/public status built on British samples was confirmed in other national settings. Both Fuller, Netter, and Stegemoller (2002), who analyzed 539 US bidders that completed multiple acquisitions over a short period of time, and Capron and Shen (2007), who employed a sample of multinational bidders, reported that the performance of acquiring companies is higher when purchasing a private business entity rather than a publicly held firm. For takeover bids announced over the 1998 to 2005 period in nine countries from East Asia, Chen, Huang, and Chen (2009) found that the incidence of cross-border M&As is influenced by financing constraints incurred by the acquirer. Cross-border deals are favored by bidders that have better access to external financing, with the exception of family-owned and state-controlled enterprises, which opt for domestic deals to avoid diluting their management control. According to Ferreira, Mass, and Matos (2010), the rate of cross-border transactions increases under the presence of foreign

M&A Activities  13 institutional ownership, mainly in countries with underdeveloped markets for corporate control and weaker regulatory environments. In an analysis of more than 300,000 M&As that took place between 1992 and 2009, Aktas, de Bodt, and Roll (2013) showed that repetitive acquirers extract significant learning benefits from undertaking successive acquisitions. These findings are consistent with the experience effect observed in earlier studies, which demonstrated the presence of important cost efficiencies ensuing from the completion of frequent acquisitions in the American banking industry at the end of the 1980s (DeYoung, 1997). However, substantial disagreements exist in the literature on whether conglomerate transactions generate wealth-enhancing or value-destroying consequences for acquiring shareholders. While some researchers demonstrate that focused acquiring companies produce significant synergistic effects to outperform unrelated acquirers (Shim, 2011) that earn negative abnormal returns (Cornett, Hovakimian, Palia, & Tehranian, 2003), others do not find that the costs of industrial diversification outweigh its benefits (Shekhar, 2005). In an examination of 446 Australian deals over the 2000 to 2007 period, Nankervis and Singh (2012) did not report any statistically significant differences in terms of announcement-related abnormal returns between acquisitions that were diversifying in nature and those that were pursuing industry specialization. Acquisition Timing and Performance Other authors associate the acquirer’s performance impairment with the dominant characteristics of the period when the transaction took place (Duchin & Schmidt, 2013). Recently, Andonova and colleagues (2013) discussed the strategic connotation of the specific timing for carrying out acquisitions earlier or later in the wave to extract either first-mover or late-mover advantages. Using a sample of 145 Colombian privately held acquiring companies, the authors provided significant support for strategic waiting where acquirers that perform M&As later in a wave benefit from more acquisition experience and knowledge about the target. Therefore, these firms exhibit stronger postacquisition performance as opposed to companies that get involved in acquisition deals at the peak of a wave to generate the lowest level of return on assets. Although the findings of McNamara, Haleblian, and Dykes (2008) are more consistent with early-mover advantages with acquirers at the top of the wave succumbing to bandwagon pressures, the authors also indicated that acquisition returns ameliorate at the farthest end of the wave due to learning by observation effects. The presence of multiple agency problems in transactions initiated during periods of high merger intensity, such as poorer quality of analysts’ predictions, weaker monitoring, and lower penalties for value-decreasing acquisitions, was highlighted in the study of Duchin and Schmidt (2013). The corporate governance standards and postdeal performance were found to be significantly weaker for merger-wave acquirers relative to non–in-wave acquirers, leading to the conduct of bad acquisitions.

14  Overview of M&As and Executive Compensation

Hubris Hypothesis Taking into consideration this well-documented evidence on postacquisition underperformance and value destruction, some authors suggest that closer attention has to be given to the analysis of cognitive and emotional processes and inherent motives of top executives who decide to engage in M&A transactions. The hubris hypothesis of corporate takeovers was conceptualized by Roll (1986) to explain why acquisitions fail to generate the expected financial benefits to acquiring shareholders. Since hubris is viewed as the dark facet of the self-conscious emotion of pride, which is associated with arrogance, overconfidence, exaggerated self-importance, and narcissistic self-aggrandizement (Bodolica & Spraggon, 2011), cognitively biased hubristic managers end up making erroneous valuation estimates that induce them to initiate value-destroying deals. Hubris-infected chief executive officers (CEOs) are more likely to overestimate the value of the target company, outbid the rivals, and win the contest for taking over the target (Hayward & Hambrick, 1997). Yet the exaggerated control premiums resulting from this contest represent the winner’s curse (Schwert, 2000; Varaiya & Ferris, 1987) due to the premiums’ detrimental effect on the abnormal returns to acquiring firms’ shareholders (Malmendier & Tate, 2008). In a review of recent hubris-related literature, Spraggon and Bodolica (in press) showed that many studies confirm the hubris hypothesis in various empirical settings. According to Ferris, Jayaraman, and Sabherwal (2013), the overconfidence of CEOs of Fortune Global 500 companies can explain a number of factors associated with international M&A deals, such as their magnitude, frequency, and method of payment. Chatterjee and Hambrick (2007) reported that narcissistic executives in computer firms initiated frequent and large-volume acquisitions that led to either big wins or big financial losses. For a sample of 5,334 UK transactions undertaken over the 1980 to 2004 period, the exaggerated self-confidence of top managers was responsible for poor announcement returns and the negative long-term performance of acquiring firms (Doukas & Petmezas, 2007). Other studies corroborate the simultaneous role of hubris and other motives that determine executive decision making in the context of corporate takeovers. The coexistence of hubris and synergy hypotheses was demonstrated on large samples of both domestic US transactions and cross-border deals involving American acquirers (Berkovitch  & Narayanan, 1993; Nguyen, Young, & Qian, 2012; Seth, Song, & Pettit, 2000). In an analysis of serial acquirers in emerging markets, Al Rahahleh and Wei (2012) concluded that the decreasing patterns of returns ensuing from subsequent M&As can be explained partially by hubris and partially by competition for corporate control. A related view of M&A occurrence is that hubristic managers pursue personal objectives of increasing their own wealth, even if it comes at the expense of corporate owners. Many empirical investigations show that

M&A Activities  15 organizational size is an important predictor of the magnitude of top management teams’ compensation (Tosi, Werner, Katz, & Gomez-Meija, 2000). Since larger companies pay more, executives have personal incentives to get involved in activities that result in an increased corporate size. According to Combs and Skill (2003), by tying their compensation to firm size, risk-averse CEOs can reduce variability in their pay as size is less variable and more under managers’ control than performance. Recognizing that self-serving managerial purposes rather than shareholder wealth maximization may drive acquisition decisions, many researchers have chosen to examine the relationship between executive compensation and expansion strategies realized through M&As (Bodolica & Spraggon, 2009a).

Market for Corporate Control Hypothesis The market for corporate control hypothesis suggests that acquisitions operate as external governance devices that take place for disciplining nonefficient target firms whose lower market value compared to real value allows acquiring companies to earn abnormal returns (Hopner & Jackson, 2006). As Spraggon and Bodolica (2011) note, M&A activities can discipline not only the poorly performing companies by transforming them into potential takeover targets but also the executives of acquiring firms who initiate value-destroying acquisitions by displacing them from their top management positions. The empirical support for this takeover market hypothesis is not consistent, with some studies confirming and others rejecting it in different regulatory contexts. On the one hand, reporting that activist investors’ block share purchases in diversified and poorly performing American companies are followed by increases in operating profitability and decreases in M&A transactions, Bethel, Porter, and Opler (1998) corroborated the governance role of the market for partial corporate control in the USA. On the other hand, finding that financial performance is not a differentiating feature between acquired and nontarget firms, Tsagkanos, Georgopoulos, Siriopoulos, and Koumanakos (2008) concluded that acquisitions in Greece occur mostly for strategic rather than disciplining purposes. Offenberg’s (2009) findings for 8,000 deals from 1980 to 1999, which indicate that the likelihood of becoming the target of a disciplinary takeover and of CEOs being penalized following a series of bad acquisitions is higher for larger than smaller firms, contradict the implicit assumptions of Moeller and colleagues (2004). The predominance of hostile deals in the fourth merger wave increased the number of studies on targets’ hostility and antitakeover provisions, contributing to the further enrichment of the complex M&A landscape. Although they are quite frequent in the USA, hostile acquisitions are nearly absent in some countries, such as Germany (Goergen, Manjon, & Renneboog, 2008) and Qatar (Bodolica, 2013), irrespective of their level of takeover market development. Thus, despite the young nature of the market for corporate control in Russia, the number of hostile takeovers in this emerging economy

16  Overview of M&As and Executive Compensation is higher than in most countries of the EU (Demidova, 2007). Hostile deals involve more competition and longer periods of time for being completed, requiring the payment of higher control premiums for winning the bid. This scenario generates beneficial wealth consequences for target owners but may be detrimental to acquiring shareholders if the takeover occurs for wrong managerial motives, such as empire building, or when the acquirer ends up paying too much for a target (Kim et al., 2010). The disciplinary role of hostile acquisitions was generally corroborated in empirical settings (Kohler, 2012; Song & Walkling, 1993) because the threat of takeover aligns managers’ interests with those of owners improving the economic efficiency. However, one obstruction to effective governance in the context of target hostility is the deployment of takeover defenses, which may diminish the disciplinary effect of markets for corporate control. Many antitakeover measures exist at both firm level (e.g., poison pill, golden parachute, staggered board, and greenmail) and state level (e.g., freeze-out law and fair price law), each of them having specific costs and benefits (Kim et al., 2010). They operate by making it very expensive for a raider to complete the deal, reducing the probability of takeover. The reliance on these defenses varies from country to country, where managers can decide to use them either separately or in combination and implement them either before the takeover attempt or postfactum (Bodolica, 2013; Demidova, 2007). For instance, since state-level antitakeover regulations in Canada are less prohibitive than the American ones, Spraggon and Bodolica (2011) and Tannous and Cheng (2007) argue that the Canadian M&A market might more effectively perform its governance objective, increasing the turnover rates of underperforming managers in both target and bad acquiring firms. The effectiveness of takeover defenses in creating stockholder wealth is open to debate, as witnessed by the inconsistency of results obtained by scholarly inquiries into the topic. Some authors maintain that takeover deterrents are harmful for shareholders because they contribute to the on-the-job entrenchment of inefficient executives, while others argue that they benefit corporate owners, as managers are better positioned to negotiate more favorable terms in a deal (Straska  & Waller, 2010). In some countries, like Australia, where the US-style antitakeover arrangements are prohibited, acquirers were reportedly more likely to engage in synergistic deals that produced positive returns to their shareholders, while bidders that destroyed value in mergers were more likely to be disciplined by the market by becoming takeover targets, compared to the extant American evidence (Humphery-Jenner & Powell, 2011). Recently, antitakeover laws were found to inhibit corporate innovation (Atanassov, 2013) and golden parachutes continued to spread across firms despite being seen as a controversial practice (Fiss, Kennedy, & Davis, 2012), whereas the presence of staggered boards did not play any role in M&A transactions undertaken by real estate investment trusts (Campbell, Ghosh, Petrova, & Sirmans, 2011).

M&A Activities  17 THEORETICAL TENSION ON THE CONDUCT OF M&A DEALS From the standpoint of the agency theory, which relies on the principle of separation of ownership and control (Jensen & Meckling, 1976), the conflicts of interest arising between value-oriented shareholders and self-interested managers who engage in empire building create the need for an effective corporate governance system that would stimulate good behavior among CEOs. Among the most common governance mechanisms for tightening the alignment of executives’ and shareholders’ interests and solving agency problems are incentive compensation and monitoring by the board of directors (Agrawal & Knoeber, 1996). Tying executive pay to firm performance should reduce managerial opportunism and encourage executives to behave in the best interests of shareholders by selecting value-enhancing acquisitions. Yet the results of empirical studies demonstrate that this assumption does not always hold. On the one hand, some authors report that managerial stock ownership and the existence of long-term incentive plans determine positive abnormal returns at acquisition announcements (Lewellen, Loderer,  & Rosenfeld, 1985; Travlos  & Waegelein, 1992). On the other hand, selected scholars find that at substantial levels of managerial shareholding, CEOs tend to emphasize non–value-maximizing risk reducing acquisitions (Wright, Kroll, Lado,  & Van Ness, 2002). The same inconsistency characterizes extant research on managerial compensation in the period following the acquisition completion. While some studies show that acquiring executives are penalized for selecting value-destroying deals (Dorata, 2008; Girma et al., 2006), others demonstrate that executive rewards are not related to different measures of postacquisition performance (Bliss  & Rosen, 2001; Schmidt  & Fowler, 1990). In an effort to clarify this conflicting evidence, the advocates of the political perspective suggest that looking at compensation arrangements through the power lens may allow understanding why executive incentives are not always an efficient remedy to the agency problem (Bebchuk & Fried, 2004). The political reality in modern corporations implies that managers exert too much power over their boards, thus gaining extensive control over the compensation-setting process in their firms. From this point of view, a board’s apparent failure to fulfill its monitoring responsibilities can be explained by the CEO’s entrenchment, where the CEO uses the de facto power associated with his/her job to influence the functioning and decisions of the board (Barkema & Pennings, 1998). This managerial entrenchment, which may come in the form of structural, ownership, expert, and prestige power (Finkelstein & Hambrick, 1988), contributes to the weak pay-for-performance relationship and inefficient design of CEO compensation packages. Moreover, due to demographic homogeneity and social rules of elitist cohesion, board members might be more interested in making decisions that maximize the wealth of executives

18  Overview of M&As and Executive Compensation to whom they are indebted for their nomination and granting of business contracts with their companies. These political assumptions have already received some empirical support in the context of M&As. Grinstein and Hribar (2004) found that it is the managerial power over the board of directors that drives the payment of large cash bonuses for acquisitiveness to American CEOs. In their analysis of the relationship between the structure of executive compensation contracts and M&A features, Bodolica and Spraggon (2009b) rely on the symbolic view to explain boards’ inability to ratify exclusively value-enhancing low-premium and cash-based deals. From a symbolic perspective, CEO compensation strategies are based on the management of impressions that aim to prevent executive pay from being questioned or criticized and guard against the social dysfunction that can result from unfair judgments (Westphal  & Zajac, 1998; Zajac  & Westphal, 1995). The authors argue that directors are willing to exert significant control over managerial behavior only when the need becomes apparent, and M&A deals give rise to such a need. Since in the predeal period, agency costs tend to be lower, boards passively ratify the choices of control premium and mode of payment made by the executives. Yet when the selection of M&A features proves to be ineffective, resulting in decreased postacquisition performance, the board is urged to intervene and push for stronger mechanisms of incentive alignment. In the postdeal period, CEOs’ legitimacy in executive positions is threatened, while boards of directors’ symbolic commitment to shareholders’ interests is enhanced by poor firm performance stemming from high acquisition premiums and stock-based financing. Directors successfully manage investors’ impressions by adopting performance-related compensation arrangements, which are more easily justified in the eyes of corporate stakeholders (Wade, Porac, & Pollock, 1997). The recent statistical data provided in this chapter indicate that M&As represent a popular strategy of corporate growth whose occurrence will continue attracting a great deal of attention from practitioners and researchers around the globe. Yet in light of the discussion, it remains unclear whether the conduct of M&A activities is determined by shareholder wealth-maximization motives or by the need of self-interested managers to extract private benefits and increase their own welfare. In the specific context of active markets for corporate control, are the compensation packages designed in a way that allows solving agency conflicts of interest between executives and shareholders, or is the managerial entrenchment responsible for undermining the effectiveness of compensation arrangements as an instrument of formal governance? One of the main purposes of this book is to depict whether the results of extant research on executive compensation around M&A transactions reflect shareholder value creation rationales or managerialist orientation or whether the empirical data start to inform one theoretical perspective over another.

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2 Incentive Design of Executive Compensation Packages

CURRENT DEBATES IN THE FIELD OF EXECUTIVE COMPENSATION A critical component of the corporate governance system is when a board of directors actively seeks to protect owners’ interests by monitoring top management actions and devising appropriate executive compensation contracts (Chatterjee, Harrison, & Bergh, 2003). Because the activities of decision makers in organizations are not readily observable by shareholders, a real possibility arises that managers, seen as utility maximizers, would fall prey to moral hazard in the execution of their tasks. This may have various manifestations such as shirking, pursuing unnecessary expansion strategies, enjoying extravagant corporate benefits, having a shortened time horizon, and withdrawing from worthwhile but risky undertakings. Agency theory adepts suggest that the incentive design and the monetary magnitude of CEO compensation packages represent a viable solution to the problem of moral hazard (Tosi & Gomez-Mejia, 1994). Yet this view is not shared by the proponents of the political perspective, who argue that executives exercise significant power over their boards to influence them in their pay-related decisions (Bebchuk & Fried, 2006). Although governance researchers have long been focusing on the examination of the effectiveness of CEO compensation as a mechanism of incentive alignment (Kim, Nofsinger, & Mohr, 2010), the interest of the general public in this topic intensified during the 1990s. This tendency can be explained by the “unstoppable climb” observed in the level of executive pay (Morgenson, 2013) and the constantly widening wage gaps between managers and average workers (Sorapop & Norton, 2014). Many critics argue that CEO pay is at best only marginally associated with firm performance, meaning that executives are often insulated from the negative consequences of their unprofitable actions and value-destroying decisions. Recently, people were enraged to witness the continuous growth in the total value of compensation packages of managers of banks despite the credit crunch and the dismal situation of other employees in these organizations (Thomsen & Conyon, 2012). The American International Group was placed at the center of controversy in 2009 when it paid out more than US$170 million in bonuses to its top executives using the taxpayers’ money

26  Overview of M&As and Executive Compensation that was provided by the American government to bail out the group (Baker, 2013). In their empirical study, Tian and Yang (2014) demonstrated that the CEOs of financial institutions in the USA fared much better during the financial crisis than the shareholders of their firms and that alterations in pay levels and incentive-pay switches are positively related to CEO power. In the midst of the financial turmoil that brought about a massive wave of corporate defaults and failures, the lavish executive pay has come under an even more intense spotlight. Considerable public criticism levied at high compensation packages of managers has colored a spirited debate as to whether CEOs are worth what they are paid that continues to animate much of the literature in this field (Bogle, 2008; Kaplan, 2008; Walsh, 2008).

Global Executive Compensation Data Pay inequality and overcompensation of American CEOs have been points of contention for scholars, practitioners, and policy makers in the United States starting from the 1980s (Crystal, 1991; Reingold & Jesperson, 2000). According to analysts’ reports, compensation-related figures of American executives have been growing over time much faster than corporate profits and other indicators of general economic health, leading to the conclusion that managers are always winners while workers are losers in this battle for an increased overall wealth (Anderson, Cavanagh, Hartman, & Klinger, 2003). The average annual compensation of a Fortune 500 CEO in the USA, which was more than US$12  million in 2012, is significantly higher than the amount earned by top executives in other developed countries (Ferdman, 2014). This number surpassed US$14 million when the top 350 companies were considered, representing an increase of 37.4 percent over the 2009 levels (Mishel & Sabadish, 2013). In 2013, Larry Ellison (the former CEO of Oracle Corporation headquartered in California) alone garnered US$96 million in total compensation. The same year, Charif Souki, the CEO of Cheniere Energy, which to date has never made a profit, was paid an impressive US$141.9 million, topping the list of the highest-paid executives of 200 publicly listed US firms tracked by Equilar (De Aenlle, 2014). The highest-paid CEOs in Switzerland, Germany, Spain, and Australia made in 2012 around US$7.4 million, US$5.9 million, US$4.4 million, and US$4.2 million, respectively (Ferdman, 2014). In the case of French, British, and Swedish chief executives, the average pay per annum oscillated between US$3.9 million and US$3.3 million. The most recent EU data gathered for the 2013 fiscal year indicate that the level of average actual total direct compensation of CEOs in Eurotop 100 companies surpassed 5.5 million euros (Towers Watson, 2014). It is worth noting, however, that there were large discrepancies in the overall value of executive pay packets across Europe. In 2013, the best-compensated CEOs (more than 6 million euros) originated from Switzerland, the UK, and Spain, while the worst-paid executives (slightly above 2 million euros) were living in Nordic countries such as Sweden, Denmark, and Norway. The median total pay of European CEOs

Incentive Design of Executive Compensation Packages  27 generally increased in 2013 compared to the previous year, with the exception of Swiss, Spanish, and German executives, whose total compensation magnitude was actually lower in 2013 than in 2012 (Towers Watson, 2014). According to Mishel and Sabadish (2013), who have published a report on long-term compensation trends of executives of large American corporations, the CEO pay grew about 875 percent over the 1978 to 2012 period, while this increase corresponded to only 5.4 percent for a typical employee. The largest gap between CEO and average worker pay around the globe was also registered in the USA, where executives got 354 times more than unskilled employees during the year 2012 (Sorapop & Norton, 2014). This is about 2.4 times higher than the third- and the fourth-largest CEO-to-worker pay ratio worldwide which was recorded in Switzerland and Germany (Ferdman, 2014). With an average executive pay of US$8.7 million and an average worker pay of US$42,253, the ratio of 206 to 1 in Canada was responsible for the second-worst compensation gap in the Western world (PressProgress, 2014). Other countries where the 2012 CEO-to-worker pay ratio was above 100 to 1 are Spain, Czech Republic, and France, while in Australia, Sweden, and the UK, CEOs made 93, 89, and 84 times the average employee, respectively.

Explaining Cross-Country Variations in CEO Pay Pay-at-Risk Conyon, Core, and Guay (2011) suggest that the significantly higher CEO compensation levels in the USA compared to those in other countries can be attributed to risk factors. A closer look at the design of executive pay packages demonstrates that important cross-country variations exist in the amount of fixed compensation versus risky forms of equity holdings. The pay-at-risk includes different compensation modes that are contingent upon firm performance such as bonuses, stock options, equity ownership, and restricted stock awards. The payouts from these elements are highly uncertain and not guaranteed, contrary to the salary, which is always paid in full disregarding the evolving financial situation of the company that the executive leads. A recent study shows that American CEOs bear more risk, as 72 percent of their compensation packet is made of performance-based incentives, compared to 54 percent for their non–US peers (Fernandes, Ferreira, Matos, & Murphy, 2013). Over the past decades, boards of directors in American corporations have been constantly increasing the equity-based component of incentive contracts, awarding to the representatives of the top management team significant amounts in stock option grants and requiring them to hold important ownership stakes in their company (Benmelech, Kandel, & Veronesi, 2010). Although about two thirds of total compensation is typically delivered to US CEOs in the form of options and other stock awards, this amount may even exceed 86 percent in larger organizations (Thomsen & Conyon, 2012). In some extreme cases, the entire compensation of an American executive may be at risk. When the ex-CEO of Oracle refused to be paid in cash during

28  Overview of M&As and Executive Compensation the 2013 financial year, the corporate directors offered him an impressive quantity of stock options, which were valued at an estimated US$77 million at the time of the grant (Kristof, 2014). Conversely, in some countries such as Belgium, China, and Japan, the proportion of fixed compensation can constitute more than 70  percent of the total package, with less than one third being reserved for performance-contingent pay (Kim et al., 2010). Indeed, the 2013 data show that the base salary constituted 64 percent of the total pay of Swedish, Danish, and Norwegian CEOs, representing a 5 percent decrease from the previous year (Towers Watson, 2014). Despite the generally pronounced tendency across the European continent to gradually enlarge the amount of variable pay in executive compensation contracts, Spanish CEOs have actually witnessed a reverse phenomenon. The proportion of fixed pay disbursed to top executives in Spain increased from 37 percent in 2012 to 45 percent in 2013. Although incentive pay was most significant in the UK, Switzerland, and Germany, where it approached the level registered in US corporations, this effect was driven by both long-term stock-based rewards and payouts made from short-term bonuses that are linked to operational targets. Corporate Governance Systems The observed cross-country variations in executive compensation magnitude and structure can also be explained by cultural factors, corporate governance systems, legal infrastructures, and specific regulatory interventions with regard to CEO pay. Relying on prior literature in the field, Thomsen and Conyon (2012) attempted to summarize both qualitatively and quantitatively the distinguishing features of governance systems in different countries around the world that may be influential in the executive pay-setting process. Common-law nations, such as the USA and the UK, are driven by market- or investor-based governance due to the large size of national stock markets and high number and value of listed companies. The typical owners of American and British corporations are institutions (e.g., insurance firms, pension funds), the influence of banks is limited, the level of investor protection is high, and the ownership concentration is relatively low (around 20 percent). The one-tier board structure in these countries is indicative of the presence of only one corporate board of directors, which is staffed by many outsiders and about 30 percent of executive members, while lower-level employees are not allowed to have board representation. Considering that the percentage of managerial performance-based pay is similar in the US and UK (70 and 50 percent, respectively), the only significant difference between the two systems refers to the prevalence of the CEO-chairperson duality (80 and 10 percent, respectively). The stakeholder type of governance dominates in Germany and Scandinavia because of the importance that multiple parties play in the corporate governance system in these civil-law European nations (Thomsen & Conyon, 2012). The ownership by members from founding families is quite common, the investor protection is average, and the level of incentive pay is relatively

Incentive Design of Executive Compensation Packages  29 low, while the role of banks is much more significant in Germany than in Norway, Sweden, and Denmark. What is specific about these countries is the two-tier board system in which the supervisory board, which is composed by nonexecutive directors who represent the company employees, oversees the activities of the management board and in which the dual CEO-chairperson position is restricted by law. The mandatory codetermination regulation particularly in Germany provides (paradoxically only) German employees with a systematic voice in critical corporate decisions, which typically translates into risk-aversive strategies and labor-friendly policies that require a close collaboration with worker councils to be implemented (von Rosen, 2007). The public governance system in France, due to high levels of governmental intervention, features medium levels of both ownership dispersion and investor protection and one-tier boards with frequent duality situations (80 percent), nonexistent employee representation, and average degree of managerial representation (40 percent). Finally, the Japanese system is labeled by Thomsen and Conyon (2012) network governance because of the predominance of corporate type of owners, where companies hold shares in each other and where banks play a crucial intermediary role between savers and organizations. Moreover, the one-tier system in Japan implies no employee representation and a significant reliance on executive membership (more than 90 percent) on the board of directors, which tends to favor seniority-related rationales rather than the performance-driven philosophy of top management pay. Some authors provide a cultural perspective for analyzing the peculiarity of national executive compensation practices. In Germany, the corporation is valued as such, private goods are deployed for the benefit of the society, long-term thinking is encouraged, and the ultimate goal is corporate survival rather than the CEO’s personal success and enrichment (Charkham, 1995; von Rosen, 2007). These predominant traits of the German corporate culture are probably responsible for the fact that until the end of the 1990s, stock options as mechanisms of incentive alignment were prohibited by law. The significant disparity in the stock option pay between German and American executives was one of the major points in the cultural misfit that ultimately led to the failure of the merger that took place in 1998 between Germany’s Daimler-Benz and the US–based Chrysler Corporation. As for Japan, the bonus system based on collective targets should be interpreted in light of the country’s collectivistic culture, which prioritizes social motives over individual objectives, promotes strong corporate family values and feelings of honor and duty, and advances a consensus-based decision-making process (Witt & Redding, 2009). NATIONAL REGULATIONS WITH REGARD TO CEO COMPENSATION

Disclosure Legislation The USA has a solid and well-established tradition on executive compensation reporting that dates back to 1934, when the Securities and Exchange

30  Overview of M&As and Executive Compensation Commission (SEC) was established. Federal securities laws and national stock exchanges stipulate a detailed and understandable disclosure of the type and amount of compensation paid to CEOs, chief finance officers (CFOs), and the three other high-ranking executives in American publicly traded corporations. The firms’ annual proxy statements ought to not only report the raw data on the level and mix of CEO pay but also offer a clear discussion to elucidate the corporate philosophy that drives executive compensation–related decisions. This “rules-based” regime in the USA has a mandatory nature in which all listed companies are expected to fully comply with all these securities’ prescriptions (Spraggon, Bodolica, & Brodtkorb, 2013). Failure to abide by this disclosure regulation indicates that the company in violation will face serious legal consequences. Other nations differ fundamentally from this highly standardized system of regulatory enforcement, leaning more toward the principle of discretionary compliance. This is the case of the UK, which is known for its flexible “comply or explain” governance regime that started with the Cadbury Code in 1992. In this regime, companies can choose to either voluntarily adopt the norms of best practice recommended by local authorities or explain the reason for deviation and the alternative means that were used to achieve the same objective. Considering its common-law origins and the high number of cross-listed firms on the US stock exchanges, Canada was very much influenced by the developments in the USA and the UK. For all Canadian publicly held companies operating on the Toronto Stock Exchange, the US–style regulation, which requires the mandated disclosure of compensation levels and structure of the five highest-paid executives, came into force in 1993 (Bodolica & Spraggon, 2009). Yet, recognizing the idiosyncrasies of the Canadian institutional context, regulators have opted for the “principlesbased” regime, which is consistent with the UK “comply or explain” logic of good governance. In a recent comparative study of the adherence to this flexible governance regime in Canada and Australia, Salterio, Conrod, and Schmidt (2013) demonstrated that “compliance by explanation” is more common in Australia than in Canada, which prefers to follow “compliance by adoption.” The strong legislative background in the USA may be the reason for the proliferation of empirical studies on executive compensation in American corporations. In other countries, the analysis of pay packages of top management teams was until recently very difficult due to the lack of transparency encouraged by the less-developed disclosure legislation. For instance, until 2005, it was practically impossible to obtain reliable information about option grants made to top executives in Germany; even after that date, special voting arrangements were permitted to maintain the secrecy around various elements of CEO pay (Thomsen & Conyon, 2012). The situation in China has also evolved over time from less to more transparency in which regulators’ continuous efforts to improve the reporting of executive pay details coincided with greater openness of the Chinese economy to foreign direct investments (Conyon & He, 2011).

Incentive Design of Executive Compensation Packages  31

Recent Regulatory Interventions Nowadays, the pressure continues to mount for boards of directors to revise both the magnitude and the structure of CEO pay in a way that will more closely tie the executive wealth to that of corporate shareholders. For policy makers, this pressure translates into a constant need to revise extant legislation and introduce new governance norms that would contain the galloping executive compensation costs and design stronger performance-enhancing incentives. In the USA, the Sarbanes-Oxley Act enforced in 2002 set the foundation for the toughest and most onerous governance system in the world, aiming to enhance information transparency and prevent Enronstyle corporate disasters. Being a direct consequence of the 2008 financial crisis, the Dodd-Frank Act signed in 2010 induced another governance reform colloquially known as “say on pay.” This is a rule that provides shareholders with the right to vote on executive compensation, allowing them to voice their discontent with the current pay arrangements in their firm. Although this vote is merely advisory, meaning that the board is not legally constrained to alter the level and incentive design of CEO compensation packages, it offers yet another vehicle for firm owners to scrutinize pay-related decisions. Additionally, the Dodd-Frank Act provided further updates on the usage of clawback provisions in executive pay contracts, allowing the company to revoke the amounts paid to senior corporate officials as incentive compensation in case of catastrophic turns of events, regardless of fault. In Canada, a series of amendments to the National Policy 58–201 (Corporate Governance Guidelines) and the National Instrument 58–101 (Disclosure of Corporate Governance Practices) were made in the post-2007 period to request additional executive pay data and alter the way these data are reported (Spraggon et al., 2013). The Securities Regulation Commission in China continues its efforts, which started in the early 2000s, to strengthen the national corporate governance regime, build investor confidence, ameliorate the structural makeup of the board of directors, and implement stronger incentives for managers (Thomsen & Conyon, 2012). Currently, a wave of regulatory changes occurs in the EU member states, with the specific emphasis on improved information reporting and enhanced shareholder rights. Among these changes are the development of new frameworks and templates for executive compensation reports (UK, Spain), the establishment of absolute pay caps for different elements of CEO compensation (Germany, France), and further modifications regarding “say on pay” such as the mandatory discussion of the pay policy (Netherlands) or a binding vote on this policy (Spain, UK). In several European countries, such as Sweden, Norway, and the Netherlands, shareholders’ votes on managerial pay are already binding (Deane, 2007). The new EU Shareholders’ Rights Directive, designed on the basis of the recent UK experience, describes several good remuneration committee practices in terms of pay for performance, long-term compensation, governance and disclosure, and shareholder participation (Towers Watson, 2014).

32  Overview of M&As and Executive Compensation Due to all these regulatory interventions, the old days of managerial excess may be drawing to an end. According to Ward (2014), more and more corporations direct their efforts toward aligning their executive pay philosophy with the firm strategy and respecting the principle of internal rather than external equity to reduce the disparity between the CEO’s compensation and that of other employees. Some practitioners argue that although corporate governance reforms boosted boards’ effectiveness in protecting investors’ interests, they did little to enhance directors’ performance in monitoring the top management team and the strategy-setting process in organizations. For Parsons and Feigen (2014), the best corporate boards are those that pursue a “quiet revolution” to transform themselves into experts for overseeing strategy and talent, adequately structuring the board, focusing on the quality of discussion, and nurturing a good relationship with the CEO. VARIOUS ELEMENTS OF CEO COMPENSATION CONTRACTS The specialized literature shows that the composition of CEO compensation packages influences the business decisions of executives, affecting the performance level of their companies (Core, Holthausen, & Larcker, 1999; Gaver & Gaver, 1995) and that alterations in the structure of CEO pay may be conceived as a lever of strategic change in organizations (Simons, 1995). The typical components of executive compensation packets are the base salary, short-term bonuses, long-term incentive plans (LTIPs), benefits, and perquisites (Bodolica, 2005). The base salary of an executive is determined via competitive benchmarking, and in large US firms, it amounts to US$1 million, representing about 20 percent of the total pay (Thomsen & Conyon, 2012). Annual bonuses are intended to reward CEOs for the achievement of short-term performance targets, while long-term incentives seek to expand the managerial time horizon, being tied to stock market or accounting-based measures of performance. Other pay elements include special benefits in the form of supplemental executive retirement plans and a generous key executive life insurance policy (known as “golden coffins”) and various perks, such as management loans, severance packages, financial counseling, and relocation assistance. Externally hired top managers can also take advantage of guaranteed “make whole” payments, which are made to substitute the earnings that will be lost due to the change in employment. Compensation plans make it possible for the benefits (that the top manager currently possesses) to be accelerated, such as an immediate option vesting (Bebchuk, Cohen, & Ferrell, 2009). Frequently, boards of directors decide to grant special payments in the form of “golden good-byes” when senior executives (who lack a golden parachute in their ex-ante pay contracts) lose their job due to a forthcoming acquisition. Recognizing the complexity of the incentive structuring of CEO pay, Bodolica and Spraggon (2009) highlight the importance of analyzing several special attributes of executive compensation contracts, including employment agreements, severance provisions, golden parachute clauses, and LTIPs.

Incentive Design of Executive Compensation Packages  33

Compensation Protection Devices Since the employment agreement, severance provision, and golden parachute clause have the common feature of guarding executives against job-related uncertainties and unforeseeable events, Bodolica and Spraggon (2009) argue that these three attributes can be included in the group of compensation protection devices. The employment agreement is a contractual agreement between the CEO and the firm that determines the levels of compensation, work duration, and other terms of employment (Sirkin & Cagney, 1996). If there is no such agreement, the executive is unsure of his or her future with the company, and with little job security, the CEO becomes very vulnerable. Knowing that their jobs could entail substantial risk, executives tend to seek maximum protection against adverse events. Some governance advocates suggest that CEOs should not have employment contracts, because they represent great defenders of executive rights and interests but limit the employers’ flexibility (Navas, Chen, & Ma, 2007; Tauber & Levy, 2002). This suggestion is not always followed, and companies that seek to recruit top executives offer these agreements to CEOs, who have come to expect them as a safety net should the employment relationship break down. Most employment agreements provide severance when the executive either is terminated involuntarily without cause or decides to terminate employment voluntarily for “good reason” (Tauber & Levy, 2002). Severance provisions differ from employment agreements, as they do not cover duties and responsibilities but are limited to specifying payments and benefits to be given to CEOs should termination of employment occur for reasons other than cause. According to Sirkin and Cagney (1996), the most common terms included in the definition of “cause” for termination refer to the commission of a crime, abuse of alcohol or drugs, willful misconduct, negligence, violation of the firm’s code of conduct, breach of confidentiality, or breach of fiduciary duty. The typical occurrences that entitle an executive to resign for good reasons are demotion in the position, failure to be reelected as a board member, late payment of salary, relocation of CEO’s workplace, and uncured breach by the employer. The golden parachute clause, which applies to situations when the termination of executive services occurs due to the change in corporate control (Bodolica, 2005), is usually included in the severance provision of CEO pay, but if this is not the case, the executive can negotiate such protection in a separate agreement. Golden parachutes generally guarantee the contract holder a continuation of base pay and bonus for one to five years, the immediate vesting of any stock options, insurance coverage, availability of outplacement assistance, and acceleration of pension plan qualifications (Patterson, 2002). Traditionally, these clauses did not require shareholder approval to be implemented but necessitated only an agreement between the manager and the board of directors (Subramaniam & Daley, 2000). Yet the recent “say on pay” governance reforms taking place across North America

34  Overview of M&As and Executive Compensation and Western Europe generally mandate nonbinding votes of shareholders on all golden parachute adoptions in publicly traded companies (Bebchuk, Cohen,  & Wang, 2014). Although it is quite improbable for corporate investors to vote against golden parachutes, it does sometimes happen. This was the case of Cooper Industries, where 59 percent of owners turned down a US$79.3 million payout that the former CEO Kirk Hachigian was supposed to receive after his firm was acquired by Eaton Corporation in 2012 (McGregor, 2014). Among the most-often-cited reasons for the implementation of golden parachutes are attracting and retaining key executives, keeping the management team intact, and deterring a hostile takeover by making the transaction more expensive for bidders (Henderson, 1997). Introduced on the American M&A scene at the end of the 1970s, golden parachute payments for CEOs became more prevalent in neighboring Canada in the late 1980s as the M&A activity intensified (St.-Pierre, 1994). In 2001, 43 percent of Canadian firms had such clauses, representing a modest percentage when compared to 71 percent of American companies (Cooke & Duffy, 2002). After North Fork Bank was sold to Capital One in 2006, North’s CEO John Kanas got US$214.3  million in severance and termination benefits (McGregor, 2014). These extreme cases of golden parachutes, particularly in the context of the recent financial crisis, have created a stir among the public and are often viewed as “insurance against incompetence” (Morrison, 1982) or “rewards for failure” (Loyola & Portilla, 2014). Although golden parachutes in large US firms remained flat over the 2011 to 2013 period, with an average value of US$30 million, corporate proxy statements still provide for giant change in control payments to be made to target CEOs. For instance, if Discovery Communications is taken over, its CEO, David Zaslav, could potentially earn US$232 million, while for David Simon, the CEO of Simon Property Group, the equivalent payout could reach US$245 million (McGregor, 2014).

Long-Term Incentive Plans Many CEO compensation contracts comprise other elements such as LTIPs, which currently account for the largest part of total executive pay in American companies, versus only 40 percent in Canadian publicly listed entities (Milkovich, Newman, & Cole, 2007). According to Tauber and Levy (2002), LTIPs tie executive pay to corporate performance and are used by employers for two purposes: to provide “handcuffs” to keep CEOs from leaving before the vesting of equity interests and to offer executives an incentive for enhancing long-term performance of the company by motivating them to act as shareholders and rewarding them for future appreciation in the stock price. LTIPs typically include one or more of the following v­ ehicles: stock ­purchase plans, stock options, stock appreciation rights, phantom stock plans, restricted stock awards, and performance units (or shares).

Incentive Design of Executive Compensation Packages  35 Stock purchase plans give recipients the possibility to purchase, under advantageous conditions, a number of shares within a short period of time, conferring immediate ownership. Some companies make stock grants or loan the CEO the required amount of money for purchasing a predetermined quantity of firm shares. Stock options offer the holder the right to buy company shares at a specified exercise price within a given long-term period, making it possible to buy stock in the future but at the current price. During the past decade, stock options became the focus of enhanced public interest due to boards’ heavy reliance on this compensation mode (in the US, stock options accounted for more than 50 percent of total CEO pay) and the controversial role played by options in corporate scandals (Certo, Daily, Cannella, & Dalton, 2003; O’Connor, Priem, Coombs, & Gilley, 2006). As many empirical studies began to report that option pay resulted in extreme corporate performance while option-loaded CEOs generated more large losses than large gains (Sanders & Hambrick, 2007), it became clear that the efficacy of stock options as mechanisms of incentive alignment could no longer be taken for granted (McGuire & Matta, 2003). Stock appreciation rights are generally attached to option grants and permit CEOs to exchange options for a cash payment equal to the stock price less the exercise price. Phantom stock plans represent cash or stock awards driven by the increase in stock price at a fixed future date. Under restricted stock awards, grants of common stock are made with the condition it may not be owned/ sold before a specified date or until a given performance target is achieved (Kim et al., 2010). Because of recent changes in US accounting regulations that mandated new and less favorable methods for expensing stock options, restricted stock became a more popular mode of executive compensation in American corporations than stock options (Thomsen & Conyon, 2012). As far as performance units are concerned, they confer the right to receive cash or stock to the extent that pre-established accounting-based performance goals are achieved over a long period, which in Canada is limited to three years due to income tax rules (Dessler, Lloyd-Walker, & Williams, 1999). ASYMMETRIC PROPERTIES OF VARIOUS ELEMENTS OF THE CEO PAY MIX Scholars argue that various attributes of CEO compensation packages possess asymmetric features and motivate opposite types of executive behavior, constituting more or less effective governance mechanisms for dealing with agency costs. Contrasting the risk properties of compensation protection devices and LTIPs (Bodolica & Spraggon, 2009) and of stock options and equity ownership (Spraggon & Bodolica, 2011), it may be possible to conclude when and under which conditions some elements of CEO pay could be considered stronger or weaker tools of incentive alignment in order to be either implemented or avoided by corporate boards.

36  Overview of M&As and Executive Compensation

Compensation Protection Devices Versus LTIPs According to Bodolica and Spraggon (2009), compensation protection devices and LTIPs have asymmetric risk properties and different adoption logics and, as such, they should lead to opposite executive behavior. According to the economic efficiency pursued by agency theorists, a perfectly devised compensation contract should include such vehicles that reward CEOs for creating shareholder value. LTIPs are put in place to perform the function of better controlling the agency costs (Sanders, 2001). By linking CEO compensation to firm performance, the board of directors can more easily monitor the managerial actions, protect shareholders’ interests, and discourage opportunistic behavior of executives. LTIPs also impose some risk on executives by increasing the levels of uncertainty in their compensation contracts. As articulated by Jensen and Meckling (1976), CEOs prefer to avoid performance-contingent pay unless it is foisted upon them by the board, and they are likely to respond to the introduction of LTIPs by reducing their risk-seeking activities, such as M&As. Given that those executives who are being compensated with LTIPs are less inclined to become involved in risky deals, LTIPs are expected to be adopted after the completion of M&A transactions. On the contrary, the largely documented political reality in modern corporations suggests that entrenched CEOs weaken board effectiveness in designing compensation packages and influence the introduction of pay modes that contribute to their personal wealth maximization (Westphal & Zajac, 1994). Proponents of a political perspective observe that the existence of power networks and informal relationships in organizations can favor the interests of managers (Lambert, Larcker, & Weigelt, 1993). Employment agreements, severance provisions, and golden parachute clauses are contractual attributes that diminish the uncertainty of CEO compensation by assuring executives that their pay is not at risk from a takeover or other situations that are out of their control (Agrawal & Knoeber, 1998). Since these attributes have similar effects of minimizing employment risks and maximizing managerial wealth, entrenched CEOs tend to exert power over the boards by influencing their decisions to adopt such compensation protection provisions. The implementation of these provisions in the preacquisition period is likely to motivate substantial managerial risk-seeking behavior, as rewards’ protection predisposes executives to make firm-specific investments and initiate some hazardous deals, such as M&As. The distinctive features of compensation protection devices and LTIPs and the opposite ways executives respond to their adoption (see Table 2.1) can also be explained using the symbolic management perspective (Bodolica & Spraggon, 2009). Advocates of this perspective are interested in the analysis of how corporate boards communicate the rationales underlying executive pay decisions in their firms (Elsbach & Sutton, 1992). To ensure their compensation decisions are not questioned by firm stakeholders, board members effectively manage their impressions by employing sound explanations that can be justified in the eyes of these stakeholders. In their study of 570 American firms, Zajac and Westphal (1995) showed that boards of

Incentive Design of Executive Compensation Packages  37 Table 2.1  Distinctive features of compensation protection devices and LTIPs Features

Compensation protection devices

LTIPs

• Employment agreement • Stock purchase plans • Severance provision • Phantom stock plans • Golden parachute clause • Restricted stock awards • Performance units (or shares) Uncertainty of CEO pay Lower Higher Protection of interests CEOs’ interests Shareholders’ interests CEO’s risk-seeking Higher Lower behavior Probability of adoption Before M&As After M&As Implementation logic Strategic human resource Agency & strategic human resource Incentive alignment Weaker Stronger Elements

Source: Adapted from Bodolica and Spraggon (2009)

directors used credible rationales for new LTIPs’ implementation in order to avoid public criticism and enhance their legitimacy. Their examination of verbal justifications published in proxy statements revealed two rationales for the adoption of new LTIPs: the agency logic, which focuses on the need to tie executive pay to firm performance, and the strategic human resource logic, which emphasizes the need to attract and retain managerial talent by approving competitive compensation contracts. When applying symbolic management insights to the analysis of proxy statements in their sample of Canadian acquiring firms, Bodolica and Spraggon (2009) observed different implementation logics for various elements of CEO compensation contracts. The dominant agency logic for new LTIPs’ adoption, which was reflected in the “philosophy of aligning the interests of executives with those of the shareholders by tying executive compensation to share price performance,” was supplemented by the strategic human resource management rationale, where LTIPs “are intended to assist in the retention of qualified and experienced executives.” These citations were extracted from the 2002 proxy statement of Barrick Gold Corporation after it completed the merger with Pangea Goldfields Inc. in August 2000. In contrast, the existence of a “retention bonus” and the determination of executive salary based on “current market conditions for comparable positions” as board justifications for the implementation of CEO compensation protection devices evoked a strategic human resource logic exclusively. The latter citations were extracted from the 1999 proxy statement of Ultra Petroleum Corporation, which was released prior to the completion of its deal with Pendaries Petroleum Ltd. in January  2001. Since the LTIPs’ adoption was more oriented toward

38  Overview of M&As and Executive Compensation shareholders via the use of agency explanations, while the compensation protection devices were rather directed toward executives, emphasizing strategic human resource justifications, Bodolica and Spraggon (2009) concluded that the former group of contractual attributes represents a stronger mechanism of incentive alignment than the latter in the case of acquiring firms. Yet these authors also warned against rushing into the conclusion of compensation protection provisions never representing effective internal governance tools. Although they may increase agency costs, these provisions are of the greatest importance when the external managerial labor market is deficient and executives are scarce human resources who cannot be easily attracted and hired. In this situation, people who are holding a managerial position within organizations have less to fear from a possible displacement. The lack of managerial skills readily available in the labor market would bolster the strategic human resource logic that CEOs should be retained via attractive compensation packages that include employment agreements, severance provisions, and golden parachute clauses (Bodolica & Spraggon, 2009). Moreover, given their lower risk-aversion properties, compensation protection devices may also be seen by corporate boards as a viable governance instrument to motivate executives to undertake riskier endeavors than they would otherwise be willing to undertake. These incentive mechanisms can thus be introduced to bring CEOs’ risk-taking behavior to the levels desired by shareholders. Conversely, the LTIPs may be adopted to reduce the managerial risk seeking to acceptable levels by the board and shareholders.

Stock Option Pay Versus Stock Ownership Based on the assumption of consistent risk aversion among agents, stock option plans and stock ownership have long been viewed by agency adepts as virtually equal equity-based compensation mechanisms that influence the behavioral outcomes of executives in a similar fashion (Bliss & Rosen, 2001; Datta, Iskandar-Datta,  & Raman, 2001). In recent years, however, researchers began questioning their congruence and acknowledging that the motivational effects generated by these pay elements do not mimic each other (Carpenter, Indro, Miller, & Richards, 2010). Failing to empirically confirm the premise of stable risk preferences of agents, studies within the behavioral decision stream have demonstrated that the relationship between executive choices of risk and corporate outcomes is more complex than prescribed by the normative agency theory (Tufano, 1996). Behavioral scholars started to distinguish between stock options and equity ownership to provide a more complete theoretical understanding of how pay affects CEOs’ strategic decisions and risk taking (Certo et al., 2003; Larraza-Kintana, Wiseman, Gomez-Mejia, & Welbourne, 2007). Arguing that alternative elements of executive compensation packets have contrasting risk properties, Spraggon and Bodolica (2011) delineated multiple features that differentiate option payments from stock ownership (see Table 2.2).

Incentive Design of Executive Compensation Packages  39 Table 2.2  Asymmetric properties of stock option pay and stock ownership Properties

Stock option pay

Stock ownership

Huge upside potential but no downside risk Timing of ownership rights Deferred Marketable value No value when granted Payout linked to Increase in stock price Fluctuation in wealth

CEO’s intentions CEO’s perceived risk Board ex-post practices CEO’s risk propensity

Both upside potential & downside risk Immediate At any time Increase in stock price & dividends Cash out the exercised Keep the stock for longer options periods Limited compensation risk Significant investment & compensation risks None Reloading, repricing, & backdating Risk taking Risk aversion

Source: Adapted from Spraggon and Bodolica (2011)

According to Sanders (2001), one difference refers to the lack of downside risk in stock option grants, which decouples the fluctuation in total wealth of option-loaded CEOs from that of shareholders. While both pay elements reward for increases in stock price, only those executives who possess equity holdings experience significant reduction in their real wealth when the market price of the stock drops, as no manager will exercise his or her options when the current share price is lower than the strike price. Stock ownership allows CEOs to incur either wealth gains or losses, while stock options offer them an unlimited upside potential and a floor to prevent losses (Sanders & Hambrick, 2007). Equity stakes confer immediate ownership to their holders and have a real marketable value at any time, as opposed to stock options that allocate only deferred ownership rights and have no marketable value when granted (Milkovich et al., 2007). Option pay is less constraining than equity ownership, as it provides managers with the right (not the obligation) to purchase an amount of stock at a future date and gives them the liberty to decide whether to exercise the underwater options (Devers, McNamara, Wiseman, & Arrfelt, 2008). Since stock options do not require initial investment from their recipients at the time of option awards, their effect on total executive wealth is not immediate (as in the case of equity ownership) but rather delayed (Certo et al., 2003). Given that options reward only the increases in the stock price and not total shareholder returns that include dividends, CEOs compensated with stock options may avoid enlarging the size of dividends in favor of using the cash for activities that would positively affect the firm’s share value in the stock market (Murphy, 1999). Several scholars have reported that option-loaded CEOs tend to redirect funds away from dividend payouts towards share repurchases, which lead to stock price increases (Sanders &

40  Overview of M&As and Executive Compensation Carpenter, 2003; Fenn  & Liang, 2001). Recent research has also shown that stock option grants are associated with stronger executive temptations to behave unethically, resulting in the manipulation of corporate finances, earnings management, and accounting misrepresentation (Burns & Kedia, 2006; Coles, Hertzel, & Kalpathy, 2006; Harris & Bromiley, 2007). For a sample of 103 firms that were forced to restate their financial results between 2000 and 2004, O’Connor and colleagues (2006) found that increases in CEOs’ stock option values positively affected the probability of fraudulent financial reporting in situations when either board stock option pay or CEO duality was present while the other was absent. Although both option pay and equity ownership are used to solve the problem of executive shortsightedness, they affect managerial time horizons and intentions with regard to corporate stock in a different way (Spraggon & Bodolica, 2011). The entitlement to immediate and continuous dividend payouts obtained via stock ownership is likely to motivate executives to keep the owned corporate stock for longer periods of time. However, due to the existence of already extended vesting windows and given that options are treated by their beneficiaries mainly as compensation, CEOs will almost always try to cash out the exercised stock and only rarely prefer to keep the stock exercised from options (Kim et al., 2010). According to Bebchuk and Fried (2006), this is one of the problems associated with stock options, and in order to improve their effectiveness as incentive alignment vehicles, companies should seek to separate the time when options can be exchanged for cash from the time when they vest. Further, both elements involve some compensation risk ensuing from the uncertainty and variability of pay flows, which are coupled with fluctuations in the firm’s stock price. Yet the perceived pay risk associated with option grants may be greatly reduced due to the board of directors’ involvement in questionable actions of restructuring the design of the previously awarded stock options. The pervasive board practices of option reloading, repricing, and backdating, which are usually linked to weaknesses in corporate governance structures or CEO retention needs (Chidambaran & Prabhala, 2003; Ertimur, Ferri,  & Maber, 2012; Yermack, 1997), increase the motivational value of stock option awards for firm executives but undermine their use as effective governance devices (Callaghan, Saly, & Subramaniam, 2004; Heron & Lie, 2007). Conversely, by providing a real threat of possible wealth losses and a hope of important financial gains, stock ownership obliges executives to accept not only a considerable compensation risk related to the unpredictability of pay outcomes but also a major investment risk that is similar to that borne by corporate investors. The strength of these risks is further exacerbated given the board’s inability to engage in practices of restructuring executive equity stakes due to the absence of exercise price, which can be easily manipulated ex-post, as in the case of stock options (Spraggon & Bodolica, 2011). Finally, the two pay schemes encourage asymmetric levels of risk-seeking behavior on behalf of CEOs (Carpenter et al., 2010; Sanders, 2001; Wiseman  & Gomez-Mejia, 1998). Since the value of options rises with stock price volatility, option-rewarded managers are induced to take excessive

Incentive Design of Executive Compensation Packages  41 risks in their resource-allocation decisions because they have nothing to lose in the case of an adverse turn of events and a lot to gain if their decisions prove to be effective (Beatty  & Zajac, 1994; Dong, Wang,  & Xie, 2010; Rajgopal & Shevlin, 2002; Williams & Rao, 2006). Chen and Ma (2011) confirmed the risk-taking effect of stock options, although this effect was somehow constrained by the personal risk avoidance of senior managers. As stock ownership penalizes the holders for downside movements in share price, executives who own firm stock tend to be more risk averse due to their fear of losing a substantial part of their total wealth (Lloyd, Hand, & Modani, 1987; Saunders, Strock,  & Travlos, 1990). Other authors have taken an alternative view with regard to stock ownership, suggesting that its effect on managerial behavior is not uniform but rather curvilinear. Denis, Denis, and Sarin (1997) and Wright, Kroll, Krug, and Pettus (2007) empirically demonstrated that at insignificant shareholding values CEOs involved in riskier projects, while the expected risk aversion occurred at very high degrees of executive equity ownership. DETERMINANTS OF EXECUTIVE COMPENSATION Pay for performance is considered by agency scholars an effective mechanism for reducing agency costs and achieving agent-principal interests’ alignment (Gomez-Mejia & Wiseman, 1997). Yet extant empirical studies on the sensitivity of CEO compensation to firm performance are still far from yielding a unanimous conclusion. There are researchers who believe in the incentive structuring of managerial pay packages predicted by the agency theory (Core, Guay,  & Thomas, 2005; Kaplan, 2008), and there are those who do not find significant support for this view, arguing that executives are paid without performance (Dalton, Daily, Certo & Roengpitya, 2003; Walsh, 2008). According to Armstrong (2013), the popular argument that managerial compensation is at best only weakly related to performance is inaccurate because of its exclusive emphasis on one element of pay. When considering the changes in an executive’s total wealth (which includes fluctuations in stock and option holdings) rather than the value of annual compensation, a strong pay–performance relationship could be depicted. In a counterargument stemming from an evidence-based review, Jacquart and Armstrong (2013) posit that incentive payments cannot be effectively linked to managerial actions because higher compensation fails to encourage superior performance, curbs the intrinsic motivation, prompts the incidence of corporate misconduct, and prevents executives from estimating the long-term implications of their decisions on stakeholders. Scholars also find that CEOs are rewarded for accidental surges in firm performance brought about by macroeconomic shocks and exogenous events that are beyond managerial control, a phenomenon that Bertrand and Mullainathan (2001) coined “pay for luck.” Bebchuk and Fried (2006) believe that these anomalies in executive pay practices result from significant

42  Overview of M&As and Executive Compensation flaws in corporate governance structures, which confer too much power to entrenched managers. As a result, boards of directors are considered to be structurally too weak to adequately perform their fiduciary duty, leading to excessive managerial perquisites and overgenerous pay arrangements, which are damaging shareholder wealth (Tian & Yang, 2014). Using the CEO pay slice (i.e., ratio of CEO’s total compensation over top five executives’ total pay) as a proxy for power, Choe, Tian, and Yin (2014) provide empirical support for the role of managerial power theory in the design of CEO compensation. According to Cremers and Grinstein (2014), the three controversial CEO compensation practices of benchmarking, pay for luck, and high CEO pay levels can be partly explained by a competitive marketplace for executive talent in which organizations compete fiercely to attract and retain qualified management. Rationales from the human capital theory and resource-based view could also be used to explain why “strategic” CFOs who possess generalist skills rather than “accounting” CFOs with specialist skills are able to command a compensation premium (Datta  & Iskandar-Datta, 2014). In a meta-analysis of different determinants of executive compensation, Tosi, Werner, Katz, and Gomez-Mejia (2000) showed that corporate performance accounts for less than 5 percent of the variance in total pay, while organizational size accounts for more than 40 percent of this variance. The significantly positive pay–size association provides an impetus for managers to enlarge the size of the company in ways that are not necessarily compatible with shareholders’ value-enhancing rationales. Reporting steady rises in executive pay in merging firms despite subsequent declines in stock prices, Bliss and Rosen (2001) concluded that merger-induced growth represents for CEOs a fast way to increase both the firm size and their compensation. Recently, Fich, Starks, and Yore (2014) indicated that boards compensate managers for their deal-making activities and that pay for deal volume rather than value creation occurs when directors’ monitoring is weak. When upward alterations in pay ensue from the conduct of M&As and other transactions, boards may easily rely on symbolic management justifications to legitimize executive compensation increases in the eyes of stockholders (Bodolica & Spraggon, 2009). The inconsistent pay–performance sensitivity and the predictable pay–size relationship reported in the literature seem to indicate that strategies of corporate growth, and principally M&A activities, constitute an opportune setting for gauging whether shareholder value creation or managerial opportunism guides CEO compensation. As we have shown in Chapter 1, M&As constitute major examples of high-profile events prompted by managers who could conceive them as a means for achieving higher levels of pay, even though they are frequently associated with disappointing returns to acquiring shareholders (Bliss & Rosen, 2001; Schmidt & Fowler, 1990). Since top executives are responsible for the initiation of risky acquisition endeavors, promising new insights can be gained into the process of determining the magnitude of pay and structuring the equity mix of executive compensation,

Incentive Design of Executive Compensation Packages  43 which can reveal important information about managerial effectiveness with regard to the pursuance of M&A deals (Spraggon & Bodolica, 2011). Another implication to be drawn from the discussion presented in this chapter is the growing recognition that no theory alone is able to render a full account of all complexities of the executive compensation landscape due to the rapid changes observed in the magnitude, substance, and composition of CEO pay packets (Gerhart et al., 2009). To conciliate the competing predictions stemming from managerial power and human capital theories, Combs and Skill (2003) offered a contingency perspective of executive pay premiums that are dependent upon specific features of managers and organizations. A multitheoretical approach to the study of CEO compensation may be particularly warranted in the context of highly uncertain M&A transactions. This view is supported by the current empirical literature in the field. Bodolica and Spraggon (2009) relied on the intertwining justifications extracted from the agency, political, and symbolic management perspectives to elucidate the adoption of special attributes of executive pay contracts around M&A deals conducted by Canadian companies. REFERENCES Agrawal, A., & Knoeber, C. R. (1998). Managerial compensation and the threat of takeover. Journal of Financial Economics, 47(2), 219–239. Anderson, S., Cavanagh, J., Hartman, C.,  & Klinger, S. (2003). Executive excess 2003. CEOs win, workers, and taxpayers lose. Tenth Annual CEO Compensation Survey, Institute for Policy Studies and United for a Fair Economy, Boston, MA. Armstrong, C. S. (2013). The ombudsman: A  closer look at the efficiency of top executive pay and incentives. Interfaces, 43(6), 590–592. Baker, D. (2013). Let’s get it straight: AIG execs got bailout bonuses, but pensioners get cuts. The Guardian, December 9. Beatty, R. P., & Zajac, E. J. (1994). Managerial incentives, monitoring, and risk bearing: A study of executive compensation, ownership, and board structure in initial public offerings. Administrative Science Quarterly, 39(2), 313–335. Bebchuk, L. A., Cohen, A., & Ferrell, A. (2009). What matters in corporate governance? Review of Financial Studies, 22(2), 783–827. Bebchuk, L. A., Cohen, A.,  & Wang, C.C.Y. (2014). Golden parachutes and the wealth of shareholders. Journal of Corporate Finance, 25, 140–154. Bebchuk, L. A., & Fried, J. M. (2006). Pay without performance: Overview of the issues. Academy of Management Perspectives, 20(1), 5–24. Benmelech, E., Kandel, E., & Veronesi, P. (2010). Stock-based compensation and CEO (dis)incentives. Quarterly Journal of Economics, 125(4), 1769–1820. Bertrand, M., & Mullainathan, S. (2001). Are CEOs rewarded for luck? The ones without principals are. Quarterly Journal of Economics, 116(3), 901–929. Bliss, R. T., & Rosen, R. J. (2001). CEO compensation and bank mergers. Journal of Financial Economics, 61(1), 107–138. Bodolica, V. (2005). Impacts of mergers and acquisitions on executive compensation of acquiring firms. PhD Dissertation, HEC Montreal. Bodolica, V., & Spraggon, M. (2009). The implementation of special attributes of CEO compensation contracts around M&A transactions. Strategic Management Journal, 30(9), 985–1011.

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3 Conceptual Framework Linking M&As With Executive Compensation

CEO PAY AROUND M&A DEALS AS A FIELD OF INQUIRY Over the past decades, the frequent occurrence of business failures and decision makers’ misconduct has led to an enhanced scholarly interest in governance practices of corporations from different regions of the world (Bhaumik & Selarka, 2012; Bodolica, 2013). The importance of building a comprehensive system of corporate governance with multiple mechanisms of control started to be increasingly emphasized for the purpose of securing the sustainability of organizations (Thomsen & Conyon, 2012). Different streams of inquiry developed aiming to identify viable solutions to complex governance dilemmas. On the one hand, the efficiency of markets for corporate control, underlying M&A activities, as an external governance instrument became a central topic of empirical investigation (Hopner & Jackson, 2006). On the other hand, the examination of the incentive structuring of executive compensation packages as an internal tool of monitoring has been continuously emphasized for tightening the alignment of managers’ and shareholders’ interests (Tian & Yang, 2014). The results of the impressive number of studies conducted within these two separate streams of research have been reviewed on several occasions (see Table 3.1). These review articles seek to determine the extent to which a cumulative body of knowledge is built to improve our understanding of the governance discipline instituted by either M&A transactions or executive pay contracts.

Reviews of the M&A Literature A vast body of academic literature on acquisition deals and their distinguishing characteristics developed over time, particularly in North American and Western European institutional contexts. To date, researchers have made significant progress in analyzing a variety of M&A–related topics regarding the governance function of Western markets for corporate control (Hopner & Jackson, 2006; Kohler, 2012), the performance implications of conducting acquisitions during merger waves (Alexandridis, Mavrovitis, & Travlos, 2012; Duchin & Schmidt, 2013), the size of control premium and method of payment

Table 3.1  Post–2000 review articles of the M&A literature, the executive pay literature, and the executive pay around M&As literature Reference

Emphasis

Reviews of the M&A literature: Chapman (2003) Theme-focused— cross-border deals Theme-focused—firm Schraeder & Self (2003) culture & deal success Bruner (2004) Theme-focused—M&A performance King, Dalton, Daily, & Covin (2004) Tuch & O’Sullivan (2007)

Theme-focused—M&A performance Theme-focused—M&A performance

Haleblian, Devers, Comprehensive—broad themes McNamara, Carpenter, & Davison (2009) DeYoung, Industry-focused— financial sector Evanoff, & Molyneux (2009) Das & Kapil (2012) Theme-focused—M&A performance Dauber (2012) Theme-focused— culture-performance link Shi, Sun, & Prescott Theme-focused— (2012) temporal perspective Schief, Buxmann, & Industry-focused— Schiereck (2013) software industry

Journal

Discipline

Journal of Economic Geography Geography Management Management Decision Journal of Applied Corporate Finance Strategic Management Journal International Journal of Management Reviews Journal of Management

Finance

Management

Management

Management

Journal of Financial Finance Services Research Journal of Strategy Management and Management Cross Cultural Management Management

Journal of Management Business & Information Systems Engineering Rossi, Tarba, & Industry-focused— International Raviv (2013) high-tech industry Journal of Organizational Analysis Ferreira, Santos, de Comprehensive—broad Journal of Business Almeida, & Reis themes & field change Research (2014)

Management Information systems

Management

Business

(Continued)

Table 3.1 (Continued) Reference

Emphasis

Reviews of the executive pay literature: Theme-focused— Tosi, Werner, pay–performance link Katz, & Gomez-Mejia (2000) Loewenstein (2000) Theme-focused— overpayment & reforms Keasey (2006) Theme- & country-focused— context of pay & United Kingdom Devers, Cannella, Comprehensive—broad Reilly, & Yoder themes & subthemes (2007) Dew-Becker (2009) Theme- & country-focused— history of legislation & USA Frydman (2009) Theme-focused— determinants of pay Gerhart, Rynes, & Theme-focused— Smithey Fulmer pay–performance link (2009) O’Reilly & Main Theme-focused— (2010) economic & psychological views Sun, Zhao, & Yang Region-focused—Asian (2010) countries Goergen & Theme-focused— Renneboog (2011) determinants of pay Rampling, Eddie, & Country-focused—China Liu (2013) Industry-focused— Shay & White (2014) healthcare sector

Journal

Discipline

Journal of Management

Management

Wake Forest Law Review

Law

Journal of Financial Finance Regulation and Compliance Journal of Management

Management

CESifo Economic Studies

Economics

CESifo Economic Studies Academy of Management Annals Industrial and Corporate Change Asia Pacific Journal of Management Journal of Corporate Finance Asian Review of Accounting Health Care Management Review Reviews of the executive pay around M&As literature: Williams, Selective—mix with Managerial Finance Michael, & non–M&A CEO pay Waller (2008) Bodolica & Comprehensive—streams Academy of Spraggon and substreams Management (2009b) Annals

Economics Management

Management

Management Finance Accounting Health care

Finance

Management

Conceptual Framework Linking M&As  51 used in M&A deals (Lee & Choi, 1992; Uddin & Boateng, 2009), the association between acquisition activities and executive compensation (Boulton, Braga-Alves, & Schlingemann, 2014; Spraggon & Bodolica, 2011), the acquisition of private versus publicly traded targets (Capron & Shen, 2007; Fuller, Netter, & Stegemoller, 2002), the occurrence of cross-border versus domestic transactions (Chen, Huang, & Chen, 2009; Ferreira, Massa, & Matos, 2010), the experience effect of repetitive versus single acquirers (Aktas, de Bodt, & Roll, 2013; DeYoung, 1997), the abnormal returns ensuing from diversifying versus industry-focusing deals (Cornett, Hovakimian, Palia, & Tehranian, 2003; Nankervis & Singh, 2012), and the target hostility and effectiveness of antitakeover defenses (Fiss, Kennedy, & Davis, 2012; Song & Walkling, 1993). As shown in Table 3.1, a search for M&A literature reviews in the post-2000 period generated 13 articles published primarily in management journals (Das & Kapil, 2012; Shi, Sun, & Prescott, 2012) but also in other disciplines such as finance (Bruner, 2004; DeYoung, Evanoff,  & Molyneux, 2009), information systems (Schief, Buxmann, & Schiereck, 2013), and geography (Chapman, 2003). Two of the identified studies conduct a comprehensive review of the complex M&A literature to detect the broad themes of acquisition-related research (Ferreira, Santos, de Almeida, & Reis, 2014; Haleblian, Devers, McNamara, Carpenter, & Davison, 2009), while others are more focused on a specific industrial sector (DeYoung, Evanoff, & Molyneux, 2009; Schief, Buxmann, & Schiereck, 2013) or theme of inquiry (Bruner, 2004; Tuch & O’Sullivan, 2007). Comprehensive Review Articles The in-depth analysis of quantitative M&A studies performed by Haleblian and colleagues (2009) resulted in the identification of several antecedents of acquisitive behavior that induce various outcomes in terms of deal performance, acquisition premium, leadership turnover, and customer and bondholder consequences. Among the key antecedents of corporate acquisitiveness are value creation (i.e., efficiency, resource redeployment, market power, and market discipline), managerial self-interest (i.e., rewards, hubris, and target defenses), environmental elements (i.e., uncertainty, regulation, imitation, resource dependence, and network ties), and firm characteristics (i.e., M&A experience, strategy, and positioning). Haleblian and colleagues (2009) have also uncovered multiple moderators of the acquisition–performance relationship that are related to transaction features (i.e., deal type and payment mode), executives’ effects (i.e., compensation, ownership, experience, and personality), firm idiosyncrasies (i.e., size, performance, and acquirer experience), and environmental aspects (i.e., acquisition waves and regulations). In a recent bibliometric analysis of leading strategy and business journals, Ferreira and colleagues (2014) discuss the intellectual alterations that occurred in the M&A field of inquiry over the 1990 to 2010 period. While the topics of corporate partnership and performance continued to be placed at the top of research agendas, scholars’ interest has gradually

52  Overview of M&As and Executive Compensation shifted from the examination of top management teams, financial theory, and integration issues to environmental influences on strategy, corporate governance, and a resource-based view of acquisitions. Reviews of Studies on M&A Performance One of the most popular merger-specific themes relates to performance implications of M&A activities. Bruner’s (2004) literature review shows that M&As constitute a value-maximizing and a value-maintaining proposition for the shareholders of target and acquiring firms, respectively. Mergers of equals, cash-financed transactions, and acquisitions of smaller, private targets and related companies are reportedly associated with higher postdeal returns (Bruner, 2004). Yet these findings contradict the meta-analytic conclusions of King, Dalton, Daily, and Covin (2004) that M&A transactions have a modest negative effect on the long-term performance of acquirers and that acquisition terms such as “industry relatedness,” “acquisition experience,” and “mode of payment” do not influence the corporate returns in the postdeal period. Furthermore, the review of Tuch and O’Sullivan (2007) generates another confounding set of outcomes. These authors conclude that M&As produce significantly negative returns in the long run; cash-financed deals and purchases of larger and hostile targets are the primary drivers of superior performance, whereas the advantages of related acquisitions remain inconclusive. According to Das and Kapil (2012), the variability in results across extant M&A performance studies is due to the diversity of measures used to assess performance, including the accounting (e.g., profit, return on equity, sales, total assets), market-related (e.g., cumulative abnormal return, total short-term gain to acquirer and target), other objective (e.g., Tobin’s q, market share, financial leverage), and subjective (e.g., learning, satisfaction, quality of innovation) indicators. To shed more light on the variety of performance determinants, Das and Kapil (2012) classified them into different groups of managerial effects, firm-level variables, deal characteristics, and macro-level factors. Seeking further clarification on this theme, King and colleagues (2004) called for additional theorizing for developing more comprehensive frameworks to uncover the performance implications of various unidentified M&A antecedents and moderators. Reviews of Industry-Focused M&A Studies Acknowledging that merger effects can be driven by industry-related idiosyncrasies, some researchers reviewed the state of the knowledge on acquisitions conducted within a given sector such as financial (DeYoung et al., 2009) and high-tech (Rossi, Tarba, & Raviv, 2013; Schief et al., 2013) industries. For instance, DeYoung and colleagues (2009) report that bank mergers, which may be motivated by a hunt for a “too big to fail” status to benefit from safety-net subsidies provided by the government for countering the systemic risk of financial institutions, affect the deposit and loan rates

Conceptual Framework Linking M&As  53 and the availability and price of small business credit. Alternatively, since the high-tech industry is very uncertain and characterized by the prevalence of small, underfunded firms, technology-driven M&As are knowledge-intensive and conducted for achieving higher levels of research and development intensity, know-how transfer, learning curves, and innovative performance (Rossi et al., 2013). According to Schief and colleagues (2013), the distinctive features of the software industry such as short product life cycles, elevated innovation rates, high product replicability, and dominance of network effects are among the key factors that influence M&A success along with the properties of the acquirer, target, combined firm, transaction, and general environment. Reviews Focusing on Temporal and Cultural M&A Perspectives Given that traditional explanations remain insufficient for understanding the complex acquisition phenomena, scholars started to place selected M&A features at the forefront of their analyses. Thus, Shi, Sun, and Prescott (2012) espoused a temporal perspective to discuss the relationship between the management of time and merger consequences, while Chapman (2003) focused on reviewing the role of cross-border M&As in the development of the space economy to highlight the contextual embeddedness of corporate activity within an intricate net of political, economic, and social realities. Because cultural perspectives have received growing attention in the literature, Schraeder and Self (2003) summarized the findings from prior studies to identify the key cultural elements to consider in the pre- and postevent periods and delineate relevant strategies for enhancing M&A success. Yet in his recent review, Dauber (2012) reports that findings of extant research are largely inconclusive due to differences in levels of cultural analysis deployed (such as team, organizational, industry, and national culture) and variations in measures used to assess merger success, going from financial ratios to synergy estimates.

Reviews of the Executive Pay Literature The field of executive compensation research has expanded dramatically over the past decades, resulting in a highly diversified literature that relies on distinct and often irreconcilable theoretical perspectives and methodological traditions. This observation induced many scholars to unify the fragmented body of knowledge into an integrative framework that would be beneficial for advancing the field into new research directions. As summarized in Table 3.1, 12 review articles of the executive pay literature have been published in the last decade and a half. The topic has proven to be of heightened interest and significance to a variety of audiences: five of these articles have appeared in academic outlets related to the discipline of (strategic) management (Devers, Cannella, Reilly, & Yoder, 2007; Gerhart, Rynes, & Smithey Fulmer, 2009; O’Reilly & Main, 2010; Sun, Zhao, & Yang, 2010; Tosi, Werner, Katz, &

54  Overview of M&As and Executive Compensation Gomez-Mejia, 2000;), two each in finance (Goergen & Renneboog, 2011; Keasey, 2006) and economics (Dew-Becker, 2009; Frydman, 2009) journals, and one each in law (Loewenstein, 2000), health care (Shay & White, 2014), and accounting (Rampling, Eddie, & Liu, 2013) journals. Comprehensive Review of the Extensive Literature Over the last 15-year period, the work by Devers and colleagues (2007) represents the only scholarly attempt to conduct a comprehensive review of the extant executive compensation studies by identifying broad categories of research streams to make sense of the widely dispersed and heterogeneous literature. The authors structure the evidence produced in the field into two general streams that inquire into the relationships between pay and firm performance and the linkages among pay and executive behavior. The former category is further divided into two substreams, which include studies focusing on the impact of performance on CEO compensation (i.e., agency-induced influences, performance surprises, and governance effects) and on the influence of managerial pay on performance (i.e., implementation of compensation plans, components of pay, and compensation of top management teams and pay dispersion). The latter category is also organized along the two following major lines of research, which refer to the incidence of pay on executive actions (i.e., goal alignment and misalignment, strategic and individual choices, risk preference alignment, contextual influences, and stock option holdings) and to the impact of executive behavior and other factors on compensation (i.e., contextual effects, governance influences, and human capital and social impacts). Reviews of Studies on Pay Determinants and Pay for Performance Witnessing a growing interest in one subcategory of the broad executive compensation literature, other scholars offer a more focused analysis of a specific area of the CEO pay-related research. In particular, Frydman (2009) and Goergen and Renneboog (2011) focus on reviewing the current state of the knowledge on determinants of executive pay. Frydman (2009) clusters the multiple factors affecting CEO compensation into two sets of contrasting theories, namely the competitive forces of the market for executive labor and the institutional influences inside and outside the organization. The former theory refers to the demand for generalist skills and scale effects, the role of product market competition, and the availability of alternative options for managers, while the latter encompasses explanations related to social norms, rents’ extraction and corporate governance weaknesses, peer benchmarking, and monitoring by large stockholders. While Frydman (2009) notices a lack of consensus regarding the main drivers of growth in top management compensation, Goergen and Renneboog (2011) conclude that the literature is more consistent with the latter theory, in which pay increases originate from structural inefficiencies in corporate governance systems. Additionally, selected reviews concentrate exclusively on summarizing the advancements made on the topic of pay for performance (Gerhart et al.,

Conceptual Framework Linking M&As  55 2009; Tosi et al., 2000). In a meta-analytic examination of 137 empirical articles, Tosi and colleagues (2000) concluded that the nature of the relationship between compensation and performance is ambiguous, probably because corporate performance is affected not only by managerial actions but also by exogenous factors (Devers et al., 2007). According to Gerhart and colleagues (2009), research in accounting, finance, and economics tends to be more supportive of the pay–performance association than does research in the field of management and strategy. A critical issue to consider that may affect empirical findings relates to the way CEO pay and firm performance are assessed. Some studies focus on the salary and short-term bonus, while others include equity-based modes of executive compensation, such as stock options and stock ownership; likewise, performance is measured using either stock-market estimates or accounting-based indicators, such as return on assets and return on equity (Gerhart et al., 2009). Reviews of Pay Regulation and Context-Specific Studies Two articles concentrate on reviewing the historical evolution and effectiveness of various regulatory interventions with regard to executive compensation (Dew-Becker, 2009; Loewenstein, 2000), going from the early disclosure legislation to the most recent tax reforms and “say on pay” initiatives. Observing a consistent trend over time toward greater disclosure of pay and conflicts of interest, Dew-Becker (2009) argues in favor of higher shareholder involvement in compensation-related decisions rather than more prohibitive tax rates for the wealthiest citizenry of the state. Researchers have also called for the adoption of a context-dependent approach to achieve a more accurate understanding of the topic of executive compensation. Keasey’s (2006) framework of analysis, which is highly sensitive to influences stemming from contextual factors, integrates three main components, including the domain (i.e., local, regional, national or global labor markets), agents (e.g., individuals and groups affecting the pay-setting process), and interactions (e.g., definition of how agents relate to each other). Many efforts have been made to summarize the progress made with regard to CEO compensation in various countries (Keasey, 2006; Rampling et al., 2013) and regions (Sun et al., 2010) of the world. In a review of executive pay dynamics in state-owned and other listed companies in China, Rampling and colleagues (2013) report that government ownership weakens the pay–performance sensitivity, undermining the effective resolution of agency problems in Chinese publicly traded organizations. The critical outlook of Sun and colleagues (2010) on executive compensation issues in Asia resulted in the demarcation of influences that contextual characteristics (in terms of pay criteria, contingency factors, and governance devices) exert on pay levels and the pay–performance link along with implications for firm performance and executive turnover. The only industry-focused review was recently conducted by Shay and White (2014), who found that in the healthcare sector, the agency theory represents the main explanatory framework,

56  Overview of M&As and Executive Compensation while the determinants of executive compensation remain largely inconclusive. Disregarding their specific focus, researchers seem to favor theoretical complementarity, urging an integration of the agency theory with sociological and institutional perspectives for better comprehending the complex managerial pay phenomenon (Shay & White, 2014; Sun et al., 2010). In their synthesis of the literature, O’Reilly and Main (2010) departed from the dominant principal-agent model to shed a psychological light on the compensation-setting process, uncovering the norms of reciprocity and social influences that operate in the boardroom when determining the magnitude and structure of CEO pay. Toward a New Paradigm for Executive Pay According to Lorsch and Khurana (2010), the current complaints about the overcompensation of American CEOs and the poor pay–performance association stem from the inherent flaws of the executive compensation system. An important component of this system represents the commonly accepted agency theory, which relies on a narrow conceptualization of managers as selfish agents who are motivated exclusively by money and are ultimately accountable to shareholders for their decisions, ignoring the managerial responsibility to a wider set of stakeholders with whom the corporation interacts. Another system constituent refers to the assumption of the existence of an efficient market for executive talent, which has proven to be flawed because pay surveys conducted by compensation consultants are used more as upward scaling tools rather than objective benchmarks of pay rates. The evidence shows that in reality, compensation arrangements in US companies represent the outcome of a vigorous negotiation process between the compensation committee and the executive, which is largely influenced by the relative power that the involved parties possess to influence each other. Recognizing that organizations are to be viewed as complex matrices of social relationships rather than economic entities alone, Lorsch and Khurana (2010) call for a new executive pay paradigm that would be based on more realistic assumptions of leaders’ behavior within an inclusive social system for building a sustainable future reliant on the principle of collective destiny.

Reviews of the Literature on CEO Pay Around M&As The continuous increase in both the frequency of M&A activities (see Chapter 1) and the level of senior managers’ pay (see Chapter 2) instigated a substantial wave of empirical studies located at the crossroads between acquisition transactions and executive compensation. Acknowledging the strategic role that managerial rewards might play in the initiation, conduct, and consequences of M&As, more and more scholars began examining the specific topic of CEO compensation around acquisition deals, contributing to its establishment as a distinct field of inquiry. To date, a considerable amount of time and effort has been dedicated to uncovering and understanding the

Conceptual Framework Linking M&As  57 multitude of relationships between M&A transactions and executive pay, with a growing recognition that the interplay between these two areas of research might produce significant consequences for the field of corporate governance. In particular, it might demonstrate whether the combination of external (i.e., market for corporate control) and internal (i.e., CEO compensation) attributes of governance can effectively discipline the top management in both underperforming targets and bad bidding companies (Mitchell & Lehn, 1990). Some researchers (Schmidt & Fowler, 1990) reported a significantly positive relationship between firm size and CEO compensation, suggesting that executives might pursue merger-induced growth strategies to augment their personal wealth. Yet Khorana and Zenner (1998) showed that acquiring managers act more in owners’ interests when they have large stockholdings in the company, meaning that different elements of CEO pay in firms involved in M&A deals can be used as mechanisms of incentive alignment. Bodolica and Spraggon (2009a) submitted that the context of an active takeover market is particularly relevant for the study of the adoption of various attributes of executive compensation packages with asymmetric risk properties. Since M&As intensify the level of executive job uncertainty, CEOs may seek protection through the negotiation of employment agreements, severance provisions, and golden parachute clauses that would guarantee their compensation in unpredictable environments. Without these contractual arrangements, executives are unsure about their future, as they might lose their jobs due to adverse takeover events. Conversely, the uncertainty brought by M&A activities in terms of shareholders’ returns implies that the proportion of variable compensation in executive contracts should increase around the period of acquisition completion (Shleifer & Vishny, 1988). LTIPs infuse higher risk levels into compensation contracts, motivating CEOs to avoid making value-reducing decisions. Hence, boards of directors’ resolutions to adopt LTIPs and refuse to offer contractual protection can constrain the self-serving behavior of managers around M&A deals. Although the number of articles examining the determination of executive compensation in the periods preceding and following the acquisition activities has increased dramatically over the last three decades, a comprehensive review that summarizes extant findings on the topic into a single study is still lacking. To the best of our knowledge, only two reviews of the literature standing at the intersection of CEO pay and M&A transactions have been published so far (see Table 3.1), one in a finance outlet (Williams, Michael, & Waller, 2008) and another one in a management journal (Bodolica & Spraggon, 2009b). While Williams and colleagues (2008) attempted to summarize some of the empirical literature on the effects of executive compensation packages on merger choice and outcomes, their review encounters several limitations. The authors classified the evidence in the field into two broad areas of research, namely on firm size and managerial pay and on equity-based compensation, risk, and mergers. The former area includes selected studies focusing on size elasticities, pay for performance,

58  Overview of M&As and Executive Compensation and mergers and changes in executive compensation, while the latter refers to studies associated with equity-based incentives and risk taking and managerial risk aversion and acquisitions. Hence, the review of Williams and colleagues (2008) is more general because it is not confined to the research on CEO pay, which was conducted exclusively in the context of M&A deals. Moreover, the compensation consequences of acquisition activities are not differentiated between the target and the acquiring firm, and the total number of merger-specific articles reviewed is very modest (i.e., around 13). Similar to the reviews that were conducted by Haleblian and colleagues (2009) for the M&A literature and by Devers and colleagues (2007) for the CEO pay literature, Bodolica and Spraggon (2009b) performed a comprehensive review of all the studies that are positioned at the crossroads of M&A activities and executive compensation. Relying on a detailed analysis of more than 70 relevant articles, the authors organized the evidence in the field into three broad streams of research, delineating the merger-induced implications for the level and structure of managerial pay across various time periods and types of companies involved in M&A transactions. The main objective of the subsequent chapters of this book is to considerably extend and update the review work made earlier by Bodolica and Spraggon (2009b) in order to summarize the advancements made to date in the area of executive compensation in the specific context of M&As. In particular, we seek to gather the findings of all the published empirical research to identify the various themes, streams, and topics of inquiry linking managerial pay with acquisition transactions, explain the inconsistencies encountered within the current set of reviewed studies, and discuss priorities for future research in this field. The review made in this book aims to make several important contributions beyond the existing studies. First, having started with an overview of the articles that synthesized the extensive M&A literature and the broad executive compensation literature, we highlighted the importance of crossing these two areas of research, cementing the CEO pay around M&A deals as a separate phenomenon worthy of scholarly exploration. Second, we incorporate in our analyses a significant amount of more than 126 different articles that were published to date across multiple time periods and business-related disciplines. Third, in the following sections of this chapter, we build an exhaustive conceptual framework that allows positioning and differentiating the included studies along various merger-related dimensions, enhancing scholars’ understanding of the extent to which a cumulative body of knowledge has developed over time in this field of investigation. Fourth, our review of the literature seeks to offer a meaningful classification of the retained empirical articles based on the sense of causality established between acquisition transactions and managerial compensation. Selecting the factor that affects (i.e., the independent variable) and the factor that is affected (i.e., the dependent variable) represents an important methodological choice that drives the research outcomes. Fifth, we perform systematic cross-study comparisons within and across the identified streams and topics of inquiry,

Conceptual Framework Linking M&As  59 offering plausible explanations of the contradictory findings generated in selected studies that employed similar research designs and tested similar theoretical hypotheses. Finally, on the basis of this comprehensive comparative analysis, we provide a detailed discussion of critical empirical questions that should be addressed in the next generation of research in this field. METHODOLOGY FOR PERFORMING THE REVIEW

Sampling Procedure In order to perform a comprehensive review of the literature on CEO pay around M&A deals, we relied on a combination of methods for identifying and selecting articles that were commonly used in prior review papers (Dauber, 2012; Haleblian et al., 2009; King et al., 2004). To secure full coverage of relevant studies, the adopted sampling procedure was a multiple-step process that involved primary identification, general screening, supplementary identification, eligibility assessment, and final inclusion. The process started with the primary identification of articles by activating different computer-aided search engines commonly available in scientific databases. We employed the keyword search technique that allowed us to obtain a preliminary set of studies that tackled the question of executive compensation surrounding acquisition transactions. Articles’ titles and abstracts were searched on specific keywords such as “executive compensation,” “managerial incentives,” “CEO rewards,” “managerial ownership,” “executive pay,” and “golden parachutes” on the one hand and “M&As,” “acquisitions,” “merger deals,” “corporate takeovers,” “change in control transactions,” and “acquisition targets” on the other hand. Because it was critical to introduce various pairs of words simultaneously in our search procedure, we made extensive use of “AND” and “OR” operators. The operator “AND” was deployed to secure the generation of items specifically located at the intersection of the two major areas of inquiry (e.g., executive compensation AND acquisition deals). With regard to the operator “OR,” it was activated to broaden the search to guarantee the inclusion of terms with synonyms or relevance for our review meanings (e.g., pay OR compensation; mergers OR acquisitions). This keyword search specification was initially applied to the database ABI/INFORM Global because it is recognized as one of the most comprehensive business databases with international coverage. Because the main purpose was to uncover all the potential themes of research linking CEO pay and M&A activities, we did not seek to confine the scope of our review, keeping the search function purposefully broad. At this stage, we did not use any filters to discriminate the articles’ selection by the number of citations or journal disciplines. It did not matter whether any particular compensation element or acquisition feature was a dependent, independent, or control variable, and the identified article need not have put its primary emphasis

60  Overview of M&As and Executive Compensation on these variables in order to be retained. We were aware that this broad search arrangement could result in the generation of a vast number of items that might be irrelevant for the scope and topic of our review. Therefore, we specified additional limits for our search in terms of source type (i.e., scholarly journals), document type (i.e., article), and language (i.e., English). The above-mentioned keyword search procedure was consequently applied to the databases EBSCO Business Source Premier and JSTOR to verify whether new and previously unidentified hits could be generated. All duplicate items were removed following a thorough comparison of results obtained across the three databases. After this preliminary database search, the process continued with the general screening step in which the abstracts were carefully examined to check the articles’ fit and to attest to their reliance on empirical research methods. This screening allowed eliminating several articles that were not relevant for our review due to a variety of reasons such as lack of M&A contextualization, theoretical or conceptual nature of papers, and emphasis on directors’ rather than executive pay. To make sure that our sample of articles was complete, the supplementary identification step was directed toward finding targeted articles that were remarked before with the help of the ancestry approach. This approach to articles’ identification proposed by Cooper (1998) permitted us to track the earlier references on which the most recent papers relied by continuing this manual process of citation analysis until no additional references were brought to our attention. Furthermore, to avoid omitting important studies on the researched topic, we made a computer-assisted double filtering of keywords and journals to restrict the focus of our database search to the leading academic outlets in business-related disciplines. The leading status of journals was determined by the impact factor retrieved from the latest ISI Web of Knowledge Journal Citation Report published annually by Thomson Reuters. We checked several highest-impact journals in major disciplines, such as management (e.g., Academy of Management Journal, Strategic Management Journal, Journal of Management Studies), finance (Journal of Finance, Journal of Financial Economics, Journal of Financial and Quantitative Analysis), economics (Quarterly Journal of Economics, Econometrica, Journal of the European Economic Association), and accounting (e.g., Journal of Accounting Research, Journal of Accounting & Economics, Management Accounting Research), which are most likely to publish articles relevant for our review. Having finalized the primary and supplementary identification, we moved to the eligibility assessment by scrutinizing the full text of all obtained articles to make a final decision about inclusion or exclusion. To eliminate the likelihood of a selection bias, this step was completed by each author independently. Although the subsequent comparison of the individually generated outcomes revealed no interrater discrepancies in papers’ assessments, it allowed enhancing the credibility of our sampling procedure. This process has also permitted us to shortlist from the broader set of papers a total of 126

Conceptual Framework Linking M&As  61 articles that compose our sample. The final inclusion step consisted of the corroboration that all sample papers met the two major criteria for inclusion. First, studies had to address the interdependencies between the two areas of inquiry pertaining to M&A transactions and executive compensation (papers that concentrated on either one or another area were automatically excluded from our review). Second, studies had to be of an empirical nature. Relevant articles were identified beginning in the early 1980s and continuing through 2014 (with only one study being published in 2015), resulting in a critical analysis of research efforts deployed during the last 35 years.

Content Analysis Taking into consideration the significant size of our sample, the next critical task was to organize the overwhelming number of identified studies on CEO pay surrounding acquisition deals in a meaningful way to delineate recurring themes that animate a vigorous debate in this field of inquiry. This required an in-depth examination of articles’ text and line of argument to establish its specific contribution to the field relative to other papers included in the final sample. Each author has individually reviewed the included studies to form an independent opinion about the predominant themes and nature of relationships tested. In line with this classification effort, each article was assigned a numerical code to denote its association with a given research question under a particular theme. This coding procedure echoed the content analysis that is typically used in studies with qualitative methodologies (Bodolica, Spraggon, & Zaidi, 2015; Spraggon & Bodolica, 2008). The results of this individual work were compared between the two authors to secure a high level of consistency in performed analyses. Only on few occasions were there discrepancies in opinions, which were subsequently resolved through discussion, argumentation, and mutual agreement. Since all the observed inconsistencies referred to those articles that tested various types of relationships simultaneously (e.g., Bliss & Rosen, 2001; Datta, Iskandar-Datta, & Raman, 2001; Hayward & Hambrick, 1997; Houle, 2003), they were easily reconciled by placing these empirical studies under several streams that pertain to the same or different themes of inquiry. In sum, the thorough analysis of articles’ content resulted in the identification of three main themes of research, five causal linkages (referred to as streams) that are made within these broader themes, and six narrower topics associated with these streams. These interconnected themes, streams, and topics of inquiry form the basis of our conceptual framework on CEO pay around M&A deals, which is described in the following section. CONCEPTUAL FRAMEWORK Figure 3.1 presents a summary of our synthesis and review effort to create a conceptual framework for structuring the complex literature on M&A

62  Overview of M&As and Executive Compensation

Figure 3.1  Conceptual framework for structuring empirical studies on M&A deals and executive compensation Source: Adapted from Bodolica & Spraggon (2009b)

activities and executive compensation based on the relative positioning of work along two dimensions, namely M&A–related phases and firm’s role in a merger transaction. The three clearly distinguished M&A phases that are represented on the horizontal axis of Figure 3.1 refer to the period preceding the acquisition announcement (before M&A), the period of time related to the conduct of an M&A deal (from its announcement till its completion), and the period following the completion of the deal (after M&A). The firm’s role in am M&A deal displayed along the vertical axis of Figure 3.1 includes the following three roles: the bidding company that bids for a target in the preacquisition period, the target firm that is being taken over during the process of M&A activity, and the acquiring company that has succeeded in completing a M&A transaction. When crossing the two axes of the figure, three main themes of research could be depicted: Theme I, incorporating studies on executive compensation of bidding companies in the period preceding the M&A deal; Theme II, with studies on executive compensation of target firms in the preacquisition period; and Theme III, related to studies on executive compensation of acquiring companies in the period after the completion of the M&A transaction. To shed more light on the diversity of causal linkages that are drawn within these broad themes of inquiry, we built another, more detailed and comprehensive framework that is illustrated in Figure  3.2. This figure highlights the extent to which different elements of executive compensation packages are associated with M&A phenomena and their characteristics. The various components of managerial compensation relate to both internal rewards (i.e., level, structure, and changes) and external rewards (i.e., membership on outside boards of directors) that are allocated to senior executives of bidding, target, and acquiring firms. Based on our content analyses of the articles included in the sample, we decided to divide the M&A phenomena into two areas—M&A occurrence and

Conceptual Framework Linking M&As  63

Figure 3.2  Typology of causal relationships tested between M&A deals and executive compensation Source: Adapted from Bodolica & Spraggon (2009b)

M&A characteristics—and consequently analyze them on different levels. This distinction is due to the temporality effect, as the acquisition deal has to be initiated first for it to be able to exhibit its inherent characteristics in the second place. The occurrence of M&A transactions is driven primarily by the bidding company (e.g., bidder’s risk taking and diversification, decision to become involved in an acquisition, and abnormal returns upon the announcement of the deal) whose acquisitive behavior affects the target firm (i.e., the threat of being taken over). As far as M&A–related characteristics are concerned, they pertain to the following key aspects: the deal likelihood (i.e., announcement and completion); the mode of payment used to finance the acquisition (i.e., cash, exchange of equity, or combination of cash and equity); the magnitude of control premium paid by the acquirer to target shareholders (i.e., high or low); the target management attitude toward the deal (i.e., friendly or hostile); and the acquisition success (i.e., positive or negative returns to acquiring shareholders). Our in-depth review of the literature suggests that different types of causal relationships, to which we refer hereinafter as streams of research, are commonly tested within each of the three previously identified themes. Two streams of investigation, (A) and (B), could be observed within Theme I on bidders’ executive compensation preceding the M&A deal (see Figure 3.2). Stream A refers to the studies that analyze the impact of bidding managers’ compensation on bidder-specific occurrence of M&A transactions, while Stream B concentrates on the effect of bidding executive

64  Overview of M&As and Executive Compensation compensation package on M&A–related characteristics. The research Theme II on targets’ executive compensation before the deal can also be organized around two main streams of inquiry, namely C and D. Stream C reverses the sense of compensation-acquisition causality in target firms by examining the impact of target-specific M&A occurrence (i.e., the threat of takeover) on target management compensation, whereas Stream D focuses on investigating the effect of executive pay in target firms on different merger-specific characteristics. Last, only one stream, conventionally labeled E, falls under research Theme III on acquirers’ managerial compensation after the deal. Stream E includes all the studies that analyze the impact of M&A characteristics on the level and structure of executive pay in acquiring companies. Furthermore, our detailed literature analysis revealed that two different topics of inquiry are commonly addressed in each of streams A, D, and E, resulting in a total of six research topics. Topic A1 and Topic A2 ensuing from Stream A  on bidder-specific M&A occurrence under the influence of bidders’ executive compensation refer to the following two relationships: first, the impact of bidding managerial pay on risk taking and corporate diversification (A1) and second, the effect of bidding executive compensation on M&A decisions and abnormal returns around acquisition announcements (A2). Stream D on the influence of premerger structuring of targets’ CEO pay on M&A characteristics is examined through the specific lenses of research Topics D1 and D2. Topic D1 assesses the impact of target executive compensation on target management attitude toward the deal, while Topic D2 estimates the effect of target executive pay on the magnitude of control premium paid in a M&A transaction. Finally, the topics of empirical inquiry, E1 and E2, are the two constitutive elements of Stream E on the postacquisition determination of acquirers’ managerial compensation. While Topic E1 evaluates the impact of M&A–related performance and growth in corporate size on executive compensation of acquiring companies, Topic E2 examines the effect of acquisition premium and mode of payment on executive pay of acquiring firms. All the conceptual linkages among the three themes, five streams, and six topics of inquiry on CEO pay around M&A deals explained above are illustrated in Figure 3.3. The subsequent chapters of this book undertake a thorough review of the empirical literature linking acquisition transactions with executive compensation. Specifically, the key purpose of the next five chapters is to discuss relevant findings from studies that fall within different themes, streams, and topics of research and to offer viable explanations of inconsistent cross-study results. As shown in Figure 3.3, Topics A1 and A2 from Stream A and Theme I are analyzed in Chapter 4; Stream B from Theme I in Chapter 5; Stream C from Theme II in Chapter 6; Topics D1 and D2 from Stream D and Theme II in Chapter 7; and Topics E1 and E2 from Stream E and Theme III in Chapter 8.

Conceptual Framework Linking M&As  65

Figure 3.3  Conceptual linkages among various themes, streams, and topics of inquiry identified and covered in different chapters of the book

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Part II

Bidders’ Executive Compensation Before the Deal Part Contents: Chapter 4.  Impact of Bidding Executive Compensation on BidderSpecific M&A Occurrence 4.1 Impact of Bidding Executive Compensation on Risk Taking and Corporate Diversification 4.2 Impact of Bidding Executive Compensation on M&A Decisions and Abnormal Announcement-Related Returns Chapter 5. Impact of Bidding Executive Compensation on M&A Characteristics

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4 Impact of Bidding Executive Compensation on BidderSpecific M&A Occurrence

ON THE STRUCTURE OF THIS RESEARCH STREAM How is the influence of bidding CEO pay on bidder-specific merger occurrence assessed in the extant literature? Scholars who addressed this question acknowledge that M&As are major, externally observable, long-term investments that are important for the purpose of shareholder wealth creation. From the standpoint of proponents of this research stream (Rose & Shepard, 1997; Williams & Rao, 2006), acquisitions represent a propitious setting for exploring the relationship between managerial incentives and the efficacy of corporate investment decisions. The empirical articles that fall within this stream are causal type studies in which bidders’ executive compensation is treated as one among other determinants of the incidence of M&A deals. Two types of causal linkages between senior management pay and acquisition endeavors in bidding firms are commonly tested in this stream of inquiry (Topics A1 and A2 in Figure 3.3). We start our review by analyzing the articles that focus on the impact of bidders’ executive compensation on risk-enhancing acquisition decisions and diversification activities in the context of conglomerate transactions (Agrawal  & Mandelker, 1987; Shekhar, 2005). Then we continue with a detailed discussion of studies that examine how the propensity of bidding top managers to initiate a M&A deal and the abnormal returns surrounding acquisition announcements are affected by the magnitude and structure of executive pay packets (Swanstrom, 2006; Travlos & Waegelein, 1992). 4.1 IMPACT OF BIDDING EXECUTIVE COMPENSATION ON RISK TAKING AND CORPORATE DIVERSIFICATION

Managerial Risk-Aversion Hypothesis The conglomerate era of the third merger wave (see Chapter  1) motivated many researchers to analyze the relationship among equity ownership structure, managerial risk taking (or risk aversion), and corporate diversifying endeavors. While a significant body of knowledge exists on the association

72  Bidders’ Executive Compensation Before the Deal between executive equity incentives and risk-maximizing behavior (Coles, Daniel, & Naveen, 2006; Duan & Wei, 2005), the empirical studies reviewed hereinafter explored this research topic within the specific context of M&A events. In particular, the key emphasis is put on risk-reducing acquisition activities achieved via diversification into unrelated industries, also referred to as conglomerate transactions. From the economic efficiency standpoint, an important motivation for M&A occurrence is the potential to achieve synergies through the combination of target and acquiring firms, which are ultimately expected to increase the financial wealth of corporate shareholders (Galpin & Herndon, 2014). However, since these synergistic gains are less obvious and typically more difficult to realize when the two merging companies are operating in completely unrelated businesses, the initiation of conglomerate M&A transactions may be due to personal motives of bidding managers. In light of these opposing efficiency and managerialist rationales, the main purpose of this topic of inquiry, which prevailed during the 1980s and 1990s, is to examine the validity of the managerial risk-aversion hypothesis. This hypothesis suggests that managers will choose to pursue those risk management strategies that would insulate their personal wealth from adverse fluctuations and value reduction, disregarding the specific consequences that these strategies may generate for stockholders. Hence, the purpose is to verify whether equity-based pay of senior managers induces them to get involved in more conservative, risk-reducing investment projects leading to an increased industrial diversification of the company they lead. Authors who tested this hypothesis in empirical settings do not find consistent evidence that conglomerate mergers are driven by self-serving managerial purposes nor that equity ownership allows increasing the alignment of manager-shareholder interests in the context of diversifying deals. In an ongoing debate between Amihud and Lev (1981, 1999) and Lane, Cannella, and Lubatkin (1998, 1999), researchers disagree on the extent to which corporate ownership structure is related to diversification decisions of top executives. As illustrated in our discussion, extant studies have either supported or questioned the agency-driven assumption that conglomerate mergers exemplify the manifestation of conflicts of interest between agents and principals. Confirming the Managerial Risk-Aversion Hypothesis In a study of 309 US mergers that took place during the 1960s, Amihud and Lev (1981) demonstrated that manager-controlled companies that are characterized by lower levels of ownership concentration are more likely to be involved in conglomerate risk-reducing mergers than their owner-controlled counterparts. The main logic behind this finding is that in the absence of outside monitoring, opportunistic senior executives in manager-controlled firms are enabled to pursue the employment-related risk decreasing strategies. Yet these strategies are not beneficial for corporate owners, who can achieve the same purpose by diversifying their portfolio of investments in the external stock market. Dong-Kyoon, Kwok, and Young (2005) provided evidence consistent with the managerial risk-aversion hypothesis in the context of 168 international deals

Impact of Bidding Executive Compensation  73 made by US companies. The propensity of executives to become involved in risk-reducing diversifying acquisitions of foreign targets increases with the level of managerial equity ownership and previously granted stock options. The results of Amihud and Lev (1981) were later corroborated for a banking industry and a larger sample of M&A transactions from the 1970s (Lloyd, Hand, & Modani, 1987), where banks controlled by managers were found to exhibit significantly lower risk-taking behavior during the period of relative deregulation (Saunders, Strock, & Travlos, 1990). Examining the relationship between the personal wealth of the CEO and the level of diversification of the acquiring company, May (1995) has also offered support for the managerial risk-aversion hypothesis. Using data on 184 US transactions over the 1979 to 1990 period, he showed that the larger the equity stakes and cash compensation of CEOs, the higher the likelihood for a firm to initiate diversifying acquisitions. In the same vein, Cai and Vijh (2007) found that larger stock and option holdings of bidding managers encourage them to diminish their stock risk by acquiring targets that operate outside the company’s primary industry (i.e., pursuing industrial diversification). Weakly Supporting or Rejecting the Risk-Aversion Hypothesis Despite testing the same hypothesis and focusing on the same geographical market for corporate control (i.e., the USA), other studies did not generate similar empirical evidence. In an attempt to verify Amihud and Lev’s (1981) findings on a new set of M&A transactions from the 1980s and using exactly the same methodology, Lane and colleagues (1998) found no statistical association between ownership structure and merger type. Based on these outcomes, Lane and colleagues (1998) concluded that there is no substantial reason to argue that managers tend to reduce risk through diversifying mergers and that these activities are costly to firm stockholders. Using data on 236 deals conducted over the period between 1967 and 1974, Amihud, Dodd, and Weinstein (1986) rejected the hypothesis that senior executives involve their firms in conglomerate mergers exclusively to satisfy their own interests at the expense of corporate owners. The authors argue that shareholders can also benefit from risk reduction pursued via conglomerate mergers, since it allows designing optimal contracts between principals and agents that improve the observability of managerial actions. Seeking to offer a non-American perspective on this topic of inquiry, Shekhar (2005) relied on a sample of 118 Australian firms that initiated M&A deals between 1994 and 2001. Although the scholar followed the path of Amihud and Lev (1981) showing that higher managerial equity stakes translate into an increased probability of diversification activities, he contested their assumption that these activities in Australia destroy shareholder wealth. Similar conclusions were reached in earlier research conducted by Rose and Shepard (1997) that involved 473 bidding executives from the USA. Uncovering a significantly positive association between the level of CEO cash compensation and diversification as predicted by May (1995), these authors do not argue that diversified firms have greater

74  Bidders’ Executive Compensation Before the Deal principal–agent conflicts. Instead, Rose and Shepard (1997) suggest that a stronger need for managerial ability and expertise in industrially diversified corporations drives higher levels of executive rewards. Pursuing similar research questions, Lewellen, Loderer, and Rosenfeld (1989) documented a weak negative relation between managerial portfolios and risk changes around M&As. This outcome induced them to conclude that there is no statistically significant support for the assumption that larger shareholdings by executives increase their motivation to seek risk reduction. Agrawal and Mandelker (1987) analyzed how the common stock and option holdings of managers relate to their investment decisions measured as a variability of the firm’s assets. They showed that large equity ownership positions by senior executives of 209 US corporations that undertook acquisitions between 1974 and 1982 were associated with risk-increasing rather than risk-minimizing actions. Cornett, Hovakimian, Palia, and Tehranian (2003) examined 423 acquisition announcements made by bidding banks to demonstrate that diversifying acquisitions earn significantly negative abnormal returns. Moreover, they found that executive shareholdings and stock options are less effective governance mechanisms in diversifying deals as compared to focusing transactions. Finally, reporting a lower stock ownership and pay-forperformance sensitivity for managers in 199 American diversified firms, Anderson, Bates, Bizjak, and Lemmon (2000) observed that agency problems in these firms are controlled via alternative governance mechanisms, such as a higher number of outside directors sitting on the board. More recently, employing a sample of 3,680 acquisitions conducted by 2,369 US corporations, Boulton, Braga-Alves, and Schlingemann (2014) rejected the managerial risk-aversion hypothesis. Finding a significantly positive relationship between the aggregate measure of equity incentives and CEO acquisitiveness, the authors have actually confirmed the risk-taking hypothesis. When disaggregating the measure of executive incentives, this positive association was particularly strong for exercisable stock options but insignificant for unexercisable options and equity ownership. Observing that mergers intensify the risk of a firm going bankrupt, Furfine and Rosen (2011) posited that this risk effect ensues from a larger proportion of option-based compensation of managers. Nonetheless, Bouton and colleagues (2014) could not provide any statistically consistent support for the association between managerial equity-based pay and propensity to either select a target firm outside the acquirer’s primary industry or make a focusing transaction. It is worth mentioning, however, that there was some significant evidence that exercisable options increase the odds of a diversifying acquisition in the model of an unconditional probability of making such an acquisition. Although Peng and Fang (2010) did not explicitly explore the question of managerial risk preferences, they tested the likelihood of purchasing target firms from another industrial sector. For a small sample of 92 M&A transactions in the Taiwanese electronics sector, they reported that managerial equity ownership is negatively associated with the probability of initiating horizontal (i.e., industry-focusing) deals.

Impact of Bidding Executive Compensation  75 Vega, Delta, and Managerial Risk Taking Few recent studies in finance and economics concentrated particularly on how two important measures of CEO incentives, namely vega and delta, shape the risk-taking behavior of executives and affect the riskiness of their M&A–related decisions. Vega, meaning the pay-risk sensitivity, estimates the variation in the value of managerial wealth in relation to changes in stock return volatility. Delta, or pay-performance sensitivity, captures the alteration in the monetary worth of executive wealth in connection with the stock price change. Increases in vega may be achieved via the incorporation of a larger amount of stock options in compensation packets, while high delta typically results from a larger number of stock (and fewer option) grants (DeYoung, Peng,  & Yan, 2013). The literature on investment (not merger-related) decisions is generally consistent in showing a positive vega-risk association, implying that high vega compensation tends to alleviate the problem of managerial risk aversion (Coles et al., 2006; Knopf, Nam, & Thornton, 2002). Yet extant research on delta and risky investment choices of CEOs is more ambiguous. Several studies report that high delta pay encourages managers to reduce risk (DeYoung et al., 2013; Knopf et al., 2002), while others either provide some evidence regarding the positive influence of delta on risk taking (John & John, 1993) or do not find any robust delta-risk association (Mehran & Rosenberg, 2007). In a recent investigation of 3,559 acquisitions, Armstrong and Vashishtha (2012) produced a strong evidence in favor of the differential analysis of a firm’s total risk, which includes idiosyncratic and systematic components. While the former risk component can be mitigated via adequate diversification, the latter can be eliminated from a portfolio mainly through hedging. The authors estimated the managerial incentive to alter the risk profile of the company, which is provided by stock options through their sensitivity to stock price (delta) and their sensitivity to stock return volatility (vega). Armstrong and Vashishtha (2012) found that delta positively and significantly affects the probability that top executives acquire target firms that increase the idiosyncratic risk of their company even though this risk cannot be hedged. However, CEOs with higher vega are more likely to make acquisitions that augment their firms’ total risk via increases in systematic risk. This finding implies that managers are not always inclined to pursue projects with higher idiosyncratic risk when opportunities to increase systematic risk are available. Using a virtually equal dataset of M&A deals over a similar time frame, Benson, Park, and Davidson (2014) also examined the effect of the CEO stock options’ sensitivity to stock return volatility (vega) on risk-taking acquisition-related behavior of managers. Contrary to Armstrong and Vashishtha (2012), the scholars reported a negative relationship between vega and postmerger equity risk, which is particularly strong for CEOs with larger option portfolios and more in-the-money options. This evidence that option-based compensation does not necessarily induce risk-averse executives to take on greater levels of risk is further supported by the positive impact of vega on the likelihood of industrial diversification. It is worth

76  Bidders’ Executive Compensation Before the Deal noting the differences in model specifications across the two studies, as Benson and colleagues (2014) did not differentiate the firm risk along its systematic and idiosyncratic components. Using a sample of 2,399 US firms over the 1990 to 2004 period, Low (2009) reported that vega plays a significant role in encouraging managers to assume higher levels of risk, while the effect of delta on risk taking is inconsistent. Hence, the empirical evidence provided by Low (2009) is generally consistent with the findings of Armstrong and Vashishtha (2012) regarding vega but not delta. The observed variations in prior empirical findings may also be driven by industry-specific characteristics of sample companies. While both Armstrong and Vashishtha (2012) and Low (2009) excluded all financial firms and utilities from their sample due to their heavily regulated nature, Benson and colleagues (2014) did not discriminate the selection of bidders on the basis of their industrial sector. Therefore, Hagendorff and Vallascas (2011) decided to focus exclusively on bank mergers to verify the current evidence on managerial risk incentives in the context of financial services institutions. For a sample of 172 US M&A deals conducted by 77 unique banks, the authors showed that vega significantly increases the risk of default, while delta contributes to reduced risk-seeking behavior of bank CEOs. These findings (particularly for vega) are consistent with the majority of prior studies in the field (Armstrong & Vashishtha, 2012; Coles et al., 2006; Low, 2009).

Interpreting the Conflicting Evidence on the Topic Table 4.1 summarizes the evidence provided by extant studies on bidders’ managerial incentives and risk reduction pursued via industrial diversification. Our preceding review suggests that the outcomes of the empirical literature on this research topic are not consistent. While some researchers (Amihud & Lev, 1981; Dong-Kyoon et al., 2005; May, 1995) suggest that executive shareholdings induce managers to initiate conglomerate mergers in order to extract personal benefits from risk reduction, others (Lane et al., 1998; Lewellen et al., 1989) postulate that corporate ownership structure and diversification endeavors are not related. Moreover, although we noticed some cross-study convergence in empirical findings, scholars’ interpretations of these findings are at odds with each other (e.g., see for instance Shekhar, 2005, versus Amihud and Lev, 1981; or Rose  & Shepard, 1997 versus May, 1995). We propose four plausible explanations that might help to make sense of these conflicting results. First, it is possible that the effect of ownership on managerial decision making is not linear, with its strength being dependent upon the amount of executive equity holdings. This argument has already received some empirical support in the study conducted by Denis, Denis, and Sarin (1997) on a large sample of 933 American companies. Splitting their data into several ownership ranges and using various measures of diversification, the researchers observed that managerial equity ownership is negatively associated with corporate diversification

1971–1980

1963–1984

1979–1982

1979–1990

1961–1976

Lewellen, Loderer, & Rosenfeld (1989)

Saunders, Strock, & Travlos (1990)

May (1995)

Servaes (1996)

218 US firms

184 US deals

38 US banks

203 US firms

371 US firms

209 US firms

1974–1982

Lloyd, Hand, & Modani (1987)

236 US mergers

1967–1974

Amihud, Dodd, & Weinstein (1986) Agrawal & Mandelker (1987)

309 US mergers

Sample

1961–1970

Period

Amihud & Lev (1981)

Authors

Stock ownership (1961–70) Stock ownership (1973–76)

Personal wealth (stock held + cash compensation)

Stock ownership (common stock + deferred stock + stock options) Stock ownership/ manager-controlled

Stock ownership/ manager-controlled

Stock ownership/ manager-controlled Security holdings (common stock + stock options)

Stock ownership/ manager-controlled

Executive compensation/ Ownership structure Decrease*/Support risk-aversion hypothesis Decrease*/Can also benefit shareholders Increase*/No support of risk-aversion hypothesis Decrease*/Support risk-aversion hypothesis Increase*/No evidence of adverse effect on shareholders Decrease*/Support risk-aversion hypothesis Decrease*/Support risk-aversion hypothesis N/A/Destroy wealth N/A/Do not destroy

Risk levels/Description

(Continued)

Negative* Positive*

Positive*

N/A

Negative

Positive*

Negative

Positive*

Positive*

Impact on diversification

Table 4.1  Review matrix of studies analyzing the impact of bidders’ executive compensation on risk taking and corporate diversification—Topic (A1), Stream (A), Theme (I)

168 foreign deals by US firms 118 Australian firms

1993–1998

1994–2001

Stock ownership, stock options

177 US banks

1988–1995

Stock ownership (of both managers and outside directors)

Stock ownership, previous stock option grants

Stock ownership, Pay for performance

199 US firms

Very high levels of stock ownership Cash compensation (salary and short-term bonus) Stock ownership/ manager-controlled

Stock ownership

Executive compensation/ Ownership structure

1985–1994

289 US mergers

1980–1987

Anderson, Bates, Bizjak, & Lemmon (2000) Cornett, Hovakimian, Palia, & Tehranian (2003) Dong-Kyoon, Kwok, & Young (2005) Shekhar (2005)

473 US CEOs

1985–1990

Rose & Shepard (1997) Lane, Cannella, & Lubatkin (1998)

933 US firms

Sample

1984

Period

Denis, Denis, & Sarin (1997)

Authors

Table 4.1  (Continued)

Decrease*/Support risk-aversion hypothesis N/A/Do not destroy shareholder wealth

Increase*/Agency theory prediction Decrease*/Weak support of risk-aversion N/A/higher CEO ability matching No relation/No evidence of adverse effect on shareholders N/A/Control through alternative mechanisms NA/Less effective in diversifying deals

Risk levels/Description

Positive*

Positive*

N/A

Negative*

No statistical association

Positive*

Positive

Negative*

Impact on diversification

92 deals in Taiwanese electronics sector 3,604 US mergers 172 US bank mergers by 77 unique acquirers

1990–2004

1997–2007

1994–2006

1993–2007

Low (2009)

Peng & Fang (2010)

Furfine & Rosen (2011)

Hagendorff & Vallascas (2011)

2,399 US firms

394 US firms

1980–1994

Malmendier & Tate (2008)

250 US deals

1993–2001

Cai & Vijh (2007)

Options’ sensitivity to stock return volatility (vega) scaled by cash pay Stock + option grants’ sensitivity to stock price (delta) scaled by cash pay

Option-based compensation

Overconfidence (delay exercising highly in-themoney vested options) Stock options’ sensitivity to stock return volatility (vega) Stock ownership

Stock + option holdings

N/A

Decrease*

(Continued)

N/A

N/A

Positive*

N/A

Positive*

Positive*

Increase*/Support risk-seeking hypothesis Increase*

N/A

Increase*/More risk-seeking behavior

Decrease*/Support risk-aversion hypothesis N/A

1992–2007

1993–2005

1992–2005

Zhao (2013)

Benson, Park, & Davidson (2014)

Period

Armstrong & Vashishtha (2012)

Authors

Table 4.1  (Continued)

3,688 US deals

577 US deals by S&P 500 CEOs

3,559 US deals

Sample Stock options’ sensitivity to stock price & stock return volatility (delta & vega) Employment contract Fixed-term contract, longer contract duration, long-term equity incentives in annual pay, accelerated stock and option vesting provisions in severance agreement, & refined definitions of CEO good-reason resignation and just-cause termination Options’ sensitivity to stock return volatility (vega); (large option portfolios & more in-themoney options)

Executive compensation/ Ownership structure

Decrease*/Support risk-aversion hypothesis

Increase*/Risk taking Increase*/Alleviate managerial risk aversion

Increase*/Idiosyncratic risk (delta); systematic risk (vega)

Risk levels/Description

Positive*

N/A N/A

Positivea; Negativea

Impact on diversification

2,369 US firms (3,680 deals) 2,190 US firms

1994–2012

1992–2012

Source: Adapted from Bodolica and Spraggon (2009a) Notes: *—Statistically significant a— Implied (not directly estimated) effect b— Not mentioned whether specifically related to M&A activities

Boulton, Braga-Alves, & Schlingemann (2014) Chintrakarn, Jiraporn, & Tong (2015) Relatively low power (CEO pay slice) Very high power (CEO pay slice)

Equity-based compensation (particularly exercisable stock options)

Increase*/Risk seekingb

Increase*/Reject (support) risk-aversion (seeking) hypothesis Decrease*/Risk-aversionb N/A

Inconsistent (across un- & conditional models) N/A

82  Bidders’ Executive Compensation Before the Deal activities. Yet the Amihud and Lev (1981) effect was detected only at very high levels of ownership, which acted as a stimulus for executives to diversify in order to satisfy their greater need for risk reduction. The curvilinear relationship between the CEO pay relative to other highest-paid executives and risk-seeking behaviors was recently demonstrated by Chintrakarn, Jiraporn, and Tong (2015). CEOs with less relative pay exhibit risk aversion, while when the relative compensation is above a certain point, executives tend to pursue risk-enhancing strategies. An alternative argument for this phenomenon is proposed by Servaes (1996), who showed that executive motives vary according to the specific timing of diversifying acquisitions. He reported that during the 1960s (1961–1970), when diversification was value destroying, managers with higher ownership stakes in bidding firms were less inclined to diversify. Nonetheless, over the time period of the 1970s (1973–1976), when the diversification discount declined to zero, top executives who decided to diversify had higher levels of ownership than their counterparts in focused firms. Second, as proposed by Lane and colleagues (1999), the divergence in opinions may be due to differences in theoretical assumptions espoused by the studies conducted on this research topic. While Lane and colleagues (1998) relied on a strategic management view of diversification and ownership structure, Amihud and Lev (1981) used a financial economics approach to frame their analysis. Moreover, under the condition of risk-aversion hypothesis, the agency-based prediction of reverse relationship between managerial equity stakes and diversification may be ambiguous (Denis, Denis, & Sarin 1999). On the one hand, the agency theory postulates that higher levels of ownership by executives should incentivize them to behave in the best interests of shareholders by increasing their risk-taking behaviors and avoiding risk-reducing conglomerate mergers. On the other hand, as the degree of ownership increases, both the employment-induced and the equity-related personal wealth of managers becomes even more tightly invested in the same company, obliging them to reduce the riskiness of their portfolios through industrial diversification. This argument is consistent with Malmendier and Tate (2008), who found that overconfident CEOs who delay exercising their highly in-the-money vested options (maintaining their exposure to firm-specific risk) are more likely to engage in diversifying mergers. In this context, the private benefits that senior executives can extract from more secure conglomerate mergers may offset the incentive effects of their equity stake in the firm, confounding the agency expectation of a negative correlation between diversification and managerial ownership. Third, the conflicting perspectives on the same question may be due to several methodological and theoretical limitations of extant studies that compose this particular topic of inquiry. Some of the most problematic issues that need to be acknowledged refer to the subjectivity of the definition of conglomerate mergers and the variability of measures employed to account for the extent of industrial relatedness in an acquisition (Cornett et al., 2003). Other critical limitations stem from the very small size of subsamples of industrially diversified companies, preventing us from making reliable interpretations,

Impact of Bidding Executive Compensation  83 and the restricted nature of ownership structure classifications, which do not allow an effective differentiation between the internal and external owners of corporate stock (Denis et al., 1999; Limmack, 1997). Moreover, the empirical results may be inconclusive due to significant endogeneity problems that exist in the relationship between the managerial risk-taking and stock-based incentives. Clearly, isolating the causation between these variables of risk and incentives is critical for securing the accuracy of models’ specification and interpretation of outcomes (Low, 2009). Fourth, the diversity of measures of managerial equity ownership employed confounds the distinctive role that various stock-related incentives play in mitigating managerial risk aversion. This measurements’ variability undermines the practical value of making cross-study comparisons. For instance, Lewellen and colleagues (1989) defined executive stock ownership as the sum of stock owned in the firm, stock options held, and stock linked to the deferred compensation plan of the top manager. Yet Agrawal and Mandelker (1987) excluded the latter pay element from their definition, while May (1995) referred to the combination of common stock held in the company and cash compensation received by the executive. Since various components of CEO pay packages can act differently in curbing the managerial propensity for risk avoidance, prior investigations examining executive motives for corporate diversification achieved via conglomerate mergers may need to be reevaluated. This possibility is inferred by a set of studies that disaggregated the measure of equity ownership and analyzed the separate impact of stock option holdings on senior executives’ decisions to involve their companies in risky M&A deals (Sanders, 2001; Williams, Michael,  & Rao, 2008; Williams  & Rao, 2006; Wright, Kroll, Lado, & Van Ness, 2002). Using American data from the 1990s, a period when stock option payments started to prevail over other compensation elements, researchers showed that option grants typically induce senior managers to take on higher levels of risk than they would otherwise accept in the absence of these grants. Consistent with this view, a more refined and differential analysis of both executives’ equity wealth sensitivity (vega and delta) and type of firm risk (systematic and idiosyncratic) may be appropriate for generating more accurate research outcomes (Armstrong & Vashishtha, 2012).

Concluding Remarks In sum, despite the observed disagreements in findings and their interpretations and due to the negative, or at best poor, performance of conglomerate mergers widely documented in the finance literature (Tuch  & O’Sullivan, 2007), many studies converge toward the view that shareholder wealth maximization is not the primary concern for the conduct of diversifying deals. Our analysis suggests that managerial ownership may not always represent an effective governance device in the context of conglomerate acquisitions. This conclusion might signal the need for moving beyond the current wisdom and exploring new mechanisms of incentive alignment that would encourage the risk-taking behavior of executives. As M&A transactions

84  Bidders’ Executive Compensation Before the Deal and their characteristics evolve from one merger wave to another (Andrade, Mitchell, & Stafford, 2001) and are normally associated with an increase in the complexity of CEO compensation, researchers’ focus on managerial shareholdings as ways of aligning manager-owner interests with regard to conglomerate deals is likely to diminish in importance over time. In their study, Bodolica and Spraggon (2009b) argued that the existence of compensation protection devices (i.e., employment agreements, severance provisions, and golden parachute clauses) may bring the risk-seeking behaviors of CEOs to the level desired by corporate owners. As discussed in Chapter 2, the employment agreement determines the terms of work-related service, including the structure and magnitude of pay; the severance provision specifies the payments to be made to executives should the termination of their employment occur for reasons other than cause; while the golden parachute clause makes these payments contingent upon the occurrence of a takeover (Tauber & Levy, 2002). Since these devices have the property of decreasing the uncertainty of managerial employment and compensation, CEOs might be more willing to accept risky endeavors sought by shareholders when they are rewarded with mechanisms that satisfy their pay- and job-related security needs. In the specific case of diversifying corporate strategies, this implies that the absence of managerial compensation protection devices in bidding firms may explain the occurrence of risk-reducing conglomerate mergers. Consistent with Bodolica and Spraggon (2009b), Zhao (2013) provided recent empirical evidence that indicates that CEO employment contracts and selected contractual provisions (see Table 4.1) alleviate managerial risk aversion and encourage bidding executives to initiate value-enhancing acquisitions. 4.2 IMPACT OF BIDDING EXECUTIVE COMPENSATION ON M&A DECISIONS AND ABNORMAL ANNOUNCEMENTRELATED RETURNS Researchers demonstrate that senior managers’ propensity to undertake M&A transactions and the abnormal returns to bidding firms ensuing from acquisition announcements are significantly influenced by the value and type of incentives included in the executive pay package. A broad variety of measures of top management compensation received empirical consideration within this topic of inquiry. Earlier studies focused primarily on different definitions of stock ownership (Lewellen, Loderer,  & Rosenfeld, 1985; Tehranian, Travlos, & Waegelein, 1987) and equity-based compensation (Bliss & Rosen, 2001; Khorana & Zenner, 1998), the stock option pay (Sanders, 2001; Williams & Rao, 2006), and the existence of LTIPs (Tehranian et al., 1987; Travlos & Waegelein, 1992). Yet recent studies extended their analysis to other elements of executive pay such as the liability insurance presence and ratio (Lin, Officer,  & Zou, 2011), the CEO pay slice (Bebchuk, Cremers, & Peyer, 2011), the employment contract and its provisions (Zhao, 2013), and pension holdings (Yim, 2013).

Impact of Bidding Executive Compensation  85

Exploring the Effect of Different Measures of Executive Pay Managerial Stock Ownership and Value-Enhancing Acquisitions In a pioneering work on this topic, Lewellen and colleagues (1985) analyzed the link between managerial stock ownership and M&A decisions for 191 US acquisitions that occurred between 1963 and 1981. They found that executive shareholdings relative to total pay are larger for bidding firms that experience positive abnormal returns when they undertake major investment decisions (such as mergers) than for firms that experience negative abnormal returns. Relying on the underlying premises of the agency theory, the authors explain that managers with substantial levels of share ownership bear higher costs from selecting a deal that decreases the company’s stock price. Ueng (1998) arrived at the same conclusion using a sample of 226 US acquirers at the beginning of the 1990s. Similar to Lewellen and colleagues (1985), Ueng (1998) reported that as the ratio of stock ownership relative to total compensation increases, managers tend to make decisions that favor shareholders’ interests by engaging in value-enhancing transactions. Walters, Kroll, and Wright (2007) also demonstrated that bidders with higher levels of managerial equity ownership exhibit higher cumulative abnormal returns (calculated over the three- and five-day windows) around the announcement of M&A events that occurred between 1997 and 2001. However, Hanson and Song (1996) did not confirm these findings in their study of 167 acquisitions completed by dual-class firms. This outcome is due to the existence of shares with disparate voting rights in the dual-class companies, which prevent the managerial ownership from playing a straightforward role in mitigating agency problems like in the case of single-class firms. The authors conclude that when senior managers prefer superior voting rights to residual cash flow claims, which enable them to gain voting control of the firm without holding the majority of the company stock, they are more likely to initiate value-reducing acquisitions. The inconsistent incentive effect of managerial ownership on strategic decision making may also be due to the fact that it operates nonlinearly, as shown in the article of Wright and colleagues (2002), who examined corporate acquisitions that took place in the USA between 1993 and 1997. In their study of 163 American acquirers, top executives with low share ownership value are found to initially emphasize value-maximizing M&A strategies, but as their equity stake within the company increases, they tend to get involved in less profitable firm investments. Tehranian and colleagues (1987) examined separately the impact that two different compensation modes—managerial stockholdings and the existence of LTIPs—exert on merger-related decisions. Employing multiple data gathered on 164 US bidders over the 1972 to 1981 period, they corroborated the result of Lewellen and colleagues (1985) related to the importance of managerial stock ownership in reducing the agent–principal conflicts of interests. Yet Tehranian and colleagues (1987) went even further than their predecessors by analyzing the incentive effect of executive LTIPs in selecting value-enhancing transactions. The evidence provided by these authors

86  Bidders’ Executive Compensation Before the Deal indicates that bidding companies that employ LTIPs to remunerate their senior management experience higher abnormal returns upon the announcement of merger proposals than firms without these incentive plans. Consistent with these two studies, Fung, Jo, and Tsai (2009) demonstrate that market-driven acquisitions exhibit significantly negative stock market returns when managers own lower amounts of corporate stock, have higher levels of both stock option pay and exercisable in-the-money options, and have no LTIPs. This implies that equity ownership and stock options provide different behavioral incentives for managers, as high option-based compensation seems to be the primary driver of value-destroying acquisitions. Contrary to prior evidence, other studies show that the level of executive shareholdings is not a significant predictor of either the three- and five-day acquisition announcement returns (Li & Srinivasan, 2011, and Lin and colleagues, 2011, respectively) or the likelihood of subsequent M&A deals (Peng & Fang, 2010). Time Horizon Problem and Managerial M&A Decisions Using a sample of 266 US acquirers over a time spectrum going from 1972 up to 1986, Travlos and Waegelein (1992) adopted an alternative approach to testing this research question by investigating the role that both managerial equity ownership and LTIPs play jointly in the initiation of corporate growth strategies. It is worth noting that the executive equity ownership was measured as a sum of common stock owned, holdings from deferred stock awards, and unexercised stock options. As predicted by the agency theory, the existence of the time horizon problem between managers and owners may be indicative of executive preferences in selecting a specific type of M&A deal. Managers who are rewarded with short-term bonus plans may be inclined to select mergers that have positive effects on earnings and cash flows in the short run, while those who are paid with LTIPs may look for transactions with positive outcomes in the long run. The results of Travlos and Waegelein (1992) indicate that bidders with high managerial equity stakes and LTIPs get significantly higher announcement-related abnormal returns than do those with small percentages of stock owned by senior managers who do not receive any LTIPs. Gao (2010) provides a more recent analysis with regard to the horizon problem in bidding firms and its association with managerial merger-related decisions. The author posited that executives with a long-term horizon invest in projects that increase the stock value in the long run, whereas their short-term–oriented counterparts emphasize those corporate actions that are consistent with the enhancement of the short-term performance of the firm. The value of the CEO’s restricted stock and options to be vested in a given year as a percentage of total compensation was used as a proxy to measure managerial horizon. The assumption is that when executives have a large incentive portfolio that becomes vested in the near future, they are more interested in the short-run stock price to secure the highest immediate outcome at the time when the equity positions are cashed out. Consistent with this prediction, Gao (2010) showed that bidding companies managed

Impact of Bidding Executive Compensation  87 by short-horizon executives with larger portfolios of restricted stock and options experience significantly higher abnormal returns around acquisition announcements compared to their long-term–oriented peers. Recently, focusing on the relationship between CEO age and acquisitiveness, Yim (2013) found that younger executives with longer career horizons who expect larger acquisition-induced compensation benefits are more likely to initiate M&A deals that experience lower announcement day returns over a three-day event window. The acquisitive behavior of these long-career-horizon managers is also explained by significantly higher option holdings, percentage of stock ownership, and equity wealth. Yim (2013) has also estimated the effect of CEO stock and pension holdings, but the positive coefficients for both pay indicators were not significant. Different Measurements of Executive Equity-Based Compensation Many scholars relied on a variety of different combinations of equity holdings, restricted stock, and options in a single measure of managerial equity-based compensation (EBC) in order to examine its role in M&A decisions. For instance, Datta, Iskandar-Datta, and Raman (2001) estimated the EBC as the value of options granted to the five highest-paid executives in the year before the acquisition divided by their total compensation in the same year. This estimation excludes the value realized by exercising previously granted stock options. The EBC definition of Bliss and Rosen (2001) refers to the dollar value of both restricted stock and options granted only to the CEO during the year prior to the merger. While Khorana and Zenner (1998) assessed the equity ownership as the number of owned shares and stock options exercisable within 60 days divided by the number of total shares outstanding, Walters and colleagues (2007) included in this measure all shares held by the CEO in the form of common stock, restricted stock, and in-themoney options. These variations in executive equity wealth estimations could be responsible for cross-study inconsistencies in generated results. For 54 large US acquiring companies during the early 1980s, Khorana and Zenner (1998) observed that the level of executive stock ownership is significantly higher for firms that perform value-enhancing deals than for bad acquirers. In explaining these results, they argue that the purpose of granting managers equity pay is to enhance their alignment with shareholders’ interests and increase the likelihood of acquisition success. Datta and colleagues (2001) corroborated the findings produced by Khorana and Zenner (1998) in a large-scale investigation of 1,719 US deals that occurred during the period between 1993 and 1998. The authors reported a strong positive relation between EBC of bidding managers and stock price performance around the date of acquisition announcements. After controlling for the acquisition mode and means of payment, Datta and colleagues (2001) showed that, compared to executives with low levels of EBC, those with high EBC acquire target companies that have higher growth opportunities and participate in M&A transactions that engender larger increases in firm risk.

88  Bidders’ Executive Compensation Before the Deal Both Cai and Vijh (2007) and Boulton and colleagues (2014) have also demonstrated a positive association between executive EBC (i.e., stock plus option holdings and stock incentives plus (un)exercisable options, respectively) and corporate acquisitive behavior, but the two investigations differ on the underlying motivation of CEOs to participate in M&A transactions. While the former authors posit that acquisitions are engendered by managers with an expectation of long-term value increase of overvalued holdings, Boulton and colleagues (2014) put forward the hypothesis that risk-enhancing acquisitions are pursued by executives because of the positive consequences of risk for their EBC. Using a sample of 1,300 Canadian deals over the 1993 to 2002 period, Dutta (2011) demonstrated that companies with higher stock versus cash pay ratios are more likely to initiate an acquisition, while the level of managerial stock ownership is not influential in making an acquisition decision. Focusing on the same research question as Khorana and Zenner (1998) and Datta and colleagues (2001), Bliss and Rosen (2001) obtained different findings. In their study of bank mergers from 1986 to 1995, the scholars reported that banks where executives receive more EBC are less likely to make acquisitions of other financial institutions. To explain these results, Bliss and Rosen (2001) suggest that the increased equity-based wealth of managers raises their concern about a negative stock price reaction to their acquisition endeavors. Since most M&A transactions tend to have negative announcement effects (Smith  & Kim, 1994; Walker, 2000), senior executives prefer to make fewer mergers when they own more stock of their bank. Additionally, the authors found that a higher ratio of CEO’s cash compensation to total compensation serves as an incentive to acquire, contrary to the EBC, which acts more as a disincentive. Reporting that CEO stock ownership significantly reduces the likelihood of an acquisition, Rosen (2005) corroborated the results of Bliss and Rosen (2001) for the specific case of firms with merger programs (i.e., serial acquisition events). CEOs with high equity stakes in their company may avoid engaging in M&A deals because these dilute the control they have and also involve some degree of risk. Moreover, Rosen (2005) demonstrated that managers who are already well paid, meaning that they enjoy higher excess compensation, are more likely to initiate acquisitions with the purpose of further increasing their total pay. Guest (2009) provided similar evidence on UK acquiring CEOs, indicating that higher levels of abnormal cash compensation ensuing from the conduct of prior M&A activities constitute a significant predictor of larger-size future acquisitions. Refined Estimators of Managerial Equity-Based Wealth In an attempt to refine the design of extant studies, Swanstrom (2006) examined the issue from an alternative angle to reiterate the previously documented positive association between executive equity incentives and abnormal returns from acquisition announcements (Lewellen et al., 1985; Ueng, 1998).

Impact of Bidding Executive Compensation  89 The methodological approach adopted in his study of 294 US deals over the 1994 to 1998 period differs in that the author used managerial equity-based wealth sensitivity to stock price (delta) instead of EBC. This measure allowed Swanstrom (2006) to obtain a stronger overall model with higher values of adjusted R-squared (10.9 percent) and F statistic (12.96) than those reported in the model of Datta and colleagues (2001) (1.25 percent and 2.45, respectively). This outcome indicates the importance of considering executives’ overall wealth invested in the firm as opposed to just a single year’s compensation when examining managerial motives to acquire another firm. Relying on the same pay-for-performance measure of CEO compensation, Minnick, Unal, and Yang (2011) confirmed the findings of Swanstrom (2006) for the banking industry. In particular, they demonstrated the dual role of incentive-based pay for bank managers, as high-delta banks were found to be substantially less likely (36 percent) to engage in value-destroying mergers and more likely (59 percent) to conduct value-enhancing deals. Yet for a large sample of 2,522 US acquisitions over the 1990 to 2003 period, Masulis, Wang, and Xie (2007) demonstrated that neither the CEO’s wealth sensitivity to stock returns nor the equity-based pay could explain the announcement returns to bidding companies. Consistent with Masulis and colleagues (2007), Boulton and colleagues (2014) have also failed to report a significant relation between bidders’ returns around acquisition announcements and either the aggregate or disaggregated (i.e., exercisable options, unexercisable options, and stock ownership) measure of managerial equity incentives. Alternative Elements of Bidders’ Executive Compensation In a recent study of 4,451 American top executives, Custodio, Ferreira, and Matos (2013) participated in an alternative research path to examine why companies pay an annual wage premium to generalist (as opposed to specialist) CEOs. They found that the pay premium is over 19  percent, particularly for companies characterized by an intense M&A activity, where the recruited CEOs are expected to execute complex tasks related to the conduct of acquisition deals. Another innovative approach to the analysis of this topic was adopted by Goel and Thakor (2010), who developed an envy-based theory of merger waves. The authors argue that mergers come in waves because top managers, who are envious of other managers based on the relative compensation they obtain by increasing their firm size through M&A transactions, are tempted to imitate the previously initiated merger strategy of other executives with the purpose of obtaining personal pay-related benefits. On the basis of this theoretical prediction, Goel and Thakor (2010) reported that the announcement of abnormal returns from acquisitions which are made by envy-driven CEOs later in a wave are significantly lower than those of bidding CEOs who acquire earlier. Bebchuk and colleagues (2011) proposed the usage of the CEO pay slice as an alternative measure of executive compensation to demonstrate that a larger percentage of the total pay to the top five managers that goes to

90  Bidders’ Executive Compensation Before the Deal the CEO is associated with higher agency problems in bidding firms. The authors showed that bad M&A decisions can be explained by the bidder’s CEO pay slice, because it is correlated with lower stock returns and higher odds of a negative stock return surrounding acquisition announcements. Although Chatterjee and Hambrick (2007) did not test the separate effect of a specific component of executive pay, they discovered that CEO narcissism is positively associated with the number and size of acquisitions. One of the elements that are included in the aggregate measure of narcissism is the CEO’s total cash and noncash compensation relative to the second highest-paid executive in the company. In the same vein, Malmendier and Tate (2008) attribute the heightened acquisitiveness of senior managers to another (although related to narcissism) feature of their personality, namely overconfidence. CEOs who persistently hold rather than exercise in-themoney options conduct more M&A deals, which experience significantly more negative market reaction compared to investment projects completed by their nonoverconfident counterparts.

Explaining the Cross-Study Variability in Results Since several studies reported a positive relation (Datta et al., 2001; Khorana & Zenner, 1998) while Bliss and Rosen (2001) found evidence to the contrary, the impact of managerial EBC on acquisition decisions is not conclusive. Although the small size of Bliss and Rosen (2001) and Khorana and Zenner (1998) samples (32 and 54 firms, respectively) seriously limits the predictive power of their statistical models, their opposing findings warrant further consideration. In his investigation of acquisition and divestiture propensity of 250 US companies between 1991 and 1995, Sanders (2001) provides one possible explanation of this dilemma. This may be due to the widely adopted practice of aggregating stock ownership and stock options into a single measure of EBC, implying that they exert equal effects on executive behavior. Exploring these incentives separately, Sanders (2001) demonstrated that firms are more likely to engage in acquisitions when their managers are paid with stock options, but they are less likely to take part in such deals when their executives own stock. The asymmetrical risk properties of these two compensation elements induce CEOs to respond to them in different ways. As discussed in Chapter 2, the real and immediate exchange value of share ownership is typically altered in direct proportion to shareholder returns. On the contrary, stock options do not have marketable value when granted, and the downward fluctuations in stock price do not generate reductions in real wealth of executives, as they can wait for the stock price to increase in order to exercise their options. Several scholars confirmed the conclusions of Sanders (2001) with regard to the risk incentive effect of the executive stock option pay (Deutsch, Keil, & Laamanen, 2007). Using a similar research design, Wright and colleagues (2002) showed that managerial stock options positively affect both the risk-enhancing M&A strategies and the abnormal returns of bidding

Impact of Bidding Executive Compensation  91 companies. Williams and Rao (2006) examined 127 bidders over the 1994 to 1996 period and reported a significantly positive association between stock option grants and the postmerger level of equity risk, particularly in the case of smaller firms. Aiming to verify whether this relationship holds in the context of the highly regulated banking industry, Williams and colleagues (2008) corroborated these findings for a dataset of 131 bank mergers undertaken between 1993 and 2002. Although Gupta and Misra (2007) have also employed a sample of mergers between publicly traded banks in the USA, they relied on a different measure of CEO pay, namely the total compensation, which includes stock options. The authors showed that highly compensated executives exhibit a greater likelihood of initiating value-enhancing bids, as opposed to CEOs who are less paid and more likely to engage in value-decreasing transactions. Another explanation of discrepancies in results when EBC is used in the analysis of managerial propensity to engage in M&A deals may be related to industry features of the bidding firm. While Khorana and Zenner (1998) and Datta and colleagues (2001) gathered mixed data for multiple industries, Bliss and Rosen (2001) examined only those companies that operate in the banking sector. According to Subrahmanyam, Rangan, and Roseinstein (1997), there are substantial differences between banks and nonfinancial firms in terms of statutory regulations, banking and antitrust laws, financial structures, operating characteristics, and length of the regulatory approval process of M&A transactions. Moreover, the existence of prudential legislation and safety-net protections in the American banking sector weakens the disciplinary role of the market for corporate control and induces a heavier reliance on regulatory supervision for monitoring the behavior of bank managers (Hughes, Lang, Mester, Moon, & Pagano, 2003). As Hagendorff, Collins, and Keasey (2007) posit, the predominance of value-destroying mergers in the banking industry may be caused by important weaknesses in banks’ governance attributes in terms of board of directors’ composition and incentive structuring of executive compensation. These industry-driven differences suggest that empirical findings on internal governance devices (i.e., CEO pay) in the context of M&A deals cannot be generalized from nonfinancial companies to financial institutions that require a separate agency analysis. Using the research of Williams and colleagues (2008), who also employed a sample of bank mergers to report a positive options–acquisitions relation, it can be inferred that the ownership of other stock included in the measure of EBC is responsible for the negative effect of EBC on merger decisions documented by Bliss and Rosen (2001). Consistent with this view is the recent evidence that the positive association between EBC and CEO acquisitiveness is strongly driven by the effect of exercisable stock options (Boulton et al., 2014). During the late 1980s when Bliss and Rosen (2001) conducted their study, the banking industry was undergoing major structural changes, and the ownership of common stock by senior managers was more popular. Conversely, the 1993 to 2002 period covered by Williams and colleagues

92  Bidders’ Executive Compensation Before the Deal (2008) coincides with the massive consolidation of the banking sector, when the largest number of mergers were undertaken by financial services firms, and the usage of stock option grants as a predominant element of executive pay packages.

Summary and Key Methodological Concerns Table 4.2 offers a review matrix of studies that analyzed the impact of bidders’ executive pay on corporate M&A decisions and abnormal returns at acquisition announcements. The empirical evidence gathered on this topic of inquiry informs us that an appropriately designed managerial compensation packet plays an important role in reducing the agency problems by encouraging CEOs to participate in M&A deals that produce positive abnormal returns to bidding shareholders. For instance, Zhao (2013) demonstrated the incentive effect of executive employment contracts and their selected individual provisions (e.g., fixed-term contract, longer contract duration, long-term equity incentives in annual pay, accelerated stock and option vesting clauses in severance agreement, and refined definitions of good-reason resignation and just-cause termination) in the initiation of value-increasing acquisitions. Despite some discrepancies in opinions and difficulties associated with weighting up the costs and benefits of EBC, important empirical support exists with regard to the incentive alignment property of this element of executive pay (Datta, Iskandar-Datta, & Raman, 2004). It is worth noting, however, that in order to measure the abnormal returns around acquisition announcements, scholars have relied on the short-term-event study methodology, which allows tracking the changes in stock returns over a short event window of several days. For instance, Datta and colleagues (2001) and Swanstrom (2006) used a two-day window, while in the studies of Hanson and Song (1996) and Bebchuk and colleagues (2011), stock price effects were calculated over an interval of 11 days. Despite the prevalent usage of this method of measuring acquisition performance, does this short event window allow us to accurately evaluate the effectiveness of executive decisions with regard to M&A activities? Finding a reliable answer to this research question is a critical step for securing the incentive nature of compensation contracts for effectively guiding the merger-related behavior of executives. It is widely acknowledged in the finance literature that short-term event studies are associated with the difficulty of finding both an appropriate event window for the examination of stock price returns and a relevant benchmark to estimate abnormal returns (Tuch & O’Sullivan, 2007). This methodology relies on the assumption of stock market efficiency, meaning that the market reacts in an unbiased manner to the newly released information and is capable of anticipating correctly the future economic implications of the announced M&A deal. Short-term abnormal announcement

1972–1986

1964–1990

1982–1986

1990–1993

1986–1995

Hanson & Song (1996)

Khorana & Zenner (1998)

Ueng (1998)

Bliss & Rosen (2001)

1972–1981

1963–1981

Period

Travlos & Waegelein (1992)

Lewellen, Loderer, & Rosenfeld (1985) Tehranian, Travlos, & Waegelein (1987)

Authors

Compensation structure

Stock ownership (relative to total compensation) 164 US Existence of LTIPs acquirers Stock ownership (common stock + deferred stock awards + unexercised stock options) 266 US Existence of LTIPs + stock ownership acquirers (common stock + deferred stock awards + unexercised stock options) 167 US deals Stock ownership (superior voting rights (dual class over residual cash flow claims) firms) 54 US firms Stock ownership (ratio of the number of owned shares + options exercisable within 60 days to total shares outstanding) 226 US Stock ownership (relative to total acquirers compensation) 32 US banks Ratio of cash compensation to total compensation Equity-based compensation (value of newly granted options + restricted stock)

191 US deals

Sample

Negative*

N/A

(Continued)

Positive*

N/A

Positive*

Positive*

Higher*

Higher*

Positive*

Positive*

Positive* Positive*

Positive*

Impact on decision to engage

Lower*

Higher*

Higher* Higher*

Higher*

Abnormal returns

Table 4.2  Review matrix of studies analyzing the impact of bidders’ executive compensation on corporate M&A decisions and abnormal announcement-related returns—Topic A2, Stream A, Theme I

1993–1997

1993–2001

1994–1998

1994–1996 1993–2001 1992–2004

Wright, Kroll, Lado, & Van Ness (2002)

Rosen (2005)

Swanstrom (2006)

Williams & Rao (2006) Cai & Vijh (2007) Chatterjee & Hambrick (2007) Deutsch, Keil, & Laamanen (2007)

Gupta & Misra (2007)

1991–1995

Sanders (2001)

1981–2004

1996–2002

1993–1998

Period

Datta, Iskandar-Datta, & Raman (2001)

Authors

Table 4.2  (Continued) Compensation structure

Equity-based compensation (ratio of the value of new option grants to total pay) 250 US firms Stock ownership Stock options 163 US firms Stock ownership (lower levels/higher levels) Stock options 2,222 US Stock ownership firms Excess compensation 294 US deals Equity-based wealth sensitivity to stock price (delta) 127 US firms Stock options 250 US deals Stock + option holdings 111 US CEOs Narcissism (e.g., CEO’s total pay relative to the second-highest-paid executive) 1,003 US Stock ownership firms Stock options 228 US bank Total compensation (including stock deals options)

1,719 US deals

Sample

N/A N/A Higher*

N/A N/A N/A

N/A N/A Higher*/ Lower* Higher* N/A N/A Higher*

Higher*

Abnormal returns

Positive* Positive* Positive

Positive* Positive* Positive*

Positive* Negative* Positive* Positive*

Negative* Positive* Positive*/Positive*

Positive*

Impact on decision to engage

394 US firms 131 bank mergers 402 US firms

1980–1994

1993–2002

1992–2005

1984–2001

1993–2004

1979–2006

Malmendier & Tate (2008) Williams, Michael, & Rao (2008) Fung, Jo, & Tsai (2009)

Guest (2009)

Gao (2010)

Goel & Thakor (2010)

5,417 or 4,134 US deals

4,528 UK deals 2,894 US deals

313 US deals

1997–2001

Walters, Kroll, & Wright (2007)

2,522 US deals

1990–2003

Masulis, Wang, & Xie (2007)

Value of restricted stock + options to be vested in a year as a percentage of total pay (short horizon) Envy (of other CEOs based on relative compensation received for making acquisitions)

Stock ownership Exercisable in-the-money options Total stock option pay Lack of LTIPs Abnormal cash compensation

Equity-based compensation (ratio of the value of option + restricted stock grants to annual total pay) Equity-based wealth sensitivity to stock price (delta) Stock ownership (common stock + restricted stock + in-the-money options) Overconfidence (delayed exercising of highly in-the-money vested options) Stock options

Lower*

Higher*

Higher* Lower* Lower* Lower* N/A

N/A

Lower*

Not significanta

Not significanta Higher*

(Continued)

Positive*

Positive

Positive Positive Positive Positive Positive*

Positive*

Positive*

Positive

Not significanta

Not significanta

159 US bank mergers 4,451 US CEOs

1993–2002

1996–2004

2002–2008

1991–2005

1993–2007

Li & Srinivasan (2011)

Lin, Officer, & Zou (2011)

Minnick, Unal, & Yang (2011)

Custodio, Ferreira, & Matos (2013)

3,504 US deals 709 deals by 278 Canadian firms

1990–2003

Bebchuk, Cremers, & Peyer (2011) Dutta (2011)

92 deals in Taiwanese electronics sector 1,241 US deals 1,300 Canadian deals

Sample

1997–2007

Period

Peng & Fang (2010)

Authors

Table 4.2  (Continued)

Stock ownership Liability insurance presence Ratio of liability insurance coverage to market value of equity Pay-for-performance sensitivity (delta or stock + option grants’ sensitivity to stock price) Annual pay premium (for generalist CEOs)

Ratio of stock option pay to cash pay Stock ownership (% of outstanding shares owned) Stock ownership

CEO pay slice

Stock ownership

Compensation structure

N/A

Higher*

Higher Lower* Lower*

Higher

Lower* & Negative* N/A N/A

N/A

Abnormal returns

Positive*

Positive*

N/A N/A N/A

N/A

Positive* Positive

N/A

Positive

Impact on decision to engage

1993–2005

1994–2012

Zhao (2013)

Boulton, Braga-Alves, & Schlingemann (2014)

Expectation of compensation benefits Percentage of stock ownership Equity wealth Stock holdings Option holdings Pension holdings 577 US deals Employment contract by S&P Fixed-term contract, longer contract 500 CEOs duration, long-term equity incentives in annual pay, accelerated stock and option vesting provisions in severance agreement, & refined definitions of CEO good-reason resignation and just-cause termination Equity-based compensation (exercisable 2,369 US options + unexercisable options + firms stock incentives) (3,680 deals) Exercisable stock options

S&P 1,500 US firms

Source: Adapted from Bodolica and Spraggon (2009a) Notes: *—Statistically significant a— Results briefly commented but not reported

1992–2007

Yim (2013)

Positive* Positive* Positive* Positive Positive* Positive Positive* Positive*

Positive*

Positive*

Lower* N/A N/A N/A N/A N/A Higher* Higher*

Lower & Negative Lower & Negative

98  Bidders’ Executive Compensation Before the Deal returns represent collective expectations of investors regarding the likelihood of a merger success rather than a real estimate of an acquisition performance (Zollo & Meier, 2008). According to Rosen (2005), the method of cumulative abnormal returns around the announcement of merger events is too noisy to constitute an appropriate measurement of merger quality. In light of these limitations, we believe that windows with longer periods of time are more appropriate for assessing the performance ensuing from an acquisition. Longer event windows allow the stock market to take into consideration the real information about the economic value generated from a given M&A transaction, making its reaction to acquisition announcements more accurate.

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5 Impact of Bidding Executive Compensation on M&A Characteristics

PRELIMINARY OBSERVATIONS ON THIS RESEARCH STREAM

Studied Elements of Bidders’ Executive Compensation Studies that fall within this stream of research (Stream B in Figure 3.3) tend to demonstrate that various elements used to reward managers of bidding firms are significantly associated with merger-related characteristics. The most commonly examined characteristics of M&A transactions are the mode of payment and acquisition premium. Two important aspects should be highlighted prior to proceeding with a more detailed review of empirical findings in this stream. The first relates to the type of executive pay components that received consideration in the relevant literature, while the second aspect addresses the specific approaches used to measure the payment mode and control premium. The majority of studies focused on exploring the incentive effect of the stock ownership element of bidders’ managerial compensation (Amihud, Lev,  & Travlos, 1990; Hubbard  & Palia, 1995; Lin, Officer, & Zou, 2011; Slusky & Caves, 1991). Yet other components of CEO pay, such as relative cash compensation (Hayward & Hambrick, 1997), relative equity-based pay (Sharma  & Hsieh, 2011), exercisable in-the-money options (Fung, Jo, & Tsai, 2009), unexercisable stock options (Boulton, Braga-Alves, & Schlingemann, 2014), liability insurance presence and ratio (Lin et al., 2011), and employment contract (Zhao, 2013), have also been analyzed in extant research.

Predominant Measurements of M&A Characteristics Measuring the Mode of Payment The mode of payment refers to the bidder’s decision to finance the acquisition using cash, share exchanges, or a combination of disbursements made in cash and exchanges of common stock. Two dominant ways to measure the choice of deal financing can be depicted, either as a dichotomous variable (Kroll, Walters, & Wright, 2008) or relying on a three-point ordinal scale (Hayward  & Hambrick, 1997). Some studies opt for a dummy variable

Impact of Bidding Executive Compensation  103 measurement that takes the value one, in the case of stock-based M&As or when the payment of the deal price is made through a combination of stock and cash, and zero otherwise (Bodolica & Spraggon, 2009a; Comment & Schwert, 1995). Yet as recent research suggests that the stock market views all equity-based transactions differently than mixed cash and equity deals (Haleblian, Devers, McNamara, Carpenter,  & Davison, 2009), the latest studies tend to employ the three-point method because it permits differentiating between pure and combined payments. For instance, Spraggon and Bodolica (2011) computed the bidding firm’s choice of acquisition financing by assigning the value one to designate a cash payment, two for a mixed cash and stock consideration, and three for pure equity-based financing. Measuring the Acquisition Premium As far as the acquisition premium is concerned, it indicates the price in excess of the market value paid to target shareholders by the bidding company to gain control of the target company. The acquisition premium, which is also referred to as control premium, is typically estimated by the difference between the purchase price of the target firm’s stock and the target’s stock price some time prior to the acquisition announcement, divided by the target’s preannouncement stock price and is expressed in percentage terms (Datta, Iskandar-Datta, & Raman, 2001; Krishnan, Hitt, & Park, 2007). Three alternative measures of the magnitude of control premium can be observed in extant studies that involve an estimate for target stock price one day, 10 days, and four weeks prior to the day when the target firm received its first official bid (Bodolica & Spraggon, 2009a; Haunschild, 1994). However, the four-week period represents the most common measure employed in the specialized M&A literature, as it allows capturing the real target stock price, which is still unaffected by the leakage of information to the market about the forthcoming acquisition (Hayward & Hambrick, 1997; Krishnan et al., 2007; Spraggon & Bodolica, 2011). TYPES OF EMPIRICAL STUDIES IN THIS STREAM OF INQUIRY

Effect of Bidders’ CEO Pay on Mode of Payment Executive Stock-Based Incentives and Mode of Acquisition Financing Both Amihud, Lev, and Travlos (1990) and Travlos and Waegelein (1992) examined the extent to which bidders’ managerial compensation affects the mode of payment used to finance the deal. In spite of their difference along the measure of executive compensation taken into consideration, the two studies draw similar conclusions. In their tests performed on 209 acquisitions undertaken by 165 US bidders, Amihud and colleagues (1990) employed the level of managerial stock ownership as an independent

104  Bidders’ Executive Compensation Before the Deal variable. Applying the control maintenance theory to corporate investment decisions, they argue that the main reason top executives with elevated shareholdings tend to use cash rather than stock when acquiring a target is that they do not want to risk the loss of control by diluting their equity stake in the firm that results from stock payment. Conversely, when managers possess insignificant ownership stakes in their company, the probability of losing control is not considerably affected by the stock-based choice of acquisition financing. The authors demonstrated that the two-day abnormal returns in cash-financed deals are positive (0.44%) but statistically insignificant, while those in stock-financed transactions are significantly negative (−1.19%). Consistent with Amihud and colleagues (1990), Boulton and colleagues (2014) have also reported negative and statistically significant (at the p < 0.01 level) abnormal returns around the announcement of all-equity M&A transactions. Travlos and Waegelein (1992) corroborated these findings on a sample of 266 American companies that engaged in M&A deals during the 1972 to 1986 period. It is worth noting that the authors relied on an alternative measure of bidders’ executive pay, pooling together LTIPs and stock ownership. The latter element of managerial compensation did not include only common stock but also deferred stock awards and unexercised stock options. Travlos and Waegelein (1992) found that managers who are rewarded with LTIPs and possess higher percentages of company stock participate in cash-based mergers that experience higher announcement abnormal returns than equity-financed transactions. As predicted by Amihud and colleagues (1990), Hubbard and Palia (1995) demonstrated that bidders with lower levels of managerial ownership tend to finance their acquisitions in stock more often than bidders with higher executive equity stakes, but this finding is not statistically significant. These empirical results were not corroborated in the study of Boulton and colleagues (2014), who showed that bidding firms are more likely to use stock as their mode of payment for acquisitions when equity-based incentives and unexercisable stock options of senior executives are high. Nonetheless, Boulton and colleagues (2014) confirmed the positive relation between CEO equity and option holdings and stock-based acquisition financing that was previously established by Cai and Vijh (2007). For a sample of 402 American corporations over the 1992 to 2005 period, Fung and colleagues (2009) analyzed the association between the equity-based mode of payment for acquisitions and four different components of senior management pay. The scholars found that stock-financed deals generate significantly negative performance implications, particularly when the compensation packages of bidding managers exclude LTIPs but include low levels of stock ownership and high amounts of stock options and exercisable in-the-money options. The reported results are consistent with both Amihud and colleagues (1990) for the equity ownership element of pay and Boulton and colleagues (2014) for the exercisable options’ component of executive compensation.

Impact of Bidding Executive Compensation  105 Long Managerial Decision Horizons and Stock-Based Financing Two studies in this stream (Gao, 2010; Sharma  & Hsieh, 2011) are concerned with testing the theory of Shleifer and Vishny (2003), who posit that stock-financed acquisitions occur when acquirer CEOs have longer while target CEOs have shorter decision horizons. Using the value of restricted stock and options to be vested in a year as a percentage of total pay as a proxy of managerial time horizon, Gao (2010) examined how this specific measure of bidders’ executive compensation influences takeover financing decisions. The main assumption of the study is that managers with a long-term horizon will employ overpriced stock to acquire the assets of the target firm, because their emphasis is on the corporate stock return in the long run. Conversely, shortsighted CEOs will avoid stock-based payments for acquisitions, as this mode of financing reveals signs of overvaluation, and will select cash-financed deals, as they are more favorably perceived by the stock market. This hypothesis was tested on a large sample of 2,894 US transactions that occurred over the 1993 to 2004 period. Gao (2010) concluded that long-horizon CEOs who have less incentive portfolio to be vested in a year are more likely to use stock to pay for their M&A deals. This choice is due to the superior long-term postacquisition performance implications of stock financing despite its detrimental effect on the firm stock price in the short run. On the contrary, Sharma and Hsieh (2011) do not provide strong support for the theory of Shleifer and Vishny (2003) regarding the horizon-related rationale for a stock-based payment in acquisitions. The authors employed seven different measures of managerial horizon based on the composition of compensation packets in bidding firms. While higher ratios of salary and cash pay to total compensation imply a shorter horizon, higher ratios of stock option awards, unvested stock, unexercised options, unexercisable options, and exercised options’ value to total compensation are indicative of a longer horizon. Sharma and Hsieh (2011) did corroborate that managers in bidding companies have longer horizons than do their counterparts in target firms. Yet their statistical tests indicate that this evidence holds not only for the subset of 246 stock-financed deals but also for 121 mergers in which cash was used as method of payment. Therefore, the authors concluded that the lengthiness of bidders’ management horizon is not significantly related to the probability of a stock-based mode of financing. Contrary to Gao (2010), Malmendier and Tate (2008) submit that the method of payment for an acquisition is not influenced by the specific time horizon of top managers in bidding firms but rather by their overconfidence. This personality characteristic manifests itself when CEOs persistently delay exercising their incentive portfolio of highly in-the-money vested options. Using a sample of 394 US companies that engaged in acquisition deals between 1980 and 1994, Malmendier and Tate (2008) demonstrated that overconfident senior executives are more likely to choose cash rather than equity to pay for their M&A transactions. Since overconfident top managers

106  Bidders’ Executive Compensation Before the Deal overestimate the value they will create by taking over target firms, they tend to select cash-based payments because they believe that the company stock is currently undervalued by the market.

Effect of Bidders’ CEO Pay on Acquisition Premium Managerial Equity-Based Compensation and Premium Magnitude Other scholars in this stream analyze the role of bidders’ agency situation in the determination of the magnitude of acquisition premium paid to target shareholders. Slusky and Caves (1991) are among the first scholars to test this relationship based on a sample of 100 mergers initiated by US nonfinancial companies over a two-year period between 1986 and 1988. They concluded that bidding managers who hold larger proportions of company shares offer smaller premiums to target shareholders, an effect driven by incentive alignment considerations. However, using data on 354 American mergers, Hubbard and Palia (1995) discovered that the relationship between managerial ownership and control premium is not unidirectional but rather nonmonotonic. The authors showed that executives tend to offer a high premium not only when their ownership stake is low (due to their perquisite consumption) but also when they own a substantial fraction of company shares (attributable to their private benefits of control). This leads to a negative premium–ownership association at low levels of top management shareholdings and a positive association at very high values of managerial ownership, with abnormal returns initially increasing and subsequently decreasing as the level of ownership increases. The statistical analysis performed by Datta and colleagues (2001) confirms the monotonic negative relationship between the magnitude of control premium and managerial EBC observed earlier by Slusky and Caves (1991). The researchers demonstrate that the acquisition premium paid by managers in high–EBC firms (35.88 percent) is significantly lower than the premium paid by their counterparts in low–EBC companies (44.66 percent). The resulting 8.78 percent difference translates into large savings of US$54.6 million for bidders that offer their executives high levels of EBC. Partitioning their sample by the stock price performance and the mode of acquisition payment, Datta and colleagues (2001) validated their findings for a subsample of good and poor performers in cash- and non–cash-financed takeovers. The researchers concluded that bidding firms awarding low EBC provide fewer incentives for senior managers to make value-maximizing decisions, inducing them to pay higher premiums for their low-growth targets. The negative EBC–premium relationship reported by Datta and colleagues (2001) was not corroborated by Cai and Vijh (2007), who found evidence to the contrary. The key argument of these scholars is that high–EBC managers possess important equity incentives to conduct acquisitions and, therefore, they are more willing to offer larger premiums to secure a deal. These

Impact of Bidding Executive Compensation  107 contradictory results can be explained by differences in the economic meaning of the measure of EBC employed across the two studies. The EBC definition of Datta and colleagues (2001) is more restrictive, as it captures only the value of new stock options (estimated using a modified Black-Scholes method) granted to executives during the year before the acquisition as a percentage of their total compensation. Conversely, the aggregate measure of stock and option holdings of Cai and Vijh (2007) permits them to account for the incentive effect of all equity possessions at a given period of time, including the grants of shares and options made several years prior to an M&A deal. Moreover, while Datta and colleagues (2001) estimated the EBC of the top five executives, Cai and Vijh (2007) focused exclusively on the company’s CEO. For a large sample of 1,667 US cash-financed transactions that occurred between 1980 and 2005, Bargeron, Schlingemann, Stulz, and Zutter (2008) examined whether the association between bidders’ executive stock ownership and acquisition premium is dependent upon the public or private status of the bidding firm. The authors found that public companies with low levels of managerial ownership offer significantly larger control premiums to target shareholders compared to private bidders when the ownership by senior executives is higher. According to Bargeron and colleagues (2008), these results are indicative of the existence of stronger incentive alignment in private bidders when high share possessions of managers make them less willing to make decisions that may be harmful to their shareholders (e.g., overpay for targets). Fung and colleagues (2009) did not only confirm the negative ownership–premium relation reported by Bargeron and colleagues (2008) but also extend their analysis to additional elements of executive compensation. They demonstrated that the disbursement of higher premiums and the negative performance implications of stock-based M&As are particularly strong for corporations in which CEOs own less equity, have no LTIPs, are paid with more stock options, and possess more exercisable in-the-money options. Other Measures of Executive Pay and Acquisition Premiums Hayward and Hambrick (1997) used another component of the top management compensation package to examine the role that CEO hubris, or exaggerated self-confidence, plays in acquisition-related pricing decisions (see Chapter 1 for more details regarding the hubris hypothesis of corporate takeovers). Measuring the CEO hubris as the ratio of CEO cash compensation relative to other highest-paid executives in the bidding corporation, the authors uncovered a positive association between managerial hubris and the magnitude of control premium. Higher cash compensation that is not contingent upon firm performance does not increase the alignment of executive and shareholder interests, persuading overconfident and self-centered CEOs to overpay for the target company. This payment of larger acquisition premiums translates into significantly lower one-year postacquisition returns, destroying the financial wealth of acquiring shareholders.

108  Bidders’ Executive Compensation Before the Deal Compared to other studies in this stream, the investigation of Lin and colleagues (2011) is unique in two important regards. First, it looks beyond the traditionally explored US market for corporate control by employing data on 278 Canadian acquiring firms that conducted 709  M&A transactions. Second, the study considers the effect on control premiums of an atypical element of executive compensation package that relates to indirect benefits rather than direct payments, namely managerial liability insurance. Observing that cumulative abnormal returns around acquisition announcements are significantly lower for companies in which managers are protected by legal liability insurance, Lin and colleagues (2011) argue that one of the possible channels through which the value loss occurs is the bidders’ overpayment for target firms. Consistent with this expectation, the ratio of liability insurance coverage to the market value of equity is found to exert a strong positive impact on the magnitude of acquisition premium. The coefficient of the liability insurance presence in regression analyses is also positive but statistically insignificant. These results imply that liability insurance in bidding firms aggravates agency problems, as entrenched managers who are insulated from the discipline of potential shareholder litigation make worse acquisition-related decisions by paying larger control premiums. Finally, the only study in this stream of inquiry that scrutinized the relationship between the existence of executive employment contracts and the magnitude of control premium offered in acquisitions is performed by Zhao (2013). Analyzing data on 577 US deals made by S&P 500 CEOs over the 1993 to 2005 period, the author provides evidence that is inconsistent with the managerial entrenchment hypothesis but rather supportive of the incentive alignment hypothesis. Bidding companies with executive employment contracts pay significantly lower acquisition premiums and generate higher abnormal returns around M&A announcements than do their counterparts without CEO contracts. Zhao (2013) found that these positive incentive effects are particularly strong for stock-based transactions. Upon a more detailed examination of individual contractual provisions, only the fixed-term contract, longer contract duration, salary and bonus indicators in annual compensation, option grants in annual pay, and accelerated stock and option vesting clauses in severance agreement are reportedly associated with smaller premiums paid to target shareholders.

Effect of Bidders’ CEO Pay on Other M&A Characteristics It is worth noting that only recently, scholars working within this research stream started extending their focus of analysis to other M&A characteristics beyond the conventionally explored mode of payment and control premium variables. Yet the scholarly efforts made in this direction are still limited and are too disparate to be summarized in a comparative table due to the diversity of both measures of executive pay used (e.g., EBC; stock incentives to be vested in a year; exercisable and unexercisable options; liability insurance existence and coverage) and merger-induced features considered

Impact of Bidding Executive Compensation  109 (e.g., acquisition frequency, volume, and speed; target private–public status; acquirer–target fit). For instance, Cai and Vijh (2007) provided some early evidence of a significant relationship between the bidder’s CEO equity-based compensation and the speed of acquisition completion. In an analysis of 250 completed US transactions, the authors argue that top executives with a higher market value of stock and option holdings are impatient to speed up the M&A process due to the strong personal incentive effect of an increased long-term value of their firm in the postacquisition period. Additionally, Gao (2010) found a larger amount of bidding CEOs’ equity incentives to be vested in a year reduces the frequency of acquisitions and results in a weaker long-term stock performance of the acquiring company. A recent investigation of 3,680 deals over the 1994 to 2012 period considered three additional merger-specific characteristics including the number of transactions, acquisition size, and the private status of the target company. In particular, Boulton and colleagues (2014) showed that at higher levels of equity-based pay, exercisable stock options, and unexercisable options, managers are more likely to make more acquisitions; at higher levels of exercisable options, they are more likely to execute larger-volume transactions; and at higher levels of equity-based compensation and exercisable options, they are more likely to acquire privately held firms. The authors concluded that these positive effects on the listed M&A characteristics, which occur when the financial wealth of bidding top executives is more closely tied to the stock price of their company, are more consistent with the underlying assumptions of the managerial risk-seeking hypothesis. Finally, Lin and colleagues (2011) found that acquisitions made over the 2002 to 2008 period by Canadian firms in which senior executives are entrenched with liability insurance tend to exhibit lower synergies due to a weak target selection process, which results in a poor acquirer–target match. SUMMARY AND CONCLUDING REMARKS Table 5.1 provides a comparative matrix of studies that examined the effect of different elements of bidding executive pay on mode of payment and control premium. Our review indicates that there has not been a large amount of empirical work testing the relationship between bidders’ managerial compensation and the two abovementioned M&A characteristics. Moreover, since researchers in this stream employed a variety of measures of top management compensation, any attempt to make comprehensive comparisons and draw definitive conclusions becomes more challenging. In light of extant empirical data, it seems that senior executives in bidding firms tend to emphasize their personal motives over the efficiency considerations of M&A deals when making acquisition financing and premium-related decisions (Cai & Vijh, 2007; Hayward & Hambrick, 1997; Malmendier & Tate, 2008). Yet despite this evidence, some indication exists that the incentive structuring of compensation packets stimulates the value-maximizing behavior of bidding managers (Bargeron et al., 2008; Slusky & Caves, 1991; Zhao, 2013).

Overconfidence (delay exercising highly in-the-money vested options)

Equity-based compensation (ratio of the value of new option grants to total pay) Stock and option holdings High stock ownership (private bidder) Low stock ownership (public bidder)

1,719 US deals

106 US deals

394 US firms

1989 & 1992 1993–1998

Hayward & Hambrick (1997) Datta, Iskandar-Datta, & Raman (2001) Cai & Vijh (2007) Bargeron, Schlingemann, Stulz, & Zutter (2008) Malmendier & Tate (2008)

100 US deals 354 US mergers

1980–1994

1986–1988 1985–1991

Slusky & Caves (1991) Hubbard & Palia (1995)

266 US acquirers

250 US deals 1,667 US deals

1972–1986

Travlos & Waegelein (1992)

High stock ownership Low stock ownership High stock ownership (common stock + deferred stock awards + unexercised stock options) + LTIPs Stock ownership Very high stock ownership Low stock ownership Relative cash compensation

Compensation Structure

209 US deals

Sample

1993–2001 1980–2005

1981–1983

Period

Amihud, Lev, & Travlos (1990)

Authors

N/A

N/A N/A N/A

Good Poor

N/A Decrease Increase Negative

Positive Negative* Higher

Abnormal returns

Cash*

Highera

Positive* Lower* Higher*

Negative* Negative*

Cash Noncash Stock* Cash Cash

Negative* Positive* Negative* Positive*

N/A N/A N/A

Impact on premium

N/A Cash Stock N/A

Cash* Stock Cash*

Payment mode

Table 5.1  Review matrix of studies analyzing the impact of bidders’ executive compensation on mode of payment and acquisition premium—Stream B, Theme I

1992–2005

1993–2004

2002–2008

1992–2007

1993–2005

Fung, Jo, & Tsai (2009)

Gao (2010)

Lin, Officer, & Zou (2011)

Sharma & Hsieh (2011)

Zhao (2013)

577 US deals by S&P 500 CEOs

367 US mergers

709 deals by 278 Canadian firms

2,894 US deals

402 US firms

Low stock ownership High exercisable in-the-money options High total options pay Lack of LTIPs Value of restricted stock and options to be vested in a year as a percentage of total pay (short horizon) Stock ownership Liability insurance presence Ratio of liability insurance coverage to market value of equity Ratio of salary and short pay to total pay (short horizon) Ratio of option awards, unvested stock, unexercised options, unexercisable options, and value of exercised options to total pay (long horizon) Employment contract Fixed-term contract, longer contract duration, salary and bonus indicators in annual pay, option grants in annual pay, and accelerated stock and option vesting provisions in severance agreement Stock N/A

Positive* Positive*

N/A

Cash & Stock Stock & Cash

N/A N/A N/A

Lower Lower Lower N/A

Stock Stock Stock Stock Cash*

Negative* Negative* Negative* Negative* Higher

(Continued)

Lower* Lower*

N/A

N/A

Positive Positive Positive*

Higher* Higher* Higher* Higher* N/A

1994–2012

Period 2,369 US firms (3,680 deals)

Sample

Source: Adapted from Bodolica and Spraggon (2009b) Notes: *—Statistically significant a— Implied but not empirically tested

Boulton, Braga-Alves, & Schlingemann (2014)

Authors

Table 5.1  (Continued)

Equity-based compensation Exercisable stock options Unexercisable stock options Stock ownership

Compensation Structure Negative* Negative* Negative* Negative*

Abnormal returns

Impact on premium N/A N/A N/A N/A

Payment mode Stock* Stock Stock* Stock

Impact of Bidding Executive Compensation  113 It is our contention that the entire question of executive compensation effects on merger-related characteristics warrants further exploration, as it may generate important implications for corporate governance research and practice. As discussed in Chapter  1, the finance literature is fairly consistent in demonstrating that cash deals perform better than equity transactions both in the short term and in the long run (Loughran & Vijh, 1997; Tuch  & O’Sullivan, 2007) and that the bidder overpayment for the target frequently results in disappointing returns to shareholders of acquiring companies (Haunschild, 1994; Krishnan et al., 2007). Assuming that the mode of payment and the size of acquisition premium serve as preliminary indicators of M&A performance, boards of directors need to adopt such elements of managerial pay that would induce value-enhancing choices of cash-based financing and smaller control premium, increasing the likelihood of a long-term acquisition success.

REFERENCES Amihud, Y., Lev, B.,  & Travlos, N. G. (1990). Corporate control and the choice of investment financing: The case of corporate acquisitions. Journal of Finance, 45(2), 603–617. Bargeron, L. L., Schlingemann, F. P., Stulz, R. M.,  & Zutter, C. J. (2008). Why do private acquirers pay so little compared to public acquirers? Journal of Financial Economics, 89(3), 375–390. Bodolica, V., & Spraggon, M. (2009a). The implementation of special attributes of CEO compensation contracts around M&A transactions. Strategic Management Journal, 30(9), 985–1011. Bodolica, V.,  & Spraggon, M. (2009b). Merger and acquisition transactions and executive compensation: A review of the empirical evidence. Academy of Management Annals, 3(1), 109–181. Boulton, T. J., Braga-Alves, M. V., & Schlingemann, F. P. (2014). Does equity-based compensation make CEOs more acquisitive? Journal of Financial Research, 37(3), 267–293. Cai, J., & Vijh, A. M. (2007). Incentive effects of stock and option holdings of target and acquirer CEOs. Journal of Finance, 62(4), 1891–1933. Comment, R., & Schwert, G. W. (1995). Poison or placebo? Evidence on the deterrence and wealth effects of modern antitakeover measures. Journal of Financial Economics, 39(1), 3–41. Datta, S., Iskandar-Datta, M., & Raman, K. (2001). Executive compensation and corporate acquisition decisions. Journal of Finance, 56(6), 2299–2336. Fung, S., Jo, H.,  & Tsai, S.-C. (2009). Agency problems in stock market-driven acquisitions. Review of Accounting and Finance, 8(4), 388–430. Gao, H. (2010). Market misvaluation, managerial horizon, and acquisitions. Financial Management, 39(2), 833–850. Haleblian, J., Devers, C. E., McNamara, G., Carpenter, M. A.,  & Davison, R. B. (2009). Taking stock of what we know about mergers and acquisitions: A review and research agenda. Journal of Management, 35(3), 469–502. Haunschild, P. R. (1994). How much is that company worth? Inter-organizational relationships, uncertainty, and acquisition premiums. Administrative Science Quarterly, 39(3), 391–411.

114  Bidders’ Executive Compensation Before the Deal Hayward, M.L.A., & Hambrick, D. C. (1997). Explaining premiums paid for large acquisitions: Evidence of CEO hubris. Administrative Science Quarterly, 42(1), 103–127. Hubbard, G., & Palia, D. (1995). Benefits of control, managerial ownership, and the stock returns of acquiring firms. Rand Journal of Economics, 26(4), 782–792. Krishnan, H. A., Hitt, M. A., & Park, D. (2007). Acquisition premiums, subsequent workforce reductions and post-acquisition performance. Journal of Management Studies, 44(5), 709–732. Kroll, M., Walters, B. A., & Wright, P. (2008). Board vigilance, director experience, and corporate outcomes. Strategic Management Journal, 29(4), 363–382. Lin, C., Officer, M. S., & Zou, H. (2011). Directors’ and officers’ liability insurance and acquisition outcomes. Journal of Financial Economics, 102, 507–525. Loughran, T., & Vijh, A. M. (1997). Do long term shareholders benefit from corporate acquisitions? Journal of Finance, 52(5), 1765–1790. Malmendier, U., & Tate, G. (2008). Who makes acquisitions? CEO overconfidence and the market’s reaction. Journal of Financial Economics, 89, 20–43. Sharma, V.,  & Hsieh, C. (2011). Managerial horizons in stock financed mergers. Quarterly Review of Economics and Finance, 51, 152–161. Shleifer, A., & Vishny, R. W. (2003). Stock market driven acquisitions. Journal of Financial Economics, 70, 295–311. Slusky, A. R., & Caves, R. E. (1991). Synergy, agency and the determinants of premia paid in mergers. Journal of Industrial Economics, 39(3), 277–296. Spraggon, M., & Bodolica, V. (2011). Post-acquisition structuring of CEO pay packages: Incentives and punishments. Strategic Organization, 9(3), 187–221. Travlos, N. G., & Waegelein, J. F. (1992). Executive compensation, method of payment and abnormal returns to bidding firms at takeover announcements. Managerial and Decision Economics, 13(6), 493–501. Tuch, C., & O’Sullivan, N. (2007). The impact of acquisitions on firm performance: A review of the evidence. International Journal of Management Reviews, 9(2), 141–170. Zhao, J. (2013). Entrenchment or incentive? CEO employment contracts and acquisition decisions. Journal of Corporate Finance, 22, 124–152.

Part III

Targets’ Executive Compensation Before the Deal Part Contents: Chapter 6. Chapter 7.

Impact of Target-Specific M&A Occurrence (Threat of Takeover) on Target Executive Compensation Impact of Target Executive Compensation on M&A Characteristics 7.1 Impact of Target Executive Compensation on Target Management Attitude 7.2 Impact of Target Executive Compensation on Acquisition Premium

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6 Impact of Target-Specific M&A Occurrence (Threat of Takeover) on Target Executive Compensation

PRELIMINARY CONSIDERATIONS ON EXTANT STUDIES IN THIS STREAM Studies on various executive compensation arrangements in the period preceding M&A deals have typically estimated the impact of top management pay on the incidence of acquisitions and their characteristics. However, in the empirical research falling within this stream of inquiry (Stream C in Figure 3.3), the sense of causality in the compensation–acquisition relationship is reversed. In particular, the main focus of analysis constitutes the extent to which the target-induced M&A occurrence, or the threat of takeover, influences the level and incentive structuring of executive pay packets in target companies. Scholars in this stream rely on two different approaches to test the acquisition–compensation association in empirical settings. Some authors examine whether the threat of takeover induces the adoption of golden parachutes, or occasionally employment contracts (Agrawal  & Knoeber, 1998), for the private benefit of senior executives in target firms (Cochran, Wood,  & Jones, 1985; Evans  & Hefner, 2009; Singh  & Harianto, 1989; Wade, O’Reilly, & Chandratat, 1990). Alternatively, the preference of other researchers is to analyze the takeover-induced determination of changes in the monetary magnitude of various elements of target executive compensation (Agrawal  & Knoeber, 1998; Cai  & Vijh, 2007; Cyert, Kang, & Kumar, 2002; Houle, 2003).

Threat of Takeover and Golden Parachute Adoption All the seven studies that evaluated the premerger implementation of golden parachute clauses corroborated the positive impact of the likelihood of takeover on the incidence of these clauses in target firms. Based on a sample of 406 US targets in 1982, Cochran and colleagues (1985) suggested that a firm’s susceptibility to takeover increases when its assets are undervalued by the stock market. This asset undervaluation is captured by a variable called EXCESS, which reflects the difference between the market value and the book value of the target’s assets. Demonstrating that the risk of takeover

118  Targets’ Executive Compensation Before the Deal is negatively and significantly associated with the value of EXCESS, the authors concluded that the adoption of golden parachutes in target firms is more likely at higher levels of takeover probability. Moreover, for companies that face a higher a priori likelihood of takeover bid, the implementation of golden parachutes is received with a more favorable stock market reaction, which is beneficial to target stockholders (Lambert & Larcker, 1985). For a large sample of 1,000 American organizations examined over the 1980 to 2006 period, Evans and Hefner (2009) showed that prior to the date of golden parachute adoption, firms with parachute clauses experience more change in corporate control activities than do nonadopting firms. The investigations conducted by Singh and Harianto (1989) and Wade and colleagues (1990) have also documented an increased probability of golden parachute implementation as a preventative antitakeover defense by companies at risk of becoming takeover targets. It is worth mentioning that both studies employed similar sample sizes (79 and 89 targets, respectively) and periods of analysis (prior to 1985 and 1984, respectively) within the same geographical market for corporate control (i.e., the USA). Although Houle (2003) gathered data on Canadian corporations, her findings are consistent with the positive takeover–parachute relationship uncovered by scholars who relied on American samples. Agrawal and Knoeber (1998) extended the research efforts deployed in this stream by concentrating on two specific devices of executive compensation packages—golden parachutes and employment contracts—which are expected to reduce the risk for a company to be taken over by another one. Partitioning their sample along the degree of takeover threat, Agrawal and Knoeber (1998) corroborated extant evidence by reporting that the risk of takeover increases significantly the likelihood of golden parachutes’ adoption. Yet the results when the employment contract was used as a dependent variable are not statistically significant, meaning that its adoption is equally likely for managers in firms with high and low takeover threat.

Threat of Takeover and Changes in Executive Pay Takeover Impact on Cash- and Equity-Based Compensation Four investigations in this stream of research explored the empirical question of whether the risk of being taken over affects the alteration in the monetary magnitude of compensation of senior managers in target firms. These studies focused on either cash-based (Agrawal & Knoeber, 1998) or equity-based (Cai & Vijh, 2007) compensation, while Cyert and colleagues (2002) and Houle (2003) examined both elements of executive pay packages. It is worth noting the substantial cross-study differences in terms of the sample size (i.e., between 58 and 1,648 firms), nationality of the market for corporate takeovers (i.e., USA and Canada), and time period under analysis (i.e., 1980s and 1990s). Some researchers reported statistically significant findings (Agrawal & Knoeber, 1998; Cyert et al., 2002; Houle, 2003), while

Impact of Target-Specific M&A Occurrence  119 others concluded that the threat of takeover is an insignificant predictor of changes in the level of target executive compensation (Cai  & Vijh, 2007; Cyert et al., 2002). Agrawal and Knoeber (1998) concentrated on the combined measure of salary and short-term bonus for a group of 446 US target managers over a ten-year period from 1984 to 1994. They argue that because the takeover attempt has two opposing effects (namely the competition and risk) on the monetary alterations in the executive cash-based pay, their net effect is not conclusive. Since a greater threat of takeover means a more competitive labor market for target top managers, the competition effect will imply a lower level of compensation. On the contrary, by making executives’ firm-specific human capital less secure, the takeover risk effect will increase target management rewards. The authors demonstrated that the competition effect on salary and short-term bonus is negative and the risk effect is positive; and since the latter one dominates, the net effect is positive. These results mean that, before an acquisition deal, senior executives in target companies experience an increase in their cash-based pay, which oscillates between US$18,700 and US$43,700. Few years later, Houle (2003) examined a small sample of 58 targets located in Canada that were acquired between 1990 and 2000. Observing that the value of short-term bonuses granted to target executives is significantly higher during the period which precedes the occurrence of M&A transactions, the author corroborated the findings of Agrawal and Knoeber (1998) for the Canadian market of corporate control. However, Houle (2003) went further in her analytical procedure by estimating the impact that the risk of being taken over exerts on two additional managerial compensation elements, including equity ownership and stock option pay. The outcomes of her statistical tests point to a considerable decrease in the proportion of both stock options and shares owned by target top managers before the incidence of takeovers. Due to the small size of the studied sample, these results still ought to be confirmed on a larger set of target-specific data in Canadian corporate settings. Although the takeover–compensation association typically explored in this stream of inquiry does not constitute the main focus of their study, Cai and Vijh (2007) did perform some robustness tests to check whether significant modifications in the equity-based pay of target CEOs occurs in anticipation of an M&A transaction. The authors tested this relationship on a sample of 250 US deals which were completed between 1993 and 2001. Contrary to Houle (2003), the findings of Cai and Vijh (2007) are not statistically significant, meaning that senior managers do not benefit from extra amounts of share and stock option grants before an acquisition. However, the study of Cyert and colleagues (2002) conducted on 1,648 American target companies went in the direction of the empirical outcomes reported by Houle (2003). According to Cyert and colleagues (2002), the external threat of takeover by a large corporate stockholder imposes strong governance

120  Targets’ Executive Compensation Before the Deal discipline on the target top management by significantly reducing the size of the equity-based compensation and not affecting the growth in fixed elements of pay. Indirect Assessments of the Takeover–Compensation Relationship Two studies in this stream provide an indirect assessment of the impact of the threat of takeover on changes in different elements of target executive compensation such as salary, bonus, equity ownership, stock options (Chakraborty  & Sheikh, 2010), and total pay (Bereskin  & Cicero, 2013; Chakraborty  & Sheikh, 2010). In particular, Chakraborty and Sheikh (2010) analyzed how the enhanced protection from the probability of being taken over insulates top managers from the disciplinary effect of the market for corporate control, resulting in higher levels of managerial entrenchment, which allows them to favorably affect their own compensation. An increase in antitakeover amendments offers the possibility for entrenched senior executives to benefit from higher levels of both short-term (i.e., salary and bonus) and total pay while reducing the amount of more risky performance-related incentives (i.e., stock and option holdings) in their compensation packets. The recent research conducted by Bereskin and Cicero (2013) also differs from prior studies in that it does not examine directly the target management compensation determination under the risk of takeover but rather focuses on the legislation-induced possibility to reduce the threat of being acquired and its consequences for executive pay. Using a sample of 589 American firms, the authors evaluated how the 1995 Delaware regulation, which increased managers’ ability to protect their firms from unfriendly takeover bids, affects their levels of compensation. The scholars showed that in Delaware-incorporated companies with staggered boards of directors and without large shareholders, the total compensation of top executives increased significantly (by 32.9  percent) in the period following the adoption of the antitakeover legislation, findings that could be explained by managerial entrenchment. INTERPRETING EXTANT EMPIRICAL EVIDENCE IN THE FIELD Table  6.1 provides a comparative summary of all the studies that tested the impact of the threat of takeover on various elements of target management compensation. In spite of the limited research effort deployed within this stream of inquiry, the empirical evidence gathered to date is fairly consistent in indicating that the risk of being acquired triggers an alteration in the level and structure of executive pay packages. In anticipation of an impending takeover, the level of salary, bonus, and total compensation increases (Agrawal & Knoeber, 1998; Bereskin & Cicero, 2013), while the amount of stock and option holdings decreases (Cyert et al., 2002; Houle, 2003). These findings suggest that the likelihood of takeover shrinks the

Impact of Target-Specific M&A Occurrence  121 time horizon of target executives who, due to the forthcoming loss of their managerial position, emphasize the short-term elements of compensation rather than the long-term payouts that can be extracted from the ownership of corporate stock. Additionally, the probability of being taken over augments the incidence of golden parachutes in target firms. In light of this evidence, what conclusion can be drawn with regard to the incentive alignment property of this specific element of executive compensation? Are golden parachute clauses used as a device for achieving high levels of managerial entrenchment or, by providing their beneficiaries with so much financial security, do they enable senior executives to act in the best interest of their shareholders? Scholars are still unable to provide a unanimous answer to this question. Since golden parachutes also play the role of antitakeover provisions, they can be implemented for two reasons, either to improve the standing of the target firm when negotiating the terms of takeover or to block a successful bid (Sokolyk, 2011). Yet in the presence of large values of golden parachutes, managers would not exaggerate with the deployment of other takeover defenses because, despite their willingness to enhance their bargaining power, they would ultimately prefer to sell their company to benefit from substantial parachute payouts (Bebchuk, Coates, & Subramanian, 2002). Which rationale of golden parachute adoption prevails—the one that enhances the executive effectiveness with regard to a takeover bid or the other that weakens the disciplining role of takeovers—remains unclear. According to Lambert and Larcker (1985), the occurrence of golden parachutes during the 1975 to 1982 period was more consistent with the incentive alignment hypothesis rather than the hypothesis of wealth transfer from owners to managers. However, more recent data are less optimistic about the incentive properties of golden parachute clauses. Bebchuk, Cohen, and Ferrell (2009) found that between 1990 and 2003, golden parachutes (along with five other provisions that the authors included in the entrenchment index) were associated with lower firm valuations and significantly negative abnormal returns to shareholders. Similar negative implications for stockholder wealth induced by the presence of golden parachutes were subsequently obtained when the aforementioned study period was extended to 2006 (Bebchuk, Cohen, & Wang, 2014), meaning that parachutes increase managerial slack and reduce the discipline installed by markets for corporate control. We posit that the two main aspects that might improve our understanding of the effectiveness of golden parachute clauses as governance mechanisms refer to their specific timing of adoption and mode of enactment.

Specific Timing of Golden Parachute Adoption Golden parachute clauses can be implemented either yearly or in anticipation of an approaching takeover. On the one hand, if golden parachutes are adopted yearly, at the time of the manager’s initial employment with the firm, it is more likely that these provisions will encourage top management

1992–1993 1990–2000

1993–2001 1980–2006 1992–2007 1995–2000

Cyert, Kang, & Kumar (2002)

Houle (2003)

Cai & Vijh (2007) Evans & Hefner (2009) Chakraborty & Sheikh (2010)

Bereskin & Cicero (2013)

Source: Adapted from Bodolica and Spraggon (2009) Notes: *—Statistically significant a— Likelihood of adoption b— Sign not reported c— Impact of antitakeover amendments d— Estimated effect (related to Delaware antitakeover legislation)

1982 1975–1982 < 1985 1984 1984–1994

Period

Cochran, Wood, & Jones (1985) Lambert & Larcker (1985) Singh & Harianto (1989) Wade, O’Reilly, & Chandratat (1990) Agrawal & Knoeber (1998)

Authors

589 US firms

250 US deals 1,000 US firms 17,305 US firm-year observations

58 Canadian firms

1,648 US firms

406 US firms 90 US firms 79 US firms 89 US firms 446 US firms

Sample Golden parachute Golden parachute Golden parachute Golden parachute Salary and short-term bonus Golden parachutea Employment contracta Equity-based compensation Fixed (non–performancerelated) compensation Short-term bonus Golden parachutea Stock ownership Stock options Stock and option holdings Golden parachute Salary + bonus Total compensation Stock and options holdings Total compensation

Changes in compensation levels/adoption likelihood

Positive* Positive* Negative* Negative* Insignificantb Positive* Positive*c Positive*c Negative*c Positive*d

Positive* Positive* Positive* Positive* Positive* Positive* Negative Negative* Positive

Impact of takeover threat

Table 6.1  Review matrix of studies analyzing the impact of the threat of takeover on target executive compensation—Stream C, Theme II

Impact of Target-Specific M&A Occurrence  123 to act in the shareholders’ best interest. The long interval between parachutes’ adoption and the occurrence of takeovers may signal their enactment by corporate directors who expect an increased managerial emphasis on value-enhancing behaviors in exchange for financial security provided by golden parachutes. Moreover, as executives’ power typically increases with their tenure within the company, it is unlikely that the adoption of parachutes shortly after the executive’s initial employment represents the outcome of managerial entrenchment. Researchers who evaluated the stock market reaction to the announcement of golden parachutes’ implementation produced mixed results (Sundaramurthy, 2000). Yet their view is consistent with the empirical outcomes generated by both Born, Trahan, and Faria (1993) and Hall (1998). Thus, Born and colleagues (1993) reported positive shareholder wealth effects only for firms that were not in the process of being acquired, while Hall (1998) found negative wealth effects if parachutes are adopted at the time when the adopting company is being sought by a bidder. In the same line of thought, Choi (2004) demonstrated that target shareholders have an incentive to implement a golden parachute well in advance of the appearance of an acquiring firm, since it can be used, at a later stage, as a means of shifting the executive compensation burden to the acquirer through the negotiation of a higher control premium. On the other hand, if golden parachutes are implemented in the face of a takeover, it is more likely that they are pushed by powerful executives who seek to either reduce the probability of being displaced from their managerial position or extract sizeable personal benefits from the sale of their firm. Splitting their sample into fresh and older parachutes relative to the timing of their adoption, Bebchuk and colleagues (2014) found that the positive relationship between the golden parachute presence and the likelihood of acquisition is partially driven by the private information hypothesis regarding the odds of receiving a bid. Therefore, the evidence reported in this stream on golden parachutes’ implementation prior to the incidence of takeovers may serve as an indication of managerial entrenchment that seeks to protect target CEOs from the disciplinary effect of markets for corporate control. Managerial entrenchment may also be the reason target executives enjoy higher levels of cash-based and total compensation before being acquired (Agrawal & Knoeber, 1998; Chakraborty & Sheikh, 2010) instead of being penalized for the poor management that made their company a takeover target.

Mode of Golden Parachute Enactment An alternative explanation of the occurrence of golden parachutes as a consequence of the threat of takeover is to consider their characteristics as antitakeover provisions, which aim to make the target less desirable and more expensive for the acquirer (Gaughan, 2007). According to Walsh and

124  Targets’ Executive Compensation Before the Deal Seward (1990), the managerial entrenchment potential of takeover deterrents depends on their specific mode of enactment, because those deterrents that do not require shareholder approval for being adopted are more entrenching than those that necessitate such approval. It is worth noting that all the studies in this stream relied on empirical data from the 1980s, 1990s, and early 2000s—a period when golden parachutes required only an agreement between the CEO and the board of directors without any subsequent shareholder approval (Subramaniam & Daley, 2000). Therefore, this type of arrangement is more conducive to one-to-one negotiations in which board members in target firms could more easily give in or weaken their vigilance under the pressure of entrenched managers. In an early analysis of the implementation of several antitakeover amendments (although excluding golden parachutes), Sundaramurthy (1996) provided strong evidence consistent with the above explanation. The author showed that corporate stockholders tend to reduce the frequency of those amendments that require their approval. As discussed in Chapter  2, the recent “say on pay” legislation enforced in 2010 in the USA (and also in several other developed economies) mandates advisory votes of shareholders on all executive compensation-related arrangements in publicly listed organizations (Bebchuk et al., 2014). Considering that firm owners are now given the opportunity to express their (nonbinding) opinions with regard to golden parachutes, whether or not they will take advantage of this opportunity to reduce the rate of parachutes’ adoption in their companies is an empirical question. A new generation of studies employing post-2010 data is welcome to evaluate how this legislation-induced alteration in the enactment of golden parachute clauses affects their underlying properties as either mechanisms of incentive alignment or tools of managerial entrenchment. REFERENCES Agrawal, A., & Knoeber, C. R. (1998). Managerial compensation and the threat of takeover. Journal of Financial Economics, 47(2), 219–239. Bebchuk, L. A., Coates, J. C., & Subramanian, G. (2002). The powerful antitakeover force of staggered boards: Theory, evidence and policy. Stanford Law Review, 54(5), 887–951. Bebchuk, L. A., Cohen, A., & Ferrell, A. (2009). What matters in corporate governance? Review of Financial Studies, 22(2), 783–827. Bebchuk, L., Cohen, A., & Wang, C.C.Y. (2014). Golden parachutes and the wealth of shareholders. Journal of Corporate Finance, 25, 140–154. Bereskin, F. L.,  & Cicero, D. C. (2013). CEO compensation contagion: Evidence from an exogenous shock. Journal of Financial Economics, 107, 477–493. Bodolica, V., & Spraggon, M. (2009). Merger and acquisition transactions and executive compensation: A  review of the empirical evidence. Academy of Management Annals, 3(1), 109–181. Born, J. A., Trahan, E. A.,  & Faria, H. J. (1993). Golden parachutes: Incentive aligners, management entrenchers, or takeover bid signals? Journal of Financial Research, 16(4), 299–308.

Impact of Target-Specific M&A Occurrence  125 Cai, J., & Vijh, A. M. (2007). Incentive effects of stock and option holdings of target and acquirer CEOs. Journal of Finance, 62(4), 1891–1933. Chakraborty A.,  & Sheikh, S. (2010). Antitakeover amendments and managerial entrenchment: New evidence from investment policy and CEO compensation. Quarterly Journal of Finance and Accounting, 49(1), 81–103. Choi, A. (2004). Golden parachute as a compensation-shifting mechanism. Journal of Law, Economics and Organization, 20(1), 170–191. Cochran, P. L., Wood, R. A., & Jones, T. B. (1985). The composition of boards of directors and incidence of golden parachutes. Academy of Management Journal, 28, 664–671. Cyert, R. M., Kang, S.-H., & Kumar, P. (2002). Corporate governance, takeovers, and top-management compensation: Theory and evidence. Management Science, 48(4), 453–469. Evans, J. D., & Hefner, F. (2009). Business ethics and the decision to adopt golden parachute contracts: Empirical evidence of concern for all stakeholders. Journal of Business Ethics, 86, 65–79. Gaughan, P. A. (2007). Mergers, acquisitions, and corporate restructurings. New York, NY: John Wiley & Sons. Hall, P. L. (1998). An examination of stock returns to firms adopting golden parachutes under certain conditions. American Business Review, 16(1), 123–130. Houle, K. (2003). La rémunération des dirigeants des entreprises absorbées en contexte de fusion et d’acquisition. Master dissertation, HEC Montreal. Lambert, R. A.,  & Larcker, D. F. (1985). Golden parachutes, executive decision-making and shareholder wealth. Journal of Accounting and Economics, 7(1–3), 179–203. Singh, H., & Harianto, F. (1989). Management–board relationships, takeover risk, and the adoption of golden parachutes. Academy of Management Journal, 32, 7–24. Sokolyk, T. (2011). The effects of antitakeover provisions on acquisition targets. Journal of Corporate Finance, 17(3), 612–627. Subramaniam, C.,  & Daley, L. A. (2000). Free cash flow, golden parachutes and the discipline of takeover activity. Journal of Business Finance and Accounting, 27(1/2), 1–36. Sundaramurthy, C. (1996). Corporate governance within the context of antitakeover provisions. Strategic Management Journal, 17(5), 377–394. Sundaramurthy, C. (2000). Antitakeover provisions and shareholder value implications: A review and a contingency framework. Journal of Management, 26(5), 1005–1030. Wade, J., O’Reilly, C., & Chandratat, I. (1990). Golden parachutes: CEOs and the exercise of social influence. Administrative Science Quarterly, 35, 587–603. Walsh, J. P., & Seward, J. K. (1990). On the efficiency of internal and external corporate control mechanisms. Academy of Management Review, 15(3), 421–458.

7 Impact of Target Executive Compensation on M&A Characteristics

ON THE STRUCTURE OF THIS RESEARCH STREAM How do various compensation arrangements of senior executives in target firms affect the specific characteristics of M&A transactions? Researchers who tested this question in empirical settings have typically focused on two major merger-related characteristics, namely the target management attitude toward the deal and the magnitude of acquisition premium paid to target shareholders. We begin this chapter by discussing the impact of target managers’ compensation on their friendliness or hostility (Topic D1 in Figure 3.3) and continue by elaborating on the relationship between target management pay and size of control premium (Topic D2 in Figure 3.3). 7.1. IMPACT OF TARGET EXECUTIVE COMPENSATION ON TARGET MANAGEMENT ATTITUDE We identified three different methodological approaches employed in extant studies that examined the association between the prebid compensation of target executives and the likelihood that they will accept or resist a takeover bid. The first approach, advanced by Walkling and Long (1984) and Agrawal and Walkling (1994), seeks to develop a model of normal compensation in order to analyze whether the overpayment or underpayment of target executives in the preacquisition period can explain the attitude they adopt toward the impending takeover deal. The three elements of managerial abnormal compensation packets that received empirical scrutiny are salary, short-term bonus, and total compensation. The second approach privileged by the vast majority of studies on this topic (Buchholtz  & Ribbens, 1994; Cotter  & Zenner, 1994; Hadlock, Houston,  & Ryngaert, 1999; Houle, 2003; Lambert  & Larcker, 1985; Morck, Shleifer, & Vishny, 1988; Shivdasani, 1993; Sokolyk, 2011; Song & Walkling, 1993; Tucker, 1991) assesses the structure of target executive compensation during the period preceding the change in corporate control. The analysis focuses primarily on the amount of stock owned by target

Impact of Target Executive Compensation  127 managers and the value of golden parachutes, with the exception of two researchers who have also estimated the role of cash-based pay (Tucker, 1991) and compensation plans (Sokolyk, 2011). Finally, the third methodological approach employed in five studies (Cai & Vijh, 2007; Cotter & Zenner, 1994; D’Aveni & Kesner, 1993; Hartzell, Ofek, & Yermack, 2004; Walkling & Long, 1984) aims to explore the alterations that occur in target management wealth ensuing from a tender offer. The analytical emphasis is placed on the monetary gains or losses in stock ownership, equity-based pay, total compensation, and golden parachute value that are incurred by target executives due to the incidence of takeover bids.

Abnormal Compensation To the best of our knowledge, only two studies employed the abnormal compensation approach (Agrawal & Walkling, 1994; Walkling & Long, 1984) to analyze whether target executives are overpaid or underpaid relative to a model of normal compensation. This model is constructed by regressing the log of compensation on the most popular pay determinants identified in the literature such as the firm size, corporate performance, governance variables, and individual characteristics of top managers. Residuals from this regression, representing the abnormal compensation, are then compared by the type of executive response to a takeover bid. In a pioneering study on the relationship between managerial abnormal compensation and bid resistance over the 1972 to 1977 period, Walkling and Long (1984) examined a sample of 105 US tender offers of which 57 are friendly, 38 hostile, and 10 initially hostile but later friendly. The results of their tests showed that senior executives who adopted a friendly attitude toward the takeover had negative levels of abnormal salary and total compensation (i.e., were underpaid), while those who were hostile exhibited positive levels of abnormal salary and total compensation (i.e., were overpaid). However, because the difference between the two groups is not statistically significant, these findings provide weak support for the managerial welfare hypothesis. Ten years later, Agrawal and Walkling (1994) tested the model of abnormal compensation on a wider dataset of 165 US targets and relatively more recent tender offers that took place between 1980 and 1986. Their results differ from the previous study in that top managers of both friendly and hostile target firms were reported to experience positive levels of abnormal compensation (of 0.112 and 0.087, respectively) measured as a sum of salary and short-term bonus. Yet, in line with Walkling and Long (1984), the two groups of 108 friendly offers and 57 hostile deals did not significantly differ from each other on their levels of overcompensation. It seems that the insignificant findings reported in both studies did not attract further scholarly efforts on the abnormal compensation approach. This research dearth may be explained by the difficulty of developing a unique and comprehensive model of normal compensation, since the determinants of executive

128  Targets’ Executive Compensation Before the Deal pay are multiple and diverse and cannot be easily identified and estimated. The observed insignificance in empirical outcomes may also be due to the sampling issues of these studies, in which the numerical overrepresentation of friendly offers relative to hostile deals weakens the statistical strength of comparisons made between two subsamples of unequal size.

Compensation Structure Managerial Stock Ownership and Hostility The element of the executive compensation package that was most commonly analyzed within this methodological approach is stock ownership. Our review shows that all researchers (apart from Hadlock et al., 1999) agree on the extent to which the ownership stakes of target managers relate to their decision to resist or accept a tender offer. Morck and colleagues (1988) compared the characteristics of hostile and friendly takeovers and found that for targets with low amounts of executive shareholdings, there is a higher probability of takeover attempt resistance. Examining 82 corporate takeovers of Fortune 500 companies that occurred over the period 1981 through 1985, the authors concluded that hostile deals are more likely to be disciplinary, while the friendly acquisitions are more likely to be synergetic. These results were confirmed by Song and Walkling (1993), who relied on a sample of 153 acquired firms and reported that hostile targets have significantly lower managerial ownership levels (6.4 percent) than their friendly counterparts (13.3 percent). In a similar investigation of 193 US targets, Shivdasani (1993) also demonstrated that the percentage of shares held by executives is negatively and significantly related to the likelihood that target management will resist the takeover. The empirical outcomes of the three subsequent studies performed by Buchholtz and Ribbens (1994), Cotter and Zenner (1994), and Houle (2003) are consistently in line with the prior literature. While Tucker (1991) was among the first scholars to contribute to the establishment of a negative ownership–hostility relationship in target companies, the author has also considered the role that executive cash-based compensation plays in takeover resistance. In particular, Tucker (1991) provided (implicit) evidence consistent with a positive association between the salary and bonus of target management and the probability of an unfriendly reaction to a takeover bid. It is worth mentioning that all of the listed investigations, with the exception of Houle (2003), concentrated on comparable samples of American industrial targets that were acquired during the same period of the 1980s. However, the previously established contention that higher target executive equity stakes increase the odds of being acquired in a friendly M&A transaction was not corroborated by Hadlock and colleagues (1999). Developing a similar research design and testing its validity on the American banking industry, the authors arrived at an opposite conclusion. Based on a sample of 84 target banks, they demonstrated that banks with higher proportions of executive ownership stakes are less likely to be acquired, while target management resistance toward the deal is more likely. Since

Impact of Target Executive Compensation  129 both the study period and sample nationality characteristics coincide across Hadlock and colleagues (1999) and other studies reviewed earlier (excluding Houle, 2003), this contradiction in findings can be explained in light of the peculiarities of the banking industry as opposed to nonfinancial services sectors. As discussed in Chapter 4, several statutory and regulatory considerations severely differentiate financial institutions from other corporations that operate in less regulated industries (Hagendorff, Collins,  & Keasey, 2007). Since the safety-net protections in the banking sector undermine the disciplinary function of the takeover market, companies activating in the financial services industry require a separate agency analysis (Hughes, Lang, Mester, Moon, & Pagano, 2003). Golden Parachutes and Target Management Hostility Five studies that used the compensation structure approach (Buchholtz & Ribbens, 1994; Cotter & Zenner, 1994; Houle, 2003; Lambert & Larcker, 1985; Sokolyk, 2011) decided to extend their analysis over another element of target management compensation, namely the golden parachute. Both Buchholtz and Ribbens (1994) and Cotter and Zenner (1994) used American samples of companies (406 and 132 targets, respectively) that were acquired during the late 1980s to demonstrate that the value of golden parachutes in target firms exerts a positive but statistically insignificant effect on takeover resistance. However, in the case of the golden parachute breadth, Buchholtz and Ribbens (1994) reported that the number of target executives to whom the golden parachute clause is extended is positively and significantly related to the likelihood of takeover hostility. This implies that senior managers are more willing to preserve their jobs rather than cash out the financial benefits associated with their parachutes when their organization experiences a change in corporate control. The authors attributed their counterpredicted findings to the existence of redundancy between executive stock ownership and golden parachutes, because in the presence of the latter variable, the negative relationship between stock ownership and target management resistance is weaker. Other scholars provide substantial evidence to the contrary. The outcomes of an earlier study by Lambert and Larcker (1985) are consistent with the conjecture that the presence of golden parachutes makes the incumbent management more willing to accept a takeover. Yet it is worth noting that these authors’ conclusions regarding the positive parachute–friendliness association are implied, as they stem from indirect statistical tests and analyses. In an examination of Canadian targets, Houle (2003) showed that the greater the value of target managers’ golden parachute payments, the higher the probability that they will adopt a friendly response toward the acquisition deal. Recently, this view was confirmed by Sokolyk (2011), who has also evaluated the effect of compensation plans on target management attitude. Finding that the existence of golden parachutes and compensation plans for target executives enhances the likelihood of corporate acquisitions, the scholar concluded that both takeover-related compensation arrangements significantly reduce the managerial resistance to M&A transactions.

130  Targets’ Executive Compensation Before the Deal With three studies reporting a significantly negative relationship, one study going in the opposite direction, and two investigations producing an insignificant outcome, the association between golden parachutes and managerial hostility is inconclusive. Several explanations can be provided to shed more light on these contrasting results. First, when analyzing the target management response to the bid, Buchholtz and Ribbens (1994) focused on the golden parachute breadth contrary to other scholars who assessed the parachute value (Houle, 2003) and presence (Lambert & Larcker, 1985; Sokolyk, 2011). Second, important cross-study differences in research designs, sampling procedures, and empirical models may be responsible for inconsistent empirical outcomes. Among these key methodological aspects, we can cite smaller (Houle, 2003; Lambert & Larcker, 1985) versus larger (Buchholtz & Ribbens, 1994; Sokolyk, 2011) sample sizes, simpler analyses of correlations between variables (Houle, 2003) versus more sophisticated logistic regression tests (Buchholtz & Ribbens, 1994; Cotter & Zenner, 1994). And last, the current research findings should be interpreted in light of the prevalent features of the national corporate governance regime (see Chapter 1). Houle (2003) is the only researcher who provided some evidence on target firms operating in a non-American setting, namely the Canadian market for corporate control. As suggested by both Zhou (1999) and Spraggon and Bodolica (2011), despite the extensive cultural and economic linkages that exist between the US and Canada, a number of institutional and market differences persist. Important variations in terms of the size of economy, takeover regulations, shareholder activism, ownership structures, and board of directors’ characteristics determine the specificity of executive pay-setting norms in these two countries, notably limiting the applicability of the American model to the Canadian context.

Changes in Managerial Wealth Alterations in Target Managers’ Equity-Based Compensation Researchers who followed this approach demonstrate that the probability of target managers resisting a takeover attempt is related to the effect that this transaction is likely to have on their personal wealth. According to Walkling and Long (1984), prior to deciding whether to acquiesce to or resist a tender offer, senior executives weight two private incentives against each other. The first relates to the potential loss of their cash compensation should they lose their job due to a successful takeover completion, while the second estimates the probable wealth gains that can be extracted from tendering the shares owned in the firm at a premium paid by the bidding firm. If target managers seek to pursue their own interests disregarding those of corporate stockholders, they are more likely to espouse cooperative behavior in a tender offer when the value of the latter financial incentive outweighs the former. The study of Walkling and Long (1984) is consistent with this view, as target executives with a friendly attitude are found to experience a significantly higher increase in both stock ownership and EBC relative to those executives who contested the tender offer.

Impact of Target Executive Compensation  131 These findings were corroborated in subsequent analyses performed by both D’Aveni and Kesner (1993) and Cotter and Zenner (1994). Although D’Aveni and Kesner (1993) focused primarily on the influence that managerial power and social network connections exert on the target response to a tender offer, they have also included the changes in managerial wealth as a control variable in their models. Based on a set of 80 American targets over the period of 1984 to 1986, the authors showed that the wealth gains in equity ownership and stock options held by target executives negatively and significantly influence their resistance to takeover bids. Reporting the same negative relationship between total managerial wealth and takeover hostility, Cotter and Zenner (1994) sought to uncover the specific executive compensation element responsible for the direction of this relationship. By disaggregating the different measures of total executive wealth, the scholars concluded that only the gains in EBC, rather than golden parachute payments, have a significant effect on the probability of an acquisition. Special Cash Bonuses and Illiquidity Discount Hartzell and colleagues (2004) examined the benefits received by 311 target CEOs in friendly M&A deals completed between 1995 and 1997. In the context of solicited tender offers rather than hostile transactions, the researchers found that target managers negotiate and receive large cash payments in the form of special cash bonuses and increased golden parachute values in exchange for relinquishing control of their firm. Hence, the cash payments that acquirers offer target managers compensate for the private benefits they lose when their company is sold. Contrary to Cotter and Zenner (1994), who reported an insignificantly positive relationship between golden parachutes and target management hostility, Hartzell and colleagues (2004) demonstrated that higher levels of golden parachute payments significantly increase the likelihood of a friendly deal. Since the latter study concentrated on mergers that occurred during the 1990s and the former on those from the 1980s, the opposing results may be due to differences in time frames, which imply different corporate control environments. According to Andrade, Mitchell, and Stafford (2001), the decade of the 1990s represented a more active merger market, with only 4 percent of deals being hostile, as opposed to the 1980s, when the relatively more passive market experienced higher levels of target resistance (14 percent). A larger number of acquisitions and a lower frequency of hostile deals in the 1990s, which induced important changes in the merger negotiation process, may assist in providing relevant explanations of Hartzell and colleagues’ (2004) findings obtained in the context of friendly deals. More recently, Cai and Vijh (2007) have also analyzed the empirical question of how the target management attitude is influenced by private benefits that can be extracted from the occurrence of an acquisition. The personal incentives of target CEOs can sometimes be so large as to outweigh the losses of control stemming from the termination of employment due to

132  Targets’ Executive Compensation Before the Deal a takeover. Since both soft and hard liquidity restrictions on all stock and option holdings of senior managers are typically eliminated upon a change in corporate control, a takeover of their firm allows them to immediately cash out their equity possessions by selling their shares or exercising their stock options. In line with their predictions, Cai and Vijh (2007) found that target executives with a higher illiquidity discount are less likely to contest a tender offer and more inclined to cooperate with the top management of the bidding firm to secure a smooth conclusion of the impending takeover.

Implications From the Three Methodological Approaches Table  7.1 provides a comprehensive summary of all the empirical studies that examined the impact of executive compensation on target management attitude toward a tender offer. Our analytical review of this topic of inquiry indicates that researchers who adopted both the abnormal compensation and changes in managerial wealth approaches focus on explaining the reasons for target management takeover resistance, while the proponents of the compensation structure approach aim to identify the elements of executive pay packages that enhance the incentive alignment. The outcomes of the former two approaches point to the predominance of managerial self-interest over the shareholder wealth-maximization concerns when reacting to an acquisition attempt. Executives who are overpaid tend to adopt a hostile attitude toward a takeover as they seek continuation of their employment within the firm (Agrawal & Walkling, 1994), whereas those who increase their personal wealth due to the bid are more willing to acquiesce to a tender offer (Cai & Vijh, 2007; Hartzell et al., 2004). Studies relying on the compensation structure approach demonstrate that the target management hostility may be reduced principally by offering managers larger proportions of equity ownership in their firm (Buchholtz & Ribbens, 1994; Cotter & Zenner, 1994) and, to a lesser extent, by providing them with more financial security through the adoption of golden parachutes and compensation plans (Houle, 2003; Sokolyk, 2011). Given that managerial bid resistance is typically detrimental to target shareholders, as takeover bids represent an opportunity for them to realize capital gains from an acquisition premium (Kim, Nofsinger, & Mohr, 2010; Weisbach, 1993), stock ownership may be viewed as an effective mechanism for solving agency problems in target firms. Yet integrating the results of studies on both compensation structure and changes in managerial wealth approaches, we infer that managerial equity ownership will effectively exert its governance function only as long as target executives’ benefits from selling their shares at a premium outweigh the losses incurred from losing their managerial job, prestige, and security. This conclusion implies that the proportion of stock ownership relative to cash compensation has to be significantly higher if boards of directors in target firms aim to induce managers to accept tender offers beneficial for their shareholders.

Buchholtz & Ribbens (1994)

165 US targets

1980–1986 406 US firms

193 US firms 153 US targets

1980–1988 1977–1986

1986–1989

80 US targets

101 US firms

1982–1985

1984–1986

82 US deals

1981–1985

D’Aveni & Kesner (1993) Shivdasani (1993) Song & Walkling (1993) Agrawal & Walkling (1994)

90 US firms

1975–1982

Lambert & Larcker (1985) Morck, Shleifer, & Vishny (1988) Tucker (1991)

105 US targets

Sample

1972–1977

Period

Walkling & Long (1984)

Authors

Compensation structure

Abnormal compensation

Changes in managerial wealth Compensation structure Compensation structure

Compensation structure

Compensation structure

Compensation structure

Abnormal compensation Changes in managerial wealth

Approach

Stock ownership Golden parachute value Golden parachute breadth

Salary and bonus

Salary and bonus Stock ownership Equity-based compensation Stock ownership Stock ownership

Stock ownership

Hostile Hostile

Stock ownership Equity-based compensation Golden parachute presence

Hostile Friendly Hostile Hostile Hostile

Hostile Hostile

Hostile Hostile Hostile

Hostile

Friendly

Hostile

Attitude

Salary, total compensation

Compensation structure

(Continued)

Positive Positive Negative* Positive Positive*

Negative* Negative*

Positive* Negative* Negative*

Negative*

Positive*a

Negative* Negative*

Positive

Relation

Table 7.1  Review matrix of studies analyzing the impact of target executive compensation on target management attitude—Topic D1, Stream D, Theme II

1993–2001

1990–2004

Cai & Vijh (2007)

Sokolyk (2011)

558 US targets

250 US deals

311 US deals

Source: Adapted from Bodolica and Spraggon (2009) Notes: *—Statistically significant a— Indirect test and analysis

1995–1997

58 Canadian targets

1990–2000

Hartzell, Ofek, & Yermack (2004)

84 US banks

1982–1992

Hadlock, Houston, & Ryngaert (1999) Houle (2003)

132 US targets

Sample

1989–1990

Period

Cotter & Zenner (1994)

Authors

Table 7.1  (Continued)

Compensation structure

Changes in managerial wealth

Changes in managerial wealth

Compensation structure

Compensation structure

Compensation structure

Changes in managerial wealth

Approach

Stock ownership Golden parachute value Special cash bonus Golden parachute value Illiquidity discount of stock and option holdings (cash-out incentive) Golden parachute presence Compensation plan presence

Total compensation Equity-based compensation Golden parachute value Stock ownership Golden parachute value Stock ownership

Compensation structure

Hostile Hostile

Negative* Negative*

Negative* Negative* Positive* Positive* Positive*

Positive Negative* Positive Positive*

Hostile Hostile Hostile Hostile Hostile Hostile Friendly Friendly Friendly

Negative* Negative*

Relation

Hostile Hostile

Attitude

Impact of Target Executive Compensation  135 7.2. IMPACT OF TARGET EXECUTIVE COMPENSATION ON ACQUISITION PREMIUM Our review of the relevant literature suggests that the two most commonly analyzed elements of target management compensation, which are considered to exert a sizeable influence on the magnitude of control premium, are the stock ownership (Bargeron, Schlingemann, Stulz, & Zutter, 2008; Hayward  & Hambrick, 1997) and golden parachute clauses (Bebchuk, Cohen, & Wang, 2014; Machlin, Choe, & Miles, 1993). Yet over the past years, scholars have started to demonstrate an enhanced interest in other elements of the executive compensation and benefits package. Among these, we can cite directorial positions (Hartzell et al., 2004; Wulf, 2004), stock and option cash-out incentives (Cai  & Vijh, 2007), unscheduled option grants (Fich, Cai, & Tran, 2011), equity grants during merger negotiations (Heitzman, 2011), compensation plans (Sokolyk, 2011), the golden parachute importance (Fich, Tran, & Walkling, 2013), and the relative severance pay importance (Qiu, Trapkov, & Yakoub, 2014).

Managerial Stock Ownership and Control Premiums Extant research produced inconsistent results concerning the relationship between the equity ownership of target managers and the size of control premiums. While some scholars reported a significantly positive ownership–premium association (Bargeron et al., 2008; Hayward & Hambrick, 1997; Song & Walkling, 1993; Stulz, Walkling, & Song, 1990), others provided substantial evidence to the contrary (Billett & Ryngaert, 1997; Houle, 2003). Yet another set of studies produced statistically insignificant outcomes that go more in the positive (Bargeron et al., 2008; Fich et al., 2013; Lefanowicz, Robinson, & Smith, 2000; Wulf, 2004) rather than negative (Buchholtz & Ribbens, 1994) direction. For a sample of 104 American tender offers completed during the 1968 to 1986 period, Stulz and colleagues (1990) found that target shareholders’ gains from acquisitions ensuing from the acquirers’ payment of control premiums increase with target management shareholdings. In the same vein, Song and Walkling (1993) and Hayward and Hambrick (1997) concluded that when target executives possess large amounts of stock in their company, they have a financial incentive to hold out for a very high price that translates into larger control premiums. However, in an analysis of 145 US cash tender offers that occurred in the period between 1980 and 1989, Billett and Ryngaert (1997) disagreed with these findings. Houle’s (2003) investigation on Canadian targets also point to the existence of a negative ownership–premium relationship. Similar to Billett and Ryngaert (1997), the author showed that the higher the proportion of shares (and stock options) owned by target executives, the lower the probability that senior managers of acquiring companies will acquiesce to pay larger control

136  Targets’ Executive Compensation Before the Deal premiums to target shareholders. Despite using a slightly modified measure of compensation, Cai and Vijh (2007) demonstrated that target CEOs tend to accept lower acquisition premiums when they have a higher illiquidity discount of stock and option holdings in their firm. We submit that these contradictory findings may be due to a number of reasons, which are discussed in what follows. First, Billett and Ryngaert (1997) excluded from their sample all partial tender offers with no cleanup merger announcement accompanying the offer. This procedure resulted in the exclusion of those offers in which low control premiums were paid, contributing to a lower variety in data on premium size, which could eventually bias the conclusions derived from statistical tests. Second, variations in empirical outcomes may originate from inconsistent measurements of executive stock ownership employed across different studies. Billett and Ryngaert (1997) argued that an increase from zero to 10 percent in equity holdings has a much higher impact on managerial bargaining power than an increase from 40 to 50 percent, where this impact is only trivial. Moreover, suggesting that any increment in shareholding levels above 50 percent does not increase the bargaining power of managers, the scholars decided to truncate their ownership measure at 50 percent, which is not the case for other researchers who analyzed this topic of inquiry. Third, it may be possible that the strength of the association between target management ownership and acquisition premiums is affected by the public versus private nature of the bidding company. Bargeron and colleagues (2008) demonstrated that the positive ownership–premium relationship is significant only for acquisition deals initiated by public bidders and not private ones. This implies that private (public) bidding firms, which were found to pay lower (higher) premiums, tend to target companies with low (high) levels of ownership by executives who are more (less) inclined to accept lower control premiums. Finally, it is worth mentioning that Houle (2003) conducted the only investigation on the Canadian market for corporate control. The USA–Canada differences in terms of executive compensation-setting processes, corporate governance practices, income taxation levels, and regulations of takeover activities could explain the limited replicability of American findings in other national contexts (Spraggon & Bodolica, 2011).

Golden Parachutes’ Role in the Premium Determination Although Machlin and colleagues (1993) and Houle (2003) relied on different sample nationalities, they agree on the extent to which the value of golden parachutes granted to target managers influences the magnitude of premiums paid in acquisitions. For a small sample of 31 US targets that were acquired from 1975 through 1988, Machlin and colleagues (1993) observed that US$1 increase in the value of golden parachutes is associated with US$10 increase in the payment of control premiums. The authors

Impact of Target Executive Compensation  137 concluded that larger golden parachute clauses encourage target executives to pursue the interests of their shareholders. Ten years later, Houle (2003) corroborated this significantly positive parachute–premium relationship for a sample of 58 target firms operating in Canada. Both Hartzell and colleagues (2004) and Sokolyk (2011) tested the same empirical question on large sets of data (311 US deals and 558 US targets, respectively) but did not find any significant (negative and positive, respectively) association between parachute payments and acquisition premiums. Similarly, Lefanowicz and colleagues (2000) reported an insignificant golden parachute coefficient, but their statistical analyses warrant a separate consideration. Using data on 306 US public companies that became targets during the period between 1980 and 1995, the scholars demonstrated that golden parachutes tend to offset the tendency of target executives, who expect to lose large salary payments, to negotiate higher premiums for the owners of their firm. This means that, when considered jointly with other types of managerial incentives, golden parachute clauses may contribute to the reduction of value-maximizing behaviors of target CEOs. Indeed, Bebchuk and colleagues (2014) reported that in the event of an acquisition, the association between the golden parachute presence and the size of acquisition premiums is significantly negative. This is consistent with the managerial self-interest or incentive hypothesis, which predicts that golden parachutes make an acquisition more in the personal interest of executives despite their loss of private benefits of control associated with the managerial position. Using a large sample of 851 acquisitions of American targets between 1999 and 2007, Fich and colleagues (2013) provided a strong support for the negative parachute–premium association. However, their study differs in the selection of a parachute proxy, positing that it is not the presence or value but rather the importance of golden parachutes to target CEOs that drives the determination of the magnitude of control premiums. The golden parachute importance is estimated by the ratio of parachute size to the expected amount of takeover-induced compensation loss. Fich and colleagues (2013) concluded that the likelihood of acquisition completion increases, while the acquisition premium decreases, with the importance of parachutes to target executives.

Evaluating the Effect of Other Compensation Elements Benefits From Retention of the Target CEO by the Acquirer Several researchers examined the extent to which the retention of the target CEO by the acquiring firm is associated with the magnitude of takeover premiums, with some reporting a strong negative relationship (Qiu et al., 2014; Wulf, 2004) and others obtaining insignificant results (Bargeron, Schlingemann, Stulz, & Zutter, 2010; Fich, Officer, & Tran, 2014; Harford & Schonlau, 2013; Hartzell et al., 2004). Hartzell and colleagues (2004) investigated target CEOs’ incentives in a sample of 311 friendly mergers during

138  Targets’ Executive Compensation Before the Deal 1995 to 1997. They found only weak support for the conjecture that target executives negotiate less favorable transaction terms for their shareholders when the acquirer offers them an extraordinary treatment (i.e., payment of special cash bonuses) and presents them with new career opportunities (i.e., membership on the acquirer’s board of directors). In the same vein, the statistical tests of Bargeron and colleagues (2010) and Fich and colleagues (2014) are not consistent with the power-for-premium hypothesis, which stipulates that target managers agree not to bargain for higher control premiums in lieu of an executive-level job in the merged business entity. Finding that target CEOs are more likely to gain additional directorial positions after the acquisition, Harford and Schonlau (2013) also showed that these results are not sensitive to the negative shareholder wealth effects stemming from a deal that involves smaller premiums. Focusing on 40 American mergers of equals completed during the 1990s, Wulf (2004) provided strong evidence on the existence of a negative relation between control premiums and private benefits for target CEOs. When negotiating the sale of their firm, target managers trade their personal power and shared governance in the postmerger organization (such as board membership or the CEO position) in exchange for target shareholders’ premium. The empirical findings of Qiu and colleagues (2014) are consistent with prior evidence regarding the negative premium implications stemming from both the relative importance of the predefined golden parachute pay (Fich et al., 2013) and the target management retention in executive or directorship positions in the combined company (Wulf, 2004). Using a recent sample of 2,198 US transactions over the 1994 to 2010 timespan, the authors have also considered the relative importance of severance pay for target executives to report a significantly negative effect on takeover premiums. Furthermore, Qiu and colleagues (2014) showed that the negative retention–premium and severance pay–premium relationships are particularly strong when the target CEO receives a higher-category position and the severance pay is negotiated during the merger process, respectively. Equity Grants During Merger Negotiations and Compensation Plans Both Fich and colleagues (2011) and Heitzman (2011) examined special benefits obtained by target executives during takeover negotiations and their association with the size of control premiums. Relying on a sample of 920 acquisitions of US targets during the 1999 to 2007 period, Fich and colleagues (2011) estimated the effect of unscheduled stock option grants made to target CEOs to substitute for golden parachutes and to offset the future merger-induced loss of managerial job and compensation. Although target companies offering unscheduled options are more likely to be acquired, their CEOs who benefit from these option grants accept lower premiums for their shareholders. Yet Heitzman (2011) did not corroborate these findings for a smaller sample of American deals that were undertaken during a similar time frame. The author showed that the equity grants made to target CEOs during merger negotiations are not significantly associated with the

Impact of Target Executive Compensation  139 magnitude of acquisition premiums. It is worth noting that these studies differ on two critical aspects that make the comparison of their empirical results problematic. While Fich and colleagues (2011) focused exclusively on option grants that are unscheduled (and therefore more likely to be related to a takeover event), Heitzman (2011) aggregated the awards of stock and options into a single equity measure without differentiating whether these awards are programmed or unscheduled. Finally, in a recent examination of American target organizations between 1990 and 2004, Sokolyk (2011) reported that compensation plans positively affect the size of the acquisition premium paid by the acquirer. The existence of compensation plans in target firms allows the acceleration of executive benefits, such as, for example, the vesting of stock options. According to the scholar, the compensation plans provide target management with a strong personal incentive to bargain for a larger takeover premium, because a higher offer price translates into an increased exercise price of managerial options.

Summary Considerations on This Topic of Inquiry Table 7.2 offers a review matrix of all the identified studies that examined the impact of target executive compensation on the magnitude of control premiums paid in acquisitions. From the standpoint of target organizations, value-maximizing top management behavior should be consistent with such executive actions that result in larger acquisition premiums, generating positive consequences for target shareholders’ wealth (Kim et al., 2010). However, the empirical evidence provided on this topic of inquiry indicates that managerial private interests, rather than efficiency rationales, are the primary drivers of premiums and that neither the executive stock ownership (Billett & Ryngaert, 1997; Houle, 2003) nor the golden parachute clauses (Bebchuk et al., 2014; Fich et al., 2013) can be considered optimal governance mechanisms for effectively solving agency conflicts in target firms. The recent wave of research on target CEO retention in managerial or directorial positions in the acquiring company also points to the predominance of managerial self-interest in the determination of the premium size (Qiu et al., 2014; Wulf, 2004). In the same vein, the unscheduled stock option grants during merger negotiations are unlikely to contribute to the enhancement of incentive alignment in target firms (Fich et al., 2011). Nevertheless, the existence of compensation plans for target CEOs seems to be consistent with shareholder wealth considerations as reflected in larger control premiums (Sokolyk, 2011). The literature indicates that different managerial incentives, not only in the form of monetary values but also in association with future executive careers, are worthy of further empirical examination. An emphasis on less-explored elements of top management compensation bears the potential of improving our understanding of the complexities surrounding the determination of premiums in acquisitions.

145 US cash tender offers 306 US public companies

1980–1989 1980–1995

1995–1997

106 US deals

1989 & 1992

Hartzell, Ofek, & Yermack (2004)

153 US targets 406 US firms

1977–1986 1986–1989

311 US deals

58 Canadian targets

31 US firms

1975–1988

1990–2000

104 US takeovers

Sample

1968–1986

Period

Houle (2003)

Stulz, Walkling, & Song (1990) Machlin, Choe, & Miles (1993) Song & Walkling (1993) Buchholtz & Ribbens (1994) Hayward & Hambrick (1997) Billett & Ryngaert (1997) Lefanowicz, Robinson, & Smith (2000)

Authors

Stock ownership Stock ownership Salary Golden parachute value Golden parachute × Salary Stock ownership Stock options Golden parachute value Special cash bonus Golden parachute value Board membership

Stock ownership

Stock ownership Stock ownership

Golden parachute value

Stock ownership

Compensation structure

Negative* Positive Positive* Positive Negative* Negative* Negative* Positive* Negative Negative Negative

Positive*

Positive* Negative

Positive*

Positive*

Impact on premium

Table 7.2  Review matrix of studies analyzing the impact of target executive compensation on acquisition premium—Topic D2, Stream D, Theme II

1991–1999

1993–2001

1980–2005

1994–2006

1999–2007

1996–2006 1990–2004

1999–2007

Wulf (2004)

Cai & Vijh (2007)

Bargeron, Schlingemann, Stulz, & Zutter (2008)

Bargeron, Schlingemann, Stulz, & Zutter (2010)

Fich, Cai, & Tran (2011)

Heitzman (2011) Sokolyk (2011)

Fich, Tran, & Walkling (2013)

851 acquisitions of US targets

920 acquisitions of US targets 471 US deals 558 US targets

914 cash-only US deals

1,667 US deals

250 US deals

40 US mergers of equals

Stock ownership Shared governance (board membership, CEO position) Illiquidity discount of stock and option holdings (cash-out incentive) Stock ownership (public bidders’ deals) Stock ownership (private bidders’ deals) CEO retention (in managerial or director position in combined firm) Unscheduled grants of stock options Negotiation equity grants Golden parachute presence Compensation plan presence Golden parachute importance (ratio of parachute size to present value of lost pay) Stock ownership

(Continued)

Positive

Positive Positive Positive* Negative*

Negative*

Negative

Positive

Positive*

Negative*

Positive Negative*

1994–2010

2,198 US deals

355 US deals

1999–2008

1990–2006

2,449 terminal US CEO years 9,277 US target firms

Sample

1996–2007

Period

Source: Adapted from Bodolica and Spraggon (2009) Note: *—Statistically significant

Qiu, Trapkov, & Yakoub (2014)

Harford & Schonlau (2013) Bebchuk, Cohen, & Wang (2014) Fich, Officer, & Tran (2014)

Authors

Table 7.2  (Continued)

CEO retention (in managerial or director position in combined firm) CEO retention (in managerial or director position in combined firm) Relative importance of the severance pay Ratio of negotiated severance pay to total pay + total severance pay Ratio of predefined golden parachute pay to total pay + total severance pay

Golden parachute presence

Board membership

Compensation structure

Negative*

Negative*

Negative*

Negative*

Positive

Negative*

Negative

Impact on premium

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144  Targets’ Executive Compensation Before the Deal consolidation, and financial performance. Journal of Banking & Finance, 27, 417–447. Kim, K. A., Nofsinger, J. R.,  & Mohr, D. J. (2010). Corporate governance. Upper Saddle River, NJ: Pearson Prentice Hall. Lambert, R. A.,  & Larcker, D. F. (1985). Golden parachutes, executive decision-making and shareholder wealth. Journal of Accounting and Economics, 7(1–3), 179–203. Lefanowicz, C. E., Robinson, J. R.,  & Smith, R. (2000). Golden parachutes and managerial incentives in corporate acquisitions: Evidence from the 1980s and 1990s. Journal of Corporate Finance, 6, 215–239. Machlin, J. C., Choe, H., & Miles, J. A. (1993). The effects of golden parachutes on takeover activity. Journal of Law and Economics, 36(2), 860–876. Morck, R. M., Shleifer, A., & Vishny, R. W. (1988). Characteristics of targets of hostile and friendly takeovers. In A. J. Auerbach (Ed.), Corporate takeovers: Causes and consequences (pp. 101–129). Chicago, IL: University of Chicago Press. Qiu, B., Trapkov, S.,  & Yakoub, F. (2014). Do target CEOs trade premiums for personal benefits? Journal of Banking & Finance, 42, 23–41. Shivdasani, A. (1993). Board composition, ownership structure and hostile takeover. Journal of Accounting and Economics, 16(1–3), 167–198. Sokolyk, T. (2011). The effects of antitakeover provisions on acquisition targets. Journal of Corporate Finance, 17(3), 612–627. Song, M. H.,  & Walkling, R. A. (1993). The impact of managerial ownership on acquisition attempts and target shareholder wealth. Journal of Financial and Quantitative Analysis, 28(4), 439–457. Spraggon, M., & Bodolica, V. (2011). Post-acquisition structuring of CEO pay packages: Incentives and punishments. Strategic Organization, 9(3), 187–221. Stulz, R., Walkling, R., & Song, M. (1990). The distribution of target ownership and the division of gains in successful takeovers. Journal of Finance, 45, 817–834. Tucker, M. (1991). CEO remuneration and share ownership in acquired firms. Mid-Atlantic Journal of Business, 27(2), 149–152. Walkling, R. A., & Long, M. S. (1984). Agency theory, managerial welfare, and takeover bid resistance. Rand Journal of Economics, 15(1), 54–68. Weisbach, M. (1993). Corporate governance and hostile takeovers. Journal of Accounting and Economics, 16, 199–208. Wulf, J. (2004). Do CEOs in mergers trade power for premium? Evidence from “mergers of equals.” Journal of Law, Economics and Organization, 20(1), 60–101. Zhou, X. (1999). Executive compensation and managerial incentives: A  comparison between Canada and the United States. Journal of Corporate Finance, 5, 277–301.

Part IV

Acquirers’ Executive Compensation After the Deal Part Contents: Chapter 8. Impact of M&A Characteristics on Executive Compensation of Acquiring Firms   8.1 Impact of M&A Performance and Growth in Corporate Size on Executive Compensation of Acquiring Firms   8.2 Impact of Acquisition Premium and Mode of Payment on Executive Compensation of Acquiring Firms

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8 Impact of M&A Characteristics on Executive Compensation of Acquiring Firms

ON THE STRUCTURE OF THIS RESEARCH STREAM How do M&A activities and their characteristics influence the postacquisition determination of executive compensation in acquiring firms? Based on our review of the relevant literature, two major topics of research could be delineated within this stream. The vast majority of studies focused on advancing the current knowledge on the first topic, which examines whether acquirers’ returns and the merger-induced growth in corporate size are associated with the magnitude and composition of managerial pay packages following M&A transactions (Topic E1 in Figure 3.3). The second, less popular topic of inquiry is dedicated to the analysis of how the monetary level and the incentive structuring of executive compensation packets in acquiring companies are influenced by two transactional characteristics, namely the control premium and the mode of payment used to finance the acquisition (Topic E2 in Figure 3.3). 8.1 IMPACT OF M&A PERFORMANCE AND GROWTH IN CORPORATE SIZE ON EXECUTIVE COMPENSATION OF ACQUIRING FIRMS

Introductory Cross-Study Observations The existing studies that explored the association between the postacquisition firm performance or corporate size and the acquirers’ executive compensation have typically used interrupted time series and quasi-experimental designs. It is worth noting that all scholars are in agreement with the conjecture that senior managers possess important financial incentives to undertake acquisition deals, mainly due to the strong positive effect of organizational size on the magnitude of executive rewards. For instance, Yim (2013) demonstrated that acquiring CEOs at S&P 1,500 corporations enjoy a significant increase in total compensation levels in the postacquisition period and that this increase is principally driven by the equity-based element of pay, which includes restricted stock awards and stock option grants. However,

148  Acquirers’ Executive Compensation After the Deal the empirical findings exhibit some heterogeneity in establishing the role that the postmerger performance plays in the executive pay-setting process, as the strength of this relationship may be affected by the managerial power over the board of directors and other corporate governance weaknesses in acquiring companies. The identified studies vary substantially along several key variables, such as the investigation period, starting from the 1970s (Lambert & Larcker, 1987) and going up to the year 2012 (Wang, Wang, & Wangerin, 2014); sample size, varying between 27 (Khorana & Zenner, 1998) and 5,722 acquisition transactions (Lee, Shakespeare, & Walsh, 2009); and characteristics of acquiring firms in terms of the ownership structure (Kroll, Simmons, & Wright, 1990; Kroll, Wright, Toombs, & Leavell, 1997), merger intensity (Bliss & Rosen, 2001; Conyon & Gregg, 1994), in-wave timeliness of M&A deals (Goel & Thakor, 2010), cross-border acquisition propensity (Gerakos, Piotroski, & Srinivasan, 2013; Ozkan, 2012), and corporate governance attributes (Fu, Lin,  & Officer, 2013; Grinstein  & Hribar, 2004; Wright, Kroll, & Elenkov, 2002). The elements of executive compensation packages that received most consideration are cash compensation (Schmidt & Fowler, 1990), total compensation (Anderson, Becher, & Campbell, 2004), bonus for acquisitiveness (Grinstein & Hribar, 2004), performance pay (Dorata & Petra, 2008), incentive-based compensation (Gerakos et al., 2013), grants of restricted stock and options (Fu et al., 2013), and membership on outside boards of directors (Harford & Schonlau, 2013). Finally, the empirical evidence is provided predominantly on American samples, with a growing number of studies using UK data (Firth, 1991; Girma et al., 2006; Guest, 2009; Ozkan, 2012) and only a single investigation covering Australian markets for corporate control (Bugeja, Da Silva Rosa, Duong, & Izan, 2012).

Executive Compensation and Postacquisition Performance Debate on Pay–Performance Association in Acquiring Firms The traditional wisdom within this topic of inquiry is that senior executives are motivated to engage in M&A activities for personal enrichment purposes rather than to create shareholder value. However, the results of Avery, Chevalier, and Schaefer (1998) are only partially consistent with this assumption. Following the careers of 131 acquiring CEOs from the beginning of 1986 to the end of 1991, the authors examined whether these CEOs receive internal rewards (in the form of higher cash pay) and external rewards (in terms of outside directorships) for acquisitiveness. While the level of cash compensation did not increase after the merger, acquiring managers still benefited in terms of external rewards, as they were significantly more likely to gain directorial positions in outside boards than were their nonacquiring peers. Arguing that an acquisition may signal that the CEO has the skills needed to manage a more complex firm, Avery and colleagues (1998) suggested that executives do not pursue M&As to raise the

Impact of M&A Characteristics on Executive Compensation  149 magnitude of their compensation but to enhance their standing in the business community. Earlier studies engaged in a debate regarding the association of top management compensation with firm performance in the postacquisition period. Focusing on American transactions from the second half of the 1970s, Lambert and Larcker (1987) and Schmidt and Fowler (1990) reported mixed results. On the one hand, Lambert and Larcker (1987) showed that in the period following an acquisition, increases in executive compensation are related to increases in stockholder wealth. Splitting their sample along the acquisition quality, they found that in the group of 21 bad deals, CEOs did not improve their cash compensation and total wealth, while in the case of 14 good deals, CEOs experienced a significant increase in their pay levels. On the other hand, Schmidt and Fowler (1990) concluded that postmerger managerial compensation is not associated with corporate returns. Using a longitudinal design covering nine years, they indicated that 41 bidders and 51 acquirers performed poorly after the transaction completion, while their CEOs experienced significant increases in their cash-based pay. Since Schmidt and Fowler (1990) demonstrated that executive rewards are driven by firm size rather than performance, they corroborated the managerial welfare hypothesis but contradicted Lambert and Larcker’s (1987) findings, in which the managerial labor market was found to exert a disciplinary effect on the acquisitive behavior of CEOs. Weak CEO Pay–Performance Association Subsequent studies continued to address this debate, either confirming or rejecting the existence of a pay–performance link following an acquisition. Using a sample of 169 UK acquirers between 1985 and 1990, Conyon and Gregg (1994) reported that the compensation of the highest-paid manager is directly associated with shareholder returns, although the estimated elasticity is small. Their merger intensity dummy variable suggests that executives undertaking three or more acquisitions experience a higher pay premium (of 6.5 percent) than do those who engaged in two acquisitions (2.5 percent). Rosen (2005) also found that the total compensation of CEOs increases significantly after program mergers (i.e., deals by repeat acquirers), but these increases are much higher when the stock market performance of the acquiring firm is growing. In a study of 323 US transactions completed in the second half of the 1990s, Dorata (2008) drew some conclusions, which are aligned with Lambert and Larcker’s (1987) outcomes. The author showed that in the presence of positive postacquisition returns, CEO cash compensation increases significantly, whereas when these returns are negative, the CEO experiences a reduction in salary and bonus (which borders on its level of significance). According to Khorana and Zenner (1998), the magnitude of executive compensation in the period after the acquisition completion is at best marginally influenced by firm performance. The scholars examined the differential impact of the quality of acquisition deals on the top management pay

150  Acquirers’ Executive Compensation After the Deal after the conduct of large US M&As from 1982 to 1986. For the group of 18 good acquisitions, there was a net positive effect on cash and total compensation, whereas the 9 bad deals were found to exert an insignificant positive effect on total compensation. When incorporating the increased likelihood of CEO dismissal after a bad acquisition, it was shown that bad transactions were not likely to increase executive rewards. In an investigation of 472 M&As initiated by 313 UK acquirers, Girma and colleagues (2006) reported that CEO compensation is not strongly associated with postacquisition returns of acquiring firms. Nevertheless, they noted that managers engaging in value-reducing deals experience significantly lower levels of cash pay than do their counterparts whose acquisitions are wealth enhancing. The authors concluded that shareholders are able to exert at least some control over the compensation of opportunistic executives who engage in empire building activities. Using a large sample of 4,528 UK deals completed between 1984 and 2001, Guest (2009) uncovered significant cash compensation increases in the postacquisition year for both good and bad transactions. However, upon inclusion of the stock ownership value and incentive share value in the measure of total wealth, the researcher demonstrated that senior managers incur a significant loss in their personal wealth from carrying out acquisitions with negative cumulative abnormal returns. Confirmation of the Managerial Welfare Hypothesis In line with Schmidt and Fowler (1990), other studies provide evidence on the lack of relationship between CEO compensation and postmerger returns, as managers are not penalized for participating in value-destroying M&A deals. Moreover, the existence of a strong size–pay link is suggestive of an important private incentive for managers to grow their company through mergers. Firth (1991) focused on a sample of 171 successful and 83 unsuccessful UK acquirers during the 1970s when examining the returns to shareholders and changes in short-term compensation and total wealth of senior management in the two postacquisition years. As changes in both indicators of managerial wealth were found to be significantly positive for both good and bad acquirers, British CEOs gain not only when the takeover results in positive returns to shareholders but also when the stock value of the acquiring firm is destroyed. Reporting significantly higher levels of executive bonuses, stock options, and stock awards following poor M&A deals, Dorata and Petra (2008) concluded that CEOs in 77 US acquiring companies in 2003 stand to personally benefit from the conduct of mergers regardless of firm performance. Bliss and Rosen (2001) further corroborated the maximization of the senior management utility hypothesis in the case of the American banking industry. Splitting equally their sample of 32 banks across the intensity in merger activity, these scholars found that M&As significantly increased managerial cash and total compensation in both high- and low-merger

Impact of M&A Characteristics on Executive Compensation  151 acquirers. Even after accounting for the typical announcement-date stock price decline, it was shown that bank mergers still enhanced CEOs’ overall wealth at the expense of shareholders. Based on a sample of 97 US merger transactions conducted among billion-dollar banks in the 1990 to 1997 period, Anderson and colleagues (2004) reported that managers of surviving banks are rewarded for their productivity. However, the authors further demonstrated that the initiation of a bad M&A deal results in significant increases in both cash and total compensation of executives in merging banks. Consistent with prior research on the banking sector (Anderson et al., 2004; Bliss & Rosen, 2001), Harjoto, Yi, and Chotigeat (2012) found that managerial motivations are the main driver of banks’ acquisitions of nonbanks. The salary, bonus, and incentive-based compensation of the top five highest-paid bank executives are substantially higher following nonbank acquisitions, even though these transactions generate subsequent reductions in profit, market value, and stock returns in acquiring banks. Contingency Explanations of the Pay–Performance Relationship Two sets of explanations can be found in the literature that can contribute to solving the ongoing debate with regard to the pay–performance relationship in the context of acquiring firms. The first set, which is favored by earlier studies on this topic of inquiry, argues that the strength of this relationship may be a function of the predominant characteristics associated with the acquirer’s ownership structure (Kroll et al., 1990, 1997). The second group of studies proposes to analyze more closely the corporate governance features and power dynamics in acquiring companies to assess the board’s real ability to tie the executive compensation to firm performance (Grinstein & Hribar, 2004; Wright, Kroll, & Elenkov, 2002). This by far most popular set of empirical investigations is described in the following section of this chapter. Analyzing 50 American acquirers in 1982 and 1983, Kroll and colleagues (1990) reported that for both manager-controlled and single-industry firms, the significant post–M&A increase in executive pay is related to nonperformance variables, such as sales volume and tenure as CEO. In the owner-controlled companies, however, managers are found to be paid on the basis of performance-related factors (i.e., profitability as a percentage of industry standard). Some years later, Kroll and colleagues (1997) extended their sample to 209 US acquiring firms between 1982 and 1991 and added to their ownership classification a new owner-manager–controlled form where the manager has significant financial investments. Reporting negative postmerger returns in manager-controlled firms where CEO compensation is based on nonperformance factors, the authors concluded that acquisition-related decisions in these firms are primarily driven by managerial self-serving motives. Conversely, in the case of owner-controlled organizations, shareholders’ interests appear to be of primary importance, since

152  Acquirers’ Executive Compensation After the Deal acquisitions produce positive returns and executive rewards are related to performance criteria. In the owner-manager–controlled firms, the compensation impacts are mixed, as CEOs appear to gain both from investing in profitable deals and for simply expanding the size of their company.

Considering the Role of Governance Configurations and Power Dynamics Evidence on Weaknesses in Corporate Governance Structures A large body of research posits that the strength of corporate governance practices, particularly the power of the board vis-à-vis the CEO, is critical for enforcing the pay–performance relation for acquiring managers. Wright, Kroll, and Elenkov (2002) explored the extent to which the intensity of corporate monitoring activities moderates the effects of acquisition-related factors on changes in CEO compensation. The intensity of monitoring is assessed on the basis of the number of analysts following a firm, ratio of independent board members, and ownership levels by activist institutional investors. Using a sample of American acquirers in the 1990s, the scholars found that in the case of 77 firms with vigilant monitors, the executive salary, bonus, and stock options were significantly influenced by acquisition returns, while in 94 firms with lax monitoring, these rewards were considerably impacted by increases in firm size. In a study of 370 US deals conducted by 361 acquirers during 1993 through 2000, Harford and Li (2007) provided new evidence on this topic. Showing that both total compensation and equity wealth of managers are not related to postmerger returns, they concluded that CEOs are always financially better off from making acquisition decisions, even when these decisions are value destroying. Yet the researchers reported that acquiring firms with stronger boards, measured relative to the CEO tenure, maintain the sensibility of CEO compensation to negative postacquisition stock performance. In other words, Wright and colleagues (2002) and Harford and Li (2007) imply that acquiring executives are enabled to be abusive in situations when the external monitoring is lax and the board of directors is weak. The empirical outcomes of the recent analysis of 166 overvalued US acquirers performed by Fu and colleagues (2013) point to governance weaknesses as primary drivers of poorly performing (high-premium and negative-synergies) M&A deals. Despite conducting bad acquisitions, top executives in companies with larger boards, lower external monitoring, and greater CEO entrenchment (due to antitakeover provisions) enjoy significant increases in the number of restricted stock and option grants. However, Guest (2009) did not provide significant support for this view, showing that compensation increases around acquisition transactions are not caused by weak corporate governance structures in UK acquiring firms. Testing separately the effect of seven indicators of weak governance (i.e., large board size, low ratio of outside directors, CEO-chairperson duality,

Impact of M&A Characteristics on Executive Compensation  153 low CEO stock ownership, low board stock ownership, long CEO tenure as director, and low external ownership), the author found that only the latter two coefficients display significant signs, proving the continuation of preacquisition trends rather than important flaws in governance configurations. Evaluating the Managerial Entrenchment Hypothesis Relying on the political perspective, Grinstein and Hribar (2004) analyzed the special rewards the acquiring CEOs receive for completing M&A deals. Based on a sample of 327 large American acquisitions conducted between 1993 and 1999, the researchers reported that 39 percent of managers are paid for their acquisitiveness and that compensation comes mainly in the form of a cash bonus. Observing that CEOs who have more power to influence board decisions receive significantly larger bonuses, they concluded that managerial power is the primary driver of acquisition bonuses. Coakley and Iliopoulou (2006) offered further support for these findings in the British market for corporate control during the period of 1998 to 2001. They contribute to the literature by conducting the first empirical study that compares executive compensation practices among 73 UK and 27 US acquiring firms. Their results suggest that both British and American managers receive higher cash compensation in the postacquisition period when the board in their firm is larger and less independent. Further, US executives get higher salary and bonuses, and their compensation is determined exclusively by the CEO dominance over the board, while their UK peers are also rewarded for their ability to complete large and intra-industry mergers. Lee and colleagues (2009) extended this topic of inquiry by analyzing the relationship between CEO compensation and corporate decisions of both buying and selling assets. Employing a large sample of 5,722 US acquisitions (and 2,860 divestitures) made over the 1992 through 2005 time period, the authors confirmed prior research results (Dorata & Petra, 2008; Firth, 1991), demonstrating that CEOs earn extra compensation for taking part in acquisition transactions that are not related to subsequent firm performance. More interestingly, however, they found that CEOs who engage in a mixed strategy of acquiring and divesting assets during their time in office gain an extra US$4.07  million in total pay. These findings are significantly associated with measures of CEO entrenchment, indicating that boards of directors work to protect managers from the full force of governance controls. Since CEOs tend to engage in the “asset churning” strategy to satisfy their own interests, Lee and colleagues (2009) concluded that a mixed acquisition and divestiture program might be the most lucrative of all for entrenched executives over the period of their tenure. In a recent study, Darrough, Guler, and Wang (2014) used goodwill impairment as a direct measure of acquisition performance to examine whether CEOs are penalized for completing value-destroying deals. Acquiring CEOs

154  Acquirers’ Executive Compensation After the Deal do pay the price for making bad acquisitions, as their total compensation is significantly diminished after firms recognize goodwill-impairment losses. In particular, the reduction in cash-based compensation occurs for executives who purchase larger targets, whereas the decrease in stock option pay is mainly incurred by senior managers of non–R&D intensive companies. Yet the provided evidence also points to the existence of managerial entrenchment, as CEOs with longer tenures are insulated from reductions in their cash compensation following the recognition of losses from an impaired goodwill. Darrough and colleagues (2014) concluded that boards of directors respond to these detrimental corporate events by decreasing the option-related component of executive compensation packages, leaving the grants of restricted stock intact. In line with Irving, Landsman, and Lindsey (2011), this finding indicates that stock options and restricted stock awards may produce asymmetrical risk-incentivizing effects on CEO behavior. Rejecting the Influence of CEO Power on Pay in Specific Contexts Wang and colleagues (2014) assessed whether and how the 2006 SEC regulation requiring more detailed executive compensation disclosure in corporate proxy statements affected the merger-related bonus and the pay-for-performance sensitivity of acquiring CEOs. For a sample of 1,417 large US acquisitions between 2000 and 2012, the authors found that in the pre-2006 period, top managers received sizable bonuses for making large M&A deals, while their total compensation was largely unresponsive to poor postacquisition performance of their firm. Yet these effects were reversed in the postregulation period when senior executives no longer benefited from merger-related bonuses and the sensitivity of their total pay to weak performance became significantly stronger. Following prior research, Wang and colleagues (2014) also assessed whether CEO power played an influential role in bonus-related decisions (Grinstein & Hribar, 2004) and whether a strong corporate board permits eliminating the decoupling of CEO pay from postmerger performance (Harford & Li, 2007). For the period following the adoption of regulation, the authors failed to provide a significant support for the impact of CEO power on the payment of bonuses and the importance of board strength for retaining the pay–performance sensitivity. These results demonstrate the effectiveness of the 2006 SEC disclosure rules in improving the executive compensation arrangements of publicly listed companies and indicate that the enhanced transparency achieved via information reporting legislation can effectively substitute the governance discipline instituted by a strong board of directors. In the only investigation conducted on the Australian market for corporate control, Bugeja and colleagues (2012) also found that acquiring CEOs receive higher levels of pay in the postdeal period and that different elements of executive compensation are positively related to firm size. Yet, contrary to Schmidt and Fowler (1990) and Harford and Li (2007), they reported

Impact of M&A Characteristics on Executive Compensation  155 that there is a significantly positive correlation between the acquirer’s stock returns (and return on assets) and the executive’s bonus, combined measure of salary and bonus, share ownership, stock options, and total compensation. Interestingly, in line with the incentive alignment theory, Australian CEOs were found to receive significantly lower bonuses and other types of compensation when they possess higher levels of power over the board (i.e., when the CEO is a member of the nominating committee, has more stock ownership, or has larger tenure or when the board is staffed by a large percentage of insiders). Hence, Bugeja and colleagues (2012) rejected the assumptions of the managerial power theory, which received empirical confirmation in the US and UK settings (Coakley & Iliopoulou, 2006; Grinstein  & Hribar, 2004). These contradictory findings with regard to the influence of CEO power on the compensation-setting process may be due to significant corporate governance differences between Australian and American or British companies. In particular, contrary to the USA and UK, in Australia, the percentage of CEOs who are members of the nominating committee is higher, the level of executive shareholdings is lower, the size of the board of directors is smaller, and the percentage of nonexecutive directors sitting on the corporate board is generally higher.

Alternative Approaches to Examining Acquirers’ CEO Compensation Acquirers’ CEO Pay and Cross-Border Acquisitions Two recent studies examined whether M&A transactions between UK acquirers and US targets result in higher levels of compensation for the top management of the acquiring firm but yielded contradictory results (Gerakos et al., 2013; Guest, 2009). On the one hand, Guest (2009) reported that initial acquisitions of nondomestic targets translate into higher levels of pay, but acquisitions of companies located in high-pay countries (i.e., the USA) do not significantly enlarge the compensation package of acquiring executives. On the other hand, Gerakos and colleagues (2013) found that, following the completion of US deals, UK CEOs do not only experience important increases in their incentive-based pay and total compensation but also witness a significant decrease in the US–UK pay gap. The authors concluded that acquisitions of highly paid US targets by British corporations are conducive toward a reduction of pay disparities and convergence of executive compensation practices across the two countries. These contradictory outcomes may be attributed to some critical methodological differences. While Guest (2009) employed a larger sample of UK acquirers (1,408 versus 416), Gerakos and colleagues (2013) gathered a more recent set of data (2002–2007 versus 1984–2001). Additionally, Guest (2009) focused exclusively on the cash-based component of CEO pay, while Gerakos and colleagues (2013) considered both cash elements and incentive components, which include the value of stock option grants and restricted stock awards.

156  Acquirers’ Executive Compensation After the Deal Ozkan (2012) also used a sample of UK acquirers to evaluate how the involvement in cross-border versus domestic M&As (and various governance factors) affects the CEO pay level and pay–performance sensitivity in the postdeal period. In line with Gerakos and colleagues (2013), the author demonstrated that acquisitions of foreign targets are associated with significantly higher increases in CEO cash and total compensation compared to acquisitions of domestic firms, irrespective of the level of firm performance. Considering the predominance of institutional stockholders in the UK securities market, Ozkan (2012) found that their role in monitoring the postacquisition managerial pay-setting process is inconclusive. While foreign institutional investors exerted a significant negative effect on CEO pay levels, neither foreign nor domestic institutional blockholders influenced the pay–performance sensitivity. Out of the five governance variables considered in the study to control for governance strength and CEO power (i.e., director ownership, board size, ratio of outside directors, CEO tenure, and CEO ownership), only director ownership was found to significantly decrease the magnitude of acquiring managers’ compensation. These findings provide only weak support for the governance effectiveness of a strong board and are more consistent with the human resource rationale that global expansion necessitates more exclusive executive talent that needs to be rewarded for the conduct of complex cross-border acquisitions. Director Labor Market, Envy-Driven Decisions, and Survivor Bias Harford and Schonlau (2013) analyzed the private benefits to acquiring CEOs not in terms of increased worth of compensation packages but rather from the standpoint of the director labor market. The scholars evaluated the extent to which the conduct of M&A deals is associated with the probability of obtaining future directorship positions for top managers of the acquiring firms. Using empirical data for the 1996 to 2009 period, Harford and Schonlau (2013) showed that being CEO during and after an acquisition leads to an increase in the number of future board seats irrespective of whether the acquisition generates value-enhancing or wealth-destroying implications for corporate stockholders. Similar to Ozkan (2012), the authors referred to human resource explanations of their findings, which indicate that the director labor market values the acquisition-related experience of executives more highly than their ability to conduct good acquisitions. The study of Goel and Thakor (2010) also differs from other research on this topic in that the authors considered how envy influences the acquisitive behavior of top managers, resulting in the occurrence of new merger waves. Using a sample of 5,417 US transactions, they found that later acquisitions in a wave made by envy-driven executives are associated with weaker synergies and result in lower increases in CEO compensation than M&A deals conducted earlier in the wave. Recently, HomRoy (2014) argued that extant literature with regard to merger influences on managerial compensation suffers from a survivor bias

Impact of M&A Characteristics on Executive Compensation  157 when estimating the size of the pay premium received for conducting M&A transactions. The researcher suggests that the commonly employed analytical procedure of excluding from the sample those CEOs who were not retained following an acquisition (Harford & Li, 2007) does not permit accurately capturing top management incentives for performing risky acquisitions. According to HomRoy (2014), the threat of postmerger turnover tempers the risk appetite of executives acting as an acquisition disincentive unless the expected pay premium is large enough to outweigh the cost of job loss. Using a sample of 932 US acquirers between 1993 and 2011, the scholar corroborated prior studies (Anderson et al., 2004; Khorana & Zenner, 1998) that report substantial increases in CEO compensation in the postacquisition period. Yet when controlling for the likelihood of dismissal to eliminate the survivor bias, HomRoy (2014) showed that the merger bonus is very small, while in the specific case of value-destroying acquisitions, managers do not benefit from a pay premium and actually experience a decline in their compensation. These findings indicate that boards can rely on the mechanism of dismissal as an alternative to managerial incentives for preventing the initiation of M&A deals that have damaging consequences for shareholder wealth.

Concluding Remarks on this Topic Table 8.1 provides a comprehensive review matrix of all the identified empirical studies that analyzed the impact of M&A performance and various governance characteristics on the structure and level of executive compensation in acquiring firms. Although the debate on pay–performance association continues to animate the literature in this field of inquiry, it is worth noting that the vast majority of scholars converge toward the view that top management compensation is at best only marginally related to the postmerger performance of acquiring companies (Firth, 1991; Girma et al., 2006; Khorana  & Zenner, 1998). This finding has important implications, as it indicates that managerial self-interests are the primary motivation for the conduct of acquisition transactions, even if they destroy shareholder wealth (Dorata & Petra, 2008; Harjoto et al., 2012; Lee et al., 2009). Moreover, the extant evidence on the weaknesses in corporate governance structures suggests that boards of directors may be too weak to effectively enforce the pay–performance association (Fu et al., 2013; Wright et al., 2002), while senior managers are too entrenched in their positions, allowing them to actively influence the pay-setting process in their personal favor (Darrough et al., 2014; Grinstein & Hribar, 2004). Although the considerable cross-study differences in terms of the employed sampling procedures and econometric models undermine our ability to generalize, the results of the reviewed studies may be particularly sensitive to the type of measurement used to assess firm performance. For instance, some researchers select a single measure of performance, such as stock market returns (Khorana & Zenner, 1998; Lambert & Larcker,

Schmidt & Fowler (1990)

1975–1979 92 US firms

41 bidding firms 51 acquiring firms

Multiple industry

Single industry

Owner-controlled

Manager-controlled

Firm/deal features

Kroll, Simmons, & 1982–1983 50 US firms Wright (1990)

Sample Size 21 bad & 14 good transactions

Period

Lambert & Larcker 1976–1980 35 US deals (1987)

Authors

Total wealth (salary + bonus + stock ownership) Short-term compensation + stock ownership Short-term compensation + stock ownership Short-term compensation + stock ownership Short-term compensation + stock ownership Cash compensation Cash compensation

Cash compensation

Compensation structure

Increase

Increase* Increase*

Decrease Decrease

Increase*

Increase*

N/A

Decrease

Increase

Increase*

Decrease

Decrease Decrease

Increase*

Increase

Decrease Increase

Increase*

Changes in pay

Increase

Returns

Table 8.1  Review matrix of studies analyzing the impact of M&A performance on executive compensation of acquiring firms—Topic E1, Stream E, Theme III

1985–1990 169 UK acquirers

1982–1991 209 US firms

Conyon & Gregg (1994)

Kroll, Wright, Toombs, & Leawell (1997)

Avery, Chevalier, & 1986–1991 131 US Schaefer (1998) acquirers

1974–1980 254 UK firms

Firth (1991)

Pay premium Cash compensation + deferred compensation + stock ownership Owner-controlled Cash compensation + deferred compensation + stock ownership Owner-managerCash compensation controlled + deferred compensation + stock ownership Industrial companies Salary + bonus Outside directorship

Pay premium

Making 3+ deals Making 2 deals Manager-controlled

Total compensation

Short-term compensation + stock ownership

Short-term compensation

All acquirers

171 successful & 83 unsuccessful acquirers

Increase*

Decrease

Increase*

Increase*

Increase

Increase

(Continued)

Increase/Decrease Increase Increase/Decrease Increase*

Lower* Increase*

Higher*

N/A Decrease

N/A

Increase/Decrease Increase*/Decrease*

Increase*

Increase*

Decrease Increase

Increase*

Increase

Girma, Thompson, & Wright (2006)

Rosen (2005)

1981–1996 472 UK deals

313 acquiring firms

CEO—more power CEO—less power 1993–2001 2,222 US firms Firms with merger programs

Bad bank deals

77 with vigilant monitors 1990–1997 97 US mergers Good bank deals

Grinstein & Hribar 1993–1999 327 US deals (2004)

Anderson, Becher, & Campbell (2004)

1993–1998 171 US firms

Wright, Kroll, & Elenkov (2002)

Cash compensation Total compensation

Total compensation

Cash compensation

Compensation structure

Cash compensation

Salary + bonus + stock options Cash compensation, total compensation Cash compensation, total compensation Merger-related bonus Merger-related bonus Total compensation

94 with lax monitors Salary + bonus + stock options

16 high & 16 low merger acquirers

1986–1995 32 US banks

Firm/deal features

Bliss & Rosen (2001)

Sample Size 9 bad & 18 good acquirers

Period

Khorana & Zenner 1982–1986 27 US firms/ (1998) deals

Authors

Table 8.1 (Continued)

N/A N/A Increase Decrease Increase Decrease

Higher* Lower* Higher* Lower Higher* Lower*

Increase*

Increase*

Increase Decrease

Increase*

Increase Increase

Decrease

Decrease Increase Increase/Decrease Increase* Increase/Decrease Increase*

Increase*

Increase*

Decrease Increase

Increase*

Changes in pay

Increase

Returns

2003

Dorata & Petra (2008)

Guest (2009)

1995–1998 323 US deals

Dorata (2008)

Cash compensation

27 US: powerful CEO 361 acquirers

Restructuring charges & asset impairments With or without CEO duality

Cash compensation

Total compensation, stock + options wealth With stronger boards Total compensation, stock + options wealth

Cash compensation

73 UK: powerful CEO, intra-industry/ large deal

Performance pay (bonus + options + stock awards) 1984–2001 4,528 UK deals 1,408 UK acquirers Cash compensation with weak and Stock ownership value strong governance + incentive share that make value domestic and US Total wealth acquisitions US–UK (cash) pay gap

1993–2000 370 US deals

Harford & Li (2007)

77 US acquirers

1998–2001 100 UK & US deals

Coakley & Iliopoulou (2006) Increase*

Increase*

Decrease*

Decrease

Decrease N/A

(Continued)

Decrease* Decrease

Increase/Decrease Increase* Decrease Decrease*

Increase/Decrease Increase*

Increase*

Lower*

Increase

Decrease

Increase/Decrease Increase*

Decrease

Decrease

Period

Sample Size

Firm/deal features

Compensation structure

Lee, Shakespeare, & Walsh (2009)

1992–2005 5,722 US deals 717 acquiring CEOs; Total compensation 674 entrenched CEOs (acquiring & divesting) 1979–2006 5,417 or 4,134 Earlier/later deals in Mean total Goel & Thakor (2010) US deals a merger wave compensation Bugeja, Da Silva 2000–2007 177 deals in All CEOs Bonus, salary + bonus, Rosa, Duong, & Australia stock ownership, Izan (2012) options, total compensation Bonus, salary + bonus, CEO power (CEO stock ownership, on nominating stock + options, committee, CEO total compensation ownership, inside directors, CEO tenure) 1992–2005 598 US deals 188 nonbank Salary, bonus, Harjoto, Yi, & Chotigeat by 89 banks acquisitions by 30 incentive-based (2012) banks compensation (stock + options)

Authors

Table 8.1 (Continued)

Increase*

Higher*/ Lower* Higher*

Decrease*

Increase*

Higher/ Lower Increase

N/A

Decrease

Changes in pay

Not related

Returns

N/A

Pay–performance sensitivity

Domestic institutional shareholders

N/A

Cash pay, total pay

Foreign institutional shareholders

N/A

Incentive-based compensation Total compensation US–UK CEO pay gap Directorship opportunities

Increase*

Decrease* Increase*

Inconclusive

Decrease

(Continued)

N/A Increase* N/A Decrease* Increase/Decrease Increase*

N/A Decrease

N/A

Pay–performance sensitivity Cash pay, total pay New grants of restricted stock + stock options

N/A

Cash pay, total pay

Inconclusive

Decrease*

Increase/Decrease Increase

Cash pay, total pay

Domestic acquisitions

Increase/Decrease Increase*

Cash pay, total pay

Cross-border deals

Director ownership Weak governance 1985–2006 166 (larger boards, over-valued lower external US monitoring, acquirers greater CEO entrenchment) 2002–2007 416 UK firms UK companies that make acquisitions of US targets

1999–2005 147 UK deals

Harford & 1996–2007 2,449 terminal 16,318 CEO-firmSchonlau (2013) US CEO years & 195,048 years director-firmyears

Gerakos, Piotroski, & Srinivasan (2013)

Fu, Lin, & Officer (2013)

Ozkan (2012)

Sample Size

Firm/deal features

1992–2007 S&P 1,500 US Younger CEOs with firms longer career horizons

Period

Source: Adapted from Bodolica and Spraggon (2009a) Note: *—Statistically significant

Decrease* Decrease*

Decrease* Increase*

Lower* Decrease* Increase* Increase Decrease Decrease*

Decrease Decrease

Decrease N/A

N/A Decrease N/A Decrease N/A Decrease

Increase*

Increase*

Changes in pay

Increase*

N/A

Bonus

Returns

N/A

N/A

Salary

Compensation structure

Equity-based pay (option + restricted stock grants) Darrough, Guler, & 2002–2009 3,543 US All firms Total compensation Wang (2014) firm-years Buying larger targets, Cash compensation CEOs with shorter tenure (less power) Not R&D intensive Stock option pay HomRoy (2014) 1993–2011 953 deals by Without controlling Total pay 932 US for the threat of firms dismissal Threat of dismissal Pay premium (bonus) controlled for Pay premium (bonus) 2000–2012 1,417 large US Pre-2006 (660 deals) Merger-related bonus Wang, Wang, & Wangerin deals Total compensation (2014) Merger-related bonus Post-2006 (757 deals), with high Total compensation or low CEO power and strong or weak board

Yim (2013)

Authors

Table 8.1 (Continued)

Impact of M&A Characteristics on Executive Compensation  165 1987), while others also include the accounting performance estimated either as a return on equity (Avery et al., 1998; Kroll et al., 1990) or return on assets (Bliss & Rosen, 2001; Bugeja et al., 2012). Despite the impressive amount of work accomplished on this research topic, the current evidence on the relationship between CEO compensation and postmerger returns in a non–US context of corporate control is still limited. Our contention is that the recently adopted approaches to the analysis of the postdeal determination of executive pay, which account for other factors such as envy (Goel & Thakor, 2010), cross-country pay gaps (Gerakos et al., 2013), and threat of dismissal (HomRoy, 2014) provide original insights into the compensation–performance debate and are worthy of further scholarly exploration. 8.2  IMPACT OF ACQUISITION PREMIUM AND MODE OF PAYMENT ON EXECUTIVE COMPENSATION OF ACQUIRING FIRMS Since the finance literature demonstrates that higher control premiums and equity-financed deals generate negative abnormal returns to acquiring shareholders (Tuch & O’Sullivan, 2007), several researchers considered the postdeal determination of CEO compensation as a result of the selection of these two M&A terms. To the best of our knowledge, only six studies examined whether the executive pay in acquiring firms is influenced by the magnitude of premium or the mode of payment used to finance an acquisition. These studies concentrate on M&A transactions that took place during the 1990s (Bodolica, 2005; Bodolica & Spraggon, 2009b; Jaggi & Dorata, 2006; Lehn & Zhao, 2006) and the 2000s (Ozkan, 2012; Spraggon & Bodolica, 2011), varying significantly across a number of other research variables such as the sample size (i.e., between 80 and 714 deals), acquirers’ nationality (i.e., US, Canada, UK), and compensation elements taken into consideration (i.e., salary, bonus, total pay, compensation protection devices, LTIPs, stock ownership, stock options).

Reviewing Extant Empirical Knowledge For a sample of 80 Canadian firms, Bodolica (2005) found that acquirers paying high control premiums to target shareholders offer significantly lower salary and bonuses to their executives, whereas equity-financed deals translate into significantly lower salary but higher bonuses and stock options. The author concluded that acquiring CEOs are penalized only in terms of salary for taking part in value-decreasing acquisitions that result from larger premiums and an equity-based payment. Overall, the losses of bonuses incurred due to a higher acquisition premium are offset by the gains in bonuses and options ensuing from the use of stock financing. Bodolica

166  Acquirers’ Executive Compensation After the Deal (2005) interpreted her findings in light of the prior research that establishes a negative correlation between the magnitude of control premium and mode of payment (Weston, Chung, & Siu, 1998). Since larger premiums are usually offered in cash transactions to compensate for taxes on capital gains paid by targets immediately, while smaller premiums are offered in equity-financed deals where the tax payments are deferred, these two M&A terms tend to exert an opposite effect on the level of CEO compensation in acquiring firms. Jaggi and Dorata (2006) used a larger sample of 646 US deals to analyze the extent to which the magnitude of control premium is associated with changes in CEO cash compensation from the pre- to postacquisition period. Their results indicate that the payment of high acquisition premiums is directly related to the self-serving motivation of CEOs to increase their salary and bonuses after the acquisition. However, the positive relationship between premiums and changes in cash pay is much weaker when the CEO holds significant equity stakes in the firm. As argued by Bodolica (2005), Jaggi and Dorata (2006) also found that the mode of payment is an important determinant of control premiums and that larger premiums are typically negotiated by target shareholders in cash-financed acquisitions because cash payment triggers a potential capital gains tax burden. Recently, Ozkan (2012) estimated the impact of the mode of deal financing on the postacquisition level of CEO compensation using a sample of 147 UK deals that took place between 1999 and 2005. The scholar reported that the cash-based payment exerts a negative but insignificant effect on the cash pay and total compensation of acquiring executives. The study of Lehn and Zhao (2006) differs from others that analyzed this research topic in that it did not estimate the financing choice implications for a specific component of the top management pay packet. Instead, the authors explored how the mode of payment for an acquisition affects the loss of entire compensation due to executive turnover. Using a sample of 714 US deals conducted during the 1990 to 1998 period, they showed that CEOs who engage in stock-financed transactions (which experience significantly negative abnormal returns) are more likely to be replaced in the period following the acquisition completion. These findings suggest that senior managers incur disciplinary consequences for initiating value-decreasing M&As that materialize through higher turnover by internal governance, takeovers, and even bankruptcy. Bodolica and Spraggon (2009b) proposed an alternative research path by examining the impact of the mode of payment and control premium not on the monetary value of CEO compensation but rather on the rate of adoption of LTIPs and compensation protection devices (i.e., employment agreements, severance provisions, and golden parachutes) for Canadian acquiring executives. To formulate their hypotheses, the authors relied on the asymmetric risk properties of these two groups of managerial pay (see Chapter 2). Since CEOs are risk averse, they prefer to avoid variable modes of compensation

Impact of M&A Characteristics on Executive Compensation  167 (i.e., LTIPs) which aim to protect shareholders’ interests, while seeking higher pay security through the adoption of compensation protection devices. Based on this argument, it was shown that at higher levels of control premiums, the frequency of compensation protection devices significantly decreases and that of LTIPs (insignificantly) increases, serving as a preliminary indication that managers are punished at least to some extent for making bad acquisition-related decisions. However, finding that board of directors’ decisions to avoid the compensation protection devices is made in the postdeal period when the choice of the premium magnitude has proven to be detrimental for acquiring shareholders, Bodolica and ­Spraggon (2009b) concluded that corporate boards in Canada are reactive rather than proactive in dealing with agency problems.

Evolving Nature of the Agency Problem Around M&A Deals In a recent study of 148 Canadian deals, Spraggon and Bodolica (2011) contributed to the literature by extending the behavioral agency theory to better comprehend directors’ decisions with regard to the incentive-disincentive structuring of executive pay packages around M&A deals. While taking into consideration the role of control premium and mode of financing, the authors posit that the postdeal mix of CEO equity ownership and stock option pay might need to be altered based on the evolving nature of the agency problem stemming from the incidence of acquisitions. Although the behavioral theory has improved our understanding of pay factors surrounding executives’ strategic choices and risk preferences, it has been rarely employed to explain the variance in boards of directors’ behavior. In light of the rational agency prescriptions, directors enact their monitoring function by routinely awarding CEOs with equity-based pay to alleviate the problems of managerial selfishness, risk aversion, and shortsightedness. Yet given the asymmetric executive responses to stock ownership and stock options predicted by behavioral scholars (as discussed in Chapter 2), boards of directors are expected to alter the reliance on these compensation schemes depending on their incentive properties and specific problem framing. Spraggon and Bodolica (2011) suggest that the enactment of boards’ monitoring duties occurs based on the evolving nature of the agency problem triggered by the executives’ recent past strategic actions. Major acquisition activities represent just one such action, which can cause the alteration in the essence of the principal–agent conflict to be solved. In the pre–M&A period, the dominant agency problem constitutes the divergent profiles of risk-averse managers and risk-neutral owners. To mitigate this problem, directors ought to bring executives’ risk-seeking endeavors up to the levels preferred by shareholders. Given that stock options boost the holder’s propensity to take risk while equity ownership reduces this propensity, boards engage in the ex-ante structuring of CEO packages, offering more option grants and shrinking the ratio of stock ownership. Since the specific features

168  Acquirers’ Executive Compensation After the Deal of stock options allow the satisfaction of private wealth maximization interests, increasing their motivational value for executives, directors can rely on option pay to secure the future payment of large amounts for prompting managerial involvement in risk-enhancing strategies. Thus, stock options are conceived as incentives for risk taking while equity ownership is a disincentive for assuming higher levels of risk. The very intention to initiate M&A activities seen as highly uncertain corporate events demonstrates the alignment of CEOs’ risk preferences with those of shareholders (Sanders, 2001). Yet acquisitions also trigger with them the alteration in the nature of the agency problem, as their success hinges upon the effective selection of M&A features in terms of the premium magnitude and mode of deal financing. Since prior research has found that CEO choices resulting in the payment of large (rather than small) premiums and equity (rather than cash) financing translate into negative outcomes for acquiring firms (Tuch  & O’Sullivan, 2007), the main problem that needs to be resolved for satisfying profit-oriented principals is the overly risky behavior of self-serving agents and its potentially detrimental value implications. Boards of directors’ fiduciary focus has now evolved from achieving tighter risk alignment between the parties involved in the agency contract to addressing the uncertain CEO choices stemming from the conduct of suboptimal high-premium and equity-financed deals (see Table 8.2). Spraggon and Bodolica (2011) posit that this altered agency problem may necessitate scapegoating after the acquisition completion, inducing directors

Table 8.2  Evolving nature of the agency problem around M&A deals and implications for boards’ pay-related decisions Descriptive factors

Before M&A deals

Nature of agency problem Divergent risk preferences of agents & principals Board’s focus

Board’s response

Implications for CEO’s incentive design

During & after M&A deals

Prior risky choices with potentially detrimental outcomes Alignment of risk Addressing the overtly preferences: curb agent’s risky & suboptimal risk aversion agent’s choices Compensation structuring Scapegoating: ex-ante (prior to the compensation choice of M&A terms) restructuring (or dismissals) Increase in equity Increase in stock option ownership disincentives incentives Decrease in stock option Decrease in equity incentives ownership disincentives

Source: Adapted from Spraggon and Bodolica (2011)

Impact of M&A Characteristics on Executive Compensation  169 to adjust their behavioral responses to prior risky managerial choices of premium and deal financing either via dismissals or by restructuring the incentive design of compensation contracts. As dismissals are irreversible and considering the asymmetric properties of stock-based pay elements, boards might prefer to redesign the CEO compensation with larger amounts of disincentives by infusing larger proportions of equity ownership and reducing option grants. Since stock ownership ties managerial wealth more closely to that of corporate owners than options, directors could rely on equity ownership more heavily to redirect the executive behavior toward the satisfaction of shareholders’ needs. This ex-post compensation structuring may permit scapegoating as CEOs suffer twice due to the infusion of higher levels of uncertainty in their pay packages via equity ownership and the loss of anticipated future gains ensuing from the reduction in stock option awards. The evolved nature of the agency problem alters the incentive–disincentive relationship between the two compensation schemes, whereby the punishment pursued by the board for managerial selection of overly risky acquisition specifications is realized with greater equity ownership disincentives and fewer option incentives. Linking the occurrence of acquisitions to an altered agency problem allows Spraggon and Bodolica (2011) to offer an alternative way of examining how boards endorse their duties as reflected in the adjustment of the incentive design of executive pay contracts based on the recent CEO choices of M&A terms. In the period after the transaction completion, they anticipate directors’ monitoring actions to be shaped by both the asymmetric properties of equity ownership and stock option pay and the effectiveness of executive selection of the magnitude of control premium and the mode of deal financing. In line with their hypothesized expectations, the scholars demonstrated that the conduct of risky and value-destroying high-premium and equity-financed acquisitions requires scapegoating, prompting corporate boards to alleviate the altered agency problem by increasing the percentage of CEO equity ownership disincentives at the expense of stock option incentives.

Final Considerations Table 8.3 provides a summary of the six studies that assessed the impact of control premium and mode of payment on the level and incentive design of executive pay packets in the postacquisition period. The empirical findings tend to indicate that top managers are either not held accountable (Jaggi & Dorata, 2006) or, at best, only marginally penalized for the selection of value-destroying acquisition specifications (Bodolica, 2005). Moreover, if the disciplinary action of the board does take place, it commonly occurs only after the enactment of suboptimal high premiums and equity-based payment, implying that corporate governance structures are still too weak for effectively overseeing executive behavior, and boards of directors are

170  Acquirers’ Executive Compensation After the Deal overtly reactive rather than proactive in dealing with agency problems (Bodolica  & Spraggon, 2009b). As argued by Spraggon and Bodolica (2011), M&A deals trigger an alteration in the nature of the agency problem as manifested in the size of acquisition premium and the mode of deal financing, requiring boards of directors to readjust the incentive design of executive pay contracts in response to the specific choice of acquisition terms made by CEOs. The current empirical evidence on the association between M&A characteristics and postdeal compensation of acquiring executives is still limited and offers many promising avenues for further exploration. Future studies Table 8.3  Review matrix of studies analyzing the impact of acquisition premium and mode of payment on executive compensation of acquiring firms—Topic E2, Stream E, Theme III Authors

Period

Sample

Bodolica (2005)

1995–2001 80

Jaggi & Dorata (2006)

1994–1998 646 US deals

Deal feature

Control Canadian premium deals Stock-based payment Control premium

Lehn & 1990–1998 714 US Stock-based Zhao deals payment (2006) Bodolica & 1995–2001 80 Control Spraggon Canadian premium (2009b) deals Stock-based payment Spraggon & 1996–2009 148 Control Bodolica Canadian premium (2011) deals Stock-based payment Ozkan (2012)

1999–2005 147 UK deals

Cash-based payment

Source: Adapted from Bodolica and Spraggon (2009a) Notes: *—Statistically significant a— Sign as predicted, but not significant

Compensation structure Salary, bonus Stock options Salary Bonus, stock options Change in cash compensation from pre- to postdeal period Loss of entire compensation (via turnover) LTIPs Compensationprotection devices LTIPs Compensationprotection devices Stock ownership Stock options Stock ownership Stock options Cash compensation Total compensation

Relation Negative* Negative Negative* Positive* Positive*

Positive*

Positivea Negative* Positivea Negativea Positive* Negative* Positive* Negative* Negative Negative

Impact of M&A Characteristics on Executive Compensation  171 may embrace the research path initiated by Spraggon and Bodolica (2011) by linking decisions about compensation structure to discrete strategic choices of managers to offer an alternative way of looking at how corporate boards enact their monitoring responsibilities. While prior literature concludes that firms actively seek to discipline CEOs they blame for poor performance or overly risky behavior, the particular conditions under which the need for resolving this dominant agency problem intensifies remain unaddressed (Bodolica  & Spraggon, 2009b; Sanders, 2001). Without considering the performance outcomes ensuing from different compensation modes and estimating the real ability of boards of directors to effectively modify the equity-based design of executive packages in order to approach the optimal pay setting in their firms, it is hard to gauge the extent to which the agency conflict can actually be resolved. In the context of companies involved in M&As with risky deal specifications, the prevailing question that still ought to be tackled is whether intervening better results or lower board vigilance will lead to less severe disciplinary action via the enlargement of the proportion of CEO incentives. Conversely, it is equally important to uncover whether weaker corporate performance or stronger directors’ vigilance will operate in the reverse direction, adding more punishment through the issuance of extra disincentives in executive contracts.

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172  Acquirers’ Executive Compensation After the Deal Dorata, N. T. (2008). The shielding of CEO cash compensation from post-acquisition earnings’ charges. Managerial Finance, 34(5), 288–303. Dorata, N. T., & Petra, S. T. (2008). CEO duality and compensation in the market for corporate control. Managerial Finance, 34(5), 342–353. Firth, M. (1991). Corporate takeovers, stockholder returns and executive rewards. Managerial and Decision Economics, 12(6), 421–428. Fu, F., Lin, L., & Officer, M. C. (2013). Acquisitions driven by stock overvaluation: Are they good deals? Journal of Financial Economics, 109, 24–39. Gerakos, J. J., Piotroski, J. D., & Srinivasan, S. (2013). Which U.S. market interactions affect CEO pay? Management Science, 59(11), 2413–2434. Girma, S., Thompson, S., & Wright, P. W. (2006). The impact of merger activity on executive pay in the United Kingdom. Economica, 73, 321–339. Goel, A. M., & Thakor, A. V. (2010). Do envious CEOs cause merger waves? Review of Financial Studies, 23(2), 487–517. Grinstein, Y., & Hribar, P. (2004). CEO compensation and incentives: Evidence from M&A bonuses. Journal of Financial Economics, 73(1), 119–143. Guest, P. M. (2009). The impact of mergers and acquisitions on executive pay in the United Kingdom. Economica, 76(301), 149–175. Harford, J., & Li, K. (2007). Decoupling CEO wealth and firm performance: The case of acquiring CEOs. Journal of Finance, 62(2), 917–949. Harford, J., & Schonlau, R. J. (2013). Does the director labor market offer ex post settling-up for CEOs? The case of acquisitions. Journal of Financial Economics, 110, 18–36. Harjoto, M. A., Yi, H.-C., & Chotigeat, T. (2012). Why do banks acquire non-banks? Journal of Economics and Finance, 36(3), 587–612. HomRoy, S. (2014). Pay increase may not be a strong incentive for undertaking acquisitions: Evidence of survivor bias in post-acquisition CEO pay. Economics Working Paper Series, 2014/018, Lancaster University Management School. Irving, J., Landsman, W., & Lindsey, B. (2011). The valuation difference between stock option and restricted stock grants for US firms. Journal of Business Finance & Accounting, 38, 395–412. Jaggi, B., & Dorata, N. T. (2006). Association between bid premium for corporate acquisitions and executive compensation. Journal of Accounting, Auditing & Finance, 21(4), 373–397. Khorana, A., & Zenner, M. (1998). Executive compensation of large acquirers in the 1980s. Journal of Corporate Finance, 4(4), 209–240. Kroll, M., Simmons, S. A., & Wright, P. (1990). Determinants of chief executive officer compensation following major acquisitions. Journal of Business Research, 20(4), 349–366. Kroll, M., Wright, P., Toombs, L., & Leavell, H. (1997). Form of control: A critical determinant of acquisition performance and CEO rewards. Strategic Management Journal, 18(2), 85–96. Lambert, R. A., & Larcker, D. F. (1987). Executive compensation effects of large corporation acquisitions. Journal of Accounting and Public Policy, 6(4), 231–243. Lee, L. F., Shakespeare, C., & Walsh, J. P. (2009). The limits of empire: Asset churning and CEO compensation. Unpublished manuscript, Ross School of Business, University of Michigan. Lehn, K., & Zhao, M. (2006). CEO turnover after acquisitions: Are bad bidders fired? Journal of Finance, 61(4), 1759–1811. Ozkan, N. (2012). Do CEOs gain more in foreign acquisitions than domestic acquisitions? Journal of Banking & Finance, 36, 1122–1138. Rosen, R. J. (2005). Betcha can’t acquire just one: Merger programs and compensation. FRB Chicago Working Paper, No. 2004–22, January.

Impact of M&A Characteristics on Executive Compensation  173 Sanders, W. G. (2001). Behavioral responses of CEOs to stock ownership and stock option pay. Academy of Management Journal, 44(3), 477–492. Schmidt, D., & Fowler, K. (1990). Post-acquisition financial performance and executive compensation. Strategic Management Journal, 11(7), 559–569. Spraggon, M., & Bodolica, V. (2011). Post-acquisition structuring of CEO pay packages: Incentives and punishments. Strategic Organization, 9(3), 187–221. Tuch, C., & O’Sullivan, N. (2007). The impact of acquisitions on firm performance: A review of the evidence. International Journal of Management Reviews, 9(2), 141–170. Wang, I. Y., Wang, X., & Wangerin, D. D. (2014). M&A and big CEO paydays: The effects of the 2006 SEC compensation disclosure regulation. Unpublished Working Paper, Michigan State University. Weston, J. F., Chung, K. S., & Siu, J. A. (1998). Takeovers, restructurings and corporate governance. Upper Saddle River, NJ: Prentice Hall. Wright, P., Kroll, M., & Elenkov, D. (2002). Acquisition returns, increase in firm size, and chief executive officer compensation: The moderating role of monitoring. Academy of Management Journal, 45(3), 599–608. Yim, S. (2013). The acquisitiveness of youth: CEO age and acquisition behavior. Journal of Financial Economics, 108, 250–273.

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Part V

Discussion and Priorities for Future Research Part Contents Chapter 9. Discussion of Extant Knowledge on M&As and Executive Compensation Chapter 10. Priorities for Future Research Endeavors in the Field

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9 Discussion of Extant Knowledge on M&As and Executive Compensation

GENERAL TRENDS ACROSS DIFFERENT THEMES OF INQUIRY We have shown in the five previous chapters that an impressive body of studies developed at the intersection of M&A transactions and executive compensation. The empirical knowledge gathered to date is indicative of the critical incentivizing role that the level and design of executive compensation packages play in driving the acquisitive behavior of top managers in corporations. A  broad diversity of scholarly research has been conducted within each of the three identified themes of inquiry to uncover and better understand the complexities surrounding the acquisition–compensation relationship. Therefore, we start this chapter by providing an overview and delineating some general summary trends across different themes before proceeding with a more systematic analysis of the extant empirical evidence offered within each theme and associated streams and topics of research. We recommend referring to Figure 3.3, which provides a definition and visual representation of all the themes, streams, and topics of inquiry.

Quantitative and Qualitative Overview of the Reviewed Studies Table  9.1 provides a quantitative and qualitative overview of scholarly efforts that were performed in the field. The empirical question which received the highest amount of attention falls within Topic A2, with as many as 35 reviewed studies, followed by Topic E1 and Topic A2, which include a total of 31 and 26 articles, respectively. With only six identified studies, the least popular so far seems to be Topic E2, followed by Stream C, which generated 11 academic articles. Overall, the most-researched theme of inquiry is Theme I, with a total of 76 published studies, a number more than 1.6 and two times higher than the scholarly output produced within Theme II and Theme III, respectively. Although the general count across the three themes results in 160 studies, this procedure does not take into consideration the duplication or triplication of selected articles that, due to their analytical breadth, where included in several streams and topics simultaneously. The absolute record breaker is

Table 9.1  Quantitative and qualitative summary of studies across different themes, streams, and topics of inquiry Na

Period

Sampleb

Compensation elements

Theme I, Stream A, Topic A1: Earliest: 1961–1970; Smallest: 38; Cash pay; pay for 24—USA; Latest: 1994–2012 Largest: 3,688 performance; 1—Australia; personal wealth; 1—Taiwan; stock ownership; Total = 26 stock and option holdings; (exercisable) stock options; prior option grants; delayed exercising of in-the-money vested options; vega; delta; CEO pay slice; employment contract; contractual provisions Theme I, Stream A, Topic A2: Earliest: 1963–1981; Smallest: 32; (Abnormal) cash pay; 31—USA; Latest: 1994–2012 Largest: 5,417 annual pay premium; 2—Canada; total pay; excess pay; 1—UK; expectation of pay 1—Taiwan; benefits; existence Total = 35 or lack of LTIPs; stock ownership; equity-based pay; (exercisable) stock options; delayed exercising of in-themoney vested options; stock and options to be vested in a year; delta; CEO pay slice; CEO pay relative to the 2nd highest-paid executive; liability insurance presence and ratio; pension holdings; envy of others’ pay; employment contract; contractual provisions

Na

Period

Sampleb

Compensation elements

Theme I, Stream B: 14—USA; Earliest: 1972–1986; Smallest: 100; (Relative) cash pay; 1—Canada; Latest: 1994–2012 Largest: 3,680 lack of LTIPs; Total = 15 stock ownership; equity-based pay; (exercisable & unexercisable) stock options; delayed exercising of in-themoney vested options; stock and options to be vested in a year; liability insurance presence and coverage; employment contract; contractual provisions Theme II, Stream C: 10—USA; Earliest: 1975–1982; Smallest: 58; Cash-based pay; 1—Canada; Latest: 1992–2007 Largest: 1,648 short-term bonus; Total = 11 total pay; stock ownership; stock options; equity-based pay; golden parachute; employment contract Theme II, Stream D, Topic D1: Earliest: 1972–1977; Smallest: 58; Salary; special cash 14—USA; 1—Canada; Latest: 1990–2004 Largest: 558 bonus; cash-based pay; total pay; Total = 15 stock ownership; equity-based pay; golden parachute presence, value, and breadth; illiquidity discount of stock and option holdings; compensation plan Theme II, Stream D, Topic D2: 20—USA; Earliest: 1968–1986; Smallest: 31; Salary; special cash 1—Canada; Latest: 1994–2010 Largest: 9,277 bonus; stock Total = 21 ownership; (unscheduled grants of) stock options; (Continued)

Table 9.1  (Continued) Na

Period

Sampleb

Compensation elements equity grants during merger negotiations; golden parachute presence, value, and importance; relative importance of severance pay; retention in directorial or managerial position; illiquidity discount of stock and option holdings; compensation plan

Theme III, Stream E, Topic E1: Earliest: 1974–1980; Smallest: 27; Salary; bonus; 23—USA; Latest: 2000–2012 Largest: 5,722 cash-based pay; 7—UK; pay premium; 1—Australia; merger-related Total = 31 bonus; total pay; stock ownership; equity-based pay; stock options; new grants of restricted stock and options; performance pay; pay–performance sensitivity; US–UK pay gap; outside directorship Theme III, Stream E, Topic E2: Earliest: 1990–1998; Smallest: 80; Salary; bonus; 3—Canada; Latest: 1996–2009 Largest: 646 cash-based pay; 2—USA; total pay; stock 1—UK; ownership; stock Total = 6 options; pre–post change in cash pay; loss of entire pay package; adoption of LTIPs; adoption of compensation protection devices Notes: a— Refers to the number of reviewed studies b— Refers to the number of reported M&A deals or acquiring/target companies

Discussion of Extant Knowledge on M&As  181 the research performed by Cai and Vijh (2007), which analyzed the association between M&A deals and executive compensation from so many different angles that we considered it relevant for inclusion in six different streams and topics of inquiry. In particular, Cai and Vijh (2007) was incorporated in Topic A1, Topic A2, Stream B, Stream C, Topic D1, and Topic D2, resulting in the coverage of Theme I  and Theme II related to issues of bidders’ and targets’ managerial pay in their entirety. Additionally, four articles were repeated three times (Boulton, Braga-Alves, & Schlingemann, 2014; Houle, 2003; Malmendier & Tate, 2008; Zhao, 2013), and as many as 21 studies were duplicated across relevant topics and streams (for example, Buchholtz & Ribbens, 1994; Datta, Iskandar-Datta, & Raman, 2001; Ozkan, 2012; Yim, 2013). After removing the 34 study repetitions from the general count, the final outcome resulted in a total of 126 different articles that were reviewed in this book. The vast majority of the reviewed studies were published in journals related to the three following disciplines, including finance (e.g., European Financial Management; Financial Management; Financial Review; Journal of Banking & Finance; Journal of Corporate Finance; Journal of Finance; Journal of Financial Intermediation; Journal of Financial Research; Journal of Financial & Quantitative Analysis; Managerial Finance; Review of Financial Studies), economics (e.g., Applied Economics Letters; Bell Journal of Economics; Economica; Journal of Economics and Finance; Journal of Financial Economics; Journal of Industrial Economics; Journal of Law & Economics; Journal of Law, Economics & Organization; Managerial & Decision Economics; Quarterly Review of Economics & Finance; Rand Journal of Economics), and accounting (e.g., Journal of Accounting, Auditing & Finance; Journal of Accounting & Economics; Journal of Accounting Research; Journal of Business Finance & Accounting; Quarterly Journal of Finance & Accounting; Review of Accounting & Finance). Only a limited number of articles in our field of interest appeared in general management journals (e.g., Academy of Management Journal; Administrative Science Quarterly; Journal of Business Research; Management Science; Organization Science) or strategic management outlets (e.g., Strategic Management Journal; Strategic Organization). As illustrated in Table 9.1, the current empirical knowledge within each theme, stream, and topic of research is largely dominated by the American evidence. The only exception constitutes Topic E2, where out of the six included studies, three were produced on Canadian data, followed by two and one articles on US and UK takeover markets, respectively. After the USA, a growing research interest can be depicted for both the Canadian and British markets for corporate control, with only two different investigations analyzing Australian organizations and one study relying on data from Taiwan. The earliest available evidence on the relationship between M&A deals and CEO pay exists within Topic A1 for the 1961 to 1970 period (Amihud & Lev, 1981), while the latest is within Topic E1 for the

182  Discussion and Priorities for Future Research timeframe between 2000 and 2012 (Wang, Wang, & Wangerin, 2014). The smallest sample size of 27 acquirers was employed in the study of Khorana and Zenner (1998), which falls within Topic E1, while the largest sample corresponds to 9,277 targets, which were analyzed by Bebchuk, Cohen, and Wang (2014) within Topic D2. A large variety of elements of executive compensation packages received empirical consideration in extant studies, which cover both cash-based components (such as salary and bonus) and equity-related incentives (such as restricted stock awards and option grants). Topic A2 seems to be the most comprehensive in terms of diversity and inclusion of analyzed elements, going from more simple estimators of cash pay, excess pay, and total compensation to more elaborated measures of stock-based incentives, such as exercisable stock options, delayed exercising of in-the-money vested options, and stock and options to be vested in a year. Moreover, Topic A2 also currently witnesses an emerging attribution of scholarly attention to some unique aspects of managerial compensation, such as pension holdings (Yim, 2013) and envy of other CEOs’ pay (Goel & Thakor, 2010). These tendencies are described in more detail in the next section.

Major Trends Across Research Themes When comparing earlier and more recent empirical investigations in the field, three predominant trends can be demarcated. The first relates to a continuous tendency to disaggregate the measure of total compensation into its different components to estimate their asymmetric incentive effect on the acquisitive behavior of top managers. This is the main rationale for the analytical differentiation made between LTIPs and compensation protection provisions (Bodolica & Spraggon, 2009) or the separate analysis of various incentives included in LTIPs, such as the stock option pay and equity ownership (Fung, Jo, & Tsai, 2009; Spraggon & Bodolica, 2011) or stock option grants and restricted stock awards (Darrough, Guler,  & Wang, 2014). In the same vein, considering the complexity and inconsistency regarding the incentive effect of stock option plans, scholars started disaggregating this specific pay element in its constitutive parts to estimate whether they produce incongruent motivational impacts on senior executives’ decisions and actions. In particular, the emphasis is placed on understanding whether the confounding empirical findings are driven by underwater or in-the-money options (Benson, Park,  & Davidson, 2014; Fung et al., 2009), unvested or exercisable options (Boulton et al., 2014; Gao, 2010), delayed or early exercises of options (Malmendier & Tate, 2008), programmed or unscheduled grants of stock options (Fich, Cai, & Tran, 2011), and newly issued or previously held options (Fu, Lin, & Officer, 2013). The second trend is associated with a gradual detachment from traditional estimations of executive pay, such as cash-based compensation, total compensation, stock ownership, and golden parachute value, in favor of

Discussion of Extant Knowledge on M&As  183 an enhanced identification of new and more diversified indicators of managerial pay. For instance, among the measurements of executive compensation that were unexplored in prior studies but recently started to benefit from heightened analytical attention are the CEO pay slice (Bebchuk, Cremers, & Peyer, 2011; Chintrakarn, Jiraporn, & Tong, 2015), golden parachute importance (Fich, Tran, & Walkling, 2013), stock options’ sensitivity to both stock price (delta) and stock return volatility (vega; Armstrong & Vashishtha, 2012; Benson et al., 2014), and cross-border target–acquirer CEO pay gap (Gerakos, Piotroski, & Srinivasan, 2013; Guest, 2009). The third trend relates to an increased examination of various psychoemotional processes and factors related to the CEO personality, which can significantly affect the quality of decision making around M&A transactions. Some behavioral manifestations of these senior managers’ psychological characteristics that began receiving empirical consideration in recent studies are narcissism (Chatterjee & Hambrick, 2007), overconfidence (Malmendier & Tate, 2008), and envy (Goel & Thakor, 2010).

SUMMARY OF THE CURRENT KNOWLEDGE WITHIN EACH THEME

Extant Knowledge on Research Theme I As discussed in Chapters 4 and 5, studies within Theme I on bidders’ executive compensation prior to the M&A deal show that top managers take the level and structure of their premerger pay into account when undertaking strategic action. Findings related to the influence of managerial stock ownership on risk-taking and diversification strategies of bidding firms are not consistent (Stream A, Topic A1). While some authors find that the amount of executive equity holdings in the corporation drives the risk-reducing behavior of CEOs via their involvement in diversifying acquisitions (Dong-Kyoon, Kwok,  & Young, 2005; May, 1995), others do not confirm the managerial risk-aversion hypothesis (Agrawal & Mandelker, 1987; Boulton et al., 2014). The basis for this inconsistency in outcomes is that there is substantial disagreement regarding the extent to which corporate diversification activities generate adverse consequences for stockholders’ wealth (Lane, Cannella, & Lubatkin, 1998; Lewellen, Loderer, & Rosenfeld, 1989). It appears that bidders’ positive abnormal returns during the day of acquisition announcement can be explained by both the existence of LTIPs (Tehranian, Travlos, & Waegelein, 1987) and the equity-based wealth sensitivity to stock price or delta (Minnick, Unal, & Yang, 2011). The liability insurance presence and ratio, exercisable in-the-money options and the delayed exercising of these options, the CEO pay slice, and envy of others’ compensation are all associated with managerial involvement in value-decreasing acquisitions (Bebchuk et al., 2011; Goel & Thakor, 2010), while the effect

184  Discussion and Priorities for Future Research of EBC on executive investment decisions is mixed (Stream A, Topic A2). Further, CEOs who are rewarded with LTIPs and own larger amounts of corporate stock display a stronger propensity to initiate value-maximizing cash-financed deals (Amihud, Lev,  & Travlos, 1990; Fung et al., 2009). Higher levels of stock ownership and EBC (Datta et al., 2001) and the existence of employment contracts (Zhao, 2013) motivate managers to act in their shareholders’ interests, offering lower control premiums to target owners, whereas liability insurance coverage (Lin, Officer, & Zou, 2011) and higher relative cash compensation (Hayward  & Hambrick, 1997) induce bidding CEOs to overpay for their targets (Stream B).

Extant Knowledge on Research Theme II Based on our analysis made in Chapters 6 and 7, the current research on target management compensation prior to the deal (Theme II) reveals a bidirectional relationship, where the target-specific occurrence of a given M&A transaction, materialized in the threat of takeover, affects the target CEO pay, which in turn determines some M&A characteristics. The takeover threat increases the value of short-term bonuses and the probability of golden parachutes’ adoption (Agrawal  & Knoeber, 1998; Evans  & Hefner, 2009), while exerting a negative effect on the proportion of stock options and shares owned by target executives (Chakraborty  & Sheikh, 2010; Houle, 2003; Stream C). The decision to adopt a friendly attitude toward a tender offer is determined by the wealth gains that can be potentially experienced by target managers in terms of cash-based bonuses, total compensation, EBC, and illiquidity discount of stock and option holdings (Cai & Vijh, 2007; Cotter & Zenner, 1994). In the same vein, target management hostility can be effectively reduced by providing senior executives with higher levels of stock ownership in their organization (Buchholtz  & Ribbens, 1994; Shivdasani, 1993; Stream D, Topic D1). Moreover, extant empirical findings allow us to understand why top managers of target firms accept lower acquisition premiums when their company is taken over (Stream D, Topic D2). The incidence of lower control premiums could be explained by the personal benefits that target CEOs could extract from an acquisition, although they are unlikely to fully cover the merger-induced personal losses of managerial position and compensation when these losses do occur (that is, they are not eliminated through successful negotiation). Among the key benefits traded by target executives that are identified in the literature are an increased adoption of golden parachute programs (Bebchuk et al., 2014), an augmented importance of golden parachutes (Fich et al., 2013), an elevated relative importance of both negotiated severance pay and predefined golden parachute payouts (Qiu, Trapkov,  & Yakoub, 2014), unscheduled grants of stock options (Fich et al., 2011), special cash bonuses (Hartzell, Ofek, & Yermack, 2004), and board

Discussion of Extant Knowledge on M&As  185 membership or CEO position in the merged entity (Qiu et al., 2014; Wulf, 2004). The current evidence indicates that the only effective mechanism of incentive alignment associated with lower agency costs and higher premiums for target shareholders is the presence of a compensation plan for target top management (Sokolyk, 2011).

Extant Knowledge on Research Theme III In light of the extensive discussion offered in Chapter 8, the empirical literature on the incentive structuring of executive compensation packets in acquiring firms (Theme III) points to senior management benefits accruing considerably from the conduct of M&A deals in terms of both internal payouts (i.e., cash and total pay) and external rewards (i.e., directorial positions in outside boards; Avery, Chevalier,  & Schaefer, 1998). Acquiring CEOs can significantly increase their personal wealth by enlarging the size of their corporation through M&A transactions, a finding relevant for companies with different ownership structures, such as manager-controlled, owner-controlled, and owner-manager-controlled firms (Kroll, Wright, Toombs, & Leavell, 1997). Yet some disagreement exists on the extent to which managers in acquiring companies experience significant compensation gains even when acquisitions impair shareholders’ wealth, with only a few researchers demonstrating that CEOs are not rewarded for carrying out value-destroying deals (Dorata, 2008; Guest, 2009). Senior executives can also obtain special merger-related bonuses due to the power they exert over their board of directors (Grinstein  & Hribar, 2004) or benefit from new grants of restricted stock and options after conducting bad acquisitions due to weaknesses in corporate governance structures in their firm (Fu et al., 2013; Stream E, Topic E1). Nonetheless, recent studies indicate that the postacquisition growth in executive pay can be effectively contained through the disciplining effect of alternative governance devices other than the corporate board of directors. HomRoy (2014) points to the effectiveness of the mechanism for managerial dismissal, while Wang and colleagues (2014) highlight the governance role of executive compensation disclosure regulations. Finally, the magnitude of control premium is negatively related to the postmerger level of salary, bonuses, and stock options and the rate of adoption of compensation protection devices (Bodolica  & Spraggon, 2009) but positively associated with the change in executive cash pay from the pre- to the postacquisition period (Jaggi  & Dorata, 2006). As far as equity-financed transactions are concerned, they tend to translate into lower levels of stock options and less frequent compensation protection provisions but higher amounts of stock ownership and an elevated rate of LTIPs’ implementation for acquiring managers (Bodolica & Spraggon, 2009; Spraggon & Bodolica, 2011; Stream E, Topic E2).

186  Discussion and Priorities for Future Research METHODOLOGICAL CONSIDERATIONS

Predominant Types of Comparative Research Designs A variety of comparative research designs were employed in extant studies located at the intersection of M&A activities and executive compensation. More specifically, we identified three predominant types of comparisons. First, pre–post comparisons seek to contrast the monetary magnitude of executive compensation between the two merger-related periods, namely before and after an acquisition. This design was adopted primarily by researchers who examined the top management compensation in acquiring firms (Theme III), because it allows tracking the careers of managers for several years preceding and following the deal. For instance, the study of Wright, Kroll, and Elenkov (2002) covers a total of three years around M&A transactions (one year before the deal, the year of acquisition, and one year after), while Schmidt and Fowler (1990) extended their analysis over a nine-year period. We believe that the longer the interval of time under consideration, the more accurate is the prediction that the observed alterations in the level of executive compensation between the pre- and postmerger periods are related to the analyzed M&A event. However, aside from adjusting the financial and compensation data for inflation, this type of methodological design has to isolate the effects of other events that might occur in organizational life over such a long period of time (e.g., managerial turnover, multiple acquisitions, changes in corporate governance structures) and that may subsequently influence the level of CEO pay in acquiring firms. Second, there are between groups cross-sectional comparisons of different executive compensation elements in the treatment group and the control group of nontarget or nonacquiring organizations. This approach involves the constitution of an additional sample of size- and industry-matched control firms that did not engage in any M&A deals over the corresponding period. The usage of a control sample allows detecting the factors that change simultaneously with the deal and isolating the pure acquisition-related consequences of changes observed in the magnitude and structure of executive compensation. If these factors affect the treatment and control groups in a similar fashion, the controls will eliminate these common effects and generate unbiased estimates of merger impacts. This design is typically employed in selected studies on top management pay in both target (Theme II) and acquiring (Theme III) firms. For instance, Agrawal and Walkling (1994) used an industry-matched random sample of 169 nontarget firms for their main sample of 165 targets, whereas Hadlock, Houston, and Ryngaert (1999) compared the 84 target banks with 121 match banks that were not acquired during the period under analysis. Similarly, Khorana and Zenner (1998) compared the alterations in compensation levels of 46 top executives from 27 acquiring firms with those of 53 senior executives from 27 control companies, while in the investigation of Avery and colleagues

Discussion of Extant Knowledge on M&As  187 (1998), analogous comparisons were made between 131 acquiring and 215 nonacquiring CEOs. And third, within groups, cross-sectional comparisons of executive compensation elements across different types of partition can be observed in extant studies in the field. In particular, in bidding corporations (Theme I), the partition is made across the magnitude of EBC or stock ownership, such as low versus high EBC or ownership (Amihud et al., 1990; Datta et al., 2001). As far as the target firms (Theme II) are concerned, executive pay data are categorized by the strength of the threat of takeover—high versus low threat (Agrawal & Knoeber, 1998) or the target management response to the tender offer—friendly versus hostile response (Cotter & Zenner, 1994; D’Aveni & Kesner, 1993). In acquiring companies (Theme III), data samples are partitioned across the merger intensity—frequent versus low-merger intensity (Bliss  & Rosen, 2001), the monitoring intensity—lax versus vigilant monitors (Wright et al., 2002), the level of CEO power over the board—more versus less power (Grinstein & Hribar, 2004), the acquisition quality—bad versus good M&A transactions (Khorana & Zenner, 1998), the type of acquisitions—domestic versus cross-border deals (Ozkan, 2012), and the year of adoption of a compensation-related legislation—before versus after 2006 (Wang et al., 2014).

Dealing With Endogeneity Concerns The large body of research included in Theme I suggests that specific elements of executive compensation influence corporate risk taking and CEOs’ decisions with regard to M&A deals (Cai & Vijh, 2007; Dutta, 2011; May, 1995). This relationship is the exact opposite of that hypothesized by studies within Theme III, where a reverse sense of causality is explored through the analysis of acquisitions’ impact on top management pay (Fu et al., 2013; Jaggi & Dorata, 2006). The same observation can be made about Theme II on target executive compensation, where studies incorporated in Stream C (Chakraborty & Sheikh, 2010; Evans & Hefner, 2009) imply an opposite causation in the pay–takeover relationship, which is examined by scholars within Stream D (Shivdasani, 1993; Wulf, 2004). If CEO compensation levels and structure affect M&A activity and subsequent levels and structure of CEO compensation, potential problems ensuing from endogenously determined variables might exist. Moreover, in the presence of lagged values of the dependent variable that are commonly included in models’ specifications of extant research (particularly within Theme III), the assumptions of ordinary least-squares (OLS) regression are violated because the equation error terms are autocorrelated. According to Hamilton and Nickerson (2003), any empirical strategic management research involving some type of performance outcome should consider addressing potential endogeneity concerns and making necessary adjustments. The instrumental variable technique is commonly used as a

188  Discussion and Priorities for Future Research means of dealing with the endogeneity problem (Greene, 2008). Since OLS regressions might generate biased parameters, researchers typically employ the two-stage least-squares (2SLS) method, which relies on instrumental variables to calculate estimated values of the endogenous predictor and utilizes these values to estimate the regression model of the dependent variable. As Angrist and Krueger (2001) argue, the choice of appropriate instruments to be used in 2SLS models represents a fundamental econometric issue. Given that the ideal instrument is expected to be exogenous and for that purpose it should be correlated with the endogenous regressor but at the same time uncorrelated with the outcome variable, identifying such an instrument that complies with these conditions is an extremely challenging task. When considering the identification of good instrumental variables, Spraggon and Bodolica (2011) were motivated by approaches commonly adopted in prior literature on M&As and executive compensation (Girma, Thompson, & Wright, 2006; Guest, 2009). Since in the presence of fixed effects in the ratio of CEO equity-based pay, their lagged dependent variable could be correlated with the model disturbance term resulting in biased estimates, the authors had to find appropriate instruments to replace this problematic variable in their 2SLS equations. In their analysis of the impact of acquisition deals on the level of managerial compensation in the UK, Girma and colleagues (2006) showed that valid instruments of the lagged dependent variable represent its typical determinants, such as CEO pay, firm size, and performance, dated in a prior year and earlier. In the same vein, Spraggon and Bodolica (2011) employed the lagged values of the prior proportions of CEO equity ownership and stock options, total firm assets, stock market returns, and accounting return on equity that were previously averaged over the three-year window preceding the deal completion. This set of instruments of the lagged dependent variable was automatically substituted into the equation as the estimate for prior levels of compensation. This procedure also permitted Spraggon and Bodolica (2011) to make required adjustments to instrument the two analyzed acquisition characteristics, namely the mode of payment and control premium. According to Bascle (2008), if the instrument set or estimation is incomplete, this affects the reliability of the reported results. The endogeneity of acquisition terms in the incentive structuring of CEO packages is a real possibility, because managers tend to self-select their companies into acquisitions on the basis of expected pay gains stemming from the enlarged corporate size (Bliss & Rosen, 2001; Schmidt  & Fowler, 1990). When the unit of analysis is the transaction in a given year rather than the repeated observations over time, the common approach is to construct instruments from the lagged values of endogenous deal characteristics. Another source of instrumental variables consists in finding such an identification restriction that determines the premium size and financing mode but not the dependent variable (i.e., equity-based pay). The bidder–target industrial relatedness and perceived cultural differences, prior acquisition experience, target management

Discussion of Extant Knowledge on M&As  189 ownership, executive hubris, and target defense tactics are among the factors that have been shown to affect the acquisition premiums and mode of payment (Bodolica & Spraggon, 2009; Haleblian et al., 2009; Hartzell et al., 2004). Yet despite this apparently large choice, prior research did not focus on producing persuasive arguments about the exogeneity of any of these factors in CEO pay equations. The use of multiple instruments might also be a cause for concern due to potential biases. One solution to avoid the weak instrument problem is to rely on fewer instrumental variables (Angrist & Krueger, 2001). If the number of instruments is equal to the number of endogenous factors, the bias of 2SLS is close to zero. Given that the choice of instruments from the lagged endogenous variables was proven plausible in previous studies on acquirers’ executive pay (Girma et al., 2006; Guest, 2009), this technique continues to be adopted in the recent literature (Spraggon & Bodolica, 2011). Acknowledging that the decision of bank managers to acquire nonbanks is endogenous, Harjoto, Yi, and Chotigeat (2012) used the two-stage Heckman treatment regression procedure to accurately model this estimation. Hence, this discussion implies that all studies in the field should take account of a possible endogeneity bias and make relevant econometric adjustments to demonstrate that least-squares parameters in their regressions are not biased by omitted variables that influence the choice variable. REASONS FOR INCONSISTENCY AND LIMITATIONS The review made in this book suggests that attempting to summarize the current understanding of the incentive design of executive compensation packages around M&A transactions is a complex undertaking. The literature started to develop more notably in the early 1980s with the publication of the pioneering study of Amihud and Lev (1981) and continued till present days, with the latest identified article being published in the early 2015 (Chintrakarn et al., 2015), offering a wide spectrum of methodological paths, theoretical approaches, and empirical findings. The multiple differences among the reviewed studies in terms of sample sizes, examination periods, industrial sectors, nationality of takeover markets, compensation elements and their measurements, and definitions of the concept of “executive” limit the possibility of generalizing and draw definitive conclusions within each theme, stream, and topic of inquiry.

General Observations Regarding Cross-Study Variations As highlighted in Table  9.1, sample sizes vary significantly among the reviewed studies, ranging from 32 (Bliss & Rosen, 2001) to 5,417 (Goel & Thakor, 2010) M&A deals in Theme I, from 31 (Machlin, Choe, & Miles,

190  Discussion and Priorities for Future Research 1993) to 9,277 (Bebchuk et al., 2014) target firms in Theme II, and from 27 (Khorana & Zenner, 1998) to 5,722 (Lee, Shakespeare, & Walsh, 2009) transactions in Theme III. Arguably, some samples may be considered too small to generate sufficient statistical power to adequately test hypothesized relationships. The additional difficulty of making reliable cross-study comparisons lies in the fact that some researchers indicate the number of companies included in their study (Lewellen et al., 1989; Shivdasani, 1993), others identify the number of M&A deals analyzed (Dorata, 2008; Hartzell et al., 2004), while few scholars refer to the total count of firm-year observations (Chakraborty  & Sheikh, 2010) without mentioning the number of either acquisitions or the involved organizations. The consensus within each theme of inquiry is also hard to reach due to the broad range of time periods and merger waves covered. In Theme I, Amihud and Lev (1981) concentrated on merger deals that were initiated in the 1960s (third wave), while Boulton and colleagues (2014) analyzed acquisitions from the 1990s and 2000s (fifth and sixth waves). As discussed in Chapter 1, M&A transactions are dynamic phenomena, and their intensity changes over time and is closely related to movements in stock markets. The 2000s represented a more active market for corporate control than the 1980s in terms of the frequency and financial value of undertaken acquisitions. The negotiation environment evolved, with a significant decrease in hostile takeovers observed in the fifth merger wave than in the preceding ones. In light of the analysis made in Chapter 2, important changes have also occurred in the incentive design of executive compensation packets. Both the magnitude and the sensitivity of CEO pay to fluctuations in stock price have increased considerably since the 1980s, while stock option grants and restricted stock awards became more popular in the 1990s and 2000s, respectively, than they were back in the 1970s. For all these reasons, the generalizability of findings from one merger wave to another is questionable. The diversity of retained definitions of the concept of “executive” also contributes to the observed cross-study inconsistencies. While many scholars focus on the analysis of pay elements of just the CEO (Bliss & Rosen, 2001; Grinstein & Hribar, 2004; Kroll et al., 1997), some examine the compensation of the highest-paid manager in the company, who is not always the same person as the CEO (Firth, 1991), and others compute the average compensation of several top executives. For instance, Schmidt and Fowler (1990) and Datta and colleagues (2001) considered the three and the five highest-paid executives, respectively, while Khorana and Zenner (1998) gathered compensation data on the top two managers in the organization. As mentioned in Chapter 4, important variations exist in the type of measurement combinations made to estimate the same compensation element, particularly the equity-based pay of executives. Finally, specific attention has to be given to the industry in which sample firms operate, since the banking industry is heavily regulated, and its predominant governance configurations do not apply to companies from nonfinancial sectors (Bliss  & Rosen, 2001).

Discussion of Extant Knowledge on M&As  191

Differences in National Corporate Governance Regimes The empirical results of extant research may be sensitive to the peculiarities of the institutional and regulatory context in which corporate governance structures are embedded. As highlighted in summary tables included in Chapters 4 through 8, although much of the evidence is based on US data, six studies each were performed on Canadian (Bodolica, 2005; Bodolica & Spraggon, 2009; Dutta, 2011; Houle, 2003; Lin et al., 2011; Spraggon & Bodolica, 2011) and UK (Conyon  & Gregg, 1994; Firth, 1991; Gerakos et al., 2013; Girma et al., 2006; Guest, 2009; Ozkan, 2012) samples, two on Australian (Bugeja, Da Silva Rosa, Duong, & Izan, 2012; Shekhar, 2005) companies, and one each on mixed US–UK acquirers (Coakley & Iliopoulou, 2006) and bidders from Taiwan (Peng & Fang, 2010). Currently, there is extensive recognition that multiple distinctions between the USA and other countries, in terms of the type of economy, regulation of takeover activities, taxation levels, average size of the board, inside versus outside directors’ representation on the board, levels of institutional shareholding, and executive compensation responsiveness to corporate performance, may limit the applicability of American findings to other national settings. Contrasting the Governance Systems in the USA and Canada According to Spraggon and Bodolica (2011), the geographical proximity of Canada to its only neighboring country, the USA, could be the reason boards of directors in Canadian acquirers tend to bestow more freedom on the CEO in the selection of M&A characteristics. The nature of both takeover and managerial labor markets in Canada is highly competitive, where the existence of less prohibitive antitakeover regulations relative to the USA permits a more effective operation of markets for corporate control as governance mechanisms for disciplining the top management in organizations. In the United States, publicly listed corporations are widely held, investors are highly diversified, and institutions are subjected to tight diversification rules of their portfolio of investments (Deutsch, Keil, & Laamanen, 2011). On the contrary, ownership structures in Canada are concentrated, where companies are typically controlled by large families with an important incentive to enhance their monitoring intensity over managerial actions and compensation-setting processes (Bodolica & Spraggon, 2009). According to Masse, Hanrahan, and Kushner (1990), the ratio of bidder size to target size is much smaller in Canada, resulting in a smaller relative size of acquiring firms. Moreover, the more unfavorable tax treatment of capital gains in Canada than in the USA affects the choice of the method of payment for an acquisition. The level of executive compensation is more responsive to firm size, and the pay–performance relationship is significantly weaker in Canadian companies than in their American counterparts for the following two reasons (Zhou, 2000). First, the relatively more intense regulation of the Canadian economy reduces the competitiveness of the economic entities in the country, which are induced to also pursue

192  Discussion and Priorities for Future Research some nonprofit-oriented objectives. Second, the significantly higher levels of income taxation in Canada as compared to the US make the Canadian employment market less attractive for talented CEOs who, in order to be retained, need to be rewarded based on general market trends rather than on contribution to firm performance (Maniam, Subramaniam, & Johnson, 2006). Executives in US firms are invested with more power to influence board processes stemming from the CEO–chairperson positions duality. While splitting the jobs of CEO and chairperson of the board is a common practice in Canada, as many as 53 percent of S&P’s top 1,500 American companies combine the two positions (The Economist, 2009). American CEOs enjoy lavish total pay packets, which are loaded with stock option grants, retirement benefits and perks, earning almost double the compensation of their Canadian counterparts. The net value of after-tax income of Canadian executives is considerably lower (Maniam et al., 2006), although larger taxes cover in part for better public goods, such as health care and education, that Canadian CEOs enjoy in contrast to their US peers, who might pay for such services personally. The executive labor market in Canada might be more competitive mainly because of its smaller size of economy, where the job opportunities in top leadership positions are scant (Bodolica & Spraggon, 2009). Therefore, in the case of an unfavorable turn of events in one ­company, it is arguably easier for an American (than a Canadian) CEO to secure employment in another firm. These reasons related to the strength of governance arrangements and the attractiveness of the American labor market could make boards of directors in Canada more aware of the risk of losing scarce executive leadership and more concerned about the potential drawbacks ensuing from the enforcement of their fiduciary responsibilities. In a context of existing and relatively powerful governance devices for mitigating the prevailing agent–principal conflicts of interest, Canadian directors may be less likely to tighten their ex-ante monitoring of the executives’ strategic choices. Therefore, Spraggon and Bodolica (2011) concluded that when the need for scapegoating is absent, acquiring boards in Canada may consider it appropriate to reduce the pressure on already disciplined CEOs by relaxing their control over the determination of M&A terms. Additional Comments on Governance Regimes in the UK and Australia The above comparison of the American and Canadian regimes coupled with the discussion of corporate governance systems operating in other developed economies around the world, which was provided in Chapter 2, permit to create a more comprehensive understanding of governance realities in the UK and Australia. Although each system is unique in that it preserves a series of cultural and regulatory peculiarities, the four nations still share different sets of characteristics with one another. For instance, one of the

Discussion of Extant Knowledge on M&As  193 key features that the British equity market has in common with the American one is the predominance of institutional blockholders. Yet as noted by Ozkan (2012), contrary to the US governance regime, nonexecutive corporate directors in the UK view their directorship role as advisory rather than disciplinary because they do not have fiduciary responsibilities to shareholders and, therefore, cannot be sued for failure to comply with these fiduciary duties. While the size of the UK stock market is smaller compared to the USA, it is still much larger than the Canadian and Australian ones. In the same vein, the number of directors sitting on the corporate board tends to be smaller in the latter two than in the former two countries, while the proportion of nonexecutive representation on the board of directors is relatively higher in Australia than in the UK and the USA (Bugeja et al., 2012). The UK, Canada, and Australia all share a “comply or explain” style of regulation and information disclosure, which is more flexible than the prescriptive “rules-based” system of governance operating in the USA. Nonetheless, there are some variations among the three states in the mode of enactment of the “comply or explain” regime. In Australia, companies are more likely to explain what alternative measures were undertaken to achieve the same governance objectives as those included in the current legislation, while Canadian corporations tend to comply with the governance norms by merely adopting the steps described in the legislation (Salterio, Conrod, & Schmidt, 2013). Canadian, Australian, and British CEOs earn less money than their American counterparts, and incentive compensation, particularly stock options and restricted stocks, plays a notably larger role in US companies. The CEO-to-worker pay ratio is similar in the UK and Australia, while this ratio is more than two and three times higher in Canada and the USA, respectively. Finally, some antitakeover provisions that prevail in the American market for corporate control are prohibited by law in Australia (Humphery-Jenner & Powell, 2011) but not in Canada, where antitakeover regulations are less restrictive.

Final Considerations Despite the substantial amount of work produced on M&As and executive compensation, research on some themes, streams, and topics is still limited. This is the case of the literature examining the impact of the threat of takeover on target management pay (Theme II, Stream C) and the impact of M&A characteristics on acquirers’ executive compensation (Theme III, Stream E, Topic E2). Extant knowledge on American data is extensive, the British evidence is sparse, and the Canadian and Australian evidence is only recently emerging, while research conducted on other national settings is nonexistent. Scholars’ analysis is typically restricted to a limited number of elements of CEO pay, such as stock and option holdings in Theme I, stock ownership and golden parachutes in Theme II, and cash-based compensation, total pay, and stock options in Theme III. Other modes included in the

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10 Priorities for Future Research Endeavors in the Field

FURTHER EMPIRICAL WORK WITHIN EACH THEME OF INQUIRY Despite the significant advancements that were made in the field, still many research questions remain unanswered and need to be addressed to enhance our current understanding of executive pay-setting processes around M&A transactions. In light of the limitations of extant studies as highlighted in Chapter  9, the roads now open for future research endeavors are multiple. Scholars could simply pursue the work already begun within the three themes, five streams, and six topics of inquiry, which form the basis of our conceptual framework illustrated in Figure 3.2, with the particular emphasis on clarifying the contradictions reported for the same compensation elements across different industrial sectors, time periods, and sample nationalities. Another way to advance the empirical evidence in the field is to pursue numerous opportunities for building analytical bridges across different themes. Alternatively, researchers could engage in more innovative routes of investigation by examining new pay variables, modifying model specifications, and considering nontraditional governance realities to extend the knowledge beyond its currently set limits. All these possibilities for further inquiry on the acquisition–compensation relationship are discussed in the following sections of this chapter.

Future Research Directions Within Theme I Some inconclusive results achieved within Theme I are indicative of the need of finding alternative paths of analysis with regard to the role played by bidders’ executive compensation in risk-seeking behavior and bid performance. The conclusion that the incentive alignment effect of managerial stock ownership is uncertain in bidding firms is consistent with Spraggon and Bodolica (2011), who argue that this effect depends on the evolving nature of the agency problem around M&A deals. In the period preceding an acquisition, stock ownership is perceived as a disincentive for risk taking, while the board’s reliance on this compensation mode increases in the postdeal

200  Discussion and Priorities for Future Research period, when stock ownership is used as an incentive for the improvement of stock market returns. Therefore, it may be relevant to examine the risk-enhancing features of other elements of pay, such as special attributes of CEO compensation contracts, which were explored within Theme III (Bodolica  & Spraggon, 2009) but did not receive sufficient consideration in the context of bidding organizations. Bidders’ boards of directors can effectively manage the time of adoption of compensation protection devices (i.e., employment agreements, severance provisions, and golden parachutes) and LTIPs to bring the risk-seeking behavior of executives to the levels preferred by shareholders. In the preacquisition period, the adoption of compensation protection devices, rather than LTIPs, may constitute a better governance choice, because they provide bidding executives with more financial security, inducing them to engage in riskier nondiversifying acquisitions. This hypothesis is in line with the recent study of Zhao (2013), who found that the employment contract and special contractual provisions alleviate managerial risk aversion. Scholars working within Stream A (Topic A2 in particular) need to reflect on the limitations of short-term event windows when assessing the bid performance, measured as abnormal returns upon acquisition announcements. Shorter windows do not allow stock markets to appropriately react to the announcement of complex events, such as M&As, preventing them from correctly anticipating the success of a given transaction in terms of economic value creation (Zollo  & Meier, 2008). Longer event windows rely on more objective information about the effectiveness of executive decisions with regard to acquisitions and are more appropriate for estimating the effectiveness of incentive compensation in stimulating value-enhancing actions of bidding CEOs. Researchers aiming to advance the knowledge on Stream B should consider exploring the impact of bidding executive compensation on other M&A characteristics beyond the control premium and method of deal financing. Only lately, research efforts that are inscribed in this direction started to burgeon. Yet these efforts are so little and disparate that they are still unable to provide sufficient empirical evidence for adequately understanding the analyzed relationships. Only few studies examined the influence of bidders’ CEO pay on a specific merger-related feature, such as the acquisition frequency (Boulton, Braga-Alves, & Schlingemann, 2014; Chatterjee  & Hambrick, 2007; Gao, 2010), the size of acquisitions (Boulton et al., 2014; Chatterjee & Hambrick, 2007), the public or private status of target firms (Boulton et al., 2014), and the long-term postdeal performance of the acquirer (Gao, 2010). In a very recent empirical investigation, Boulton and colleagues (2014) demonstrated that the equity-based incentives of managers in bidding companies are associated with their propensity to acquire more firms, to conduct larger-volume transactions, and to purchase privately held targets. The number and size of acquisitions are the two features of M&As

Priorities for Future Research Endeavors in the Field  201 that were previously found to be determined by CEO narcissism, which includes in its measurement the total compensation of the CEO relative to the second-highest-paid executive in the company (Chatterjee & Hambrick, 2007). Gao (2010) showed that bidding CEOs with shorter time horizons, measured as the amount of incentive portfolio (restricted stock and options) to be vested during a given year as a percentage of total pay, tend to initiate acquisitions that result in poorer long-term postdeal performance.

Future Research Directions Within Theme II Further research within Theme II on recently conducted M&As in different markets for corporate control could provide new insights into the relationship between target management compensation and acquisition deals and their characteristics. Studies on larger samples of Canadian targets are welcome to establish whether the findings of the work initiated by Houle (2003) can be extended to all Canadian firms that were acquired during the wave of the 1990s. To clarify the role of golden parachutes as a mechanism of incentive alignment or an instrument of managerial entrenchment in target organizations, scholarly focus could be directed toward the specific timing of parachutes’ implementation relative to the occurrence of a takeover. We suggest that early parachute adoptions at the time of executive employment may serve as a better incentive for managers to act in their shareholders’ interests than an adoption in the face of a takeover or even during merger negotiations (Fich, Cai, & Tran, 2011), which is more likely to be pushed by entrenched managers under the risk of being displaced. A more fine-grained understanding of the consequences of managerial hostility for target owners is needed in order to design executive pay packages that induce a beneficial-for-shareholders attitude towards a takeover. Although a hostile attitude is typically seen as value destroying, some authors have shown that it could result in higher acquisition premiums and, thus, contribute to the maximization of target owners’ financial wealth (Cotter, Shivdasani, & Zenner, 1997). However, too much hostility on behalf of target managers can convince bidders to withdraw their tender offers and be equally harmful for target shareholders. This statement can be illustrated through the example of Yahoo that occurred at the beginning of 2008, when Microsoft withdrew its offer to acquire the company for a 62 percent premium. A closer examination of cases when hostile takeovers became friendly and their outcomes in terms of value creation in target firms should help us identify the optimal level of managerial hostility. The empirical research on Stream D could be extended beyond the commonly explored topics that delve into the question of the impact of target executive pay on target management attitude (Topic D1) and size of acquisition premium (Topic D2). The complexity of the M&A landscape offers a rich opportunity for examining the influences of target CEO compensation on other important facets of acquisition activities, such as the

202  Discussion and Priorities for Future Research performance of the acquiring firm, the deal value, the length of the M&A negotiation process, and takeover success or failure. Recently, relying on various measures of target management compensation, scholars started to make some progress consistent with this recommendation (Fich et al., 2011; Fich, Tran, & Walkling, 2013; Heitzman, 2011). They found that both a higher golden parachute importance (relative to the loss of compensation due to takeover-induced turnover; Fich et al., 2013) and the issuance of unscheduled stock option grants to target CEOs (Fich et al., 2011) translate into significantly higher stock market returns for acquiring shareholders, pointing to the wealth transfer from the target to the acquiring company. Heitzman (2011) examined the equity grants made to target executives during the process of deal negotiation but found that these grants are not influential in the success or failure of acquisitions. Further work using the relative importance of golden parachutes (rather than their mere presence or absolute monetary value), grants of equity, and awards of unscheduled options to target managers for estimating the implication of these elements of target management pay for the financial wealth of acquiring shareholders would be valuable.

Future Research Directions Within Theme III The focus of the next generation of research on Theme III could be more specifically on whether returns from acquisitions or increases in firm size impact executive compensation, as moderated by different corporate governance variables. Wright, Kroll, and Elenkov (2002) have proven that the study of moderating effects of corporate monitoring activities improves the pay–performance link for acquiring managers. Future studies can consider the extent to which the intensity of structural board independence from management, which includes both formal and informal sources of structure in CEO–board relationships (Westphal, 1998), moderates the association of executive compensation with postacquisition performance. Prior research on Topic E1 focused on different measures of corporate governance strength such as board size, institutional ownership, board equity holdings, lack of CEO–chairperson duality, and number of analysts following a firm. Yet recent empirical investigations show that another governance factor that affects the quality of monitoring is the presence of foreign directors on the board. According to Masulis, Wang, and Xie (2012), board members’ foreignness is associated with higher top management pay, greater financial misreporting, and lower CEO turnover–performance sensitivity. Testing this apparent lack of effectiveness of foreign independent directors with regard to the incentive structuring of acquirers’ executive compensation in the context of cross-border acquisitions could constitute a fruitful avenue for further inquiry. Alternatively, given the current research scarcity on Topic E2, scholarly efforts can be directed toward enhancing our emergent comprehension of

Priorities for Future Research Endeavors in the Field  203 the way the magnitude of control premium and mode of payment affect different compensation elements of acquiring CEOs. Stream E could be significantly extended through the consideration of other relevant M&A characteristics and their specific effects on acquirers’ executive pay configurations. Recently, Ozkan (2012) analyzed whether the time to complete a deal and the degree of corporate diversification influence the magnitude of cash and total pay of acquiring executives but did not find statistically significant effects. When estimating the differential impact of acquisitions of publicly held versus private targets, Guest (2009) did not uncover any substantial consequences for managerial pay in acquiring companies. Apart from the public–private status of the target firm, there is also the need to clarify the limited and inconclusive evidence regarding the effect of target nationality and its predominant CEO compensation practices relative to the country of the acquiring firm. Two recent studies on acquisitions of US targets by UK acquirers reported contradictory findings (Gerakos, Piotroski, & Srinivasan, 2013; Guest, 2009), preventing us from drawing reliable conclusions on whether M&A deals in high-pay countries result in increases in CEO pay. Related to this direction for future research, there is the question of whether target management hostility affects the compensation level of acquiring executives. If target resistance decreases the returns to acquiring shareholders (Hitt, Harrison, & Ireland, 2001) and also translates into lower levels of postacquisition pay, the hostility of target managers may constitute a viable disincentive for the conduct of both value-reducing and wealth-destroying deals by acquiring CEOs. OPPORTUNITIES FOR BUILDING BRIDGES ACROSS THEMES Besides pursuing further work within each theme, our conceptual framework illustrated in Figure 3.2 also creates fruitful opportunities for building bridges across different themes, streams, and topics of inquiry. Other cross-theme causal relationships on the intersection of M&A deals and executive pay, which received little scrutiny but are equally important, could be explored as delineated next.

Bridging Theme I and Theme II Researchers may be interested in examining how the differences in managerial compensation levels and composition between the bidding and target companies in the period preceding a merger influence various transactional characteristics, such as the likelihood of deal occurrence or merger-induced performance. This avenue for further investigation would link Themes I and II from our conceptual framework. Prior studies in organizational behavior have shown that many M&A transactions ultimately fail due to human factors, discrepancies in organizational practices, and clashes of corporate

204  Discussion and Priorities for Future Research cultures (Carleton  & Lineberry, 2004). Therefore, larger premerger gaps and discrepancies in the magnitude and structure of executive pay in merging companies can create important integration challenges after the completion of a merger, reducing the probability of its success. The scale of postmerger integration problems can be particularly high in the case of cross-border deals. Some may recall the US$40  billion stock-financed merger concluded in May 1998 between the Germany-based industrial manufacturer Daimler-Benz AG and the American automaker Chrysler Corporation. One of the controversies surrounding the transaction was that investors launched lawsuits over whether the deal was a “merger of equals” or rather a Daimler-Benz takeover of Chrysler, where the US shareholders believed they were misled and denied a takeover premium (Edmondson, 2004). Another controversial issue that raised equity concerns and caused significant managerial distress was that German executives resented that their American counterparts earned a significantly higher compensation, which came mostly in the form of stock options. After several years of integration difficulties, in August 2007, DaimlerChrysler have finally completed the sale of Chrysler group. The substantial gaps in pay levels and structure between German and American senior managers may be among the main culprits in the failure of the Daimler–Chrysler merger. In her theoretical paper published more than a decade ago, Tuschke (2003) highlighted the detrimental consequences of multiple differences in executive pay packages for the postmerger integration of American and German firms. As discussed in Chapter 2, the stakeholder-based governance system in Germany differs fundamentally from the market-driven governance in the USA (Thomsen & Conyon, 2012), giving rise to many incompatibilities in underlying assumptions on which these systems rely to operate effectively. According to Tuschke (2003), the significant discrepancies in the magnitude and composition of top management compensation packets in American and German organizations represent a serious impediment for a successful corporate integration in the context of cross-border M&A deals. Important pay disparities may adversely affect executives’ behavior in merging companies, reducing their willingness to coordinate monitoring efforts, accumulate social capital, overcome cultural barriers, and engage in innovative undertakings—activities that are critical prerequisites for the realization of synergies. Related to this future research recommendation, it has to be acknowledged that Lynch and Perry (2002) have already engaged in a similar path of investigation, employing a sample of 321 mergers between 1994 and 1996. Yet the authors focused exclusively on the analysis of potential determinants of premerger differences in the composition of executive compensation in merging firms. Since pay inequities may create high levels of managerial dissatisfaction, we propose going further by analyzing the extent to which these discrepancies in CEO compensation in the two combined companies affect the deal performance, measured as a degree of successful postmerger

Priorities for Future Research Endeavors in the Field  205 integration. Recently, Ro, Lamont, and Ellis (2013) attempted to make some progress in this regard. For 305 M&A deals during the 1995 to 1998 period, they found that larger acquirer–target CEO pay disparities prevent top managers from engaging in fruitful exchange of information and open communication, which are the prerequisites of informational justice. In turn, the reduced emphasis on informational justice due to compensation disparities exerts a negative influence on performance during the process of M&A integration. A promising path for further research bridging Themes I  and II could be the analysis of a combined influence of both bidder and target executive pay on various idiosyncrasies of the M&A process. For instance, Cai and Vijh (2007) used a sample of 250 US deals to demonstrate that both bidding and target CEOs could have important personal (although different) incentives to accelerate the completion of an acquisition. The motivation of bidding senior managers to perform a transaction within the shortest period of time stems from their willingness to increase the long-term value of their significant stock and option possessions within the firm. Conversely, the impatience of target CEOs to sell their company is explained by their high cash-out incentives, as the acquisition allows them to remove the liquidity constraints on their equity holdings. Thus, Cai and Vijh (2007) provided early evidence that both bidder CEOs with larger equity-based pay and target CEOs with higher illiquidity discount significantly increase the speed of an acquisition. Testing this relationship on larger samples of more recent, and eventually cross-border, M&A transactions could be beneficial for generating a richer understanding of the dynamic interplay between the combined incentives of target and bidding executives and the various facets of the complex acquisition process. The recent work conducted by Sharma and Hsieh (2011) for a sample of 367 US mergers over the 1992 to 2007 period can also be inscribed in this direction. The scholars examined whether the differences in acquirer and target managerial horizons, estimated on the basis of composition of executive compensation packages, affect the stock-based mode of acquisition financing.

Bridging Theme II and Theme III An interesting path for future exploration in the field could be the question of whether the postacquisition compensation structure of senior executives in acquiring firms (Theme III) can be explained by the magnitude and composition of target CEO compensation in the preacquisition period (Theme II). In his recent study, Guest (2009) showed that compensation increases for acquiring managers are larger following acquisitions of targets with relatively high pay, providing a preliminary confirmation of the existence of a relationship between the executive compensation designs in target and acquiring firms. In the context of cross-border M&A transactions, the role of target nationality in the modification of acquirer’s CEO pay could be

206  Discussion and Priorities for Future Research studied in relation to the broader concern of whether mergers between companies incorporated in different cultural and regulatory environments bring about more convergence in executive compensation practices. Another research possibility that would analytically link Themes II and III could be extracted from the recent investigation conducted by Fich, Officer, and Tran (2014). The bargaining power of target senior executives who tend to engage in despicable trade-offs between their private benefits and target shareholders’ gains obtained from the M&A transaction (Hartzell, Ofek,  & Yermack, 2004; Qiu, Trapkov,  & Yakoub, 2014) may have important consequences for the acquiring company. In particular, Fich and colleagues (2014) demonstrated that acquiring corporations that offer employment in high-level executive or directorial positions to low-quality target CEOs experience substantial declines in cumulative abnormal returns and postdeal operating performance. Considering the presence of a strong association between target management benefits and acquirers’ returns in the period following an acquisition, it would be relevant to examine whether the retention of target CEOs is a significant driver of the alteration in the level and incentive design of executive compensation packages in the merged company.

Bridging Theme I and Theme III A potential avenue for bridging research Themes I  and III constitutes the analysis of the extent to which the changes in the magnitude and structure of managerial compensation between the pre- and postacquisition periods influence or are influenced by different performance metrics in acquiring corporations. Taking into consideration the motivational side of compensation, it may be expected that the larger the pay fluctuation between the two M&A–related periods in relation to firm performance, the stronger the incentive for acquiring managers to perform better after the acquisition completion. This specific path of inquiry could also shed more light on the sense of causality in the compensation–performance relationship. Recent studies identify different sources of value destruction in M&A transactions conducted by entrenched managers. According to Harford, Humphery-Jenner, and Powell (2012), shareholders’ wealth is significantly damaged when bidders with entrenched CEOs display the following types of acquisitive behavior: acquisitions of privately held target firms are avoided; in acquisitions of private targets, equity-based financing is not used for the purpose of transferring an important blockholder to the acquirer; the size of control premiums is exaggerated; and the target selection process results in the identification of low-synergy firms. The level of managerial entrenchment is commonly measured using the governance index of Gompers, Ishii, and Metrick (2003), which aggregates 24 takeover defenses, where the adoption of a greater number of defenses is associated with higher entrenchment. This evidence leads to two possible research questions that could be addressed

Priorities for Future Research Endeavors in the Field  207 in future empirical investigations. First, to what extent is the entrenchment index alteration at the time of acquisition associated with changes in the level and incentive design of executive pay packages between the pre- and postdeal periods? Second, if acquisitions of privately held targets, the reliance on all-equity offers in private targets’ transactions, the payment of lower premiums, and the choice of high-synergy targets are associated with value creation, what combinations of managerial incentives influence the ex-ante selection of these M&A terms, and how should be managers be rewarded for their selection ex-post?

ADDITIONAL RECOMMENDATIONS FOR FURTHER INVESTIGATION IN THE FIELD

Extending Current Research to Other Cultural and Regulatory Frameworks Scholars could strive to extend their examination of acquisition–compensation phenomena uncovered on US samples to other national settings with different governance structures and institutional environments. Since the distinctive feature of the most recent merger wave (see Figure 1.1) is that M&A deals became a truly global phenomenon with the appearance of bidding companies operating in emerging markets, this should stimulate a heightened research interest on the disciplinary nature of the global market for corporate control. The current empirical evidence on cross-border transactions oscillates around American acquirers without an explicit emphasis on implications for top management incentives in these firms (Chari & Chang, 2009). Almost six years ago, Guest (2009) pointed to the lack of studies on the executive compensation consequences of acquisitions of nondomestic targets. Since then, little progress has been made in this regard. Although Gerakos and colleagues (2013) have recently examined the acquisitions of US targets by UK acquirers, their study is still grounded within the advanced governance framework of two developed economies. M&A transactions that involve companies from different countries bring about complex organizational arrangements due to geographic dispersion, cultural incompatibilities, and differences in corporate governance systems. Data on underexplored geo-markets represent a rich and untapped source of increased understanding of the essence of managerial compensation around acquisition deals. In particular, more studies on the incentive structuring of CEO pay packages in the context of cross-border acquisitions initiated by emerging market bidders would be valuable (Bodolica, 2013). Yet the feasibility of these empirical investigations is highly dependent upon the level of development of national governance regimes in emerging economies, which influences the degree of information transparency. It has to be noted that the availability of relevant data may be limited because of the highly sensitive

208  Discussion and Priorities for Future Research and secretive nature of the topic of executive compensation in many developing and transitional nations. More diversified samples of M&A deals should be employed in future research to reflect the dominant characteristics of each merger wave. Although the fifth merger wave featured a growth in cross-border transactions, this was not accompanied by an increase in studies on top management pay within the specific context of acquisitions involving nondomestic targets (Ozkan, 2012). Since the global diversification of firms increases the level of complexity of corporate activities and managerial responsibilities, senior executives engaged in cross-border acquisitions may bargain for more attractive pay packages to reward their heightened international expertise. Interestingly, the few investigations that focused exclusively on the sixth merger wave, which is characterized by a surge in shareholder activism, provided some evidence that is consistent with a stronger incentive alignment around acquisition deals (Bugeja, Da Silva Rosa, Duong,  & Izan, 2012; Darrough, Guler, & Wang, 2014; Wang et al., 2014).

Tackling New Research Questions to Improve Extant Knowledge Firm-Related Idiosyncrasies and Better Governance Controls Our context-dependent understanding of the determination of executive pay preceding and following M&A transactions may increase with the inclusion of additional firm-specific characteristics. Since recent studies indicate that in companies in which founders serve as a director, the CEO excess compensation is lower and both the CEO pay-for-performance sensitivity and the CEO turnover–performance sensitivity are higher (Li  & Srinivasan, 2011), it would be relevant to assess whether this incentive alignment in founder–director firms is equally strong around acquisition events. The examination of industry-related idiosyncrasies and their association with the incentive structuring of CEO pay in the periods surrounding major acquisitions ought to continue. The highly regulated nature of the banking sector (Anderson, Becher, & Campbell, 2004; Gupta & Misra, 2007) or the R&D intensity of companies operating in the high-tech industry (Rossi, Tarba, & Raviv, 2013) might influence the executive compensation in bidding, target, and acquiring firms, warranting a differentiated agency analysis. Since takeover markets were shown to play an important role in disciplining target top managers, their disciplinary effect could be further clarified in the case of acquiring executives who completed bad acquisitions. In other words, is the market for corporate control effective in penalizing managers of bad acquirers by increasing their likelihood to become targets? In their study of 1,158 public firms, Mitchell and Lehn (1990) reported that companies that make M&A deals that substantially reduce the value of their equity are subsequently sold, while Bodolica (2005) noted that 6 out of 80 acquirers in her sample became takeover targets within the two-year period following the acquisition. Adopting a longitudinal design that would allow

Priorities for Future Research Endeavors in the Field  209 following the fate of bad acquirers over a period of several years, scholars could explore whether the postacquisition compensation levels and composition of bad acquiring executives increase the threat of their companies being taken over. Although it may not be tractable to include all governance-related variables in a single study, extant model specifications could still be improved by incorporating new governance controls using better measurements, which could affect the strength of the acquisition–compensation relationship. For instance, with regard to board vigilance, it is a complex theoretical construct in which many factors could be at play in determining its effective operationalization (Spraggon & Bodolica, 2011). Prior efforts were directed toward achieving higher levels of contextualization and a better fit with the developed theory, leading to measurement proliferation at the expense of uncaptured benefits stemming from measurement convergence. In an attempt to conciliate the ongoing tension between construct precision and generalizability (Cording, Christmann,  & Weigelt, 2010), future endeavors might be undertaken to examine the phenomenon of board vigilance in greater detail by making a more consistent distinction between different sources of board power and vigilance and identifying its more fine-grained measures. Recent Regulatory Changes and the Governance Role of the Media The incessant regulatory changes in the field of corporate governance occurring in the USA and worldwide indicate that the executive compensation landscape is likely to continue evolving over time. Empirical evidence still ought to be gathered on the effectiveness of “say on pay” legislation so that the pre–post types of comparative study designs are particularly welcome. A promising area for further inquiry is whether the advisory shareholder voting procedure on the adoption of golden parachutes enhanced its governance role as a mechanism of incentive alignment around acquisition events. Furthermore, did the level of shareholder activism improve in the period following the enforcement of “say on pay” regulation? And if yes, how did this heightened stockholder activism contribute to the tightening of pay–performance association for securing top management involvement in value-increasing acquisitions? In their recent study, Wang, Wang, and Wangerin (2014) analyzed the effect of the 2006 SEC legislation, which requires a more comprehensive disclosure of executive compensation practices, on the alteration of acquirers’ CEO pay between the pre- and postregulation periods. The authors demonstrated that the SEC regulation resulted in improved investors’ monitoring of managerial compensation and increased sensitivity of executive pay to weak performance in acquiring firms. The role of the media as a governance mechanism received limited attention in the literature on M&As and executive compensation. Prior studies examined the importance of the media in corporate governance but did not find consistent results. Dyck and Zingales (2002) provided evidence in

210  Discussion and Priorities for Future Research favor, demonstrating that the media is a powerful tool that can shape executives’ reputation, affect company choices, and push regulators to enact stricter legislation. Yet Core, Guay, and Larcker (2008) found evidence against, showing that firms did not respond to negative press coverage by decreasing the magnitude of managerial pay. We believe that in the context of markets for corporate control, the media can be particularly important, as M&A strategies are highly publicized, whereas executive compensation constantly attracts public scrutiny. By releasing negative information about CEOs’ rewards and their growth strategies, the media can exert considerable pressure on the boards to make sound decisions in response to unfavorable media interest. An avenue for future governance research may be to assess how compensation practices in bidding, target, and acquiring firms are directed by media-related reporting. More specifically, we expect that the concomitant negative coverage in press, ensuing from both high CEO compensation levels and poor returns from acquisitions, is likely to force corporate directors to constrain the magnitude and improve the design of executive pay packages in their firms.

IMPORTANT METHODOLOGICAL AND THEORETICAL CONSIDERATIONS

Treatment of Acquisition-Related Performance Given that the treatment of acquisition performance is of critical importance in M&A and CEO compensation research, it deserves a discussion of its own. In the broader M&A literature, performance has been proxied in a variety of ways. According to Zollo and Meier (2008), the different measures of the acquisition-related performance can be situated on three levels of analysis: task level (e.g., synergy realization, knowledge transfer, integration process performance, customer retention); transaction level (e.g., short-term financial performance, acquisition survival, overall acquisition performance); and firm level (e.g., long-term financial performance, accounting performance, variation in market share). As appears in our review, studies on the intersection of M&A activities and executive compensation have relied predominantly on stock market and accounting metrics of performance. Recently, however, Darrough and colleagues (2014) employed the impairment of goodwill as an alternative estimator of acquisition performance. Since various performance measures shed light on different facets of the complex acquisition process, we might be in need of using multiple proxies for performance; otherwise, the econometric models relying on single measures may be seriously underspecified. As discussed in Chapter  1, M&A transactions may be initiated for a variety of reasons, such as synergy realization, learning new capabilities, knowledge increase, enhancing innovation capacity, and penetrating new

Priorities for Future Research Endeavors in the Field  211 markets. Scholars showed that acquisitions with the purpose of gaining new knowledge can generate positive returns (Uhlenbruck, Hitt, & Semadeni, 2006), whereas higher control premiums paid by acquirers determine larger postacquisition layoffs, which negatively affect subsequent firm performance (Krishnan, Hitt, & Park, 2007). To be able to properly account for the effectiveness of executive decisions with regard to M&A activities, we encourage researchers to consider the objectives that were set for the acquisition ex-ante and relate different executive compensation elements to the achievement of these objectives ex-post. Rajagopalan (1996) suggested that managerial behavior is motivated by the type of incentive offered and the performance criteria on which the payment of these incentives depend. For instance, if the main purpose set for the M&A deal is the increase in company stock price, the payment of stock-based rewards (e.g., stock ownership, stock options, restricted stock awards) to managers should be tied strictly to stock market returns following the acquisition. When the realization of synergies between the two involved companies is targeted, longer periods of time should be allowed for such synergies to occur, and special LTIPs should be designed for acquiring CEOs in a way that allows payments under these plans to be made based on explicit performance criteria that measure the degree of achievement of expected synergies. Alternatively, if the executive priority after the deal is managing the integration process and preserving valuable human capital, which is so critical for organizational success, the payment of bonuses should be made based on human resource metrics of performance. These metrics could evaluate the extent to which the top manager is refraining from laying off personnel, is investing in human capital–development programs, and is focusing on harmonizing the organizational culture of the merged firms. Tying different elements of executive pay packets to precise measures of performance to which these elements relate represents a powerful governance device for directing top management efforts toward the realization of preestablished objectives for an acquisition.

Implications for Theory The conflicting evidence that describes much of the literature on M&A activities and executive compensation has important theoretical implications. As shown in prior chapters of this book, the reviewed studies start to inform us that managerial self-interests, rather than shareholder wealth maximization, are the primary motives explaining the occurrence of M&A deals from the point of view of bidding, target, and acquiring firms. Although there is a substantial indication that incentive compensation helps to reduce agency conflicts by aligning manager–shareholder interests, and due to the existence of power relationships between the management and boards of directors, the whole question regarding CEO pay and takeover markets as effective governance mechanisms remains unsettled. This conclusion is further exacerbated

212  Discussion and Priorities for Future Research by the existence of a compensation “contagion” effect (Gabaix & Landier, 2008), which manifests itself when an increase in executive pay levels that occurred at a subset of firms in response to an exogenous governance shock gradually spreads over other companies in the wider economy. A  recent empirical investigation demonstrated how the positive impact of Delaware antitakeover rulings on the magnitude of total compensation of managers in Delaware-incorporated firms spilled over other organizations, which are not covered by these rulings, contributing to an overall escalation in executive pay (Bereskin & Cicero, 2013). Complementarity and Substitution Among Governance Mechanisms Extant empirical findings still point to important weaknesses in corporate governance structures, calling for further improvements and better monitoring arrangements in companies engaging in acquisition transactions. Alternative mechanisms of control should be identified and their role in curbing managerial opportunism explored in combination with or as a replacement of the incentive effect of executive compensation. Some authors advocate the complementarity among different governance attributes in mitigating agency problems, establishing the optimal level of use of each mechanism (Agrawal & Knoeber, 1996). Others argue in favor of substitution among various managerial incentives, such as LTIPs and compensation protection provisions (Bodolica & Spraggon, 2009) or among other governance tools, such as strong boards of directors and constraining legislation (Wang et al., 2014), or performance-based top management pay and mechanism for dismissal (HomRoy, 2014). In a continuous search for optimal governance configurations, it is important to uncover which bundles of devices can strengthen the discipline instituted by each other or can effectively substitute for each other. For instance, debt financing and media can be considered such alternative modes of control that, coupled with CEO compensation, could enhance the effectiveness of governance arrangements in merging firms. In many large M&A deals, an all-cash method of payment may mean that the bidder has to incur debt. According to Jensen (1986), the use of debt financing can reduce agency costs by constraining the selfish behavior of executives. When managers rely on borrowed capital to finance the deal, they may experience an elevated pressure to make sound decisions with regard to acquisition activities to prevent future creditors’ claims. Yet Dalton, Hitt, Certo, and Dalton (2007) note that the use of debt carries with it unwanted risk consequences, such as greater increase in bankruptcy risk or higher likelihood that managers would focus on short-term (rather than long-term) returns in an attempt to reimburse the company creditors. Several scholars have shown that moderate levels of leverage can produce better outcomes in terms of acquisition performance and product market growth (Campello, 2006; Hitt et al., 2001). Thus, future studies could focus on uncovering the optimal level of debt financing in association with appropriate performance-based

Priorities for Future Research Endeavors in the Field  213 rewards as efficient combinations for monitoring executive actions in bidding and acquiring firms. Advancing Multitheoretical Research Approaches The next generation of research in the field needs to be multidisciplinary, with insights from the agency theory complemented by inputs from many other well-known theories, such as political, equity, symbolic, stewardship, stakeholder, and resource-based views. Researchers may continue analyzing the interplay between alternative or contrasting governance attributes that are advanced by different theoretical approaches. According to Sundaramurthy and Lewis (2003), an appropriate balance between control, prescribed by the agency theory, and collaboration, promoted by the stewardship theory, may represent an optimal governance arrangement in today’s organizations. Alternatively, institutional and symbolic management proponents suggest that some elements of executive compensation are affected by legitimacy concerns in the eyes of corporate shareholders (Westphal & Zajac, 1998), but they are not the only important stakeholders. Arora and Alam (2005) argued in favor of studying the top management pay as an incentive to align CEO interests with those of primary stakeholders, such as customers, employees, and suppliers. The institutional legitimacy of executive compensation in the context of an active takeover market could be examined in light of other organizational stakeholders. Furthermore, applying the underlying assumptions of the equity theory could be particularly useful for understanding the motivational implications of executive pay disparities between the target and acquiring firms and their impact on the likelihood of integration success (Ro et al., 2013). A better integration of future research within these theoretical frameworks might point out new explanatory factors of managerial pay around M&A activities that were ignored in current literature. The nature of resources demanded by the firms involved in M&A transactions may inform us about the most efficient structure of corporate boards, including a mix of both inside and outside directors who have the required knowledge and expertise to design compensation packages that induce value-enhancing executive behaviors. According to Certo, Dalton, Dalton, and Lester (2008), boards of directors might well assume a double role of both principals, in their function of monitoring the executive actions, and agents, in their relationships with firm owners. While the former board role is widely explored in the extant literature (Montgomery  & Kaufman, 2003), shifting our attention toward analyzing how the latter role operates might improve our knowledge of specific contingencies that induce directors to restructure the internal mechanisms of incentive alignment in acquiring firms (Spraggon & Bodolica, 2011). This reorientation could not only add to the growing body of research on multiple agency theory (Deutsch, Keil, & Laamanen, 2011) but also allow us to reconcile the control and monitoring responsibilities of directors prescribed by the normative agency model with the conflicting

214  Discussion and Priorities for Future Research objectives and incentives of different self-motivated parties on a board predicted by the behavioral perspective.

FINAL THOUGHTS We have shown that significant alterations in the level and design of executive pay take place around major acquisition transactions. Researchers should continue enhancing our understanding of the variety of mechanisms through which such changes occur to decipher the optimal compensation arrangements in different cultural and institutional settings. On the one hand, the current global governance reforms influence the degree of investor protection in each country, affecting the propensity of corporations to participate in domestic and cross-border acquisitions (Kim  & Lu, 2013). On the other hand, the executive compensation landscape is continuously evolving due to heightened public scrutiny, shareholder activism, and regulatory intervention. Therefore, the scholarly interest on the topic of incentive structuring of CEO pay in the specific context of M&A activities should persist over time. It is our belief that all theoretically sound future research endeavors that were delineated in this chapter would substantially gain if addressed through qualitative research methods. Case studies developed via in-depth interviews with senior managers and board members allow uncovering the context-related specificities and complex internal dynamics of managerial compensation-setting processes that are difficult to grasp through quantitative techniques. In sum, the close alignment of the M&A and executive compensation literatures that was discussed throughout this book carries strong potential benefits and offers fertile terrain for further exploration.

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About the Authors

Virginia Bodolica, PhD, is an Associate Professor in the School of Business Administration at the American University of Sharjah, UAE. She regularly teaches in the areas of business policy and strategy, corporate governance, compensation systems, and human resource management. Her primary research interests are related to governance issues in for-profit settings, family-owned enterprises and healthcare institutions, board of directors’ dynamics, and the incentive design of executive compensation packages in the specific context of corporate growth strategies such as mergers and acquisitions. Among other journals, Bodolica has published in the Academy of Management Annals, Strategic Organization, Journal of Business Research, Strategic Management Journal, Journal of Business Ethics, and Business Ethics: A European Review. She received a Research and Scholarship Award from the UAE National Research Foundation for her collaborative project on corporate governance arrangements in UAE–based family businesses that culminated in the publication of the practice-oriented book titled Managing Organizations in the United Arab Emirates: Dynamic Characteristics and Key Economic Developments. Bodolica assumed consulting roles in private and public organizations and delivered executive education sessions and customized programs to companies in North America, the Middle East, and Latin America. Her involvement in academic services has earned her two Outstanding Reviewer Awards from the Academy of Management Business Policy and Strategy Division. She was a Visiting Fellow at the Middle East Center, London School of Economics and Political Science, where she conducted research on corporate governance initiatives in publicly listed and family-run organizations located in the Gulf region. Martin Spraggon, PhD (HEC Montreal, Canada), is an Associate Professor of Strategic Management at the American University of Sharjah, UAE. He lectures on a variety of topics in strategic management, international marketing, organizational behavior, and innovation management and is actively involved in executive education programs. Dr. Spraggon has extensive international experience, having conducted many consulting

220  About the Authors projects and delivered customized executive programs for North American, Western European, Latin American, and Middle Eastern organizations and educational institutions. His research, which concentrates on emerging economies, executive compensation, behavioral governance, merger and acquisition transactions, knowledge dynamics in innovative firms, and healthcare management, has been published in scholarly journals such as Strategic Management Journal, the Academy of Management Annals, Strategic Organization, Journal of Business Research, Health Expectations, and Journal of Managerial Psychology. Spraggon received the 2013 Rupert Chisholm Best Theory-to-Practice Paper Award of the Academy of Management Organizational Development and Change Division. He regularly presents the results of his scientific research, serves as a chair and discussant of business and management sessions, and assumes responsibilities as a member of international program committees at academic conferences around the world. Spraggon was awarded a competitive grant from the UAE National Research Foundation, which has significantly expanded his research agenda on governance configurations in companies operating in the Middle East. He has recently coauthored a collection of case studies of UAE–based organizations that permits him to uncover and assess the opportunities and challenges of managing local small firms, family businesses, and entrepreneurial ventures.

Index

abnormal compensation 126 – 7, 132 – 3 abnormal returns 5, 10, 13 – 15, 51, 63, 64, 71, 84, 86 – 90, 92 – 4, 96, 104, 106, 108, 110 – 12, 200; cumulative 85, 98, 108, 150, 206; negative 10, 13, 74, 85, 165, 166; positive 11, 12, 17, 85, 92, 121, 183 acquisition experience 13, 52, 188 acquisitiveness 6, 18, 51, 74, 87, 90, 91, 148, 153 Actavis plc 7 advantages 52; early-mover 13; first-mover 13; fiscal 9; late-mover 13; monopoly power 9; strategic 9 Africa 7 agency costs 18, 35, 36, 38, 41, 185, 212 agency problems 13, 17, 55, 74, 85, 90, 92, 108, 132, 167, 170, 212 amendments: antitakeover 120, 122, 124; frequency of 124; series of 13 American Comcast Corporation 4 America Online 4, 6 Anheuser – Busch InBev 4 antitakeover provisions (or defenses) (or protections) 5, 12, 15, 16, 51, 118, 121, 123, 152, 193; see also amendments Asia Pacific 7, 8 asymmetric properties 35, 39, 169 AT&T Inc. 7 attitude: friendly 127, 130, 184; hostile 132, 201; target management 63, 64, 126, 129, 131, 132 – 4, 201

Australia 13, 16, 26, 27, 30, 73, 78, 148, 154, 155, 162, 178, 180, 181, 191 – 3 bandwagon pressures 13 banking industry (or sector) 10, 13, 73, 89, 91, 92, 128, 129, 150, 151, 190; see also banks Bank of America Merrill Lynch 4 banks 25, 28, 29, 73, 74, 76, 77, 78, 88, 89, 91, 93, 128, 134, 150, 151, 160, 162, 186; see also banking industry bankruptcy 11, 166, 212 Barrick Gold Corporation 37 Belgium 28 benefits 32, 33, 34, 76, 92, 108, 131, 132, 135, 137, 139, 206; compensation 87, 89, 97, 178, 185, 194; corporate 25; expected 3, 9, 13, 14, 16; financial 129; learning 13; private 18, 82, 106, 123, 131, 137, 138, 156, 184, 206; retirement 192; wealth 5 bias 189; potential 189; selection 60; survivor 156 – 7 Biomet Inc. 7 Black-Scholes method 107 bonus 25, 27, 29, 33, 108, 111, 120, 122, 128, 133, 140, 148 – 55, 158 – 62, 164 – 6, 170, 180, 182; acquisition (or merger-related) 153 – 4, 157, 160, 164, 180, 185, 211; annual 32; cash 18, 131, 134, 138, 153, 179, 184; executive 155; retention 37; short-term 28, 32, 55, 58, 86, 119, 122, 126, 127, 179, 184

222  Index Cadbury Code 30 Canada 6, 16, 27, 30, 31, 34, 35, 118, 119, 130, 136 – 7, 165, 167, 178 – 80, 191 – 3 capital gains 132, 166, 191 Capital One 34 cash-financed transactions (or deals) 6, 52, 104, 105, 107, 166, 184 cash flow 10, 12, 85, 86, 93 cash reserves 8 Charif Souki 26 Cheniere Energy 26 China 28, 30, 31, 50, 55 Chrysler Corporation 29, 204 civil-law nations 28 clawback provisions 31 code of conduct 33 coding procedure 61 collapse 6 Colombia 13 common-law nations (or origins) 28, 30 compensation plans 32, 54, 127, 129, 132, 134 – 5, 13 – 18, 141, 179 – 80, 185, 194 compensation protection devices (or provisions) 33, 35 – 8, 84, 165 – 7, 180, 182, 185, 200 competition 12, 14, 16, 119; product market 54 complementarity 112; theoretical 56 confidentiality: breach of 33 conglomerate era 5, 71 conglomerate mergers (or deals) 3, 10, 13, 71, 72, 73, 76, 82 – 4 consolidation 4, 5, 6, 92 constraint: financing 12; liquidity 205 content analysis 61 contingency 43, 55, 151 contract: agency 168; business 18; compensation 18, 25, 28, 31, 32, 34, 36 – 7, 43, 57, 92, 169 – 70, 200; employment 33, 80, 84, 92, 97, 102, 108, 111, 117 – 18, 122, 178 – 9, 184, 194, 200; executive 57, 171; incentive 27 Cooper Industries 34 corporate failure 6 corporate governance system (or regime) 17, 25, 28, 31, 54, 130, 191 – 2 Corus Group 7 Covidien plc 7 credit crunch 8, 25; see also crisis

crisis: financial 7, 26, 31, 34; see also credit crunch criticism: public 26, 37 cross-border deals (or acquisitions) 3, 10, 12, 14, 49, 51, 53, 148, 155, 156, 163, 183, 187, 202, 204, 205, 207, 208, 214 cross-study comparisons (or variability) 58, 64, 76, 83, 87, 90, 118, 130, 147, 157, 189, 190 Czech Republic 27 Davis Polk & Wardell 4 deal financing 10, 11, 102, 166, 168 – 70, 200 debate 3, 16, 25 – 6, 61, 72, 148 – 9, 151, 157, 165 debt 4, 5, 11, 212 decisions: envy-driven 156; investment 71, 74, 85, 98, 104, 184; merger-related 6, 15, 64, 71, 75, 84 – 8, 90 – 3, 107 – 8, 151 – 2, 167; pay-related 25, 31, 36, 55, 153, 168 default 26, 76 deferred compensation 83, 159 deferred stock 77, 86, 93, 104, 110 delta 75, 76, 79 – 80, 83, 89, 94 – 6, 178, 183 Denmark 26, 29 Daimler-Benz AG 29, 204 directors: board of 17, 18, 25, 28 – 9, 31, 33, 36, 40, 91, 124, 130, 138, 148, 152, 154 – 5, 167, 185, 193, 194, 219 disciplinary takeover 15 disclosure 9, 29, 30, 31, 55, 154, 185, 193, 209 Discovery Communications 34 disincentive 88, 157, 167 – 9, 171, 199, 203 dismissal 150, 157, 164 – 5, 168 – 9, 185, 212 diversification 63, 71 – 3, 75 – 8, 80, 82, 183, 191; corporate 64, 71, 76, 83, 183, 203; global 208; industrial 13, 72 – 3, 75 – 6, 82 divestiture 90, 153 dividends 39 Dodd-Frank Act 31 domestic deals (or acquisitions) 3, 6, 10, 12, 14, 51, 156, 161, 163, 187, 214

Index  223 downturn 6; see also crisis dual-class firms 85 duality 28, 29, 40, 152, 161, 192, 202 Dubai Ports World 7 DirecTV LLC 7 earnings 32, 40, 86 Eaton Corporation 34 EBC 87 – 92, 106 – 8, 131, 184, 187 economic recovery 3 effect: adverse 77 – 8; announcement 88; competition 119; “contagion” 212; detrimental 14, 91; disciplinary 16, 120, 123, 149, 185, 208; experience 5, 13, 51; fixed 188; incentive 82, 85, 90, 92, 102, 107 – 9, 182, 199, 212; learning 13; moderating 202; motivational 38; network 53; risk-taking 41, 74, 119, 154; scale 54; synergistic 13; temporality 63 eligibility assessment 59 – 60 emerging economy 15, 207, 220 empire building 16, 17, 150 employment agreement 32, 33, 36 – 8, 57, 84, 166, 200; see also contract endogeneity 83, 187 – 9 Enron 6, 31 entrenchment: managerial 16 – 18, 108, 120 – 1, 123 – 4, 152 – 4, 163, 201, 206 – 7 Equilar 26 Europe 6, 8, 10, 11, 12, 26, 28, 31, 34, 48, 220 EU Shareholders’ Rights Directive 31 events: adverse 33, 41, 57; corporate 154, 168; exogenous 41; high-profile 3, 4, 42; M&A 72, 85, 98, 139, 186, 208, 209; serial acquisition 88; turn of 31, 41, 192; unforeseeable 33; various 6 event study methodology 92 event window 87, 92, 98, 200 expansion 8, 9, 15, 25, 156, Facebook Inc. 7 failure 4, 6, 17, 26, 29, 48, 202, 204 fiduciary duty 33, 42 foreign direct investments 30 Forest Laboratories Inc. 7

Fortune Global 500 companies 14 framework: comprehensive 52, 62; conceptual 48, 58, 61, 62, 199, 203; cultural 207; explanatory 55; governance 207; integrative 53; new 31; regulatory 207; theoretical 213 France 27, 29, 31 friendliness 126, 129 Germany 15, 26 – 31, 204 “golden coffins” 32 “golden good-byes” 32 golden parachute 16, 32 – 4, 36 – 7, 57, 59, 84, 117 – 18, 121 – 4, 127, 129 – 42, 166, 179 – 80, 182 – 4, 193, 200 – 2, 209 Goldman Sachs 4 goodwill impairment 153 – 4 Hachigian, Kirk 34 “handcuffs” 34 horizon: career 87, 164; long-term 86, 105, 111; managerial 86, 105, 205; short-term 87, 95, 105, 111; time 25, 32, 40, 86, 105, 121, 201 hostility 6, 8, 15, 16, 51, 126, 128 – 32, 184, 201, 203; see also resistance hubris 9, 14, 51, 107, 189 human capital 42, 43, 54, 119, 211 hypothesis: hubris 14, 107; incentive alignment 108, 121, 137; inefficient management 9; information 9, 123; managerial entrenchment 108, 153; managerial risk-aversion 71 – 4, 77 – 82, 183; managerial welfare 127, 149 – 50; market for corporate control 15; overpayment 11; power-forpremium 138; risk-taking (or risk-seeking) 74, 109; senior management utility 150; synergy 9; wealth transfer 121 illiquidity discount 131 – 2, 134, 136, 141, 179 – 80, 184, 205 incentive alignment 18, 25, 29, 35, 37 – 8, 40, 57, 83, 92, 106 – 8, 121, 124, 132, 139, 155, 185, 199, 201, 208 – 9, 213 income taxation 136, 192

224  Index inequality: pay 26 information 30, 31, 43, 92, 98, 154, 205, 210; leakage of 103; operational 5; objective 200; private 123 informational justice 205 innovation 53, 210, 219; corporate16; quality of 52 institutional investors 152, 156 institutions 28, 191; educational 220; financial 26, 52, 76, 88, 91, 129 insurance 28, 33; liability 84, 96, 102, 108, 109, 111, 178 – 9, 183 – 4, 194; life 32 “insurance against incompetence” 34 interest: conflict of 17 – 18, 55, 72, 85, 192 investor confidence 31 investor protection 28, 29, 214 Japan 7, 28, 29 labor market 38, 55, 119; director 156; managerial 149, 191 – 2 Larry Ellison 26 Latin America 7, 219, 220 legislation 31, 50, 120, 124, 154, 187, 193, 209 – 10, 212; antitakeover 120, 122; disclosure 29 – 30, 55; prudential 91; see also regulation legitimacy 18, 37, 213 leveraged buyouts 5 litigation: shareholder 108 LTIPs 32, 34 – 8, 57, 84 – 6, 93, 95, 104, 107, 110 – 11, 165 – 7, 170, 178 – 80, 182 – 5, 200, 211 – 12 “make whole” payments 32 managerialist orientation 18 manipulation 40 Mannesmann 4 market efficiency 92 media 209 – 10, 212 Medtronic Inc. 7 mega-merger mania 5 merger intensity 8, 13, 148 – 9, 187 merger negotiations 135, 138 – 9, 180, 201 merger programs 88, 160 merger wave 4 – 7, 10, 13, 15, 48, 71, 84, 89, 156, 162, 190, 207 – 8

meta-analysis 42 Microsoft 201 Middle East 7 – 8, 219 – 20 misreporting: financial 202 misrepresentation: accounting 40 moderator 51, 52 monitoring 17, 25, 32, 48, 54, 91, 152, 156, 167, 169, 171, 187, 191 – 2, 202, 204, 212 – 13; external 72, 152, 163, 209; weak 13, 42, 152 monopoly 5, 9 moral hazard 25 Morgan Stanley 4 multitheoretical approach (or research) 43, 213 narcissism 90, 94, 183, 201 nationality 118, 129, 165, 189, 203, 205 Netherlands 31 9/11 attacks 6 nominating committee 155, 162 nonbanks 189 nondomestic targets 155, 207, 208 nonfinancial companies 91, 106, 129, 190 non – in-wave deals 10, 13 North Fork Bank 34 Norway 26, 29, 31 OLS regression 187 – 8 one-tier board 28, 29 opportunistic behavior (or opportunism) 17, 36, 42, 212 Oracle Corporation 26 organic growth 3, 8 overcompensation 26, 56, 127 overconfidence 14, 79, 90, 95, 105, 110, 183 overpayment 11, 50, 108, 113, 126 overvaluation 6, 105 ownership concentration 28, 72 ownership dispersion 29 package: compensation (or pay) 17, 18, 25 – 8, 30 – 2, 35 – 6, 38, 41, 48, 57, 62, 64, 83 – 4, 92, 104, 107 – 8, 118, 120, 128, 132, 135, 147 – 8, 154 – 6, 167, 169, 171, 177, 180, 182, 189, 194, 201, 204 – 8, 210, 213 Pangea Goldfields Inc. 37

Index  225 paradigm 56 pay-at-risk 27 pay for luck 41, 42 pay-for-performance 17, 31, 41, 54, 57, 78, 89, 96, 154, 208 pay gap 155, 161, 163, 165, 180, 183 payment: method (or mode) of 5, 11, 12, 14, 18, 48, 52, 63, 64, 102 – 5, 108 – 10, 113, 147, 165 – 6, 169 – 70, 188 – 9, 191, 203, 212 pay slice 42, 81, 84, 89 – 90, 96, 178, 183 Pendaries Petroleum Ltd. 37 Peninsular & Oriental Steam Navigation Co. 7 pension funds (or holdings) 28, 84, 87, 97, 178, 182, 194 perquisites 32, 42 personality 51, 90, 105, 183 poison pill 16 political perspective 17, 25, 36, 153 portfolio 75, 82, 87, 191; incentive 86, 105, 201; investment 72; managerial 74; option 75, 80 power 17, 25, 36, 42, 56, 81, 90, 121, 151 – 3, 164, 185, 190, 192, 206, 211; board 209; de facto 17; managerial 18, 26, 42, 43, 123, 131, 136, 138, 148, 153 – 6, 160, 162, 164, 187; market 51; monopoly 5, 9 premium: acquisition (or control) 6, 9, 11, 14, 16, 18, 48, 51, 63, 64, 102 – 3, 106 – 13, 123, 126, 130, 132, 135 – 42, 147, 152, 165 – 70, 184 – 5, 188 – 9, 200 – 1, 203 – 4, 206 – 7, 211; compensation (or pay) 42, 43, 89, 96, 149, 157, 159, 164, 178, 180; exaggerated 10, 14 principal – agent conflicts 56, 72, 74, 85, 167 – 8 private/public status 12, 107, 109, 200, 203 proxy statement 30, 34, 37, 154 Qatar 8, 15 quasi-experimental design 147 “quiet revolution” 32

rationale 36, 37, 42, 72, 121, 156, 182; efficiency 5, 9, 139; horizonrelated 105; seniority-related 29; value creation 18, 42 real estate investment trusts 16 recession: financial 3, 8; see also crisis, downturn, credit crunch reforms: governance 6, 31 – 3, 214; tax 55 regime: “comply or explain” 30, 193; governance 31, 130, 191 – 3, 207; “principles-based” 30; “rules-based” 30 regulation: accounting 35; antitakeover 16, 191, 193; codetermination 29; Delaware 120; disclosure 30, 185; industry 6; national 29; “say on pay” 209; SEC 154, 209; statutory 91; takeover 130, 136, 191; see also legislation reputation 210 resistance 127 – 9, 131 – 2, 203; see also hostility restricted stock 27, 34, 35, 37, 86 – 7, 93, 95, 105, 111, 147 – 8, 152, 154 – 5, 163 – 4, 180, 182, 185, 190, 193, 201, 211 return on assets 13, 55, 155, 165 return on equity 52, 55, 165, 188 review 10, 14, 48 – 50, 52 – 61, 71, 76 – 7, 92 – 3, 109 – 10, 128, 132 – 3, 135, 139 – 40, 157 – 8, 170, 189, 210; evidence-based 41; literature 51 – 2, 58, 63 – 4, 147 “rewards for failure” 34 risk: equity 75, 91; firm-specific 82; idiosyncratic 75 – 6, 80, 83; systematic 75 – 6, 80, 83; systemic 52 risk aversion 38, 71 – 4, 77 – 82, 183 risk taking 38, 39, 58, 63 – 4, 71, 75 – 7, 80, 168, 187, 199 robustness tests 119 Russia 7, 15 salary 27 – 8, 32 – 3, 37, 55, 78, 105, 108, 111, 119, 120, 122, 126 – 8, 133, 137, 140, 149, 151 – 3, 155, 158 – 60, 162, 164 – 6, 170, 179 – 80, 182, 185 Sarbanes-Oxley Act 6, 31 “say on pay” 31, 33, 55, 124, 209

226  Index Scandinavia 28 scapegoating 168 – 9, 192 scrutiny 126, 203, 210, 214 SEC 30, 154, 209 sector: banking 10, 91 – 2, 129, 151, 208; biotechnological 8; electronics 74, 79, 96; financial 49, 52; healthcare 8, 50, 55; industrial 51, 74, 76, 189, 199; nonfinancial 129, 190; utilities 8 security 77, 132; financial 121, 123, 132, 200; job-related 33, 84; pay-related 167 self-confidence 14, 107 self-interest 51, 132, 137, 139, 157, 211 sensitivity: equity wealth 83, 89, 94, 95, 184; pay-for-performance 41 – 2, 55, 74 – 5, 96, 154, 156, 163, 180, 208 – 9; pay-risk 75, 190, 202; stock option 75, 79, 80, 96, 183 serial acquisition 88 severance provisions 32 – 4, 36 – 8, 57, 80, 84, 92, 97, 108, 111, 135, 138, 142, 166, 180, 184, 194, 200 shared governance 138, 141 share repurchases 39 Shearman & Sterling 4 Simon Property Group 34 single-class firms 85 Spain 26, 27, 28, 31 specialization 5, 13 staggered board 16, 120 stakeholders 3, 18, 36, 41, 56, 213 stock options: exercisable 74, 81, 86 – 9, 91, 93, 95, 97, 102, 104, 107 – 9, 111 – 12, 178 – 9, 182 – 3; exercised 39 – 40, 105, 111; in-the-money 75, 82, 86, 95, 102, 104 – 5, 107, 110 – 11, 178, 182 – 3; unexercisable 74, 88 – 9, 97, 102, 104 – 5, 108 – 9, 111 – 12, 179; unexercised 86, 93, 104 – 5, 110 – 11; unscheduled 135, 138 – 9, 141, 179, 182, 184, 202; vested 79, 82, 86, 95, 105, 108 – 11, 178 – 9, 182, 201 stock ownership 17, 38 – 41, 55, 74, 77 – 9, 83 – 5, 87 – 90, 93 – 7, 102 – 4, 107, 110 – 12, 122, 127 – 30, 132 – 6, 139 – 41, 150, 153, 155, 158 – 9, 161 – 2, 165,

167, 169 – 70, 178 – 80, 182 – 85, 187, 193, 199, 200, 211 stock price 12, 34, 35, 39, 40, 42, 75, 79 – 80, 85 – 90, 92, 94 – 6, 103, 105 – 6, 109, 151, 183, 190, 211 strategy 32, 51, 52, 55: “asset churning” 153; firm 32; growth 3; inversion 8; merger 89; mixed 153; popular 18 structure: board 28, 202, 213; compensation 18, 28, 30 – 2, 56, 58, 62, 64, 71, 84, 93 – 4, 96, 110 – 12, 120, 126, 128, 129, 132 – 4, 140 – 2, 157 – 64, 170 – 1, 183, 186 – 7, 204 – 6; corporate governance 11, 40, 42, 152, 157, 169, 185 – 6, 191, 207, 212; cost 9; financial 91; industry 5; market 5; ownership 71 – 3, 76 – 8, 80, 82 – 3, 130, 148, 151, 185, 191 substitution 212 Sweden 26, 27, 29, 31 Switzerland 26, 27, 28 symbolic management 36, 37, 42, 43, 213 synergy 9, 11, 53, 206, 207, 210 Taiwan 74, 79, 96, 178, 181, 191 takeover defenses (or deterrents) 5, 12, 16, 51, 121, 124, 206 Tata Steel 7 taxes 8, 166, 192 technique: instrumental variable 187; keyword search 59; metaanalytic 10; quantitative 214 threat of takeover 16, 63, 64, 117 – 20, 122 – 3, 184, 187, 193, 209 theoretical tension 17 theory 43, 54, 105, 209, 211; agency 17, 25, 38, 41, 55, 56, 78, 82, 85 – 6, 167, 213; control maintenance 104; envy-based 89; equity 213; financial 52; human capital 42; incentive alignment 155; managerial power 42, 155; stewardship 213 Time Warner 4, 6 timing 13, 39, 82, 121, 123, 201; acquisition 13 too big to fail 52

Index  227 Toronto Stock Exchange 30 transparency 30, 154; information 31, 207; lack of 30 turmoil: economic 7; financial 26 turnover 12, 16, 51, 55, 157, 166, 170, 186, 202, 208 UK 8, 14, 26, 27, 28, 30, 31, 88, 95, 148, 149, 150, 152 – 3, 155 – 6, 159 – 66, 170, 178, 180 – 1, 188, 191 – 3, 203, 207 Ultra Petroleum Corporation 37 uncertainty 6, 36, 37, 40, 51, 57, 84, 169; job 57; target valuation 9 underpayment 126 underperformance 10, 14 United Arab Emirates 8 USA 4 – 6, 15, 26 – 31, 50, 73, 85, 91, 118, 124, 136, 155, 178 – 81, 191, 193, 204, 209 utility maximizers 25 value: book 117; economic 98, 200; financial 7, 190; lagged 187 – 8; market 11, 15, 96, 103, 108, 109, 111, 117, 151, 156;

marketable 39, 90; monetary 139, 166, 202 value-destroying deals 14, 15, 17, 25, 86, 89, 91, 150, 153, 157, 169, 185 variable: dependent 58, 118, 187, 188; dichotomous 102; dummy 102, 149; independent 58; omitted 189 vega 75 – 6, 79 – 80, 83, 178, 183 vigilance 124, 171, 209 Vodafone AirTouch 4 volatility: stock price 40; stock return 75, 79 – 80, 183 war in Iraq 6 wealth destruction 10 wealth maximization 10, 15, 18, 36, 83, 132, 168, 211 WhatsApp Inc. 7 winner’s curse 14 WorldCom 6 Yahoo 201 Zimmer Holdings Inc. 7