Free Cash Flow, Golden Parachutes, and the Discipline of Takeover Activity

Abstract

We conjecture that golden parachutes are initiated when the agency cost of free cash flow is most severe. We examine the relation between golden parachutes and investment levels in firms that have been successfully acquired. Our results support these three conclusions. First, target firms overinvest prior to an acquisition when golden parachutes are present. Second, the acquirers of targets with golden parachutes reduce investment subsequent to the takeover. Third, the reversal in capital investment by the combined firm is correlated with the magnitude of the target's pre-acquisition overinvestment. The latter findings indicate the takeover acts as a disciplining mechanism with the acquirer reversing the target overinvestment subsequent to the acquisition Copyright Blackwell Publishers Ltd 2000.

Are Golden Parachutes an Optimal Contracting Response or Evidence of Managerial Entrenchment?: Evidence from Successful Takeovers

“…predictions of the managerial entrenchment theory regarding excess returns to targets, bidders, and bidder/target pairs are all supported by the data. This paper provides additional evidence consistent with Subramaniam and Daley (2000) who found that takeover targets with GPs over-invest in physical capital in the years preceding a takeover and that after the takeover the investment activity of the combined entity reverses that over-investment. Evidence in these papers are consistent with GPs reflecting severe cases of managerial entrenchment.…”

“…This is consistent with managers using their power to entrench themselves. Subramaniam and Daley (2000) provide evidence that takeover targets with GPs overinvest in physical capital in the years preceding a takeover and that after the takeover the investment activity of the combined entity reverses that over-investment. This is consistent with GPs reflecting severe cases of managerial entrenchment.…”

“…For a review of this literature see Jarrel, Brickley and Netter (1988). 2 For example, see Subramaniam and Daley (2000), Hall and Anderson (1997), Shemanske and Khan (1995), Born, Trahan and Faria (1993), Sinha (1992), Berkovitch and Khanna (1991), Wade, O'Reilly and Chandratat (1990), Harris (1990), Singh and Harrianto (1989), Cochran, Wood and Jones (1985) and Lambert and Larcker (1985). 3 While it has long been common in the US mergers and acquisition scene Raghavan and Sims (2000) report that GPs for top management of targets has recently emerged in a number of European takeovers.…”

When Target CEOs Contract with Acquirers: Evidence from Bank Mergers and Acquisitions

“…The golden parachute frequency in our paper is substantially higher than that found in other 13 studies (Cotter and Zenner, 1994;Subramaniam and Daley, 2000;and Lefanowicz, Robinson, and Smith, 2000).…”

The implementation of special attributes of CEO compensation contracts around M&A transactions

“…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). These clauses do not require shareholder approval to be adopted, but necessitate only an agreement between the manager and the board of directors (Subramaniam and Daley, 2000). Among the most cited reasons for the adoption of golden parachutes are: the attraction and retention of key executives, keeping the management team intact, and deterring a hostile takeover by making the transaction more expensive for bidders (Henderson, 1997).…”