Takeovers and Agency Problems: A Reexamination of the Pre-Acquisition Operating Performance of Targets

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Both the issue of agency problems in corporate takeovers and the role of takeovers as an external control mechanism have been addressed extensively in previously published empirical literature. This existing literature suggests that removal of inefficient management to improve operating performance is one of the key underlying motives for takeovers. However, the results of the analyses of the pre-acquisition operating performance of targets have not been conclusive concerning the efficacy of this motivation to improve underperformance in target firms. I propose that the existing research fails to adequately account for other factors that may also act as control mechanisms, such as managerial ownership, institutional holdings and leverage, which should also be considered when analyzing the pre-acquisition operating performance of targets. These alternative means of controlling agency problems may prevent managers from wasting resources. In this paper, I have sought to contribute to the debate on the inefficient management hypothesis. I do so by examining the pre-acquisition operating performance of targets in the presence of alternative control mechanisms such as insider holdings, institutional holdings and leverage. I have also investigated whether the takeover announcement abnormal returns are higher for targets with poor performance and potentially higher agency costs. I found that target firms are characterized by higher operating expenses compared to control firms. The results of my analysis suggest that targets with entrenched managers and low external monitoring have significantly higher operating expenses. I also found weak evidence that the announcement period abnormal returns are higher for targets with poor operating performance.