Entrenchment through Discretion over M&A Contractual Provisions

Abstract

We apply the idea that managers of acquiring firms intend to entrench themselves through M&A in the sense of Shleifer and Vishny’s (1989) entrenchment strategy through manager-specific investments. We propose that these managers implement bidder termination fee provisions in M&A contracts to make it costly for acquirers’ shareholders to disapprove the deal after announcement and to prevent the manager from such entrenchment through M&A. In such cases, managers announce M&A deals before getting dis-missed after bad performance. Consistently, we find that the market reacts on average negatively to deal announcements if bidder termination fees are high and if the likelihood of imminent forced CEO turnover is high. For these firms we detect significant increases in their level of entrenchment post offer announce-ment. This finding is economically significant and is more pronounced if the CEO’s motivation for entrench-ment is high, subordinated managers are not motivated to intervene, directors are busy, and the deal is characterized as a diversifying takeover. The results suggest that small- to moderate-sized bidder termina-tion fees might serve as efficiency enhancing contractual devices, whereas excessively high fees destroy shareholder value and possibly signal agency problems.