Antitakeover Amendments, Ownership Structure, and Managerial Decisions: Effects on R&D Expenditure * Ali R. Malekzadeh St. Cloud State University Victoria B. McWilliams Villanova University 610 519 4313 (contact author) Nilanjan Sen Arizona State University West Abstract This study provides evidence that antitakeover amendments affect managerial behavior and provide long–term implications for the firm. Our study links the change in R&D expenditure after amendment adoption to board composition and ownership structure. Results are consistent with the hypothesis that the amendments provide an environment that allows managers to focus on long–term objectives. R&D expenditures significantly increased in the period subsequent to amendment adoption. Additionally, higher levels of R&D subsequent to amendment adoption are positively related to increasing levels of board representation as well as share ownership by directors who have some affiliation with the firm. * For further information, please contact: Victoria B. McWilliams; Chair, Department of Finance; College of Commerce and Finance; Villanova University; 800 Lancaster Ave.; Villanova, PA 19085; (610) 519–7395, (610) 519–6881 (fax), MCWILLIAM@CF_FACULTY.VILL.EDU (e–mail). We are grateful to Steve Ferris, Tom McWilliams, Marty Meznar, Afsaneh Nahavandi, and participants at workshops held at Drexel University and Villanova University for comments on earlier drafts of this manuscript.
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Antitakeover Amendments, Ownership Structure, and Managerial Decisions:
Effects on R&D Expenditure*
Ali R. MalekzadehSt. Cloud State University
Victoria B. McWilliamsVillanova University
610 519 4313 (contact author)
Nilanjan SenArizona State University West
Abstract
This study provides evidence that antitakeover amendments affect managerial behavior
and provide long–term implications for the firm. Our study links the change in R&D
expenditure after amendment adoption to board composition and ownership structure.
Results are consistent with the hypothesis that the amendments provide an environment
that allows managers to focus on long–term objectives. R&D expenditures significantly
increased in the period subsequent to amendment adoption. Additionally, higher levels of
R&D subsequent to amendment adoption are positively related to increasing levels of
board representation as well as share ownership by directors who have some affiliation
with the firm.
* For further information, please contact: Victoria B. McWilliams; Chair, Department of Finance;College of Commerce and Finance; Villanova University; 800 Lancaster Ave.; Villanova, PA 19085;(610) 519–7395, (610) 519–6881 (fax), MCWILLIAM@CF_FACULTY.VILL.EDU (e–mail). We aregrateful to Steve Ferris, Tom McWilliams, Marty Meznar, Afsaneh Nahavandi, and participants atworkshops held at Drexel University and Villanova University for comments on earlier drafts of thismanuscript.
Antitakeover Amendments, Ownership Structure, and Managerial Decisions:
Effects on R&D Expenditure
I. Introduction
The adoption of antitakeover amendments has been controversial leading to arguments
opposed to and in favor of the amendments. Opponents of the amendments argue that
they help to entrench management, allowing target managers to successfully prevent
takeovers that could benefit shareholders. Amendment proponents suggest that the
amendments increase incumbent manager’s bargaining power to elicit higher bids for the
target firm’s shares (for example see DeAngelo and Rice, 1983 and Linn and McConnell,
1983). In addition, antitakeover amendments may also contribute to optimal managerial
contracting. Knoeber (1986) argues that deferred compensation is a crucial component of
optimal managerial contracts since, as time passes, the firm has better information about
actual managerial performance. In hostile takeovers, incumbent managers may lose
outstanding deferred compensation due to subsequent firing or the re–writing of contracts.
Hostile takeovers put high performing incumbent managers entitled to deferred
compensation at risk of losing deferred claims. Antitakeover amendments allow for more
effective managerial contracting since they protect against hostile takeovers and provide
incentives for managers to pursue long–term strategies.
Several studies try to identify the stock price reaction to the amendments, and attempt
to explain the cross–sectional variation of that reaction (for summaries see Jensen and
Ruback, 1983; Jarrell, Brickley, and Netter, 1988; and McWilliams, 1994). Results of
these studies are mixed, leading to the conclusion that uncertainty remains regarding
whether the amendments are beneficial or detrimental. Although these results are mixed,
several studies demonstrate that the stock price reaction to the amendments is affected by
board composition and ownership stake in the firm (e.g., Jarrell and Poulsen, 1987;
Agrawal and Mandelker, 1990; McWilliams, 1990; McWilliams and Sen, 1997). Our
study moves away from trying to explain the stock price reaction to the amendments, and
instead focuses on trying to understand whether, over time, the amendments affect
managerial behavior and have long-term implications for the firm under an appropriate
governance structure.
Specifically, we seek to determine whether there is a relation between the change in
R&D expenditure subsequent to amendment adoption and the adopting firm’s ownership
structure and board composition. If the amendments do provide an environment
conducive to long–term contracting, as suggested by Knoeber (1986), then after adoption
we should observe managers focusing on longer term, riskier endeavors such as R&D
ventures which have been shown to have the potential for long–term profitability and firm
value enhancement. For example, Ben–Zion (1984) tests whether the firm’s market value
is related to R&D expenditure, and finds a statistically significant positive relation between
the firm’s investment in R&D and market value, and Lichtenberg and Siegel (1991) report
positive returns to R&D investment. Further, Sundaram, John, and John (1996) find a
positive market reaction to R&D spending when the announcing firm’s competitors adopt
a matching strategy. One objective of this study is to determine whether, in the presence
of antitakeover amendments, such focus on the firm’s long–term objectives occurs when
managers hold an increasing ownership stake in the firm and have increased representation
on the board.
Additionally, Stein (1988) develops a theory which suggests that managerial behavior
is affected by the potential of takeover threat. When takeover threats exist, managers may
focus on less profitable short–term projects to increase current profitability at the expense
of more profitable long–term endeavors. Antitakeover amendments, which ostensibly
protect against unwanted takeovers, should provide managers the protection required to
allow them to shift focus to long–term projects and expenditures. Meulbroek, Mitchell,
Mulherin, Netter, and Poulsen (1990) and Pugh, Page, and Jahera (1992) test Stein’s
theory. Meulbroek, et al. report that R&D expenditures decrease after amendment
adoption; however, Pugh, Page, and Jahera conclude that both R&D and capital
expenditures increase subsequent to amendment adoption. Hall and Weinstein (1996) take
a different approach by looking at firms’ actions in periods of financial distress. If U.S.
managers are more myopic than Japanese managers, then, in episodes of financial distress,
U.S. firms would decrease their R&D expenditure more than Japanese firms. However,
Hall and Weinstein find that financial distress causes R&D to fall in both countries by
approximately the same amount.
Our study extends the work of Meulbroek, et al. and Pugh, et al. by linking the change
in R&D expenditure after amendments are adopted to the firm’s ownership structure and
board composition. Knoeber’s (1986) arguments related to antitakeover amendments and
Stein’s (1988) theory about managerial behavior lead us to hypothesize that there is a
relation between the change in R&D expenditures following amendment adoption and the
firm's ownership structure. More specifically, as insider and affiliated outside directors
hold an increasingly high level of the firm’s shares, these directors should have incentives
which are more closely aligned with those of outside shareholders, leading them to take
actions which maximize shareholder wealth (Jensen and Meckling, 1976). One such
action would be increasing R&D expenditures, which is positively related to the firm’s
market value (Ben–Zion, 1984). Therefore, we hypothesize that there is a positive
relation between insider and affiliated outsider directors’ share ownership and the change
in R&D expenditures once the amendments are adopted. Similarly we also expect a
positive relation between the proportion of insider and affiliated outsider directors on the
board and the change in R&D expenditure subsequent to amendment adoption. If the
amendments, due to their protection against hostile takeovers, provide managers the
opportunity to adopt a long–term value maximizing focus, then we should observe an
increase in R&D expenditure once the amendments are in place. This increase should
occur especially when the board is increasingly controlled by individuals who have an
affiliation with the firm, whether as employees or by some other connection (e.g., firm’s
banker), since these individuals have the most to gain from the takeover protection.
Our results suggest that the amendments provide long–term benefits for the firm and
affect managerial incentives. The compositions of the board along with the firm’s
ownership structure affect R&D strategy once antitakeover amendments are adopted.
Results indicate that firms adopting antitakeover amendments significantly increase their
R&D expenditure in subsequent periods. Further, the increase in R&D expenditure is
positively related to the extent of share ownership and representation on the board by
insiders and affiliated outside directors.
The manuscript proceeds with Section II describing the sample and methodology,
while Section III presents test results. Section IV contains concluding remarks.
II. Sample and Methodology
A. Sample
We identify 265 firms that propose antitakeover amendments during the period 1980
through 1990. We focus on three specific amendments whose unambiguous function is to
act as a takeover defense. These amendments are fair price, staggered board, and
supermajority vote amendments. Other types of amendments are not considered in this
study because they may be used for purposes other than defending against takeover. For
example, the authorized issuance of common/preferred stock may be used in the event of a
hostile takeover to establish a poison pill rights offering and, therefore, is categorized as
an antitakeover amendment. However, the authorization may instead be used as a source
of new financing for positive NPV projects, which has nothing to do with fighting an
unwanted takeover attempt.
The sample is constructed from two primary sources. Relevant firms (i.e., those that
propose fair price, staggered board, supermajority vote amendments) are identified from
McWilliams (1990). The second primary source for sample firms is a data base maintained
by IRRC that identifies additional firms, from 1984 through 1990, which adopted fair
price, staggered board, and/or supermajority vote amendments.i The sample includes 90
firms due to the lack of R&D expenditure data for other firms adopting antitakeover
amendments during the 1980 – 1990 time period. Our sample is smaller than the
Meulbroek et al. (1990) sample because we focus on the three amendments described
above due to their unambiguous takeover defense function, while the Meulbroek et al.
sample includes other types of antitakeover amendments.ii
To determine board composition, we use a three–way classification technique
described in Byrd and Hickman (1992) and developed by Baysinger and Butler (1985).
We use information contained in the sample firm’s proxy statement the year of amendment
proposal to identify inside directors, outside affiliated directors, and independent outside
directors. Inside directors are those individuals who are current officers of the firm (i.e.,
current employees) or former employees who are currently retired. A director is classified
as outside affiliated when that individual either is or was associated with the firm in some
capacity (e.g., firm’s legal council, commercial banker, investment banker), but is not an
employee of the firm. Independent outside directors are those individuals who have no
affiliation, past or present, with the firm other than their position on the firm’s board of
directors (e.g., private investors, executives from other firms with no business dealings
with the sample firm).
In addition to the information described above, we collected several other variables for
this study from the sample firms’ proxy statements. Specifically, we identify the proxy
mailing date to verify when the amendments were proposed to shareholders, board share
ownership, share ownership by various groups of directors, and managerial shareholdings.
There are 84 sample firms for which the share ownership information is available.
B. Methodology
Regression analysis is used to determine whether significant relations exist between the
change in R&D expenditure once amendments are adopted and various measures of board
composition and share ownership. These variables include board composition, board
share ownership, managerial (i.e., officers and directors as a group) share ownership, and
Shark Repellents and Managerial Myopia: An Empirical Test, Journal of Political
Economy 98, 1108–1117.
Pugh, W.N., D.E. Page, and J.S. Jahera Jr., 1992, Antitakeover Charter Amendments:
Effects on Corporate Decisions, Journal of Financial Research XV, 57–67.
Stein, J.C., 1988, Takeover Threats and Managerial Myopia, Journal of Political
Economy 96, 61–81.
Sundaram, A.K., T.A. John, and K. John, 1996, An Empirical Analysis of Strategic
Competition and Firm Values: The Case of R&D Competition, Journal of Financial
Economics 40, 459-486.
FOOTNOTESTable 1
Director and Share Ownership Descriptive Statistics The sample reflects firms adopting fair price, staggered board, and supermajority vote amendments from1980 through 1990 for which data are available (N = 84). All variables are reported as a percentage.Managerial share ownership is the percent of shares owned by the firm’s officers and directors.
Variables Mean Minimum MaximumStandardDeviation
Independent Outside Directors 55.2 11.1 88.9 18.2
Affiliated Outside Directors 12.8 0.0 66.7 14.4
Inside Directors 32.0 9.1 77.8 15.6
Inside plus Affiliated Outside Directors 44.8 11.1 88.9 18.2
Board Share Ownership 8.9 0.03 56.5 12.4
Independent Outside Director ShareOwnership 0.9 0.0 12.0 2.2
Affiliated Outside Director ShareOwnership 1.8 0.0 33.0 5.3
Inside Director Share Ownership 6.2 0.0 43.7 11.0
Inside Plus Affiliated Outside DirectorShare Ownership 8.1 0.0 56.5 12.2
Managerial Share Ownership 9.9 0.1 46.6 11.6
Non–director Managerial ShareOwnership
1.0 0.0 13.2 1.8
Table 2R&D Expenditure Changes
The sample reflects firms adopting fair price, staggered board, and supermajority vote amendments from1980 through 1990 for which data are available. R&D expenditure data are available for 90 sample firms.All variables are reported as a percentage. R&D Change is the size– and industry–adjusted percentagechange in R&D expense from one year before to one, two, and three years after amendment adoption. Astandard one–tailed t–test is used to test for a significant increase in the percentage change in the size–and industry–adjusted R&D expenditures after amendment adoption.
VariablesMean
(R&D measurescaled by assets)
t–statisticMean
(R&D measurescaled by sales)
t–statistic
R&D Change (–1, +1) 9.0 2.85* 7.2 1.77**
R&D Change (–1, +2) 11.5 2.58* 9.7 1.52***
R&D Change (–1, +3) 9.1 2.14** 12.8 2.10**
*Significant at 1%; **Significant at 5%; ***Significant at 10%.Table 3
Results of Regression Analysis for Size– and Industry–adjusted Percentage Change in R&D Expense fromthe Year Before to Three Years After (–1, +3)
Amendment AdoptionThe sample reflects 90 firms adopting fair price, staggered board, and supermajority vote amendmentsfrom 1980 through 1990 for which data are available. Independent variables are measures of boardcomposition as a percent of total number of directors. A standard two–tailed t–test is used to test forsignificant coefficient estimates.
Variable Coefficient t–statistic R2
Panel A: R&D measure scaled by assets
Intercept –0.226 –2.27**
Inside Plus Affiliated Outside Directors as a Percentof Total Directors 0.621 3.01* .10
Panel B: R&D measure scaled by sales
Intercept –0.212 –1.27Inside Plus Affiliated Outside Directors as a Percentof Total Directors 0.739 2.13** .05*Significant at 1%; **Significant at 5%.
Table 4Results of Multiple Regression Analysis for Size– and Industry–adjusted Percentage
Change in R&D Expense from One Year Before to Three Years After (–1, +3)Amendment Adoption.
The sample reflects 84 firms adopting fair price, staggered board, and supermajority vote amendmentsfrom 1980 through 1990 for which data are available. Independent variables are measures of shareownership and are measured as a percent of the firm’s total shares outstanding. Managerial shareownership is the percent of shares owned by the firm’s officers and directors. A standard two–tailed t–testis used to test for significant coefficient estimates.
Insider Plus Affiliated Outsider Board Share Ownership
F–statistic 30.81* 15.24* 8.99R2 0.27 0.27 0.31
Table 4 (continued)Results of Multiple Regression Analysis for Size– and Industry–adjusted Percentage
Change in R&D Expense from One Year Before to Three Years After (–1, +3)Amendment Adoption.
The sample reflects 84 firms adopting fair price, staggered board, and supermajority vote amendmentsfrom 1980 through 1990 for which data are available. Independent variables are measures of shareownership and are measured as a percent of the firm’s total shares outstanding. Managerial shareownership is the percent of shares owned by the firm’s officers and directors. A standard two–tailed t–testis used to test for significant coefficient estimates.
Insider Plus Affiliated Outsider Board Share Ownership
F–statistic 6.99* 4.37*
R2 0.07 0.09*Significant at 1%; **Significant at 5%; ***Significant at 10%.
Table 5Results of Multiple Regression Analysis for Size– and Industry–adjusted Change in R&D Expense fromthe Year Before to Three Years After Amendment Adoption (–1, +3) Based on Board Composition and
Per–capita Share Ownership.The sample reflects 84 firms adopting fair price, staggered board, and supermajority vote amendmentsfrom 1980 through 1990 for which data are available. Independent variables are measures of boardcomposition as a percent of total number of directors along with per–capita share ownership. A standardtwo–tailed t–test is used to test for significant coefficient estimates.
Variables Model 1R&D measure
scaled by assets
Intercept –0.270(–2.67)*
Inside Plus Affiliated Outside Directors as a Percent of Total Directors 0.616(3.03)*
Per–capita Insider Plus Affiliated Outsider Board Share Ownership 2.372(1.87)***
F–statistic 6.40*
R2 0.14*Significant at 1%; **Significant at 5%; ***Significant at 10%.
i We are grateful to parties at the New York Stock Exchange; Kidder, Peabody, and Co.;
and IRRC for making these data available to us.
iiThe same observation applies to our sample as it relates to Pugh, Page, and Jahera (1992)
since they take their sample from Meulbroek et al.
iiiThe four–year interval, measured as (–1, +3), was chosen as the dependent variable in the
regression models presented in Tables 3, 4, and 5 because we felt that the longest interval
reflected the cumulative effect of the amendments on changes in R&D expenses.
However, regression results using the other two intervals reported in Table 2 are not
qualitatively different from the ones reported for the (–1, +3) interval and are available on
request.
ivOur findings and the findings of Pugh, et al. are inconsistent with results reported by
Meulbroek, et al. (1990). Pugh, Page, and Jahera construct their sample from the same
sample used by Meulbroek, et al., and indicate that there are differences in sample sizes
between the their study and Meulbroek, et al. because, for example, Meulbroek, et al.
include insignificant observations (Compustat code .0008) in their sample. However,
when Pugh, et al. attempt to replicate the Meulbroek, et al. sample, they are still unable to
reproduce the results reported in Meulbroek, et al.
vThe regression results for the analysis using the percentage of independent outside
directors as the independent variable are not reported since this percentage is a linear
function of the percentage of inside plus affiliated outside directors on the board and,
therefore, contains the same information as the regressions reported in Table 3.