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Director Compensation Incentives and Acquisition Outcomes

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Corporate Board of Directors

Abstract

The principal objective of this chapter is to investigate the relation between director compensation structure and shareholder interests in the context of acquisitions. Our evidence suggests that acquirer firms that compensate their directors with a higher proportion of incentive-based compensation have significantly higher stock returns around the announcement. An increase in director equity-based pay results in a lower probability of value-destroying acquisitions and a lower acquisition premium for targets. We further find that acquirers with higher equity-based pay exhibit greater improvements in stock price and operating performance following acquisitions.

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Notes

  1. 1.

    We note that all values are expressed in constant 2010 dollars.

  2. 2.

    CEOs with longer tenure.

  3. 3.

    Harford and Li (2007) provide evidence that bidding firm CEOs are rewarded with substantial new grants of stock and options after acquisitions. This flow of new grants may offset the negative effect of poor merged-firm stock performance on the CEO’s pre-acquisition portfolio and reduce the sensitivity of his/her compensation and wealth to negative stock performance.

  4. 4.

    The acquisition premium is defined as the ratio of the final offer price to the target share price four weeks prior to the acquisition announcement, minus one.

  5. 5.

    One might suppose that inside (or employee) directors are paid for their service on the board. Nevertheless, this compensation is not separately disclosed and is presumably included in their executive pay and therefore unobservable (Fedaseyeu et al. 2013). For convenience purposes, we use the term “director compensation ” to refer to outside (or non-employee) director compensation .

  6. 6.

    As modified by Merton (1973) to adjust dividend payouts.

  7. 7.

    We require such deals to meet the following criteria: (a) the transaction is completed; (b) the deal value is greater than $1 million; (c) the acquirer owns at least 50% of the target company after the transaction; (d) the acquirer has director compensation data available from the ExecuComp database one year prior to the acquisition announcement. Applying these criteria, we end up with a sample of 3187 acquisitions involving 1013 unique acquirers.

  8. 8.

    Please refer to the subsection 3.5.2 (Chapter 3) for more details on this index.

  9. 9.

    The third column of Table 4.3 also shows that director cash compensation is positively and significantly related to our proxies for firm performance . Thus, our results do not completely refute the hypothesis of a positive association between director pay and firm performance .

  10. 10.

    CEO tenure is frequently used to proxy for entrenchment (see Berger et al. 1997, among others).

  11. 11.

    “Busy Board” is a dummy variable that takes the value of one when the majority of independent directors hold three or more directorships in the S&P 1500 universe of firms, and zero otherwise.

  12. 12.

    Given that the announcement dates provided by the SDC database are not always accurate, we follow Cai and Sevilir (2012) and Masulis et al. (2007), and use a five-day window centered on the announcement date to estimate abnormal announcement returns. Indeed, using a random sample of 500 acquisitions announced from 1990 to 2000, Fuller et al. (2002) find that the announcement date recorded by SDC was correct at 92.6% of the sample, while it was off by no-more than 2 days in the remaining cases.

  13. 13.

    These variables include the acquirer’s size (Moeller et al. 2004; Humphery-Jenner and Powell 2011), leverage (Maloney et al. 1993), free-cash-flow (Jensen 1986), the strength of shareholders rights (Masulis et al. 2007), the target’s size relative to the acquirer (Asquith et al. 1983), the form of payment (Travlos 1987), whether the bidder and target operate in the same industry (Morck et al. 1988), whether the target is a private or a public company (Chang 1998), whether the deal is hostile or friendly (Schwert 2000), board size (Yermack 1996), board independence (Byrd and Hickman 1992), CEO age and tenure (Faleye 2011), the average age of directors (Cai and Sevilir 2012).

  14. 14.

    We include non-acquiring firms in our calculation for the equity-based compensation cut-off points since equity-based compensation itself may influence the decision to acquire , as illustrated in detail in the next subsection.

  15. 15.

    In unreported results, however, we find that the reverse is not true: the coefficient on the interaction term between director equity-based pay (%) and a dummy variable indicating whether a firm’s CEO equity-based compensation is in the low-third of the observations is insignificant.

  16. 16.

    Even after addressing the omitted variable bias, we acknowledge that the potential endogeneity problem may still exist.

  17. 17.

    To compute abnormal returns, we follow Barber and Lyon (1997) and use a control firm approach, where sample firms are matched to a control firm based upon size and book to market. The pool of potential control firms is first screened on the basis of size (market value of equity between 70 and 130% of the sample firm’s market value of equity). The firm with the closest book-to-market ratio to that of the sample firm is then selected as a control firm.

  18. 18.

    We also note that of a sample firm is delisted during the measurement time interval, the buy-and-hold return of that particular firm is computed over the time period for which return data are available in the Datastream database.

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  1. University of Burgundy, Auxerre, France

    Ismail Lahlou

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Lahlou, I. (2018). Director Compensation Incentives and Acquisition Outcomes. In: Corporate Board of Directors. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-05017-7_4

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  • DOI: https://doi.org/10.1007/978-3-030-05017-7_4

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