SHAREHOLDER VOTING RIGHTS AND MUTUAL FUND TRADING IN TAKEOVERS

Jim Hsieh (George Mason)Qinghai Wang (Georgia Tech)

NTU, 12/11/2008

Corporations and Shareholders’ Rights Public corporations are like republics: Shareholders

elect directors who in turn manage the firms.

Under the US laws and regulations: Shareholders elect the directors, but have little control over

most of corporate decisions. The board of directors is given the power to manage the

company. The vast majority of corporate policies are made by the board of directors or by the management to whom the board has delegated authority.

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Shareholders and Corporate Governance Mixed evidence on the effectiveness of corporate

governance mechanisms. Board of directors Executive incentive compensation Large shareholders and institutional investors Market for corporate control

Recent scandals highlight failures of corporate governance.

Bebchuk: The case for increasing shareholder power. Bainbridge: The case for limiting shareholder rights.

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Corporations and Shareholder Voting Rights While shareholder voting rights are an integral part of

corporate governance, shareholder control through voting is somewhat limited.

Shareholders have the rights to: Elect directors Approve extraordinary items, e.g., amendments of bylaws,

voluntary dissolution, asset sales, ... etc.

But, strangely, shareholder voting rights are not required in determining some of the important corporate decisions.

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Surprisingly, Not All Takeovers Need to Be Approved by Acquirer Shareholders

M&As are one of the largest corporate investments. M&As affect shareholder wealth:

Numerous studies have shown that many takeovers destroy shareholder value.○ Travlos (1987), Bradley et al. (1988), Fuller et al. (2002), Moeller et

al. (2004).

M&As are riddled with agency problems Acquiring-firm managers are rewarded thru takeovers even

though shareholders are not.○ Grinstein & Hribar (2004), Harford & Li (2007)

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Shareholder Voting Rights in M&As Shareholder voting rights exist but differ:

All M&As have to be approved by target shareholders. Acquirer shareholder voting rights can be bypassed.

The 20% Rule: No Vote If newly issued shares to finance the deal < 20%.

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Objectives of This Study

Do shareholders value their voting rights?

Whether and how do shareholder voting rights and trading from mutual fund investors exert influence during the takeover process?

Probability of deal completion

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Valuable Voting Right Hypothesis

If shareholders value their voting rights, we should observe a positive relation between their (net) trading and the presence of voting rights in acquisitions.

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Why Shareholders Value Their Voting Rights? Shareholders (especially institutional investors) can

exercise their voting rights to monitor managerial decision-making.

Voting from institutional investors is effective in constraining managerial behavior in some situations. Brickley et al. (1994); Bethel & Gillan (2002)

Shareholder proposals result in positive changes in firm value. Black (1992); Gordon & Pound (1993); Pozen (1994)

Firms adopting equity-based compensation plans without shareholder approval tend to suffer from LT poor performance. Balachandran et al. (2004)

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Why Shareholders Might Not Care About Voting Rights?

Shareholder proposals have no impact on firm value. Karpoff et al. (1996)

Shareholders’ votes on electing directors only result in marginal improvement in firm performance. Cai et al. (2008)

Burch et al. (2004): For mergers, if shareholders do vote, they tend to vote for the pending offers.

Conflicts of interest among shareholders:○ Davis & Kim (2006): business ties○ Matvos & Ostrovsky (2008): cross-holding

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Why Shareholders Might Not Care About Voting Rights? Because they have another way of expressing their

opinions – Exit by selling their shares.

Maug (1998) and Kahn & Winton (1998): Monitoring vs. Trading

Parrino et al. (2003) provide the first evidence of institutional investors “voting with their feet”.

Admati & Pfleiderer (2008): “Wall Street walk” is a credible threat of exit.

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Sample Selection

Sample of acquisitions: from SDC, 1990-2005 Classify acquisitions with and without shareholder

voting rights: Search Form 8-K (Merger Agreement) and S-4 (Registration

Statement), public announcements, and any public information Mutual fund holdings from Thomson Financial and

CRSP Mutual Fund Database Only actively managed U.S. domestic equity funds No –

Sector funds, international funds, bond funds, index funds

Total 2,090 deals

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Measuring Mutual Fund Trading

Raw Trade = (Buy – Sell)/ShrsOut Net Trade = Raw Trade – Normal Trade

Normal Trade is estimated using two approaches: Portfolio approach: 27 characteristic-based portfolios by size,

market-to-book, and momentum (3x3x3) Historical trading approach: Mean of mutual fund trading in the

past two quarters prior to the announcement quarter

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Mutual Fund Trading Patterns Before Announcement -- Table 2, Panel B.2

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  Cash No-Vote Vote   Difference Between

(N=526) (N=462) (N=1,102) Two Groups

  [1] [2] [3]   [3] - [1] [3] - [2]

Raw Trades 0.389*** 0.565*** 0.483*** 0.094 -0.082

[0.103]*** [0.153]*** [0.165]*** [0.062]* [0.012]

Net Trades 0.202** 0.321*** 0.241*** 0.039 -0.080

[0.030] [0.019] [0.010]*** [-0.020] [-0.009]

* All figures are in percentage.

Mutual Fund Trading Patterns During Announcement Quarter -- Table 2, Panel B.1

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  Cash No-Vote Vote   Difference Between

(N=526) (N=462) (N=1,102) Two Groups  [1] [2] [3]   [3] - [1] [3] - [2]Raw Trades 0.394*** 0.036 0.427*** 0.033 0.391**

[0.103]*** [0.059] [0.109]*** [0.006] [0.050]**Net Trades 0.245* -0.175 0.214** -0.031 0.389**  [0.075]* [-0.041] [0.061]**   [-0.014] [0.102]**

* All figures are in percentage.

Test The Valuable Voting Right Hypothesis – Table 4

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Dependent Variable: Mutual fund trades from the quarter ending before deal announcement to the quarter ending after announcementSample: All Deals Sample: Stock and Mixed Deals Only

Raw Trades Net Trades Raw Trades Net Trades Raw Trades Net Trades Raw Trades Net Trades  (1) (2) (3) (4) (5) (6) (7) (8)

Voting Rights 0.442 0.451 0.659 0.673 0.400 0.418 0.555 0.572(0.020) (0.016) (0.030) (0.025) (0.039) (0.029) (0.077) (0.065)

Lag(Fund Holdings) -0.042 -0.036 -0.060 -0.054 -0.048 -0.041 -0.073 -0.066(0.000) (0.002) (0.000) (0.001) (0.001) (0.002) (0.000) (0.001)

Lag(Fund Trades) 0.099 0.045 0.018 -0.008 0.089 0.035 -0.002 -0.030(0.109) (0.456) (0.825) (0.917) (0.212) (0.607) (0.982) (0.731)

* P-values are in parentheses.* Other control variables are not reported here.

Momentum 1.519 1.195 1.398 1.097 (0.000) (0.000) (0.000) (0.000)

Year Fixed Effect Yes Yes Yes Yes Yes Yes Yes YesNobs. 2090 2090 1307 1307 1564 1564 942 942Adjusted R2 0.013 0.010 0.053 0.039 0.019 0.016 0.054 0.043

Test The Valuable Voting Right Hypothesis – Table 6- Do Mutual Funds Trade Differently in Good vs. Bad Deals?

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* P-values are in parentheses.* Other control variables are not reported here.

 

Dependent Variable: Mutual fund trades from the quarter ending before deal announcement to the quarter ending before deal resolution

Offer Quality is Defined by Acquirer Returns Offer Quality is Defined by Synergistic Gains

Bad Deals Good Deals Bad Deals Good DealsRaw Trades Net Trades Raw Trades Net Trades Raw Trades Net Trades Raw Trades Net Trades

  (1) (2) (3) (4) (5) (6) (7) (8)

Voting Rights 0.843 0.833 0.396 0.342 0.784 0.789 0.561 0.527(0.022) (0.022) (0.411) (0.473) (0.076) (0.071) (0.155) (0.173)

Lag(Fund Holdings) -0.059 -0.054 -0.061 -0.055 -0.068 -0.062 -0.048 -0.044(0.004) (0.008) (0.002) (0.006) (0.007) (0.014) (0.008) (0.013)

Lag(Fund Trades) -0.002 -0.027 -0.016 -0.033 -0.064 -0.091 0.036 0.026(0.985) (0.775) (0.863) (0.740) (0.621) (0.463) (0.586) (0.715)

Momentum 1.579 1.310 0.918 0.541 1.831 1.552 0.830 0.485 (0.000) (0.000) (0.007) (0.106) (0.000) (0.000) (0.001) (0.043)

Year Fixed Effect Yes Yes Yes Yes Yes Yes Yes YesNobs. 826 826 481 481 554 554 753 753

Adjusted R2 0.056 0.047 0.043 0.019 0.063 0.052 0.039 0.027

Joint Effect of Shareholder Voting Rights and Mutual Fund Trading on Probability of Success – Table 8

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          Subsamples by Offer QualitySample: All Takeover Transactions Bad Deals Good Deals

  (1) (2) (3) (4) (5) (6) (7) (8)

Voting Rights -0.533 -0.534 -0.051 -0.050 -0.586 -0.588 -0.422 -0.431(0.008) (0.009) (0.002) (0.002) (0.021) (0.021) (0.231) (0.223)

Raw Trades 0.109 0.010 0.118 0.088 (0.000) (0.002) (0.000) (0.007)

Net Trades 0.106 0.009 0.121 0.075 (0.000) (0.003) (0.000) (0.019)

(Voting Rights)x(Raw Trades) 0.002(0.560)

(Voting Rights)x(Net Trades) 0.003(0.532)

Nobs. 2090 2090 2090 2090 1339 1339 751 751

Pseudo R2 0.284 0.283 0.304 0.304 0.307 0.307 0.257 0.256

Joint Effect of Shareholder Voting Rights and Mutual Fund Trading on Probability of Success – Summary Both shareholder voting rights and mutual fund trading

significantly affect the probability of deal completion. Deal success is influenced by mutual funds’ granted rights to

“vote with their ballots” and their decisions to “vote with their feet”.

Results suggest that mutual funds’ decisions to vote with their feet are … Critical if shareholders do not have the rights to vote on

proposed deals. Less important if shareholders have the voting rights.

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Robustness Checks on the Relationship between Shareholder Voting Rights and Mutual Fund Trading1) Use a variety of remedies to address two forms of

endogeneity: reverse causality and omitted variables.2) Control for other corporate governance mechanisms.3) Use a new measure of normal mutual fund trading.4) Control for mutual funds’ cross-holding effect.5) Control for the impact of merger arbitrage on measuring

mutual fund trading.

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Conclusions: Do Mutual Fund Managers Value Shareholder Voting Rights?

Our results suggest: They care. Our results support the valuable voting right hypothesis:

Mutual fund trading is significantly higher in deals with shareholder voting rights.

The difference in fund trading between deals with and without voting rights is even more striking when the transactions appear to reduce shareholder wealth.

We also conduct the first study that investigates the interaction between “voting with ballots” and “voting with feet” and their joint effect on the probability of deal completion.

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