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Blockholders and Corporate Governance

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Jin-Mo Kim

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BLOCKHOLDERS AND CORPORATE GOVERNANCE
By

J in-Mo Kim

A DISSERTATION

Submitted to
Michigan State University
in partial fulﬁllment of the requirements
for the degree of
\

DOCTOR OF PHILOSOPHY

Department of Finance

2005

ABSTRACT

BLOC KHOLDERS AND CORPORATE GOVERNANCE

By

J in-Mo Kim

This study contains two essays. In the ﬁrst essay, we study the role of foreign

investors in the corporate governance of US. ﬁrms. Using a sample of 257 partial

acquisitions of US. ﬁrms by foreign ﬁrms during the period 1981-1999, we show that

foreign blockholders from countries with strong shareholder rights play a more active

role in disciplining managers of US. targets than do those from countries with weak

shareholder rights. In particular, the probability of nonroutine top executive turnover

and the extent of other governance activities by foreign investors, such as the threat of

hostile takeovers and the demand for representatives on the target’s board, are

positively related to the shareholder rights score of their home countries. This positive

relationship, however, is mainly driven by the subsample of acquisitions in which

foreign investors do not have any business relationships with US. targets (unrelated

foreign investors). Abnormal announcement returns for US. targets of unrelated

foreign investors also display a strong positive association with the level of

shareholder rights protection in the acquiring ﬁrm country. This result suggests that

the stock market takes the increase in the frequency of a foreign acquiring ﬁrm’s

value-enhancing future governance activities for US. targets into account when

assessing their market values.

In the second essay, we examine the role of geographic proximity in corporate

govemance. Using a sample of 698 partial acquisitions in the US. during the period

of 1990-1999, we ﬁnd that geographically proximate block acquirers are more likely

to be involved in governance activities in target ﬁrms than are remote block acquirers.

Acquirers located within the same state as targets (in-state acquirers) or those who are

located within 250 miles of target ﬁrms (local acquirers) are more likely to have their

representatives on the target’s board and replace target management after block share

purchases. In addition, targets of in-state and local acquirers experience higher

abnormal announcement returns and post-acquisition operating performance than

those of other acquirers. Furthermore, these effects are strongest when target ﬁrms are

small or have poor past performance and higher insider ownership. Finally, we ﬁnd

that block acquirers have strong preference for local ﬁrms. Our results suggest that

geographically proximate investors have signiﬁcant advantages in terms of

governance activities over remote investors and such governance activities affect

operating performance and the value of ﬁrms.

Cepyright by
Jin-Mo Kim

2005

To my parents, my wife, and my daughter and son

for their unqualiﬁed love and support

ACKNOWLEDGMENTS

I would like to thank my advisor, Dr. Jun-Koo Kang, for his encouragement,
suggestions, and guidance. Throughout my doctoral work he encouraged me to develop
as an independent thinker both empirically and theoretically. Most of all, his passion and
excitement for knowledge have served as a great inspiration to my own academic pursuit.

Dr. Ted Fee and Wei-Lin Liu both offered valuable insight as dissertation committee
members. I am grateful to Dr. Booth and Elizabeth Booth for their continual support and
encouragement. I also thank Dr. Charlie Hadlock, who advised me and helped me in
various aspects of my research. I would like to acknowledge many fruitful discussions
with Dr. Naveen Khanna.

Last but not least, I want to thank my parents, my wife and my daughter and son for
always being there when I needed them most. I thank my parents for supporting me
through all these years. J eung-Yun, my wife, provided me with encouragement, love, and
support, allowing me to achieve a lifelong goal. Ha—Kyung and Ha—Jin, my daughter and
son, have been a source of energy and motivation during this lengthy procedure. This

dissertation is dedicated to them.

Vi

TABLE OF CONTENTS

LIST OF TABLES

LIST OF FIGURES

ESSAY 1. Foreign Blockholders, Shareholder Rights, and Corporate Governance:

1.1

1.2

1.3

1.3.1

1.3.1.1

1.3.1.2

1.3.2

1.3.2.1

1.3.2.2

1.3.2.3

1.3.3

1.3.4

1.4

1.4.1

Evidence from Partial Acquisitions of US. Firms by Foreign Firms

Introduction

Sample Selection and Data

Empirical Results

Post-Acquisition Governance Activities
Governance Activities of Foreign Acquirers
Governance Activities of Domestic Acquirers
The likelihood of governance activity

Threat of Hostile Takeovers

Demand for Representatives on the Target’s Board
All Types of Governance Activity

Top Executive Turnover

The Announcement Effects

Alternative Explanations

Information Asymmetry

vii

xiii

11

20

20

20

22

23

26

29

31

33

39

42

42

1.4.2 Creditor Rights and Other Shareholder Rights
1.4.3 Cultures and Religions

1.4.4 Legal Origin

1.5 Summary and Conclusions

APPENDIX 1 TABLES OF ESSAY 1
APPENDIX A DATA DEFINITIONS
BIBLIOGRAPHY 1 REFERENCE FOR ESSAY l

ESSAY 2. Geography and Corporate Governance

2. 1 Introduction

2.2 Hypotheses and Literature Review

2.2.1 Geographic Proximity and Information Advantage
2.2.2 Geographic Proximity, Monitoring Costs, and Governance Activities
2.3 Data and Descriptive Statistics

2.3.1 Data

2.3.2 Descriptive Statistics

2.4 Geographic Proximity and Governance Activities
2.4.1 Likelihood of Board Representation

2.4.2 Likelihood of Top Executive Turnover

2.4.3 Marginal effects of geographic proximity

viii

43

44

45

45

48

78

81

87

91

91

92

94

94

95

100

103

108

111

2.5 Geographic Proximity and Target performance

2.5.1 Announcement Effects

2.5.1.1 The Relation between Distance and Target Returns

2.5.1.2 Cross-sectional Variation in Target Returns

2.5.1.3 Changes in Operating Performance

2.6 Summary and Conclusion

APPENDIX 2 TABLES AND FIGURES OF ESSAY 2
APPENDIX B DISTRIBUTION OF BLOCK-ACQUIRERS

AND TARGET FIRMS BY STATES

BIBLIOGRAPHY 2 REFERENCE FOR ESSAY 2

ix

112

112

112

116

119

122

124

148

150

LIST OF TABLES

TABLES FOR ESSAY 1

Table 1.1

Table 1.2

Table 1.3

Table 1.4

Table 1.5

Table 1.6

Table 1.7

Table 1.8

Distribution of Foreign Acquisition Activity in the US. by
the Level of Shareholder Rights Protection in the Acquiring
Firm Country, Target Industry, and Year

Descriptive Statistics for US. Targets in Foreign and
Domestic Acquisitions

Frequency of Holding Periods, Acquisitions with Control
Purpose, and Active Investors by the Relatedness of the
Acquirer and the Target

Post-Acquisition Governance Activities Initiated by
Acquirers during the Holding Period of Block Shares
Logit Regression Estimates of the Likelihood of Hostile
Takeover Activity by Large-Block Acquirers

Logit Regression Estimates of the Likelihood of Large-
Block Acquirers’ Demanding Board Representation

Logit Regression Estimates of the Likelihood of
Governance Activities by Large-Block Acquirers and OLS
Regression Estimates of the Governance Activity Index
Frequency of Nonroutine Top Executive Turnover by
Shareholder Rights in the Acquiring Firm Country and the

Relatedness of the Acquirer and the Target

49

51

54

56

58

60

62

66

Table 1.9

Logit Regression Estimates of the Likelihood of Nonroutine

Top Executive Turnover

Table 1.10 Cumulative Abnormal Returns (CARS) for Targets around
the Announcement Date

Table 1.11 Regression of Cumulative Abnormal Returns (-1, 1) for
Targets on the Degree of Shareholder Rights Protection and
the Quality of Law Enforcement in the Acquiring Firm
Country and Other Target Characteristics

Table 1.12 Logit Regression Estimates of the Likelihood of
Governance Activities by Foreign Large-Block Acquirers

TABLES FOR ESSAY 2

Table 2.1 Distribution of Partial Acquisition Activity by Year and
Target Industry

Table 2.2 Extent of Local Bias

Table 2.3 Descriptive Statistics for Target Firms

Table 2.4 Frequency of Holding Periods and Acquisitions with
Control Purpose

Table 2.5 Frequency of Board Representation and Nonroutine Top
Executive Turnover by Distance between Acquirer and
Target

Table 2.6 Tobit Regression Estimates of the Fraction of Board

Representation by Block Acquirers

xi

68

71

73

75

127

128

129

130

131

133

Table 2.7

Table 2.8

Table 2.9

Table 2.10

Table 2.11

Table 2.12

Table 2.13

Logit Regression Estimates of the Likelihood of Nonroutine
Top Executive Turnover

Marginal Effects of Key Variables on the Likelihood of
Governance Activities

Cumulative Abnormal Returns (CARS) for Targets around
the Announcement Date

Mean and Median Cumulative Abnormal Returns [CAR (-
10, 10)] for Targets for Subsamples Categorized by
Distance Between Targets and Block Acquirers

OLS Regression of Cumulative Abnormal Returns (-10, 10)
for Targets

Change in Industry-adjusted Ratio of Operating Income to
Assets Following Block Share Purchase

OLS Regression of Operating Performance Changes

xii

135

137

139

140

142

144

145

LIST OF FIGURES

FIGURES FOR ESSAY 2

Figure 2.1 Distribution of Block-Acquirers and Target Firms Across 125

the US.

xiii

ESSAY 1. Foreign BlockMers, Shareholder R_ights¢r_r_d Corporate

Governance: Evidence fromfPartial Acquisitions of US. Firms by Foreign Firms

1.1 Introduction

Recent research has demonstrated that legal environments, such as the legal
protection of investors and the quality of law enforcement, affect the development of a
country’s ﬁnancial markets (La Porta, Lopez-de-Silanes, Shleifer, and Vishny (1997),
hereafter referred to as LLSV), the acceleration of economic grth (Demirguc-Kunt and
Maksimovic (1998)), the extent of ownership concentration (LLSV (1999)), and the
difference in ﬁnancial policy (LLSV (2000b)). In particular, LLSV (1997, 1998, 1999,
2000a) show that differences among countries in the structure of laws and their
enforcement explain the differences in ﬁnancial market development, and that such
development is promoted by better protection of investors. Moreover, several studies
have established a link between legal environments and agency problems. For example,
Dyck and Zingales (2002) show that stronger minority shareholder rights and a higher
quality of law enforcement are associated with lower levels of a country’s private
beneﬁts of control. DeFond and Hung (2003) also document that strong law enforcement
institutions signiﬁcantly improve the sensitivity of top executive turnover to poor
performance.

In this paper, we extend this literature by providing evidence on the importance of
legal rules and their enforcement in fostering corporate governance activities. Our
evidence comes from corporate governance activities of foreign ﬁrms who acquire at

least 5 percent, but less than 50 percent, of voting shares in US. ﬁrms. Speciﬁcally, we

examine whether the extent of corporate governance activities, such as hostile takeovers,
board representation, and nonroutine top executive turnover, of foreign blockholders in
US. targets is related to shareholder rights and the quality of law enforcement in their
home countries. We also investigate whether these legal environments have any
explanatory power in regard to the cross-sectional variation in abnormal announcement
returns for US. targets. If strong protection of investors in the acquiring ﬁrm country
fosters good corporate governance in targets, and good corporate governance leads to an
increase in target value,1 we should observe a positive relationship between investor
protection by the legal system and target returns.

We focus on partial acquisitions since unlike mergers where target ﬁrms are
subsequently delisted from stock exchanges after the transaction, those involved in partial
acquisitions still survive on stock exchanges and therefore detailed public information on
post-acquisition governance activities of foreign blockholders is readily available.
Further, partial acquisitions represent a setting where block acquirers have strong
incentives to monitor target managers, so the governance activities of foreign investors
are expected to be magniﬁed in this case.

There are several possible reasons why legal rules protecting minority shareholders
and their enforcement in the foreign acquiring ﬁrm country might inﬂuence corporate
governance activities in US. ﬁrms. First, these legal rules and law enforcement allow
shareholders to function actively as govemance mechanisms in their home countries. For

example, legal rights of shareholders, such as cumulative voting, proportional

 

' Several studies have shown that the legal environment has an effect on corporate valuation. For example,
LLSV (2002) show that ﬁrms in countries with better shareholder protection have a higher Tobin’s q than
those where such protection is weaker. Nenova (2003) ﬁnds that voting premium is higher in countries with
poor shareholder protection.

representation of minorities on the board of directors, and calling for extraordinary
shareholders’ meetings, facilitate the governance activities of minority shareholders and
thus support shareholder activism for corporate governance. Furthermore, the investor
protection by legal systems, especially shareholder rights, is an essential element of
governance structures and has an important inﬂuence on the governance activities of
shareholders. The shareholder rights limit the expropriation of minority shareholders by
corporate insiders by providing speciﬁc governance mechanisms through which
shareholders can protect their interests. In this context, shareholder rights foster the
governance activities of minority shareholders and even determine the scope and
effectiveness of their governance activities (Shleifer and Vishny (1997), LLSV (2000a)).
To the extent that foreign ﬁrms in strong protective regimes can transfer their corporate
governance standards to domestic ﬁrms in the host country, they are expected to perform
an important governance role in domestic targets.

Second, the high frequency of governance activities by minority shareholders in
countries with strong shareholder rights and a high quality of law enforcement allow
investors to become acquainted with better governance skills and experience than those in
countries with poor shareholder rights and a low quality of law enforcement. DeFond and
Hung (2003) also argue that strong law enforcement creates an environment that fosters
good corporate governance. These arguments suggest that foreign shareholders from
countries with stronger shareholder protection and law enforcement would possess
governance skills and expertise that are superior to those from countries with poor

shareholder protection.

Finally, as discussed in Shleifer and Vishny (1997), investor protection and
governance structure mitigate the agency problem between managers and outside
investors, which arises from the separation of ownership and control, and thus affect ﬁrm
value. For example, protected shareholder rights might provide corporate managers with
strong incentives to maximize shareholder wealth. In contrast, weak shareholder
protection might allow managers to exploit minority shareholders more easily and thus
increase the incentive to carry out expropriation. Therefore, the variation in the degree of
shareholder rights protection across countries can create a difference in managerial
incentives to maximize ﬁrm value, which in turn affects the incentives for managers of
foreign ﬁrms to perform an active governance role in domestic targets.

Foreign acquisitions in the US. provide important advantages that make them
particularly well suited to an investigation of the link between the level of shareholder
rights protection and the extent of corporate governance activity. First of all, these
acquisitions allow us to examine the corporate governance activities of foreign investors
at a level of detail and consistency that would be hard to aggregate across countries.
Furthermore, unlike in the US, where they are strong, the degree of shareholder rights
protection and the quality of law enforcement are poor in many countries. These
countries sometimes prevent foreign investors from actively participating in governance
activities in domestic ﬁrms. Focusing on the US. market, therefore, allows us to avoid
the measurement bias in cross-country analysis that arises from poor protection of legal
rights and the severe regulation of the governance activities of foreign ﬁrms.

In addition to gaining insight into the link between shareholder rights protection and

corporate governance, our research contributes to the literature on large shareholders by

comparing the role of domestic block ownership and foreign block ownership in
corporate governance. Although the presence of foreign ownership in the US. and other
countries has substantially increased over the last three decades,2 systematic evidence of
its role in corporate governance is scarce. Previous studies show that large domestic
shareholders play an important role in corporate governance (Shivdasani (1993), Denis
and Serrano (1996), Bethel, Liebeskind, and Opler (1998)). Unlike small shareholders
who like to free-ride the corporate governance activities of other shareholders (Grossman
and Hart (1980)), large shareholders have strong incentives to monitor managerial
performance and take actions that enhance ﬁrm value (Shleifer and Vishny (1986)).
However, a priori, the role of foreign shareholders in corporate governance is unclear.
If foreign investors are less well informed about a domestic ﬁrm than are domestic
investors and have to pay additional costs to overcome such an information disadvantage
(e.g., costs associated with searching for information, costs associated with multinational
operations, costs associated with traveling, etc.), their incentives to engage in corporate
governance are expected to be smaller than those of domestic investors. In contrast, if
foreign multinational ﬁrms have ﬁrm-speciﬁc advantages (e.g., superior management
skills, better production technology, and a stronger ﬁnancial position) over domestic
ﬁrms in the host country (Hymer (1976), Kindleberger (1960), Caves (1971), Harris and

Ravenscraﬁ (1991), Kang (1993)) and can internalize these advantages in their

 

2 According to the NYSE Fact Book, at year-end 1970, foreign investors owned only 3 percent of the total
equity in the US. ﬁrms. Foreign equity ownership, however, had increased to 11 percent by year-end 2001.
The growth of foreign ownership is also common in many other countries, possibly due to the ongoing
process of globalization. For example, Hiraki, lnoue, Ito, Kuroki, and Masuda (2003) report that foreign
ownership for ﬁrms on the Tokyo Stock Exchange increased from 7.01 percent to 18.6 percent between
1985 and 1999. Dahlquist and Robertsson (2001) show that equity ownership held by foreigners in Sweden
increased from 8.2 percent to 32.4 percent during the period 1991-1997. In addition, the Korean Financial
Supervisory Service reports that foreign equity ownership in Korea had increased to 37.5 percent by
August 2003 since 1992 when the Korean government opened the stock market to foreign investors.

monitoring function, we would expect foreign blockholders to perform a more active
governance role in domestic ﬁrms than do domestic blockholders.

To explore the role of foreign ownership in a systematic and comprehensive way, we
construct a control sample of domestic partial acquisitions and compare post-acquisition
governance activities of foreign blockholders in targets to those of domestic
blockholders. Since previous research has shown that potential business relations with
ﬁrms inﬂuence the monitoring incentives of domestic investors (Brickley, Lease, and
Smith (1988)),3 we classify large-block acquirers into two groups, related and unrelated
ones. Related large—block acquirers are those who have maintained a business
relationship with target ﬁrms or have announced their intention of establishing such a
relationship in the future. Given that the role of foreign investors in corporate governance
has not yet been examined, our paper presents the ﬁrst empirical evidence on such a role.

We ﬁnd that compared to foreign blockholders from countries with strong
shareholder rights, those from countries with weak shareholder rights are less likely to
engage in governance activities in US. targets. In particular, the probability of nonroutine
top executive turnover and the extent of other governance activities by foreign investors,
such as the threat of hostile takeovers and the demand for representatives on the target’s
board, are positively related to the shareholder (anti-director) rights score of their home
countries. This positive relationship, however, is mainly driven by the subsample of

acquisitions in which foreign investors do not have any business relationships with US.

 

3 Brickley et al. (1988) show that banks and insurance companies that tend to be inﬂuenced by existing
business relations with ﬁrms are more likely to vote for management-proposed anti-takeover amendments
than are other institutions such as mutual funds and public pension funds which do not have business
relationships with management. While their study focuses on the role of large ﬁnancial shareholders in
corporate governance and classiﬁes them into afﬁliated and unafﬁliated blockholders, we classify all types
of acquirers into related and unrelated large blockholders according to their actual business relationship

targets. Thus, related foreign investors are less likely to be involved in governance
activities in US. targets than are unrelated foreign investors. These results are generally
consistent with those of Brickley et a1. (1988). Accounting standards and the rule of law
that measure the quality of law enforcement, however, do not explain the extent of the
governance activities of foreign blockholders.

We also ﬁnd that the extent of the governance activities of domestic acquiring ﬁrms
is statistically indistinguishable from that of the subsample of foreign ﬁrms from
countries with strong shareholder rights, but is signiﬁcantly greater than that of the
subsample of foreign ﬁrms from countries with weak shareholder rights. Since the degree
of shareholder rights protection in the US. is similar to that in foreign countries with
strong shareholder rights, these results further conﬁrm that the legal protection of
investors plays an important role in predicting the variation in governance activities
among large-block shareholders.

We perform several robustness checks on the data, using creditor rights and other
shareholder rights in the acquiring ﬁrm country as additional control variables and
geographic, religious, and cultural differences as alternative explanations, and ﬁnd that
the results are qualitatively unchanged.

Overall, our results suggest that the governance activities of foreign ﬁrms in US.
targets are largely inﬂuenced by the structure of legal rules protecting minority
shareholder rights in their home countries. The results are also consistent with the view
that foreign multinational ﬁrms from strong shareholder protection countries are able to

carry their strength in governance skills and expertise across national borders, which

 

with target ﬁrms. Hence, our deﬁnition of related investors includes corporate and individual blockholders
as well as ﬁnancial blockholders.

allows them to perform an active governance role in disciplining managers in domestic
ﬁrms.

We also examine the effect of the legal protection of investors and the quality of law
enforcement in the acquiring ﬁrm country on the value of US. targets by analyzing the
valuation effect of announcements of block share purchases. We ﬁnd that the abnormal
returns for US. targets of unrelated foreign investors are positively related to the
shareholder rights score in their home countries. This result suggests that the stock
market takes the increase in the frequency of a foreign unrelated ﬁrrn’s value-enhancing
future governance activities for US. targets into account when assessing their market
values.

Our paper is related to a few recent studies on cross-border takeovers. Bris and
Cabolis (2002) use a sample of 9,277 cross-border mergers from 1985 to 2000 to
examine the changes in corporate governance induced by these mergers. They show that
the acquisition of ﬁrms in weaker shareholder protection countries by ﬁrms in stronger
protective regimes signiﬁcantly increases the Tobin’s q of the target industry. Rossi and
Volpin (2004) examine the determinants of cross-border mergers and acquisitions by
focusing on differences in laws and regulations across countries. They show that the
volume of mergers and acquisitions activity is signiﬁcantly larger in countries with
stronger shareholder protection and better accounting standards. Target premiums are
also higher in countries with stronger shareholder protection. They also ﬁnd that the
probability that a given deal is a cross-border rather than a domestic merger decreases
with the degree of investor protection of the target’s country. These results suggest that

cross-border mergers and acquisitions represent an important mechanism for the

contractual transfer of corporate governance. Kuipers, Miller, and Patel (2003) examine
the link between the legal environment and corporate valuation by examining the
cumulative abnormal returns (CARS) to US. targets, foreign acquirers, and the portfolio
of target and acquirer for a sample of 181 cross-border tender offers from 1982 to 1991.
They ﬁnd that both acquirer and portfolio returns are positively related to the degree of
Shareholder rights protective mechanisms where the acquiring ﬁrm is domiciled but
target returns are not.

We extend this literature by providing evidence for an explicit link between
Shareholder rights protection of the foreign acquiring ﬁrm and corporate governance
activity in the US. target. Unlike the studies listed above, we use partial acquisitions of
US. ﬁrms by foreign ﬁrms and focus on the effect of the investor protection of the
acquiring ﬁrm’s country on governance activity in target ﬁrms as well as its impact on
target market value.

Our paper is also related to recent studies that examine corporate governance
convergence in the world, as argued by Coffee (1999). For example, Pagano, Roell, and
Zechner (2002) and Reese and Weisbach (2002) Show that ﬁrms from countries with
poor investor rights list their securities in the US. market more frequently than do those
with strong investor rights. They argue that the dual listing of securities in the US.
market allows foreign ﬁrms to follow the better corporate governance standards of the
US, such as high transparency in accounting rules, frequent disclosure of ﬁnancial
information, and effective enforcement of US. law. In a Similar vein, Doidge, Karolyi,
and Stulz (2004) argue that a US. listing reduces the extent to which controlling

shareholders can engage in expropriation and increases ﬁrms’ ability to take advantage of

growth opportunities. All these arguments suggest that a dual listing can provide foreign
ﬁrms with an important channel for institutional changes in corporate governance. In
contrast, Siegel (2004) Shows that the SEC in the US. has not been effective in enforcing
the law against U.S.-listed Mexican ﬁrms and argues that reputational bonding explains
the success of their cross-listings better than legal bonding. Bris and Cabolis (2002) and
Rossi and Volpin (2004) also argue that cross-border mergers provide foreign ﬁrms that
have weak legal institutions with a mechanism for the contractual transfer of better
corporate governance standards. Although these studies Show that the institutional
changes or reputational bonding in the governance structures of foreign ﬁrms are
important determinants of convergence in corporate governance, our paper suggests that
foreign block ownership could also be another alternative mechanism for the transfer of
corporate governance. To the extent that foreign investors from countries with good
governance structures have an ability to carry their superior governance Skills and
expertise across national borders, they have the potential to play an instrumental role in
improving the corporate governance in the host country. Since foreign large-block
shareholders have already become an important part of ownership in many large ﬁrms
around the world, they are expected to serve as an effective mechanism for corporate
governance convergence.

This paper proceeds as follows. Section 1.2 describes the data and sample
characteristics. In Section 1.3, we Show the results of post-acquisition governance
activities by large-block Shareholders and abnormal target returns. Section 1.4 Shows the

results of our robustness tests. Section 1.5 summarizes and concludes the paper.

10

1.2 Sample Selection and Data

Our sample consists of block Share acquisitions of US. targets by foreign ﬁrms
between 1981 and 1999. We obtain the initial sample of US. targets from the Security
Data Corporation (SDC) Platinum of Thomson Financial. We ﬁrst identify cross-boarder
partial acquisitions in which the foreign ﬁrm initially held less than 5 percent of a US.
target ﬁrm’s outstanding shares before the acquisition, and then purchases more than 5
percent but leSS than 50 percent of its outstanding shares. We eliminate cases where
foreign acquiring ﬁrms come from tax haven countries, such as the Cayman Islands,
Bermuda, and the British Virgin Islands. To be included in the ﬁnal sample, we require
that the initial public announcement date of block share purchase be available in Dow
Jones Newswire. We use as the announcement date the date that a news announcement
ﬁrst appears in this publication. We also require that stock returns and ﬁnancial data for
US. targets be available in the CRSP returns and COMPUSTAT tapes, respectively.
These restrictions result in the ﬁnal sample of 270 US. targets. However, in 13 cases, the
measures of investor protection in the acquiring ﬁrm country, such as the level of
shareholder rights protection and the quality of law enforcement, are not available in
LLSV (1998) from which we collect most of the information on index scores for these
measures. Therefore, our tests employing variables measuring the degree of investor
protection are conducted over 257 samples, though our results are Similar if we use the
entire sample instead by assigning the lowest values of Shareholder rights protection and
law enforcement to these 13 cases. The appendix summarizes the deﬁnitions and sources

of the variables used in this paper.

11

We obtain equity ownership and top executive data on US. targets from proxy
statements and annual reports, respectively. To examine post-acquisition governance
activities of foreign acquirers in US. targets, we use several sources, including 13D
ﬁlings (general statement of acquisition of beneﬁcial ownership), Dow Jones Newswire,
proxy statements, and annual reports of target ﬁrms. All sources are examined for stories
during the holding period of block shares by foreign ﬁrms up to three years after the
acquisition. We deﬁne the holding period as the period from the date when the foreign
ﬁrm announces the acquisition of a target ﬁrm’s block equity to the date when it
decreases its holding in the target to less than 5 percent. The sales of block shares by
foreign ﬁrms are identiﬁed by closely following news articles and 13D ﬁlings up to three
years after the announcement date of acquisition. If we are not able to identify the sale
dates of block equity from this process, we search target ﬁrms’ proxy statements to see
whether the foreign ﬁrms still hold block equity in the targets. If foreign or other bidders
acquire more than 50 percent of outstanding equity in the target ﬁrms (18 cases), the date
prior to the announcement of the this acquisition is assumed to be the last date of equity
holdings in the targets by the foreign ﬁrms.

To compare the governance activities of foreign large blockholders with those of
domestic ones, we construct a control sample of 270 US. targets in domestic partial
block acquisitions between 1981 and 1999. A US. target involved in the domestic
acquisition is matched to that in the foreign acquisition by acquirer industry (ﬁnancial or
nonﬁnancial), target industry (at least to the ﬁrst two digits of the SIC code), target Size
(the closest in book value of assets), year of acquisition, and relatedness of the acquirer

and the target. We determine the relatedness of the two ﬁrms by searching Dow Jones

12

Newswire, proxy statements, and annual reports of the target for three years prior to and
subsequent to the announcement date of block Share purchases. We search for
information about whether the two ﬁrms involved in the acquisition have strategic
agreement, business alliance, joint venture, or other product market partnerships such as
supply, marketing/distribution, and technology-sharing relationships. As in Allen and
Phillips (2000), we deﬁne the related acquisitions as those in which the acquiring ﬁrms
have maintained at least one of these relationships with target ﬁrms before the
acquisition, or have announced their intention of establishing such relationships in the
future. We classify the remaining acquisitions as unrelated ones. If no ﬁrm matches by
year of acquisition, a control target matched in the previous or following year is used.
Although in 267 of the 270 cases, we are able to identify control samples using these
matching criteria, we cannot match three targets of foreign acquisitions with control
targets based on the relatedness of acquisition. For these three cases, we obtain matching
ﬁrms without applying a relatedness criterion.

Panel A of Table 1.1 shows the distributions of the sample of 270 US. targets of
foreign acquirers by the shareholder rights protection of the acquirer’s country and the
target’s industry. The measure of shareholder rights protection is from LLSV (1998) and
ranges from zero to six. Following LLSV (2000b), we classify the country with an index
score smaller or equal to three as one with weak shareholder protection and the country
with an index score larger than three as one with strong shareholder protection. We ﬁnd
that foreign acquirers from countries with strong (weak) shareholder protection account

for about 59.7 (35.5) percent of the total sample. A breakdown of the acquisitions by

13

target industry shows that most of the US. targets are in manufacturing (53 percent),
services (14.4 percent), and transportation and public utilities (9.3 percent).

Panel B of Table 1.1 summarizes the frequency distribution of foreign acquisition
activity by year. The years 1988 and 1995 are the most active years of acquisition
announcements with 30 (11.1 percent) and 28 (10.4 percent) cases, respectively. In
contrast, no acquisition announcements are observed in 1981 and 1982.

Although not reported here, 52 of the targets are acquired by UK. ﬁrms, followed by
Japanese (33 acquisitions) and Canadian (29 acquisitions) ﬁrms. Given the large number
of UK. acquirers in our sample, we examine the robustness of our ﬁndings by repeating
all analyses below excluding acquisitions involving U.I(. ﬁrms and obtain results that are
qualitatively Similar to those reported in the paper.

Table 1.2 presents the summary statistics of a sample of 257 US. targets of foreign
acquirers for which we are able to ﬁnd the index score of Shareholder rights protection
from LLSV (1998), and a sample of 257 US. control targets of domestic acquirers. The
ﬁrst three rows of Table 1.2 compare the level of shareholder rights protection and law
enforcement in the acquiring ﬁrm country across the two groups: U.S. targets of foreign
ﬁrms from countries with strong shareholder protection and those from countries with
weak shareholder protection. We measure the quality of law enforcement by country
scores for two variables, accounting standards and the rule of law. Accounting standards
measure the disclosure quality of accounting information and the rule of law assesses the
law and order tradition in the acquiring ﬁrm country. We ﬁnd that the median score of
the shareholder rights index for foreign ﬁrms from countries with strong (weak)

shareholder protection is 5 (2). The difference in the level of Shareholder rights between

14

the two groups is statistically Signiﬁcant at the 1 percent level. The median score of the
accounting standards index for foreign acquirers from countries with strong shareholder
protection is again Signiﬁcantly larger than that of the accounting standards index for
foreign acquirers from countries with weak shareholder protection (74 compared to 65).
In contrast, acquirers from strong Shareholder protection countries score lower on the
rule-of-law measure than do those from weak shareholder protection countries.

The next two rows compare the holding period of block Shares and the percent of
shares purchased across the two subsamples of US. targets in foreign acquisitions and
the sample of US. control targets in domestic acquisitions. Foreign acquirers with weak
shareholder rights on average hold block shares in US. targets longer than do both
domestic acquirers and foreign acquirers with strong Shareholder rights. Although 57
percent of foreign acquirers with weak Shareholder rights hold block shares in US.
targets for longer than three years, the corresponding numbers of domestic acquirers and
foreign acquirers with strong Shareholder rights are only 35 percent and 43 percent,
respectively. These differences in holding periods are Signiﬁcant at the 1 percent and 5
percent levels, respectively. We also ﬁnd that foreign ﬁrms with weak shareholder rights
purchase a larger percentage of block shares than do domestic ﬁrms and foreign ﬁrms
with strong shareholder rights (a median of 11.7 percent compared to medians of 9.9
percent and 9.8 percent).

To see whether foreign ﬁrms prefer U.S. targets with certain characteristics, Table 1.2
also compares target characteristics across the three groups before the acquisitions. We
measure target characteristics at the ﬁscal year-end that comes immediately before the

announcements of the acquisition of block Shares.

15

Several features of the target characteristics are worth noting. Although the median
equity ownership by managers (the sum of equity ownership by ofﬁcers and directors) is
not statistically different among the three groups, the median equity ownership by
institutional investors is Signiﬁcantly higher for the targets of foreign ﬁrms with strong
shareholder rights than for those of foreign ﬁrms with weak shareholder rights (22
percent compared to 17 percent). The means Show a Similar pattern.

Following Denis, Denis, and Sarin (1997), we deﬁne the CEO as the top executive of
the ﬁrm. If a ﬁrm has no CEO, the chairman (or president if there is no chairman) is
assumed to be the top executive of the ﬁrm. The mean and median ages of top executives
are Signiﬁcantly younger in the targets of foreign ﬁrms with weak shareholder rights than
they are in the other two types of targets. The mean and median tenures of top executives,
however, are not Signiﬁcantly different among the three groups. The fraction of ﬁrms in
which a chairman (founder) is the top executive is not Signiﬁcantly different among the
three groups, except that it is signiﬁcantly larger for US. targets of foreign ﬁrms from
countries with strong shareholder rights than it is for US. targets of domestic ﬁrms.

The mean and median sizes (market value of equity) of targets Show no statistical
difference among the three groups. The median leverage ratio (total debt to total assets) is
signiﬁcantly larger for the targets of foreign ﬁrms from countries with strong shareholder
rights than it is for those of domestic ﬁrms.

When we compare the median past performance for the three groups of targets using
the ratio of cash ﬂow (the sum of operating income and depreciation) to total assets, we
ﬁnd that it is lowest for targets of foreign ﬁrms with weak shareholder rights (4 percent),

followed by targets of domestic ﬁrms (7 percent), and then targets of foreign ﬁrms with

16

strong shareholder rights (8 percent). In contrast, the median Tobin’s q (the sum of
market value of equity and book value of debt / book value of total assets) is highest for
the targets of foreign ﬁrms with weak shareholder rights (1.24) and lowest for those of
foreign ﬁrms with strong Shareholder rights (0.95). The tests of median differences in
past performance and Tobin’s q between the targets of foreign ﬁrms with strong
shareholder rights and those with weak shareholder rights strongly reject the null
hypothesis of equality. The means Show a similar pattern. These ﬁndings suggest that the
foreign acquirers with strong Shareholder rights prefer U.S. targets with a large cash ﬂow
and low grth opportunity, compared to those with weak Shareholder rights. To the
extent that this type of target has a more severe agency problem than do other types of
targets (Jensen (1986a)), our results indirectly indicate that acquirers from strong
Shareholder protection countries tend to choose U.S. targets for which their disciplinary
actions have the potential to induce target managers to take actions that lead to the
reallocation of the target resources in an efﬁcient way.

To better understand the differences in the nature of foreign and domestic block
ownership in US. targets, Table 1.3 summarizes detailed information on holding periods,
the purpose of acquisitions, and the activeness of acquirers (whether the intention of
acquirers is to inﬂuence target policies or not) by the relatedness of the acquirer and the
target. We classify our sample according to the relatedness of the two ﬁrms since
Brickley et a1. (1988) Show that large ﬁnancial blockholders in the US. who have
business relationships with ﬁrms are less likely to play an active role in inﬂuencing
managers. If investors who have maintained business relationships with targets purchase

large Shares of targets, they would have few incentives to monitor target management

17

Since active intervention can jeopardize such relationships. Furthermore, target
management is usually involved in the process of selecting related blockholders.
Therefore, related blockholders are expected to be less active in disciplining target
managers.4

Panel A of Table 1.3 presents summary statistics for holding periods. Although 68
percent of foreign acquirers in related acquisitions hold block Shares for longer than three
years, the corresponding number of those in unrelated acquisitions is only 27 percent. We
ﬁnd Similar patters for domestic acquisitions (46 percent compared to 24 percent). In
contrast, the fraction of foreign acquirers in unrelated (related) acquisitions in which the
holding period is less than one year is 34 (12) percent. The corresponding number of
domestic acquirers in unrelated (related) acquisitions is 54 (23) percent. These results
suggest that both foreign and domestic acquirers in related acquisitions hold block
ownership in US. targets for longer than do those in unrelated acquisitions. They also
indicate that foreign acquirers are more likely to hold block ownership for a long period
than are domestic acquirers.

Panel B of Table 1.3 summarizes the ﬁactions of acquirers who indicate that the
purchase of Shares is for control purpose. It also Shows the fractions of acquirers who are
classiﬁed as active investors. We determine the purpose of acquisitions from 13D ﬁlings.
We classify the acquisition as control purpose if the acquiring ﬁrm discloses in a ﬁling of

13D that it seeks the control of the target. Following Bethel, Liebeskind, and Opler

 

’ Related investors, however, typically possess industry knowledge or operating expertise that is superior to
that of unrelated investors. Since the stock prices of acquirers are affected by those of targets via a change
in the market value of their equity holdings in targets, related investors might have strong incentives to
fully utilize their information advantage and operating expertise in order to maximize target value. In this
case, we expect related investors to be more actively involved in governance activities in targets than
unrelated investors.

18

(1998), we deﬁne active investors as those who announce their intention of inﬂuencing
ﬁrm policies or who are known for active policies in the past.

The main ﬁnding in Panel B is that unrelated investors are more likely to seek the
control of ﬁrms or to play an active role in inﬂuencing target management. Of the 125
unrelated foreign investors, 22 (18 percent) disclose their intentions of control purpose
and 25 (20 percent) can be classiﬁed as active investors. However, only four (3 percent)
of 132 related foreign investors indicate their intention of control purpose and none of
them are classiﬁed as active investors. We obtain Similar patterns for domestic acquirers.
These ﬁndings suggest that unrelated investors have stronger incentives to inﬂuence
target managerial behavior than do related investors, which is generally consistent with
the ﬁndings of Brickley et a1. (1988).

To see if our results are sensitive to the degree of Shareholder rights protection in the
acquiring ﬁrm country, Panel C of Table 1.3 further divides related and unrelated foreign
acquirers into those from countries with strong shareholder rights and those from
countries with weak shareholder rights. Of the 97 (28) unrelated foreign investors from
countries with strong (weak) shareholder rights, 23 percent (43 percent) hold block
ownership for longer than three years. Twenty percent (11 percent) of these investors also
disclose their intention of control purpose and 28 percent (4 percent) can be classiﬁed as
active investors. Thus, unrelated investors from countries with strong Shareholder rights
hold block shares in targets for a Shorter time than do those with countries with weak
Shareholder rights, but have stronger incentives to engage in corporate governance

activity in targets. Related investors, however, do not Show such patterns.

19

1.3 Empirical Results
1.3.] Post-Acquisition Governance Activities

Firms that acquire block shares might have strong incentives to monitor managerial
performance in targets and take action that enhances target ﬁrm value. In this section, we
examine various kinds of corporate governance activities that acquiring ﬁrms initiate
during the holding period of block shares up to three years. We classify the corporate
governance activities that acquirers undertake into seven categories: (1) threat of hostile
takeovers; (2) proxy contests or threat; (3) expression of opposition to or attempts to
amend anti-takeover provisions; (4) seeking representatives on the target’s board; (5)
threat of top executive turnover or involvement in the selection of a new top executive;
(6) asset downsizing; and (7) other governance activities, such as heading an investor
alliance, expressing an opinion on a target’s major decisions, requesting a meeting with
target management to address the potential way to maximize shareholder value, and so

forth.

1.3.1.1 Governance Activities of Foreign Acquirers

Post-acquisition governance activities of foreign acquirers are summarized in Table
1.4. While some acquiring ﬁrms engage in a Single governance activity, several acquiring
ﬁrms are involved in multiple activities. Thus, the classiﬁcations are not mutually
exclusive. During the period from 1981 to 1999, 257 foreign acquiring ﬁrms announce a
total of 84 involvements (33 percent of the total sample) in governance activities. Out of
these 84 activities, other governance activities are reported most frequently (21 cases),

followed by threat of hostile takeovers (19 cases), seeking board representation (18

20

cases), and asset downsizing (11 cases). Of the 19 foreign ﬁrms that threaten hostile
takeovers, three eventually acquire more than 50 percent of target equity. For the 18
foreign acquirers that seek or demand representation on targets’ boards, 10 are eventually
represented but 8 are not.5 Six foreign acquirers are involved in proxy contests and
another six demand changes to the top executive. In the remaining three cases, acquirers
ofﬁcially express opposition to or attempt to amend anti-takeover provisions proposed by
target management.

A breakdown of the governance activities by the relatedness of the acquirer and the
target and the degree of Shareholder rights protection in the acquiring ﬁrm country Shows
that these activities are mainly rendered by unrelated investors from countries with strong
Shareholder rights. This type of investor accounts for 93 percent (78 cases) of the total
governance activities. In contrast, unrelated investors from countries with weak
Shareholder rights engage in only two governance activities. Although related acquirers
from countries with weak shareholder rights are involved in four governance activities,
surprisingly, those from countries with strong shareholder rights are not involved in any
types of governance activities. Therefore, unrelated acquirers from strong protective
regimes stand in Sharp contrast to other types of acquirers regarding post-acquisition
governance activities in target ﬁrms. These ﬁndings clearly suggest that acquirers that are
incorporated in countries with strong shareholder rights, particularly those that do not
have any business relationships with targets, have strong incentives to actively intervene

in the governance process of target ﬁrms.

 

5 We also ﬁnd that several targets of foreign acquirers, mostly engaged in related acquisitions, exchange
board representatives with acquirers. This result suggests that the extent of the board’s independence is less

21

1.3.1.2. Governance Activities of Domestic Acquirers

Table 1.4 also summarizes the governance activities of US. blockholders from 1981
to 1999. During this period, 257 domestic acquiring ﬁrms announce a total of 134
involvements (52 percent of the total sample) in governance activities. Thus, U.S.
acquirers are more than 1.6 times as likely to engage in post-acquisition governance
activities as are foreign acquirers. The threat of hostile takeovers is the most frequently
observed type of governance activity (34 cases), followed by other governance activities
(31 cases), and seeking board representation (27 cases). Thirteen acquirers initiate the
threat of proxy contests against target management. U.S. acquirers also frequently
demand top executive turnovers (11 cases). Ten firms in the sample oppose or attempt to
amend anti-takeover provisions proposed by target management. There are eight cases
where U.S. acquirers demand some form of asset downsizing. Overall, in all governance
activities except demanding asset downsizing, U.S. acquirers take governance action
more frequently than do foreign acquirers.

We also ﬁnd that of the 134 governance activities, 110 (82 percent of the total
activities) are undertaken by unrelated U.S. acquirers, while the remaining 24 (18 percent
of the total activities) are undertaken by related ones. Thus, like foreign acquisitions, U.S.
acquisitions in the sample display evidence of signiﬁcantly high levels of governance
activities by unrelated investors.

In summary, the analysis of post-acquisition governance activities indicates that
foreign ﬁrms operating under strong shareholder rights protection perform a more active
governance role in their US. targets than do those operating under weak shareholder

rights protection. This result suggests that strong Shareholder rights create an

 

in related acquisitions than in unrelated acquisitions.

22

environment that fosters active corporate governance and thus inﬂuence managerial
incentives to engage in such activities. The frequent governance activities associated with
strong shareholder protection, however, are entirely driven by unrelated foreign investors.
Therefore, our results Show that related foreign investors who have current or potential
business relationships with target ﬁrms are less likely to take disciplinary actions against
target management. We also ﬁnd that the frequency of governance activities in targets is
much higher in domestic acquisitions than in foreign acquisitions. U.S. acquirers are
almost twice as likely to engage in threats of hostile takeovers, proxy contests, and top
executive turnovers, and at least three times as likely to oppose target management-
proposed anti-takeover amendments. Like foreign unrelated acquirers, U.S. acquirers that
do not have any business relationships with targets play a more active role in corporate

governance.

1.3.2 The likelihood of governance activity

In this section, to clarify the relation between legal rules covering the protection of
Shareholders and the likelihood of post-acquisition governance activity, we perform
multivariate logistic regressions in which the dependent variable is set to one if a
particular governance activity occurs and zero otherwise. AS a primary measure of legal
rules covering the protection of Shareholders, we use the Shareholder rights index in the
acquiring ﬁrm country. We also consider the indices for accounting standards and the
rule of law in the acquiring ﬁrm country as additional explanatory variables for the
likelihood of post-acquisition governance activity. LLSV (1998) argue that strong law

enforcement institutions can act as a substitute for poor Shareholder rights since a well-

23

ﬁrnctioning court tends to replace the Speciﬁc legal rules protecting the interests of
investors. For example, DeFond and Hung (2003) document that a strong system of law
enforcement signiﬁcantly improves the sensitivity of top executive turnover to poor
performance, while strong investor protection does not. These ﬁndings suggest that high-
quality law enforcement is sometimes more important than strong investor protection in
fostering the corporate governance activities of investors.

Since the univariate results in the previous section show that the relatedness of the
acquirer and the target is an important determinant of the likelihood of post-acquisition
governance activity, we include a dummy variable, which equals one if the two ﬁrms are
related and zero otherwise.

Large shareholders’ incentives to perform governance activities in targets can be
inﬂuenced by the duration of their block holding period. For example, Demsetz and Lehn
(1985) argue that large shareholders as long-term investors have strong incentives to
monitor management. In contrast, Butz (1994) views large Shareholders as Short-term
investors who have an incentive to inﬂuence the ﬁrm to divesture its assets and then
leave soon after to obtain a rapid improvement in wealth. These studies suggest that long-
term and short-terrn blockholders have different incentives concerning corporate
governance. Therefore, we include an indicator, which equals one if the holding period of
block shares acquired by investors is longer than three years and zero otherwise.

We also include the percent of Shares acquired. Shleifer and Vishny (1986) Show that
as the size of equity ownership by large Shareholders increases, their optimal choice of
monitoring increases. Hence, we expect a positive relationship between the size of equity

ownership acquired by large shareholders and their governance activities in targets.

24

It is shown that the board of directors plays an important role in corporate
governance. For instance, Jensen (1986b) argues that the board of directors serves as one
of the most important internal governance mechanisms. Weisbach (1988) documents that
the sensitivity of top management turnover to ﬁrm performance is higher for ﬁrms with
outsider-dominated boards than for those with insider-dominated boards. Shivdasani
(1993) also Shows that an effective board structure and hostile takeovers are substitute
mechanisms for corporate control. Therefore, we include the ratio of the number of
members of the board of directors represented by large blockholders in the target’s board
during the holding period up to three years after the acquisition.

Equity ownership by target managers can also have an effect on the likelihood of the
acquirer’s post-acquisition governance activity. According to Jensen and Meckling
(1976), concentrated managerial ownership aligns the interests of managers with those of
Shareholders, thus minimizing the agency problem that arises from the separation of
ownership and control. Concentrated managerial ownership, however, can insulate
managers from outside inﬂuence and thus leave them unconstrained. For example, Stulz
(1988) argues that high management ownership effectively precludes takeover threats and
thus decreases ﬁrm value. These arguments suggest that target management ownership
affects the acquirer’s incentives to conduct post-acquisition governance activities since it
could create a different level of agency problems in targets.

The next variable we consider is equity ownership by other institutional investors
before the acquisition of block Shares. If acquirers and other institutional shareholders
interact with each other to monitor target management and cooperate in governance

activities in targets, we expect such institutional ownership to be positively related to the

2S

likelihood of governance action by acquirers. For example, Zwiebel (1995) shows that
minority blockholders can exert control through coalitions with other blockholders.

To control for other important target characteristics, we also include ﬁrm size (log of
the market value of equity), leverage, past performance (the ratio of cash ﬂow to total
assets), and Tobin’s q.

As Shown in Section II.A, the threat of hostile takeovers and the demand for
representatives on the target’s board are the two governance actions most frequently
carried out by both foreign and domestic large-block investors. Furthermore, the previous
studies show that the threat of external takeovers and having outside directors on the
board play an instrumental role in external and internal governance, respectively.6
Therefore, in investigating the role of large-block shareholders in corporate governance
below, we focus on hostile takeover and board representation activities as their key
governance roles. AS a robustness check, we also consider all governance activities that

acquirers undertake during the holding period of block Shares in the analysis.

1.3.2.1 Threat of Hostile Takeovers

Table 1.5 reports the results from logistic regressions where the dependent variable
equals one if large-block acquirers are involved in hostile takeover activity and zero
otherwise. In the ﬁrst two regressions, we report the results for the targets of foreign
acquirers. Both shareholder rights and the rule of law are positively and Signiﬁcantly
related to the probability that foreign acquirers engage in hostile takeover actions. Thus,
controlling for other factors, foreign acquirers are more likely to engage in hostile

takeover activities when they come from countries with stronger Shareholder rights or

26

stronger law enforcement. To the extent that strong shareholder rights and strong rule of
law allow foreign acquirers to have better Skills or experience in performing governance
activities in their home countries and thus reﬂect the effectiveness of their govemance
structures, our results suggest that foreign investors are able to carry these Skills or
experience across national borders and transfer their governance standards to domestic
targets.

We also ﬁnd that the coefﬁcient on equity ownership by managers is negative and
signiﬁcant (p-value = 0.04) in the ﬁrst regression, suggesting that foreign acquirers are
less likely to undertake hostile takeover activity for US. ﬁrms with high management
ownership. This observation is consistent with the argument of Stulz (1988) that
signiﬁcant control by managers results in effective opposition to takeovers. The
coefﬁcient on the equity ownership by institutional investors is also negative and
Signiﬁcant (p-value = 0.06) in the second regression, indicating that the threat of hostile
takeovers by new large-block acquirers is less likely to arise when ownership by the
ﬁrm’s other institutional Shareholders is high. Therefore, foreign investors have few
incentives to take hostile takeover actions if other institutional investors already hold
large equity claims in targets before the acquisition of block Shares.

The coefﬁcient on Tobin’s q is negative and signiﬁcant at the 5 percent level. If
Tobin’s q measures either growth opportunities or the managerial ability of the ﬁrm

(Lang, Stulz, and Walkling (1989), Servaes (1991)), this result suggests that US. ﬁrms

 

6 See Jensen and Warner (1988) and Black (1992) for a review of this literature.

27

with low growth opportunities or inefﬁcient management teams are more likely to be the
target of hostile takeovers by foreign acquirers.7

In the next two regressions, we report the logistic regression estimates for the targets
of US. acquirers. As with the previous results for the targets of foreign acquirers, the
likelihood of hostile takeover activity decreases with equity ownership by managers,
equity ownership by existing institutional investors, and Tobin’s q. Unlike the results for
foreign acquirers, however, the coefﬁcient on the dummy variable for the duration of
block ownership is negative and signiﬁcant. Thus, U.S. acquirers are less likely to be
involved in hostile takeover activity when they hold block ownership for longer than
three years. We also ﬁnd that the coefﬁcient on the cash ﬂow ratio is positive and
Signiﬁcant at the 1 percent level, suggesting that ﬁrms with larger cash ﬂows are more
likely to be the targets of hostile takeover activity by US. acquirers (Jensen (1986a),
Lang, Stulz, and Walkling (1991)).

The previous univariate analysis shows that the frequency of hostile takeover activity
in targets is much higher in domestic acquisitions than in foreign acquisitions. To
investigate this result ﬁrrther, in the last two regressions, we estimate the difference in
takeover likelihood between foreign and domestic acquisitions for a pooled sample of
259 targets of foreign acquirers and 259 control targets of US. acquirers. The ﬁfth
regression includes the dummy variable, which equals one if a large-block acquirer is
from the foreign country and zero otherwise. It Shows that the coefficient on this dummy
is negative and Signiﬁcant at the 5 percent level, suggesting that foreign acquirers are less

likely to engage in hostile takeover activity than are domestic acquirers, even after

 

7 We do not include the dummy for the relatedness of the acquirer and the target in these regressions since
there is only one case of hostile takeover activity for related acquisitions.

28

controlling for other explanatory variables. In the sixth regression, we separate the
foreign country dummy into two dummies according to the level of shareholder rights
protection in the acquiring ﬁrm country: the dummy for a foreign country with strong
Shareholder rights and the dummy for a foreign country with weak Shareholder rights. In
other words, we use the domestic acquisitions as the reference group for comparison. The
coefﬁcient on the ﬁrst country dummy is negative but insigniﬁcant. Thus, the probability
of hostile takeover activity occurring in the targets of foreign acquirers from countries
with strong shareholder rights is Similar to that occurring in the targets of US. acquirers.
Since the shareholder rights score in the US. belongs to the category of countries with
strong shareholder rights used in this paper, our result further indicates that the
Shareholder rights protection of the acquirer’s country is an important factor that
determines corporate governance activity in targets. The coefﬁcient on the second
country dummy, however, is negative and signiﬁcant at the 1 percent level, suggesting
that US. targets are less likely to experience the threat of hostile takeovers when their
acquirers are from weak Shareholder protection countries than when they are from the

US.

1.3.2.2 Demand for Representatives on the Target’s Board

In Table 1.4, we examine the effect of the legal protection of investors and the quality
of law enforcement on the likelihood of acquirers’ demanding board representation. The
dependent variable equals one if large-block acquirers announce that they seek or demand
representatives on the target’s board and zero otherwise. In the ﬁrst two regressions, we

report the logistic regression estimates for the targets of foreign acquirers. In these

29

regressions, the estimated coefﬁcients on shareholder rights are positive with p-values of
0.03 and 0.04, respectively, while none of the law enforcement variables are signiﬁcant.
These ﬁndings suggest that although the likelihood of acquirers’ demanding board
representation is not affected by strong law enforcement institutions in foreign home
countries, it increases with the degree of their Shareholder rights protection.

Consistent with the results of the univariate tests, in the ﬁrst regression, the
coefﬁcient on the dummy for related investors is negative and statistically signiﬁcant at
the 5 percent level. Tobin’s q is also negative and signiﬁcant, suggesting that foreign
acquirers are more likely to demand board representation when the target ﬁrms have poor
growth opportunities or inefﬁcient management teams.

In regressions (3) and (4), we report the results for the targets of US. acquirers. AS in
the results for those of foreign acquirers, the coefﬁcients on the dummy for related
investors are negative and Si gniﬁcant.

In regressions (5) and (6), we use a pooled sample of the targets of foreign acquirers
and those of domestic acquirers. We ﬁnd that the coefﬁcients on the foreign country
dummy and the dummy for a foreign country with strong Shareholder rights are not
signiﬁcant, while the coefﬁcient on the dummy for a foreign country with weak
Shareholder rights is negative and signiﬁcant. These results are generally consistent with
those in Table 1.5 and further suggest that investor protection of the acquirer’s country is

an important determinant of corporate governance activity in US. targets.

30

1.3.2.3 All Types of Governance Activity

To ﬁrrther examine the effect of legal environments in the acquirer’s country on the
likelihood of undertaking governance activities in targets, Panel A of Table 1.7 reports
the results from logistic regressions that consider all types of governance activity
undertaken by acquirers. The dependent variable equals one if acquirers are involved in at
least one of the seven governance activities categorized in Table 1.6.

The results in regressions (l) and (2) Show that, as in the regressions for hostile
takeover and board representation activities, the probability that foreign acquirers take
any type of governance action is positively and Signiﬁcantly related to shareholder rights
at the 1 percent level. It is also positively related to the percent of Shares acquired (p-
value = 0.00). However, this probability is negatively and signiﬁcantly related to the
dummy for relatedness between the acquirer and the target, to equity ownership by
managers, to equity ownership by institutional investors, and to Tobin’s q. The positive
coefﬁcient on the percent of Shares acquired and the negative coefﬁcient on equity
ownership by institutional investors suggest that the existence of other shareholders in
targets before the acquisition of block shares adversely affects the incentives for foreign
blockholders to take an active role in post-acquisition governance activities.

In regressions (3) and (4), we re-estimate the full regression separately for the
subsample of US. targets of unrelated foreign acquirers and for the subsample of US.
targets of related foreign acquirers. The results indicate that our ﬁndings for the full
sample mirror those for the subsample of unrelated targets. In contrast, none of the
variables in the subsample of related targets are signiﬁcant. Along with the negative

coefﬁcients on the dummy for relatedness between the acquirer and the target in

31

regressions (l) and (2), these ﬁndings suggest that when Share ownerships are in the
hands of related investors, these ownerships prevent them from effectively monitoring
their targets.

In regressions (5) through (8), we estimate logistic regressions Similar to those in
regressions (1) through (4) for governance actions by US. acquirers. AS in the results for
foreign acquisitions, the coefﬁcients on the dummy for relatedness between the acquirer
and the target and equity ownership by managers are negative and Signiﬁcant. However,
the coefﬁcients on the percent of Shares acquired and equity ownership by other
institutional investors are not signiﬁcant.

In regressions (9) and (10), we report the regression estimates for a pooled sample of
the targets of foreign acquirers and those of US. acquirers. The coefﬁcients on the
foreign country dummy and the dummy for a foreign country with weak Shareholder
rights are again negative and Signiﬁcant. The likelihood that acquirers undertake any type
of governance action is also inversely related to relatedness between the acquirer and the
target.

To check the robustness of the results, in Panel B of Table 1.7, we perform the
ordinary least squares (OLS) regressions using the governance activity index as the
dependent variable. We construct an index aggregating governance activities by adding
one when large-block acquirers undertake one of the seven governance activities
described in Table 1.6. Therefore, the score of this index ranges from zero to seven, with
a higher score meaning the acquirer undertakes governance activities more frequently.
We ﬁnd that the results in Panel B of Table 1.7 are similar to those in Panel A of Table

1.7.

32

In summary, the analysis of post-acquisition governance activities of foreign acquirers
indicates that the probability of these activities being undertaken increases when the
acquirers come from countries with strong Shareholder rights protection. Although the
likelihood of undertaking governance activities is Similar for foreign acquirers from
countries with strong Shareholder rights and domestic acquirers, foreign acquirers from
countries with weak shareholder rights are less likely to engage in governance activities
than are domestic acquirers. These results suggest that the extent of post-acquisition
governance activities by large-block acquirers is a function of the legal protection of
investors in their home countries. We also ﬁnd some similarities in factors that determine
the governance activities of foreign and domestic acquirers. For both foreign and
domestic acquirers, the probability of undertaking governance activities decreases when
they have business relationships with targets and when institutional Shareholders or

managers in targets hold large equity claims.

1.3.3 Top Executive Turnover

One potential problem in our previous analysis is that to identify post-acquisition
governance activities initiated by acquirers, we have used reports from newspapers, SEC
ﬁlings, and other public information sources. To the extent that some companies decided
not to reveal such information to the public, several governance activities we have
examined from these sources might be biased downward and thus we may have
underestimated the extent of such activities. Therefore, to Show that our results are not
driven by this bias, having collected complete information on nonroutine top executive

turnover events for targets that took place during our sample period, we examine whether

33

the likelihood of such events is related to the variables we have considered in the
previous regressions.8

We focus on nonroutine top executive turnover since the removal of the top executive
is one of the most aggressive actions taken by governance mechanisms. Furthermore,
several studies Show that blockholders play an important role in the process of top
executive turnover. For example, Denis, Denis, and Sarin (1997) document that the
probability of top executive turnover occurring is positively related to the presence of
large outside shareholders. Bethel, Liebesind, and Opler (1998) Show that such a
probability is high for ﬁrms experiencing activist block purchases. Kang and Shivdasani
(1995) also Show that for large Japanese ﬁrms, nonroutine turnover is more likely when
ownership by the top 10 shareholders is high.

We obtain the sample of top executive turnover events from proxy statements and
annual reports. For the holding period up to three years after the formation of block
shares, we search these sources for changes of presidents, chairmen, and CEOS. For each
turnover, we also collect data on the background of the departing top executive, such as
age and tenure, from proxy statements and annual reports. Since our objective is to
evaluate the effect of disciplinary actions by large blockholders on the likelihood of top
management turnover, we focus on turnover events that are most likely to be disciplinary
and thus exclude those that are likely to represent normal succession. We deﬁne the top
executive as the CEO. If a ﬁrm does not have a CEO, we use the chairman of the board
as the top executive. Otherwise, the top executive is deﬁned as the president. Following

Denis, Denis, and Sarin (1997), we refer to turnover events where the top executive is

 

8 One disadvantage of using this approach is that it overestimates the extent of governance activities of
foreign and domestic acquirers since some turnovers we consider might be initiated by other investors.

34

removed due to death, illness, or other normal reasons as routine turnover. We classify a
management change as normal if the stated reason for the change is retirement and the
retiring manager is between the ages of 64 and 66. We refer to all others as nonroutine
turnover.9 This procedure yields a ﬁnal sample of 57 nonroutine turnovers (22 percent of
the total sample) for US. targets of foreign acquirers and a ﬁnal sample of 55 nonroutine
turnovers (21 percent of the total sample) for US. targets of domestic acquirers (Panel A
of Table 1.8). Forty—three (27 percent) out of 159 targets of foreign ﬁrms from countries
with strong shareholder rights experience top executive turnovers, while only 14 (14
percent) out of 98 targets of foreign ﬁrms from countries with weak shareholder rights
experience top executive turnovers. Thus, acquirers from countries with strong
Shareholder rights are over three times as likely to be involved in removals of the top
executive as are those from countries with weak shareholder rights.

Panel B of Table 1.8 further divides 57 nonroutine turnovers for US. targets of
foreign acquirers into four subgroups according to shareholder rights and the relatedness
of the acquirer and the target. The main ﬁnding is that the targets of unrelated acquirers
from countries with strong shareholder rights experience the highest frequency of top
management turnover. Twenty-seven (28 percent) out of 68 targets of unrelated acquirers
from countries with strong shareholder rights experience nonroutine top executive
turnovers. This result is consistent with that of Table 1.4, which Shows that the frequency
of all governance activities obtained from public information sources is highest for the
subsample of targets of unrelated foreign investors from strong shareholder protective

regimes.

 

9 We also experiment with an alternative deﬁnition of nonroutine turnover assuming that normal retirement
takes place at any age above 60 or 64. Our results are qualitatively similar with this approach.

35

Table 1.9 Shows the results from the logistic regressions where the dependent variable
is one if nonroutine turnover occurs and zero otherwise. In addition to including all
explanatory variables used in the previous regressions, we also control for other variables
that may affect top executive turnover. Speciﬁcally, the regressions control for the age
and tenure of the top executive, and also include a chairman dummy, which equals one if
the top executive is the chairman of the board, as well as a founder dummy, which equals
one if the top executive is the founder of the ﬁrm. We deﬁne founders as those who are
described as founders in the proxy statement or the annual statement, or those who have
held the position of top executive Since the inception of the ﬁrm.

Although we incorporate the age of the top executive in classifying nonroutine
turnover, the age and tenure of the top executive can still affect turnover likelihood, either
positively or negatively. For example, if they are an indicator that the top executive is
close to retirement or to being removed due to normal management changes, the turnover
probability is expected to be positively related to them (Weisbach (1988)). In contrast, if
the age and tenure of the top executive represent the extent of control that he or she has
over ﬁrms, the turnover probability is likely to decrease with these variables.

The status of the top executive either as chairman or founder may also affect the
process of top executive turnover. For example, Fama and Jensen (1983) argue that the
concentration of decision management and decision control in an individual reduces the
effectiveness of the internal governance system in monitoring top management. Denis,
Denis, and Sarin (1997) also Show that the probability of top executive turnover is
Signiﬁcantly smaller when the top executive is the founder or a member of the founding

family. These results suggest that top executives who are also founders or who have

36

chairmanship have more control over ﬁrms than other types of top executives and thus
there will tend to be a low probability of top executive turnover.

The ﬁrst two regressions report the logistic regression estimates for the targets of
foreign acquirers. The coefﬁcients on shareholder rights are again positive and Signiﬁcant
at the 5 percent level, indicating that foreign acquirers from countries with strong
Shareholder rights are more likely to replace target management subsequent to an
acquisition of large minority ownership. This ﬁnding suggests that the shareholder rights
protection of the acquirer’s country has a Signiﬁcant inﬂuence on the acquirer’s
managerial incentives to perform an active role in disciplining target managers. The
board representation ratio by foreign acquirers is also positively and Signiﬁcantly related
to turnover likelihood. Given that the board members represented by large-block
acquirers are independent outside directors, this result suggests that outside directors play
an important governance role during the process of top management turnover (Weisbach
(1988)). Nonroutine turnover is signiﬁcantly more likely when the percent of shares
purchased by acquirers is high. This ﬁnding is consistent with the monitoring role of
large shareholders argued by Shleifer and Vishny (1986). The coefﬁcients on the dummy
variable for the duration of block ownership are positive and signiﬁcant at the 5 percent
level, indicating that acquiring ﬁrms that hold target equity for a long period are more
likely to replace target management. The coefﬁcients on the age of top management are
positive and signiﬁcant, while those on the tenure of top management are negative and
signiﬁcant.

In regressions (3) and (4), we examine the results for the targets of unrelated foreign

investors and those of related foreign investors, respectively. AS in the results Shown in

37

Table 1.7, all of the Signiﬁcance in the total sample is driven by the subsample of
acquisitions in which foreign investors do not have any business relationships with US.
targets.

In regressions (5) through (8), we report the results for the targets of US. acquirers.
We ﬁnd that most of the results for US. acquirers are similar to those for foreign
acquirers. The main exception is that for targets of related acquirers, the coefﬁcients on
the percent of Shares acquired and the dummy variable for the duration of block
ownership by acquirers are positive and signiﬁcant at the 5 percent level. These ﬁndings
suggest that unlike foreign related acquirers, domestic related acquirers who have
Si gniﬁcant equity claims on targets or maintain a long-term equity relationship with them
play an important role in the decision to remove target management.

Regressions (9) and (10), which use a pooled sample of targets of foreign acquirers
and those of domestic acquirers, show that the coefﬁcients on the dummy for foreign
acquirers from weak protective regimes are negative and Signiﬁcant at the 1 percent level.
The coefﬁcients on the dummy for related investors are also negative and signiﬁcant at
the 5 percent level in both regressions.

Overall, the results from the analysis of nonroutine top executive turnover conﬁrm
those of the previous analysis for various governance activities and ﬁrrther Show that
Shareholder rights protection of the acquirer’s country inﬂuences its corporate
governance activities in the host country. Our results also suggest that relation-speciﬁc or
deal-Speciﬁc characteristics, such as the business relationship between the acquirer and

the target, the holding period of block ownership, and the percent of shares purchased,

38

create different incentives for foreign and domestic acquirers to undertake various

governance activities in targets.

1.3.4 The Announcement Effects

In this section, we examine the effect of differences in the legal protection of
investors and law enforcement in the acquiring ﬁrm country on the value of US. targets
by analyzing the valuation effect of announcements of block Share purchases. To assess
the valuation effect of acquisition events, we compute abnormal returns using a standard
event-study methodology. We obtain our estimates of the market model by using 200
trading days of return data, beginning 220 days before and ending 21 days before the
announcement of the block share purchase. We use as the market return the CRSP
equally weighted return. We sum the daily abnormal returns to get the cumulative

abnormal return (CAR) from day tl before the announcement date of the block Share
purchase to day t2 after the announcement date of the block Share purchase. We use the t-

statistics to test the hypothesis that the average CARS are equal to zero, and the Sign-rank
test statistic to test the hypothesis that the CARS are distributed symmetrically around
zero.

Panel A of Table 10 reports the CARS for the targets of foreign and domestic
acquirers for different event windows. Shareholders of US. target ﬁrms cam, on average,
statistically signiﬁcant positive gains. The average CAR (-1 , 0), CAR (-1, l), and CAR (-
5, 5) for the targets of foreign acquirers are 4.8 percent, 6.0 percent, and 7.4 percent,
respectively, all of which are statistically Signiﬁcant at the 1 percent level. The

corresponding CARS for the targets of domestic acquirers are 6.9 percent, 8.2 percent,

39

and 9.4 percent, respectively. They are also Signiﬁcant at the 1 percent level. These
ﬁndings are consistent with those of Mikkelson and Ruback (1985), who document
positive announcement returns for target ﬁrms who sell 5 percent or more of their equity
stakes to other companies. Tests of differences in mean CAR (-1, 0) and CAR (-1, 1)
between the targets of foreign acquirers and those of domestic acquirers are rejected at
the 5 percent level. The medians Show a similar pattern.

In Panel B of Table 10, we examine the variation in valuation effects for targets of
foreign acquirers by stratifying the sample ﬁrms into four subgroups according to the
degree of Shareholder rights protection and the relatedness of the acquirer and the target.
U.S. targets of unrelated foreign investors from weak Shareholder protection countries
realize small and insigniﬁcant returns, while the other three subgroups realize large and
signiﬁcant returns. In particular, the differences in mean and median CARS (-1, 1)
between unrelated investors from weak shareholder protection countries and those from
strong shareholder protection countries are signiﬁcant at the 5 percent and 1 percent
levels, respectively. Related investors, however, do not Show such differences. These
ﬁndings suggest that for unrelated acquisitions, strong shareholder rights of the acquirer’s
country are more likely to be perceived positively by US. investors than are weak
Shareholder rights.

In sum, our results suggest that managers of unrelated foreign ﬁrms that come from
countries with strong Shareholder rights have different objectives from those that come
from countries with weak shareholder rights when they acquire ﬁrms in the US, and that

the stock market clearly differentiates these differences in managerial incentives.

4O

To understand better the cross-sectional variation in target returns, we present the
estimates from multivariate regressions. All regressions are estimated using OLS. The
regression results are presented in Table 1.9. In the ﬁrst regression, we regress the CAR
(-1, 1) for targets of foreign acquirers on shareholder rights and the quality of law
enforcement in the acquiring ﬁrm countries, the relatedness of the acquirer and the target,
the percent of shares acquired, the extent of board representation by acquirers, and other
target-speciﬁc characteristics. The coefﬁcient on shareholder rights is insigniﬁcant.
However, the coefﬁcient on the board representation ratio by acquirers is positive and
Signiﬁcant at the 10 percent level, indicating that Shareholders of target ﬁrms realize a
greater wealth gain when foreign investors actively seek representatives on the target’s
board.

In regressions (2) and (3), we report the regression estimates for the subsample of
targets acquired by unrelated foreign investors. In regression (3), the Shareholder rights
score is positively and Signiﬁcantly related to CAR (-1, 1) at the 1 percent level. A
regression coefﬁcient of 0.026 indicates that an increase of the shareholder rights score
by one point in the acquiring ﬁrm country is associated with a 2.6 percent increase in
abnormal returns for US. targets. Therefore, the effect of Shareholder rights protection in
the acquiring ﬁrm country on target value seems to be both statistically and economically
signiﬁcant. The percent of Shares acquired by foreign investors also has a positive and
Signiﬁcant effect on the CAR (-1 , 1) for targets. This ﬁnding is consistent with theoretical
work on the role of large Shareholders by Shleifer and Vishny (1986). We also ﬁnd that
the coefﬁcient on the board representation ratio by foreign investors is positive and

Signiﬁcant at the 5 percent level in regression (2). The positive signiﬁcance of these

41

variables are generally consistent with that in the previous analysis of logistic regressions
and conﬁrms the importance of investor protection and board structure as a determinant
of the effectiveness of corporate governance. Consistent with the results from the
previous logistic regressions, none of the regression coefﬁcients on explanatory variables
are signiﬁcant when we use the subsample of targets of related foreign investors
(regressions (4) and (5)).

For comparison, regressions (6) through (8) Show the estimates for the total sample of
targets of domestic acquirers, the subsample of targets of unrelated domestic acquirers,
and the subsample of targets of related domestic acquirers, respectively. Unlike the
regressions for targets of foreign acquirers, the coefﬁcients on most of the explanatory
variables are not signiﬁcant and the adjusted R-square of the regressions are relatively
low, suggesting that the regression speciﬁcations used for targets of foreign acquirers do

not ﬁt well for targets of domestic acquirers.

1.4 Alternative Explanations
To rule out alternative explanations that are also consistent with our ﬁndings, we

conduct several additional tests. Below, we brieﬂy summarize the results of these tests.

1.4.1 Information Asymmetry

If foreign investors are less well informed about ﬁrms in the host country than are
domestic investors, they will have fewer incentives to undertake an active governance
role in these ﬁrms because the costs of overcoming information asymmetry are higher.

Since the information asymmetry that foreign investors face in the host country varies

42

depending on their language barrier, geographical difference, and experience in the US.
prior to the acquisition, one would expect these measures of information asymmetry to
have a Signiﬁcant effect on the likelihood of their post-acquisition governance activities
in targets. To see whether our results are sensitive to considering the effect of information
asymmetry, we re-estimate the previous logistic regression in Table 1.7 by including
additional variables that act as a proxy for the extent of information asymmetry faced by
foreign acquirers: the language (English) dummy, which equals one if the primary
language of foreign acquirers iS English; the geography dummy, which equals one if
foreign acquirers are from the same geographical region as the US. targets (i.e., the
Americas); and the US. operation dummy, which equals one if the foreign acquirers have
US. operations prior to the acquisitions. The results are reported in regression (1) of
Table 1.12. It turns out that the coefﬁcients on these dummy variables are not Signiﬁcant.
Controlling for information asymmetry does not change the signiﬁcance of the
coefﬁcients on other explanatory variables, including the Shareholder rights of the

acquirer’s country.

1.4.2 Creditor Rights and Other Shareholder Rights

Although we have shown that Shareholder rights protection is an important
determinant of the governance activities of foreign acquirers in the US, other legal rules
covering the protection of Shareholders can also affect the likelihood that such activities
occur. For example, LLSV (1998) argue that investors are better protected when dividend
rights are closely tied to voting rights such as the one share—one vote rule. They also

argue that the mandatory dividend right can serve as a legal substitute for the weakness of

43

other protections of minority shareholders. Therefore, we check the robustness of our
results by including the dummy for the one share—one vote rule and the dummy for the
mandatory dividend right. We also include the creditor rights index of the acquirer’s
country as an additional explanatory variable. To the extent that stronger creditor rights
protection provides lenders with more incentives to monitor managerial performance and
to take more actions that preserve or enhance ﬁrm value, we expect it to be positively
related to the likelihood of post-acquisition governance activities in targets. None of these
three variables in regression (2), however, are signiﬁcant. Including these variables does

not change the main results we document.

1.4.3 Cultures and Religious

Stulz and Williamson (2003) document that investor protection, particularly creditor
rights protection, is related to culture. They Show that a country’s primary religion
explains the cross-sectional variation in creditor rights better than do legal origins,
language, and country’s openness to international trade. Since foreign investors’
incentives to undertake post—acquisition governance activities also tend to be affected by
their cultural backgrounds, we include a proxy that measures the cultural difference
between the acquirer and the target as an additional explanatory variable. Speciﬁcally,
following Stulz and Williamson, we include in the regression a Catholic dummy, which
equals one if the primary religion of a country that the foreign acquirer comes from is
Catholic, and a Protestant dummy, which equals one if it is Protestant. The third

regression of Table 1.12 Shows that the coefﬁcients on these two dummy variables are

44

not statistically signiﬁcant. The Sign and Signiﬁcance of the coefﬁcients on other

explanatory variables remain about the same.

1.4.4 Legal Origin

LLSV (1998) Show that legal rules pertaining to investor protection differ
substantially across legal origins and that countries with a common law origin tend to
have the strongest legal protection of Shareholder rights. Therefore, as a further
robustness check, in the last regression, we use a legal origin variable (a dummy for
common law countries) as a broad indicator of shareholder rights protection. However, in
our sample, the correlation coefﬁcient between the common law origin dummy and
shareholder rights index variables is 79 percent. Since including such highly correlated
variables in the same regression causes severe collinearity problems, we do not include
the shareholder rights index variable in the regression. The results show that the
coefﬁcient on the common law origin dummy variable is positive and statistically
Signiﬁcant at the 1 percent level. This result ﬁrrther conﬁrms our previous ﬁnding that
investor protection by the legal system in the acquiring ﬁrm country is an important

factor in determining the likelihood of governance activities in US. targets.

1.5 Summary and Conclusions

In this paper, we have studied the role of legal rules and law enforcement for foreign
acquiring ﬁrms in fostering their corporate governance activities in US. targets. We ﬁnd
that foreign ﬁrms that purchase block shares of US. targets undertake several governance

activities after the acquisition, such as the threat of hostile takeovers, the demand for

45

appointment of their representatives to the target’s board, nonroutine top executive
turnover, proxy contests, the expression of opposition to and attempts to amend anti-
takeover provisions, and so forth. These post-acquisition governance activities are less
likely to occur when acquirers are from foreign countries with weak Shareholder rights
than when they are either from countries with strong Shareholder rights or from the US.
In particular, the likelihood of governance activities including the threat of hostile
takeovers, the demand for representatives on the target’s board, and nonroutine top
executive turnover increases with the level of the Shareholder rights score of the
acquirer’s country. The analysis of the abnormal returns for US. targets at the
announcement of block share purchases also indicates that they are positively related to
the Shareholder rights score of the acquirer’s country.

Taken together, these results are consistent with the view that the legal protection of
investors, especially Shareholder rights, is an essential element of corporate governance
and has an important inﬂuence on governance activities. They also suggest that foreign
investors from countries with good governance structures have an ability to carry their
superior governance skills and expertise across national borders and perform an
instrumental role in improving the corporate governance standards of US. targets.
However, these results are mainly driven by the subsample of acquisitions in which
foreign investors do not have any business relationships with US. targets, suggesting that
the relatedness of the acquirer and the target is a key determinant of the likelihood of
post-acquisition governance activities and the valuation effect of announcements of such

activities. We obtain similar results for US. targets of domestic acquirers.

46

Overall, our results Show that the likelihood of governance activity of foreign
acquirers in US. targets is a function of the legal protection of investors in their home
countries and that the relatedness of the acquirer and the target plays a critical role in this
process. Therefore, our study sheds light on the issue regarding a link between investor

protection and corporate governance and extends the literature on the law and ﬁnance.

47

APPENDIX 1
TABLES OF ESSAY l

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77

Appendix A

Description of Variables

 

Variable Description Source

 

Shareholder (anti— It is created by adding one when (l) shareholders are La Porta et al.
director) rights index allowed to mail their proxy vote; (2) shareholders are (1998)
not required to deposit their shares prior to the general
shareholders’ meeting; (3) cumulative voting or
proportional representation of minorities on the board
of directors is allowed in the law; (4) an oppressed
minorities mechanism is in place; (5) the minimum
percentage of share capital that entitles a shareholder
to call for an extraordinary shareholders’ meeting is
less than or equal to 10 percent (the sample median);
or (6) when shareholders have preemptive rights that
can only be waived by a shareholders’ vote. The
range for the index is from zero to six and a higher
score indicates better protection.

Accounting It is created by the C enter for International Financial La Porta et a].
standards index Analysis and Research by examining the contents of (1998)

1990 annual reports on their inclusion or omission of

90 disclosure items. These items fall into seven

categories (general information, income statements,

balance sheets, funds ﬂow statement, accounting

standards, stock data, and special items).

Rule of law index Assessment of the law and order tradition in the La Porta et a].
country produced by the country risk-rating agency (1998)
International Country Risk. Average of the months of
April and October of the monthly index between 1982
and 1995. The range for the index is from zero to ten
and a higher score indicates a greater tradition of law

and order.
Creditor rights It is created by adding one when (1) the country La Porta et a].
index imposes restrictions, such as creditors’ consent, to ﬁle (1998)

for reorganization; (2) seemed creditors are able to
gain possession of their security once the
reorganization petition has been approved (no
automatic stay); (3) secured creditors are ranked ﬁrst
in the distribution of the proceeds that result from the
disposition of assets of a bankrupt ﬁrm; and (4) the
debtor does not retain the administration of its
property pending the resolution of the reorganization.
The range for the index is from zero to four and a
higher score indicates better protection.

78

Common law
dummy

One share—one vote
dummy

Mandatory
dividend dummy

Related acquirer
dummy

Strong shareholder
rights dummy

Weak shareholder
rights dummy

Active investor

Nonroutine top
executive turnover

A dummy variable that takes the value of one if the
legal origin of the company law or the commercial
code of the country is English common law and zero
otherwise.

A dummy variable that takes the value of one if the
company law or the commercial code of the country
requires that ordinary shares carry one vote per share
and zero otherwise.

A dummy variable that takes the value of one if the
company law or the commercial code requires ﬁrms
to distribute a certain percentage of their net income
as dividend among stockholders and zero otherwise.

A dummy variable that takes the value of one if the
large-block acquirer is classiﬁed as a related investor
and zero otherwise. We determine the relatedness of
the acquirer and the target by searching several
sources for three years prior to and subsequent to the
announcement date of block share purchases. We
deﬁne the related acquisitions as those in which the
two ﬁrms engaged in the acquisitions have
maintained strategic agreement, business alliance,
joint venture, or other product market partnerships
such as supply, marketing/ distribution, and
technology-sharing relationships before the
acquisition, or have announced their intention of
establishing such relationships in the future.

A dummy variable that takes the value of one if the
shareholder rights index is greater than three and zero
otherwise.

A dummy variable that takes the value of one if the
shareholder rights index is smaller or equal to three
and zero otherwise.

Following Bethel, Liebeskind, and Opler (1998), we
deﬁne active investors as those who announce their
intention of influencing ﬁrm policies or who are
known for active policies in the past.

We deﬁne the top executive as the CEO. If a ﬁrm
does not have a CEO, we use the chairman of the
board as the top executive. Otherwise, the top
executive is deﬁned as the president. Following
Denis, Denis, and Sarin (1997), we refer to turnover

79

La Porta et al.
(1998)

La Porta et al.
(1998)

La Porta et al.
(1998)

13D, proxy
statement,
annual
statement, Dow
Jones Newswire

La Porta et al.
(1998)

La Porta et al.
(1998)

13D, Dow Jones
Newswire

Proxy statement,
annual statement

Top executive
founder dummy

Governance
activity index

Governance
activity dummy

Foreign investor
dummy

events where the top executive is removed due to
death, illness, or other normal reasons as routine
turnover. We classify a management change as
normal if the stated reason for the management
change is retirement and the retiring manager is
between the ages of 64 and 66. We refer to all others
as nonroutine turnover.

A dummy variable that takes the value of one if the
top executive is the founder of the ﬁrm. We deﬁne
founders as those who are described as founders in
the proxy statement or annual statement, or those who
have held the position of top executive since the
inception of the ﬁrm.

The index is formed by adding one when acquirers
undertake at least one of the following seven
governance activities: (1) threat of hostile takeovers;
(2) proxy contests or threat; (3) expression of
opposition to or attempts to amend anti-takeover
provisions; (4) seeking representatives on the target’s
board; (5) threat of top executive turnover or
involvement in the selection of a new top executive;
(6) asset downsizing; (7) other governance activities,
such as heading an investor alliance, expressing an
opinion on a target’s major decisions, requesting that
the meeting with target management address the
potential way to maximize shareholder value, and so
forth. The range for the index is from zero to seven
and a higher score indicates more frequent activities.

A dummy variable that takes the value of one if
acquirers undertake at least one of the seven
governance activities listed above and zero otherwise.

A dummy variable that takes the value of one if the
ultimate parent country of the acquirer is not the US.
and zero otherwise.

Proxy statement,
annual statement

13D, proxy
statement,
annual
statement, Dow
Jones Newswire

13D, proxy
statement,
annual
statement, Dow
Jones Newswire

Securities Data
Corporation

 

80

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81

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86

ESSAY ;. Geography and Corporate Governﬂ
Evidence from PLtial Acquisitions
2.1 Introduction

Recent empirical evidence suggests that geography plays an important role in
ﬁnancial economics. Professional money mangers and individual investors exhibit a
strong preference for geographically proximate equities (Coval and Moskowitz (1999),
Huberman (2001), Zhu (2002)). Furthermore, their local investments outperform their
remote investments, suggesting that geographically proximate investors have signiﬁcant
information advantages over distant investors (Coval and Moskowitz (2001), Ivkovic and
Weisbenner (2003), Bodnaruk (2003)).

While these studies have focused on the effect of geography on investor portfolio
choice, Coval and Moskowitz (2001) argue that the governance activities of
geographically proximate investors facilitate their information advantage over remote
investors: “This information may be the result of improved monitoring capabilities or
access to private information of geographically proximate ﬁrms.” (pp. 812, 838) This
observation suggests that geographically proximate investors may be better monitors than
other investors. Investors located near the ﬁrm may be more likely to engage in
governance activities than distant investors, since they would bear lower transaction costs
involved in their governance activities such as costs of acquiring information, traveling,
and communication, compared to distant investors.

In this paper, we investigate the effect of geography on the corporate governance
activities of large-block acquirers. Examining the post-acquisition governance activities

of large-block acquirers who acquire at least 5 percent, but less than 50 percent of voting

87

shares in target ﬁrms, we ﬁnd that geographically proximate acquirers are more actively
involved in governance activities in target ﬁrms than are remote block acquirers”).
Speciﬁcally, acquirers who are located within the same state as targets (hereafter referred
to as in-state acquirers) or who are located within 250 miles of target ﬁrms (hereafter
referred to as local acquirers) are more likely to have their representatives on the target’s
board and replace target management after block share purchases. In addition, targets of
in-state and local acquirers experience higher abnormal announcement returns and post-
acquisition operating performance than those of other acquirers. Moreover, these effects
are more pronounced when target ﬁrms are smaller, have worse past performance, or
have higher insider ownership.

Our ﬁndings suggest that geography has an important inﬂuence on large-block
acquirers’ incentives to engage in governance activities in target ﬁrms. Iii-state acquirers
and local acquirers who are expected to possess advantages in terms of information
acquisition and lower monitoring costs are more likely to be involved in governance
activities in targets and the stock market anticipates the increase in governance activity of
these acquirers and views it positively. Therefore, our results suggest that an information
advantage and lower monitoring costs of geographically proximate blockholders foster
their active corporate governance activities, and impact the operating performance and
ﬁrm value. The ﬁrrther analysis shows that the effect of geographic proximity on ﬁrm

value is concentrated in small ﬁrms, ﬁrms with higher insider ownership, and ﬁrms with

 

'0 We focus on large-block acquirers since detailed information on their ownership changes and post-
acquisition governance activities is publicly available. More importantly, unlike small shareholders who
like to free-ride the corporate governance activities of other shareholders (Grossman and Hart (1980)),
large shareholders have strong incentives to monitor managerial performance and take actions that enhance
ﬁrm value (Shleifer and Vishny (1986)). For instance, Shivdasani (1993), Denis and Serrano (1996), and
Bethel, Liebeskind, and Opler (1998) document that blockholders play an important role in corporate
governance.

88

poor past performance, where local acquirers may have superior access to information
about the ﬁrm since information about these companies gets out more slowly and is likely
to be communicated through private channels (Hong, Lim, and Stein (2000), Ball,
Kothari, and Robin (2000)). These ﬁndings also suggest that ﬁrm-speciﬁc characteristics,
such as ﬁrm size, insider ownership, and past performance, have an effect on information
asymmetry between local and nonlocal shareholders.

In addition, the fraction of board representation by blockholders and the probability
of nonroutine top executive turnover are negatively related to the physical distance from
the target. If investors’ monitoring costs increase with physical distance from the target
because of extra communication costs and transportation costs (Sussman and Zeira
(1995), Peterson and Rajan (2002), Degryse and Steven Ongena (2004)), this ﬁnding
suggests that monitoring costs associated with geography may be an important
determinant of their governance activities. Furthermore, the stock market appears to
anticipate value-enhancing governance activities of geographically proximate acquirers.
We ﬁnd that targets of in-state acquirers earn higher abnormal returns at the formation of
block ownership when the acquirer is appointed to the target’s board or their top
executives are replaced following the block share purchase.

We also examine whether large shareholders exhibit a bias toward locally
headquartered ﬁrms as mutual fund managers do. We ﬁnd that on average, large-block
acquirers are 1,603 kilometers away from target ﬁrms, which is similar to the 1,654
kilometers from holding stocks for fund managers (Coval and Moskowitz (1999)).
Hence, large-block acquirers appear to have a strong preference for locally located ﬁrms.

Given that geographic proximity is related to that information asymmetry and monitoring

89

costs of investors, our results suggest such information asymmetry and monitoring costs
are important determinants of investment decisions of large shareholders.

Several studies have documented that the information asymmetry between domestic
and foreign investors or local and nonlocal investors may drive their preference for
domestic and local stocks that are geographically proximate to them (Kang and Stultz
(1997), Coval and Moskowitz (1999), Ivkovic and Weisbenner (2003)). This paper shows
that geography has an important inﬂuence on investors’ incentives concerning their
corporate governance activities. We argue that corporate governance factors associated
with geographic proximity are another important determinants of home or local bias and
therefore, investors choose domestic or local ﬁrms because they can be better monitors in
those ﬁrms than remote investors.

Finally, by providing a link between geography and corporate governance, this paper
provides an additional dimension to the role of geography in economics. Previous
literature has focused on inforrnation-based explanations of the role of geography in
terms of portfolio decision. For example, Coval and Moskowitz (2001) and Ivkovic and
Weisbenner (2003) examine investor portfolio returns and document that investors earn
substantial excess returns from their investment in local stocks. They argue that such
excess returns are due to an information advantage of local investors. This paper,
however, examines the effect of geography on the value and operating performance of the
ﬁrm and shows that ﬁrms acquired by local investors are more subject to active
governance activities and outperform those acquired by nonlocal investors. Therefore,
our ﬁndings suggest that geographic proximity may have real effects on the value and

operating performance of ﬁrms through the governance activities of local investors.

9O

This paper is organized as follows. We discuss our hypotheses and review previous
studies in Section 2.2. In Section 2.3, we describe our data and methodology. The

empirical results are in Section 2.4 and 2.5. Section 2.6 concludes this paper.

2.2 Hypotheses and Literature Review

2. 2. 1 Geographic Proximity and Information Advantage

It is well documented that despite the substantial gains from international
diversiﬁcation, investors exhibit a strong preference for domestic stocks (French and
Poterba (1991), Kang and Stultz (1997)). Furthermore, such a bias in international
portfolio selection (the so-called home bias) extends to regions within the same country
and investors prefer to hold geographically proximate stocks (the so-called local bias).
Recent studies also document the geographic link between investor portfolio choice and
investment performance. For example, Coval and Moskowitz (1999) analyze the role of
geographic proximity in the context of US. mutual fund managers and show that US.
fund managers exhibit a bias toward locally headquartered ﬁrms, particularly with small,
highly leveraged ﬁrms that produce nontraded goods. Coval and Moskowitz (2001) also
show that on average fund managers generate an additional return of 2.65 percent per
year from their local investments compared to their nonlocal investments. They argue
that fund managers earn such abnormal returns in their local holdings as compensation
for information they acquire about local companies. Ivkovic and Weisbenner (2003)
examine the stock investments of US. households and show that individual investors
exhibit a local bias to an even larger degree than professional money managers do. They

also ﬁnd that the average household generates an additional return of 3.7 percent per year

91

from its local holdings relative to its nonlocal holdings. Moreover, Malloy (2004) shows
that geographically proximate analysts provide more accurate earnings forecasts, update
their forecasts more frequently and impact stock prices more than nonlocal analysts. In
the context of acquisitions, Kedia, Panchapagesan, and Uysal (2005) show that acquirers
have a strong preference for local ﬁrms. They also show that bidder returns in local
transactions are higher than those in nonlocal transactions.

Overall, these ﬁndings suggest that investors can access to information more easily
for local ﬁrms than nonlocal ﬁrms, which translates into better investment performance.
Speciﬁcally, local investors could acquire information about the ﬁrm with lower costs
than nonlocal investors. Local investors may use less time and face lower costs associated
with traveling and searching for information about a particular ﬁrm. They may follow the
ﬁrm through local media reports or even place a local call directly to the ﬁrm for
instance. In addition to lower costs associated with obtaining such information, investors
may have informal sources of information about local companies, such as conversations
with employees, managers, suppliers of the ﬁrm, and customers. In particular, large
shareholders located near the ﬁrm can visit the ﬁrm and meet CEOs face-to-face more

often to obtain information.

2. 2.2 Geographic Proximity, Monitoring Costs, and Governance Activities

Monitoring of management involves substantial costs to investors and such
monitoring costs may be related to the distance between investors and the ﬁrm.
Monitoring costs tend to increase with the distance from the ﬁrm because of extra

communication costs or transportation costs incurred by investors. For example, Sussman

92

and Zeira (1995) present a model in which banks face monitoring costs that increase in
distance. Empirically, Peterson and Rajan (2002) and Degryse and Ongena (2005) show
that transportation costs cause price discrimination in bank lending. In the context of
US. venture capital, Lerner (1995) ﬁnds that the board membership of VCs in private
biotechnology ﬁrms is partly determined by the distance between the ﬁrms and the
venture capitalist. Lerner argues that the monitoring costs associated with frequent visits
and intensive involvement can be reduced if the venture capitalist is located near a
company’s headquarters.

Furthermore, Coval and Moskowitz (2001) argue that fund managers’ information
advantages may be the result of improved monitoring capabilities over local ﬁrms, which
suggests that the governance activities of investors may enhance their information
advantage. For instance, shareholders who have their representatives on the board of
directors are expected to have superior access to information about the ﬁrm.

Given that local investors face lower transaction costs associated with their
governance activities, they may be more likely to monitor managerial performance and
pursue active governance strategies compared to nonlocal investors. Moreover, the
governance activities of local investors may be more effective than those of nonlocal
investors since investors located near the ﬁrm can closely monitor management and take

governance actions quickly in respond to management decisions.

93

2.3. Data and Descriptive Statistics
2.3.1 Data

Our sample consists of domestic block share acquisitions between 1990 and 1999.
We obtain the initial sample of block share acquisitions from Thomson Financial’s
Security Data Corporation (SDC) Platinum database. We ﬁrst identify partial acquisitions
in which the acquirers initially held less than 5 percent of a target ﬁrm’s outstanding
shares, and then purchased more than 5 percent but less than 50 percent of its outstanding
shares.

We exclude cases where either the acquirer or target ﬁrm is foreign. We also exclude
the cases where targets are ﬁnancial or regulated ﬁrms (SIC 6000-6999, 4000-4099,
4500-4599, and 4800-4899). We eliminated the cases where acquirers are investors
groups in SDC since we cannot determine their location. Since we study the role of
outside shareholders in corporate governance, we exclude all Employee Stock Ownership
Plan and Employee Beneﬁts Trust. Finally, to avoid the effect of outlier, we exclude
cases in which target ﬁrms or acquirers are located in Alaska, Hawaii and Puerto Rico.

We require that the initial public announcement date of block share purchase be
available in F activa and use as the announcement date the date that a news announcement
ﬁrst appears in this publication. We also require that stock returns and ﬁnancial data for
target ﬁrms be available in the CRSP returns and COMPUSTAT tapes, respectively.
These restrictions result in a ﬁnal sample of 698 targets.

We obtain data on top executive, board of director, and managerial ownership of
target ﬁrms from proxy statements and annual reports. These sources are examined

during the holding period of block ownership up to three years after the acquisition. We

94

deﬁne the holding period as the period from the date when investors announces the
acquisition of a target ﬁrm’s block equity to the date when it decreases its holding in the

target to less than 5 percent.

2.3.2 Descriptive Statistics

Figurel shows the geographic distribution of our sample acquirers and targets across
the continental United States. It shows that the distribution of our sample acquirers and
targets resembles a plot of population by locations. Appendix I also shows the
distribution of our sample acquirers and targets by states. New York has the highest
frequency of acquirers (25.64 percent), followed by California (16.19 percent) and Texas
(7.59 percent). Given the large number of acquirers from New York State in our sample,
our main ﬁndings may be driven by these samples. Hence, we examine the robustness of
our ﬁndings by replicating the key analyses excluding these samples and obtain results
that are qualitatively similar to those reported in the paper.

Table 2.1 shows the distributions of the sample of 698 block acquisitions by target
industry, year, and geographic proximity. In this paper, we use two spatial units of
observation to capture the effect of geographic proximity on information asymmetry and
monitoring costs of investors. First, as in the previous literature, we use physical distance
between the investor and the ﬁrm as a measure of geographic proximity. Ivkovic and
Weisbenner (2003) argue that the distance of 250 miles is a plausible upper bound on the
span of local information since the distance of 250 miles is reachable with a daily round

trip by car and local media coverage. Hence, we set the perimeter of locality at a distance

95

of 250 miles and regard all block acquisitions where the block acquirer and the target are
within 250 miles of each other as local.

Second, we adopt the state as our primary measure of geographic proximity. The state
may be a geographic boundary to information ﬂows since investors located in the same
state as the ﬁrm may have signiﬁcant information advantages over investors located out
of the state. Investors may derive some of their information about local ﬁrms from
statewide information sources. For instance, local media, such as newspaper, radio, and
TV stations, occasionally provide coverage of the local events within the state. In
addition, investors within the same state as the ﬁrm are expected to have more
information about state regulations that can inﬂuence corporate policy, performance, and
even their governance activities”. In this context, the state may capture an important
information advantage of local investors and can be a measure of informational distance.
In-state acquisitions are the cases in which the acquirer and the target are located in the
same state. By contrast, out-of-state acquisitions are the cases in which the acquirer and
the target are located in different states. Most of the targets are in manufacturing (53.4
percent), services (25.2 percent), and wholesale and retail trade (11.9 percent). The years
1996 and 1995 are the most active years of acquisition announcements with 113 (16.2
percent) and 100 (14.3 percent) cases, respectively.

We use SDC data to obtain the location of acquirer and target ﬁrms. We match this

location data with the data from the US. Census Bureau’s Gazetteers and Zip Code

 

” Audretsch and Feldrnan (I996) emphasize that the most relevant unit of policy-making is at the level of
the state. In addition, Coffee (2004) argues that in the US, the regulatory energy for investor protection
came from the state level rather than from the Security and Exchange Commission (SEC) (Federal
Securities Law Reports). Therefore, state government and legal system, such as state courts and state
legislature, may have an important inﬂuence on ﬁrms’ operation and governance activities of investors.

96

Database to get latitude and longitude for acquirer and target ﬁrms. We use the standard
formula for calculating the distance, did, between the acquirer and the target as follows:
d,-,J=arc cos {cos(lat,-)cos(loni)cos(latj)cos(lon,-)+ cos(lat,-)sin(lon,-)cos(latj)sin(lonj)
+ sin(lat,)sin(layy) } 2 nr/ 3 60,
where lat and [on are latitudes and longitudes of the acquirer and the target locations,
respectively, and r denote the radius of the earth (approximately 6,378 kilometers).

Coval and Moskowitz (1999) gauge a bias toward to local stocks in terms of physical
distance and show that on average, US. fund managers are located 1,654 kilometers from
the company they hold while they are located 1,814 kilometers from potential holdings.
They use the cross section of 1995 holdings data. Since their sample period overlaps with
our sample period, we can compare the level of local bias of fund managers with that of
large-block acquires. Table 2.2 shows that on average, large-block acquirers are 1,603
kilometers away from their target ﬁrms. If the large-block acquirers’ distance from
potential holdings is similar to that of fund managers, this result suggests that large-block
acquirers may have a similar level of local bias as fund managers12 .

Following Kedia, Panchapagesan, and Uysal (2005), we estimate the expected
probability that the target will be acquired by a ﬁrm within the same state. We assume
that all public ﬁrms located within the same state as a target could be a potential acquirer.
Hence, the fraction of all public ﬁrms that reside in a certain state relative to all public

ﬁrms in the US. will be the target’s expected probability of being acquired by ﬁrms in

the same state. Speciﬁcally, for every transaction of block acquisition, we estimate this

 

'2 Our sample includes the cases where large-block acquirers are mutual fund managers. The total number
of fund manager acquirers in our sample, however, is only 57. Four of them are in-state acquisitions and 53
of them are out-of-state acquisitions. Furthermore, our main ﬁndings are not affected when we exclude
such cases from our analyses.

97

fraction of block acquisition in the year prior to the announcement. We obtain company
headquarter data from COMPUSTAT. As shown in Table 2.2, the mean and median
expected probability of being acquired by a ﬁrm located in the same state is 7.04 and 5.53
percent, respectively. The actual fraction of targets purchased by in-state acquirers in our
sample, however, is 18.34 percent. Large shareholders are expected to have stronger
incentives to acquire information about the ﬁrm and monitor managerial performance,
relative to small individual shareholders. Therefore, our ﬁndings show that even such
large shareholders exhibit a strong preference for geographically proximate companies.
Table 2.3 presents the summary statistics of target ﬁrms. We measure target
characteristics at the ﬁscal year-end that comes immediately before the announcement of
the acquisition of block shares. The mean and median sizes of the targets show statistical
differences between the two groups: in-state and out-of-state acquisition. The mean
(median) asset value of the targets of in-state acquisition is $163.45 ($29.35) million in
comparison to $345.98 ($64.61) million for the targets of out-of-state acquisition. The
mean and median equity ownership by managers (the sum of equity ownership by
ofﬁcers and directors) are signiﬁcantly higher for the targets of in-state acquisition than
for those of out-of-state acquisition. Therefore, large-block acquirers are likely to acquire
target ﬁrms that are small and have high insider ownership when they choose local ﬁrms.
Leverage, operating income to asset, and Tobin’s q, however, show no statistical
difference between the two groups. Following Denis, Denis, and Sarin (1997), we deﬁne
the CEO as the top executive of the ﬁrm. If a ﬁrm has no CEO, the chairman (or
president if there is no chairman) is assumed to be the top executive of the ﬁrm. The

mean and median ages of top executives are signiﬁcantly younger in the targets of in-

98

state acquisition than out-of-state acquisition. The mean tenure of top executives is also
signiﬁcantly shorter in the targets of in-state acquisition than out-of-state acquisition,
while the median of the two groups is not signiﬁcantly different. The fraction of ﬁrms in
which a chairman (founder) is the top executive is not signiﬁcantly different between the
two groups. We also ﬁnd that in-state acquirers purchase a larger percentage of block
shares than out-of-state acquirers (a median of 9.35 percent compared to 7.70 for out-of-
state).

The difference in percent of shares acquired is signiﬁcant at the 1 percent level. If
ﬁrms with smaller size, higher insider ownership and top executive with younger age and
shorter tenure have greater information asymmetry between local and nonlocal investors
than other ﬁrms, these ﬁndings suggest that local investors choose the sorts of ﬁrms in
which they may have signiﬁcant information advantages and such information
advantages would be most valuable (Coval and Moskowitz (1999), Malloy (2004), Ball,
Kothari, and Robin (2000).

In Table 2.4, we compare important transaction characteristics of in-state acquisition
and those of out-of-state acquisition. Panel A of Table 2.4 presents summary statistics for
holding periods of block ownership. Forty-four percent of in-state acquirers hold block
shares for longer than three years in comparison to 30 percent for out-of-state acquirers.
Although 43 percent of out-of-state acquirers hold block shares for less than one year, the
corresponding number for in-state acquirers is only 27 percent. These differences in
holding periods are signiﬁcant at the 1 percent level, indicating that in-state acquirers
tend to hold block ownership for a long period than out-of-state acquirers. These results

are consistent with Coval and Moskowitz (2001), who show that fund managers trade far

99

more ﬁ’equently in their remote holdings than in their local holdings. Bushee (1988) also
shows that “dedicated” institutional investors have a long investment horizon while
“transient” institutional investors have a short-tenn time horizon. In this context, our
ﬁndings suggest that in-state acquirers may be “dedicated” investors, who adopt longer-
tenn strategies and actively monitor management, while out—of-state acquirers may be
“transient” investors, who have a short-terrn strategy and are therefore less likely to
engage in governance activities in the ﬁrm.

Panel B of Table 2.4 summarizes the fractions of acquirers who indicate that the
purchase of shares is for control purpose. It also shows the fraction of block-acquires who
choose targets in the same industry and the fraction of those who are ﬁnancial institutions
or individual investors. We classify the acquisition as control purpose if the acquiring
ﬁrm discloses in a ﬁling of 13D that it seeks the control of the target. Five percent of all
deals in both in-state and out-of-state acquisitions are with control purpose. In addition,
14 percent of in-state acquisitions and 15 percent of out-of-state acquisitions take place in
the same industry. In addition, 66 percent of in-state acquirers are ﬁnancial blockholders,
while 60 percent of out-of-state acquirers are ﬁnancial blockholders. These differences in
the investment purpose and the type of investor are not signiﬁcant between in-state and

out-of-state acquisitions.

2.4. Geographic Proximity and Governance Activities

In this section, we examine the relation between geographic proximity and

governance activities of large-block acquirers.

100

To explore a link between geographic proximity and corporate governance, we
examine the effects of distance on the extent of governance activities of large-block
acquirers. Speciﬁcally, we examine two important governance activities of large-block
acquirers: board representation by large-block acquirers and nonroutine top executive
turnover in target ﬁrms. Previous studies show that having outside directors on the board
plays an instrumental role in improving internal governance systems in monitoring top
management. Brickley and James (1987), Weisbach (1988), and Byrd and Hickman
(1992), for example, show that independent outside directors protect the interests of
shareholders when there are agency problems. Given that the board members represented
by large-block acquirers are independent outside directors, they may play an important
monitoring role in target ﬁrms.

In addition, we examine nonroutine top executive turnover since the removal of the
top executive is considered to be one of the most aggressive governance actions taken by
shareholders. For example, Denis, Denis, and Sarin (1997), Bethel, Liebesind, and Opler
(1998), and Kang and Shivdasani (1995) document that outside blockholders play an
important role in the process of top executive turnover.

We obtain the information about board representation and top executive turnover
events from proxy statements and annual reports. For the holding period up to three years
after the formation of block shares, we search these sources for board representation by
large-block acquirers and changes of top executives in target ﬁrms. Following Denis,
Denis, and Sarin (1997), we refer to turnover events where the top executive is removed
due to death, illness, or other non-govemance related as routine turnover. We classify a

management change as normal if the stated reason for the change is retirement and the

101

retiring manager is between the ages of 64 and 66. We refer to all others as nonroutine
turnover.l3

Table 2.5 summarizes director appointments by large-block acquirers and nonroutine
top executive turnover during holding periods of block equity ownership. It shows that
46.1 percent (59 out of 128) of in-state block acquires are appointed as directors or have
their representatives on the target’s board, while only 27.5 percent (157 out of 570) of
out-of-state acquirers do. Additionally, the fraction of new blockholder director on
target’s board for in-state acquisitions is 14.53 percent in comparison to only 6.80 percent
for out-of-state acquisitions. The differences in the frequency of board representation by
block acquirers between the two groups are signiﬁcant at the 1 percent level. These
ﬁndings indicate that in-state block acquires are more likely to intervene in the internal
governance process of target ﬁrms than are out-of-state acquires.

Table 2.5 also shows that 43 percent (55 out of 128) of targets of in-state acquisition
experience top executive turnover during the holding periods of block ownership up to
three years after the initial purchase. By contrast, only 21.8 percent (123 out of 570) of
targets of out-of-state acquisition experience top executive turnover. Thus, in-state
acquirers are about two times as likely to be involved in removals of the top executive as
are out-of-state large-block acquirers. When we estimate top executive turnover for three
years regardless of their holding periods, 46 percent of targets of in-state large-block

acquirers experience top executive turnovers while 32 percent of those of out-of-state

acquirers experience top executive turnover.

 

'3 We also employ an alternative deﬁnition of nonroutine tumover assuming that normal retirement takes
place at any age above 60 or 64. Our results, however, are not sensitive to the deﬁnition of normal

102

2.4.1 Likelihood of Board Representation

In order to better understand the relation between geographic proximity and the
likelihood of director appointment of block acquirers, we perform multivariate Tobit
regressions.

As discussed above, we use the state and the local boundary as measures of
geographic proximity. We include an indicator, which equals one if the acquirer and the
target are located within the same state. We also include another indicator, which equals
one if the acquirers and the target are within 250 miles of each other. To the extent that
in-state or local acquirers bear lower transaction costs associated with their governance
activities compared to remote acquirers, they will be more likely to engage in governance
activities in target ﬁrms.

We control for important target characteristics that might affect the likelihood of the
acquirer’s governance activity.

Firm size is widely argued to be a useful measure of the rate of information diffusion.
For example, Hong, Lim, and Stein (2000) argue that information about small ﬁrms gets
out more slowly because investors who face ﬁxed costs of information acquisition are
willing to spend more resources to learn about a ﬁrm in which they can take large
positions. Coval and Moskowitz (1999) ﬁnd that investment managers exhibit a strong
preference for locally headquartered ﬁrms, particularly small ﬁrms. In addition, Malloy
(2004) shows that local analysts covering small stocks are signiﬁcantly more accurate
than other analysts. These ﬁndings suggest that the information advantage arising from

geographic proximity is concentrated in small ﬁrms.

 

retirement.

103

Equity ownership by target managers can have an effect on the extent of information
asymmetry between local and nonlocal investors. For instance, Ball, Kothari, and Robin
(2000) show that information is likely to be communicated through private channels
when ownership is concentrated. Thus, local acquirers’ information advantages over
remote acquirers are expected to be particularly signiﬁcant when the target has higher
managerial ownership because they have superior access to private information of the
ﬁrm. On the other hand, managerial ownership can have an effect on the likelihood of the
acquirer’s governance activities because it could create a different level of agency
problems in targets. For example, Jensen and Meckling (1976) argue that concentrated
managerial ownership aligns the interests of managers with those of shareholders, thus
minimizing the agency problem that arises from the separation of ownership and control.
Stulz (1988), however, argues that concentrated managerial ownership can insulate
managers from outside inﬂuence and thus leave them unconstrained.

Past performance can be related to the rate of information diffusion. Hong, Lim, and
Stein (2000) show that negative information about the ﬁrm diffuses slowly across
investors. Hence, ﬁrms with poor performance may have more information asymmetry
than other ﬁrms and the effect of an information advantage of local investors is more
likely to be pronounced in those ﬁrms. In addition, if operating performance is an
indicator of managerial ability, governance activities of investors could be more valuable
when the target has an inefﬁcient management team.

To control for other important target characteristics, we also include leverage (total
debt / market value of equity plus book value of debt), and Tobin’s q (market value of

equity plus book value of debt / book value of total assets).

104

The duration of block ownership may have an affect on the extent of information that
investors can access to the ﬁrm. Investors with a long investment horizon can accumulate
information about the ﬁrm over their holding periods and thus may have signiﬁcant
information advantages over those with a short investment horizon. Moreover, the
holding periods can inﬂuence large shareholders’ incentives to perform governance
activities. For example, Demsetz and Lehn (1985) argue that large shareholders with
long-terrn horizon have strong incentives to monitor management. Therefore, we include
an indicator, which equals one if the holding period of block shares acquired by investors
is longer than three years and zero otherwise.

We also include the percent of shares acquired. In their theoretical work, Shleifer and
Vishny (1986) show that the optimal level of monitoring by large-block acquirers
increases with the size of their equity ownership. Hence, we expect a positive relationship
between the size of equity ownership acquired by large-block acquirers and the extent of
their governance activities in target ﬁrms.

Audretsch and Feldman (1996a), Audretsch and Stephan (1996b), and Jaffe,
Trajtenberg, and Henderson (1993) show that geographic proximity has an effect on
innovative activity and knowledge spillovers in various industries. Further, Ellison and
Glaeser (1997) show that industries tend to be concentrated because of cost advantages
and industry-speciﬁc spillovers. These ﬁndings suggest that block acquirers who choose
target ﬁrms in the same industry may have different investment incentives from other
block acquirers, which can affect their governance activities in target ﬁrms. Thus, we
include an indicator, which equals one if large-block acquirers purchase targets in the

same industry (two-digit SIC codes) and zero otherwise.

105

Table 2.6 reports the results from Tobit regressions where the dependent variable is
the fraction of directors afﬁliated with block acquirers on the target’s board”. In the ﬁrst
three regressions, we use the state as a measure of geographic proximity and include a
dummy for the same state. The coefﬁcient on the same state dummy is positive and
statistically signiﬁcant at 1 percent level, indicating that the extent of board
representation is greater for in-state block acquirers than out-of-state block acquirers.

In the second regression, we include target characteristics and in the third regression,
we add transaction characteristics. The estimated coefﬁcients on same state dummy are
positive with p-values of 0.00. Thus, controlling for other factors, large-block acquirers
are more likely to have board representation on target’s board when they are located
within the same state as targets. These ﬁndings suggest that the geographic proximity has
a signiﬁcant inﬂuence on large shareholders’ incentives to perform an active role in the
board of directors. The coefﬁcients on the size of target ﬁrm are negative and signiﬁcant
at the 1 percent level. To the extent that ﬁrm size is positively related to the rate of
information diffusion, this result suggests that large-block acquirers are more likely to
have their representative on target’s board when target ﬁrms have more information
asymmetry. The percent of shares acquired is positive and signiﬁcant at 1 percent level.
This ﬁnding is consistent with theoretical work on the role of large shareholders by
Shleifer and Vishny (1986)”. The coefﬁcient on the dummy variable for the duration of
block ownership is positive and statistically signiﬁcant at 1 percent level, suggesting that
large-block acquirers who hold target equity for a long period are more likely to provide

board members to target ﬁrms. This ﬁnding is consistent with Demsetz and Lehn (1985),

 

106

who argue that blockholders with a long-term investment horizon have strong incentives
to monitor management. The coefﬁcient on Tobin’s q is positive and signiﬁcant at the 1
percent level. If Tobin’s q is a proxy for growth opportunities, this result suggests that
large-block acquirers are more likely to have their representatives on target’s board when
targets have higher growth opportunities.

In regressions (4) through (6), we use the dummy for local transaction as an
alternative measure of geographic proximity. The estimated coefﬁcients on this local
dummy are positive and signiﬁcant at least at the 5 percent level. These results are
generally consistent with those of Lerner (1995), who ﬁnds that the distance between a
venture capitalist and the ﬁrm is an important determinant of the board membership of
venture capitalists in private biotechnology ﬁrms”. Our results, however, show that even
for large shareholders in public ﬁrms, distance plays an important role in board
representation decisions. The coefﬁcients for other control variables are qualitatively
similar to those in previous regressions using the same state dummy variable.

In the last regression, we include physical distance between the target and the
acquirer. We ﬁnd that the fraction of board representation by large-block acquirers is
negatively related to their physical distance from the targets. The estimated coefﬁcient on
the log of distance between the acquirer and the target is negative and signiﬁcant at the 1
percent level. To the extent that blockholders’ monitoring costs increase with physical

distance from the target, our ﬁndings suggest that monitoring costs and information

 

'5 Kaplan and Minton (1994) also document that in the Japanese public ﬁrms, the probability of corporate
director appointments increases with blockholder ownership.

'6 Lerner (1995) shows that venture capital organizations located within ﬁve miles from a ﬁrm’s
headquarters are twice as likely to provide board members to the ﬁrm as those more than 500 miles away.
Lerner argues that the transaction costs associated with frequent visits and intensive involvement prevent
remote venture capitalist from actively participating in the governance activity in the ﬁrm.

107

asymmetry from geography are important determinants of their director appointment

decisions.

2.4.2. Likelihood of Top Executive Turnover

Table 2.7 shows the results from logistic regressions where the dependent variable is
one if nonroutine turnover occurs and zero otherwise. In addition to including all
explanatory variables used in the previous regressions, we also control for other variables
that may affect top executive turnover. Speciﬁcally, the regressions control for the age
and tenure of the top executive, and also include a chairman dummy, which equals one if
the top executive is the chairman of the board, as well as a founder dummy, which equals
one if the top executive is the founder of the ﬁrm. We deﬁne founders as those who are
described as founders in the proxy statement or the annual statement, or those who have
held the position of top executive since the inception of the ﬁrm.

In the ﬁrst three regressions, the coefﬁcients on the same state dummy are again
positive and signiﬁcant at the 1 percent level, which suggests that in-state block acquirers
play a more active role in the process of top management turnover compared to out-of-
state acquirers. This result is also consistent with the view that investors located near the
ﬁrm are more likely to engage in corporate governance activities in targets since they
have signiﬁcant advantages over distant investors because of an information advantage
and lower monitoring costs.

In the second and third regressions, both operating income to total assets and Tobin’s
q of targets are negatively related to the probability of top executive turnover occurring,

indicating that block acquirers are more likely to replace target management when targets

108

show bad operating performance or they have poor growth opportunities or inefﬁcient
management teams. The coefﬁcient on the age of top management is positive and
signiﬁcant, suggesting that age may be an indicator that the top executive is close to
retirement or to being removed due to normal management changes (Weisbach (1988)).
The coefﬁcient on the tenure of top management, however, is negative and insigniﬁcant.
The dummy for the chairmanship of top management is negative and signiﬁcant. This
ﬁnding is consistent with Fama and Jensen (1983), who argue that the concentration of
decision management and decision control in an individual reduces the effectiveness of
the internal governance system in monitoring top management.

As in the result from board representation, the coefﬁcients on the percent of shares
purchased by acquirers and the duration of block ownership are positive and signiﬁcant,
indicating that nonroutine turnover is signiﬁcantly more likely when the percent of shares
purchased by acquirers is high and block acquirers hold target equity for a long period.
Those acquirers who have large equity ownership with a long-tenn investment horizon
may be better able to replace inefﬁcient management because of their strong voting rights
and accumulated information over holding periods. The dummy for board representation
by the block acquirer is also positive and signiﬁcant at the 1 percent level. Since the
board members represented by large-block acquirers are independent outside directors,
this result suggests that outside directors play an important governance role in the process
of top management turnover (Weisbach (1988)). Finally, consistent with Stulz (1988),
equity ownership by managers is negative and signiﬁcant, which suggests that signiﬁcant
control by managers may prevent governance mechanisms from removing inefﬁcient

management teams.

109

In regressions (4) through (6), we use the dummy variable for local transaction
instead of the same state dummy to estimate the effect of geographic distance on top
management turnover. The estimated coefﬁcients on the dummy for the local transaction
are again all positive and statistically signiﬁcant at the 1 percent level, indicating that
block acquirers are more likely to replace target management when target ﬁrms are
geographically proximate to them. These ﬁndings suggest that distance is an important
determinant of the governance activities of large shareholders. The results for our other
control variables are qualitatively similar to these from board representation

In regression (7), which uses the actual distance between the acquirer and the target,
the probability of top management turnover is negatively and signiﬁcantly related to this
distance. If block acquirers’ monitoring costs increase with the physical distance from
targets, this ﬁnding supports the hypothesis that monitoring costs from geographic
proximity are important determinants of the governance activities of large shareholders.

Overall, these results conﬁrm those of the previous analysis for board representation
and further suggest that information asymmetry and monitoring costs associated with
geographic proximity affect incentives for large shareholders to undertake governance
activities in target ﬁrms. Our results also suggest that deal-speciﬁc characteristics, such
as chairmanship of top management, the holding period of block ownership, and the
percent of shares purchased, have an effect on the extent of governance activities of large

shareholders.

110

2.4.3. Marginal effects of geographic proximity

In order to gauge economic signiﬁcance of geographic proximity, we calculate
marginal effect of the same state and local dummy variable on the probability of
governance activities. Table 2.8 presents the marginal effect of the same state and local
dummy variable and other key variables from logistic regressions. The marginal effect
of state or local dummy variables indicates the difference in the probability of
governance activities between in-state or local block acquirers versus out-of-state or
nonlocal block acquirers.

In Panel A of Table 2.8, we report marginal effect of the key variables on the
likelihood of board representation by new block acquirers. The marginal effect of the
same state dummy is 0.134, indicating that, after controlling target and transaction
characteristics, the probability of director appointment is 13.4 percent higher when a
new block acquirer comes from the same state as the target than when they comes from
outside of the target’s state. In comparison, the marginal effect of the dummy variable
for block acquirers who are located within 205 miles of targets is 0.074, which indicates
that probability of board representation by block acquirers increases by 7.4 percent
when they are located within 250 miles of target ﬁrms. The marginal effect of the
dummy variable for block acquirers who are located within 100 kilometers of targets,
however, is statistically insigniﬁcant.

Panel B of Table 2.8 shows the marginal effect of the geographic proximity on the

probability of nonroutine management turnover. The marginal effect of the same state
dummy variable is 0.187, indicating that the probability of top management turnover in

targets is about 18.7 percent greater for in-state acquirers compared to out-of-state

111

acquirers, which is greater than those of dummy variables for 250 miles and 100
kilometers, 11.8 and 14.9 percent. The results also show that those acquires serving as a
director in target ﬁrms play an important role in the process of top management turnover.
In the ﬁrst regression, the marginal effect for the dummy of director appointment of
block acquirers is 0.174, indicating that the probability of top management turnover
increased by 17.4 percent when new block acquirers are appointed to target’s board.
There is also negative relationship between the likelihood of nonroutine management
turnover and operating performance. Fifty percent drop in operating performance is
associated with about 6 percent increase in the probability of nonroutine management
turnover in target ﬁrms.

In sum, the effect of geographic proximity on the likelihood of governance activities
in target ﬁrms seems to be both statistically and economically signiﬁcant. Furthermore,
the effect of state boundary appears to be more important than those of local boundary of

250 miles and 100 kilometers.

2.5 Geographic Proximity and Target performance
2.5.1 Announcement Effects
In this section, we examine the effect of geographic proximity on the value of target

ﬁrms by analyzing the valuation effect of block ownership formation.

2.5.1.1 The Relation between Distance and Target Returns

To assess the valuation effect of block share formation, we compute abnormal returns

using a standard event-study methodology. We obtain our estimates of the market model

112

by using 200 trading days of return data, beginning 220 days before and ending 21 days
before the announcement of the block share purchase. We use as the market return the
CRSP equally weighted return. We sum the daily abnormal returns to get the cumulative

abnormal return (CAR) from day tl before the announcement date of the block share
purchase to day 12 after the announcement date of the block share purchase. We use the t-

statistics to test the hypothesis that the average CARS are equal to zero, and the sign-rank
test statistic to test the hypothesis that the CARS are distributed symmetrically around
zero.

Table 2.9 reports the CARS for the targets of in-state and out-of-state block
acquisitions for different event windows. Target ﬁrms cam, on average, statistically
signiﬁcant positive gains. This ﬁnding is consistent with that of Mikkelson and Ruback
(1985), who document positive announcement returns for target ﬁrms who sell 5 percent
or more of their equity stakes to other companies. The average CAR (-1, 1), CAR (-5, 5),
and CAR (-10, 10) for the targets of in-state acquisitions are 9.3 percent, 13.3 percent,
and 19.1 percent, respectively, and are signiﬁcant at the 1 percent level. The
corresponding CARS for the targets of our-of-state acquisitions are 7.3 percent, 8.7
percent, and 9.2 percent, respectively. They are also signiﬁcant at the 1 percent level. The
differences in mean CAR (-5, 5) and CAR (-10, 10) are statistically signiﬁcant at the 5
percent level and 1 percent level, respectively, indicating that there are signiﬁcant
differences in the stock market reactions to announcements of block purchases. The
difference in mean CAR (-1, 1), however, is not signiﬁcant. The medians Show a similar

pattern. Following Allen and Phillips (2000), we use a 21-day (-10 to +10) interval

113

centered on the announcement dates of block acquisition in our analyses of
announcement effects”.

Panel A of Table 2.10 reports CAR (-10, 10) for targets for subsamples categorized
by distance between targets and block acquirers. The average (median) CAR (-10, 10) for
targets located within 100 kilometers of block acquirers is 16.0 (11.2) percent. The
average (median) CAR (-10, 10) decrease to 11.24 (8.54) percent when the target is
located between 100 kilometers and 200 kilometers of the acquirer. They drop to 8.04
(7.03) percent when the distance is between 200 kilometers and 300 kilometers. The
median CAR (-10, 10) for targets decrease to 6.86 percent when the distance is longer
than 300 kilometers, while the average CAR (-10, 10) slightly increase to 9.85 percent.
These average and median CARS for targets of block acquisitions located over 300
kilometers from the target are signiﬁcantly different from those for the targets of block
acquirers located within 100 kilometers of the target.

Coval and Moskowitz (1999, 2001) and Mallloy (2002) deﬁne local investors as
those who are located less than 100 kilometers from a ﬁrm’s headquarters. Panel B of
Table 2.10 summarizes CARS (-10, 10) for targets for subsamples categorized by the
distance of 100 kilometers. It shows that the average (median) CAR (-10, 10) for targets
of acquirers located within 100 kilometers of targets is 16.0 (10.95) percent in

comparison to 9.87 (6.97) percent for those of acquirers located out of 100 kilometers of

 

'7 Allen and Phillips (2000) focus on the case of corporate block acquirers. They argue that the stock
market could know about the pending stake before it is announced and an announcement of this type event
may not be reported until several days after the actual purchase. They report that CAR (~10, 10) for the
targets of block acquisition is 9.1 percent, which is similar to the corresponding number of 9.2 percent for
the targets of out-of-state acquisition in our sample.

114

targets. These differences in average and median CAR (-10, 10) are statistically
signiﬁcant at the 5 percent and 10 percent levels respectively.

Ivkovic and Weisbenner (2003) argue that the distance of 250 miles is a plausible
thread of locality since the distance of 250 miles is reachable with a daily round trip by
car and through local media coverage. Therefore, we classify CAR (-10, 10) by the
distance of 250 miles (Panel C of Table 2.10). According to this classiﬁcation of local
transaction, the average (median) CAR (-10, 10) of local acquisitions is 14.91 (10.75)
percent, while those of non—local acquisitions is 9.39 (5.33). In particular, the median
CAR (—10, 10) for targets of local acquirers is about twice as large as that of nonlocal
acquirers. The differences in mean and median CAR (-10, 10) between local and nonlocal
acquisitions are Signiﬁcant at the 5 percent and 1 percent levels respectively.

Finally, we classify CAR (-10, 10) for targets by sample median distance. Panel D of
Table 2.10 shows that the average (median) CAR (-10, 10) for targets of acquirers that
reside shorter than the sample median distance from them is 13.30 (8.68) percent. The
corresponding CAR for the targets of acquirers located longer than the sample median
distance is 9.46 (5.73) percent. The differences between the two groups are statistically
signiﬁcant.

In sum, these ﬁndings indicate that target returns on average decrease as the distance
between the target and the acquirer increase. They suggest that local investors have
different abilities and objectives concerning corporate governance from nonlocal
investors when they purchase large block ownership, which translates into different

valuation effects in the stock market.

115

2.5.1.2 Cross—sectional Variation in Target Returns

Table 2.11 presents the estimates from multivariate regressions. All regressions are
estimated using ordinary least squares (OLS). In the ﬁrst regression, after controlling for
important target and transaction characteristics, the coefﬁcient on the dummy for the
same state is positive and statistically signiﬁcant at the 1 percent level, showing a
coefﬁcient of 0.079. Evaluating the estimated coefﬁcient indicates that, all else constant,
abnormal returns for the targets of in-state acquisitions are greater than those of out-of-
state acquisitions by 7. 9 percent. Therefore, the effect of geographic proximity on target
returns is both statistically and economically signiﬁcant. This result suggests that
geographic proximity has an important effect on corporate valuation.

To more closely examine the role of geographic proximity on the value of target
ﬁrms, we include interaction terms between the same state dummy and ﬁrm-speciﬁc
variables that can gauge the extent of information asymmetry in target ﬁrms. In the
second regression, the interaction between the dummy if the target’s size is in the bottom
25 percent for the sample and the same state dummy is positive and statistically
signiﬁcant at the 1 percent level. This ﬁnding indicates that the ﬁrm Size effect on the
value of target ﬁrms is different between in-state and out-of-state acquisitions. To the
extent that ﬁrm size is negatively related to the rate of information diffusion (Hong, Lim,
and Stein (2000)), this result suggests that the effect of geographic proximity on ﬁrm
value is concentrated in small ﬁrms for which local investors can exploit their
information advantage.

In the third regression, the interaction between the dummy if target’s equity

ownership by managers is above the sample median and the same state dummy is positive

116

and statistically signiﬁcant at the 1 percent level, with a coefﬁcient of 0.165. If
information is likely be communicated through private channels when ownership is
concentrated (Ball, Kothari, and Robin (2000)), this ﬁnding suggests that in-state
acquirers’ information advantages would be magniﬁed among target ﬁrms that have high
insider ownership since they may have informal sources of information about local ﬁrms.
Alternatively, if concentrated managerial ownership can insulate managers from outside,
this result suggests that the stock market anticipates the increase in monitoring by new
block acquirers in those ﬁrms.

In the fourth regression, the interaction between the dummy if target’s operating
income to total assets is in the bottom 25 percent for the sample and the same state
dummy is positive and signiﬁcant at the 10 percent level. There are two possibilities for
this result. First, if negative information about the ﬁrm diffuses slowly across investors
and thus ﬁrms with poor performance have more information asymmetry (Hong, Lim,
and Stein (2000)), the effect of an information advantage of in-state acquirers is most
likely to be pronounced in those ﬁrms. Second, if operating performance is an indicator
of managerial ability, the result suggests that monitoring of in-state acquirers could be
more valuable when the target has inefﬁcient management teams.

If the stock market takes acquirers’ value-enhancing governance activities for target
ﬁrms into account when assessing the market values of targets, we would expect the
returns to targets to be related to these activities. In the ﬁfth regression, we include the
interaction between the same state and the dummy indicating that the acquirer is
appointed to the target’s board or the top executive of the target is replaced following

block share purchases. The coefﬁcient on the interaction variables is positive and

117

statistically signiﬁcant at the 10 percent level. This ﬁnding, coupled with the positive
relation between the same state dummy and the likelihood of governance activity in the
previous analyses, supports the hypothesis that in-state acquirers who have advantages in
terms of information acquisition and monitoring costs are more likely to engage in
governance activities in target ﬁrms and the stock market anticipates the increase in the
governance activities of in-state acquirers and views it favorably.

In the Sixth regression, the coefﬁcient on the interaction between the same state
dummy, small size dummy and the governance activity dummy is positive and
signiﬁcant. The coefﬁcient of 0.260 indicates that small target ﬁrms acquired by ﬁrms
located in the same state realize 26 percent higher returns than other targets when
governance activities of in-state acquirers are expected in target ﬁrms. This ﬁnding
suggests that the stock market anticipates that in-state block acquirers play an important
governance role in target ﬁrms for which information asymmetry between in-state and
out-of-state acquirers may be largest.

In the seventh and eighth regressions, we use the local transaction dummy as an
alternative measure of geographic proximity. In the seventh regression, the coefﬁcient on
the local transaction dummy is positively related to the target returns. In the last
regression, the interaction between the dummy if target’s size is in the bottom 25 percent
for the sample and the local dummy is positive and statistically signiﬁcant. These results
conﬁrm those of the previous analysis using the state as a measure of geographic
proximity and further suggest that geographic proximity is an important determinant of

target returns.

118

In the last regression, the interaction between the same industry dummy and the same
state dummy is negative and statistically insigniﬁcant, indicating that the effect of
geographic proximity is not different between same industry and different industry block
acquisitions. To the extent that same industry transactions are likely to have more
geographic synergies such as cost saving and industry-speciﬁc spillovers than different
industry transactions (Audretsch and Feldman (1996a,b), Trajtenberg, and Henderson
(1993)), this ﬁnding suggests that positive abnormal returns for the targets of in-state
acquisitions are unlikely to be explained by synergies associated with geographic
proximity.

Overall, our results show that geographically proximate target ﬁrms realize higher
announcement returns particularly when they are small, have poor past performance, or
have higher insider ownership. These ﬁndings are consistent with those of previous
studies. For example, Coval and Moskowitz (2001) and Malloy (2002) document that the
effect of geographic proximity is concentrated in small stocks and stocks with poor past
returns. Therefore, to the extent that small ﬁrms, ﬁrms with concentrated ownership
structures and ﬁrms with poor performance are those where geographically proximate
shareholders have superior access to information and where such information would be
most valuable, our results show that the effect of geographic proximity on corporate

valuation is magniﬁed in those ﬁrms.

2.5.1.3 Changes in Operating Performance

In this section, we examine the change in operating performance of target ﬁrms

following the acquisition of block ownership. Table 2.12 reports industry-adjusted

119

percentage changes in operation income to total assets by the geographic proximity. It
shows that the targets of in-state acquisitions exhibit insigniﬁcant increases in mean and
median industry-adjusted operating income to total assets during the (-1,+3), (-l,+4), and
(-l,+5) years. By contrast, targets of out-of-state acquisitions Show statistically
signiﬁcant decreases in mean industry-adjusted operating income to total assets during
the (-l,+3) and (-l,+4) years. The differences between the two groups, however, are
insigniﬁcant. In the last two rows of the table 2.11, we calculate average performance of
targets for three years and ﬁve years following the acquisition of block ownership. We
examine whether these average operating performance improve relative to one year
before the block purchase. The targets of out-of-state acquisitions exhibit signiﬁcant
decreases in the average of industry-adjusted operating performance for three and four
years following block share purchases, while the targets of in-state acquisitions do not
show signiﬁcant changes.

Table 2.13 reports the regression estimates. The dependent variable is the change in
average of post-acquisition operating performance for three years following the block
purchase relative to one year before (Mean (Years +1, +2, +3) - (Year -1)). Allen and
Phillips (2000) document that target ﬁrms forming an alliance or joint venture with block
acquirers experience subsequent increases in operating performance and investment.
Therefore, we include an indicator, which equals one if the block acquirer forms an
alliance or joint venture with the target and zero otherwise”.

In the ﬁrst regression, the coefﬁcient on the dummy for the same state is positive and

statistically signiﬁcant at the 10 percent level. The coefﬁcient on the dummy for the same

120

state is 0.079, indicating that industry-adjusted changes in operation performance for the
targets of in-state acquisition is greater than that of out-of-state acquisition by 7.9
percent. Target size is positively related to the change in post-acquisition operating
performance, which suggests that in general large ﬁrms improve their operating
performance after a block share purchase. The coefﬁcients on operating income to total
assets, and Tobin’s q are positive and signiﬁcant at the 5 percent level. These results
indicate that ﬁrms with good past performance and high growth opportunities or efﬁcient
management teams improve their operating performance following the block share
purchases of outside investors.

In the second regression, the interaction between the dummy if target’s size is in the
bottom 25 percent for the sample and the same state dummy is positive and statistically
signiﬁcant at the 5 percent level, suggesting that the effect of geography on operating
performance is more pronounced in small ﬁrms. In the third regression, the interaction
between the dummy if the target’s operating income to total assets is in the bottom 25
percent for the sample and the same state dummy is positive and signiﬁcant at the 10
percent level. These ﬁndings suggest that there may be a signiﬁcant interaction between
the effect of geographic proximity and the extent of information asymmetry in the ﬁrm.
When we include above two interactions in the model, the interaction between small size
and the state is still positive and signiﬁcant while the interaction between low operating
performance and the same state is not statistically signiﬁcant any more.

In sum, our results Show that compared to targets of out-of-state acquisitions, those of

in—state acquisitions realize higher post—acquisition operating performance and these

 

'8 We search Factiva for information whether they make any type of formal alliance such as strategic
agreement, business alliance, or joint venture for three years prior to and subsequent to the announcement

121

effects are strong among target ﬁrms that are smaller and have worse past performance.
These results conﬁrm those from the announcement effects and further suggests that the
effect of geographic proximity on operating performance is concentrated in small ﬁrms

and ﬁrms with bad past performance.

2.6 Summary and Conclusion

This paper documents a link between geographic proximity and corporate
governance. Using a sample of 698 partial acquisitions in the US. during the period of
1990-1999, we ﬁnd that geographically proximate acquirers are more likely to be
involved in governance activities in target ﬁrms than are remote acquirers. Large-block
acquirers are more likely to be appointed to the target’s board and replace target
management following block share purchases when they are located within the same state
as targets and the acquirer and the target are within 250 miles of each other. In addition,
targets of such acquirers experience higher abnormal announcement returns and post-
acquisition operating performance than those of other acquirers. Furthermore, these
effects are particularly strong when target ﬁrms are small, have poor past performance, or
have higher insider ownership. We also ﬁnd that block shareholders have strong
preference for locally located ﬁrms. The fraction of targets acquired by a ﬁrm located in
the same state is 18.34 percent. By contrast, the mean and median expected probability of
being acquired by a ﬁrm located in the same state is only 7.04 and 5.53 percent,
respectively.

Our ﬁndings suggest that geographically proximate investors may have signiﬁcant

advantages in terms of their governance activities over remote investors and their

 

date of block share purchases.

122

governance activities affect the value of the ﬁrm. Speciﬁcally, local investors may
acquire information about the ﬁrm with lower costs and bear lower monitoring costs
compared to distant investors. These comparative advantages allow local investors to
perform more active governance activities in targets. Consistent with this View, the effect
of geographic proximity on ﬁrm value is particularly strong among the ﬁrms that are
small, have high insider ownership, or have poor past performance for which the
information asymmetry between local and nonlocal investors may be largest and thus
information advantage of local investors would be most pronounced. In addition, the
likelihood of governance activities of block acquirers is negatively related to the physical
distance from the target, supporting the view that monitoring costs associated with
distance is an important determinant of their governance activities.

Our results provide an important dimension to the role of geography in facilitating
governance activities. Previous literature has focused on the role of geography in
determining portfolio selection from the perspective of investors. This paper, however,
Shows that geography may have real effects on the value and operating performance of

the ﬁrm through the governance activities of local investors.

123

APPENDIX 2
TABLES AND FIGURES OF ESSAY 2

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APPENDIX B

I47

Appendix B
Distribution of Block-Acquirers and Target Firms by States

The sample consists of 698 targets in block share acquisitions between 1990 and 1999. We obtain
the sample of partial acquisitions in which the ﬁrm acquires more than 5 percent but less than 50
percent of the outstanding shares from the Security Data Corporation (SDC) Platinum of
Thomson Financial. To avoid outlier effect, we eliminate cases where ﬁrms or block shareholders
located in Alaska, Hawaii, or Puerto Rico.

 

 

Actual Expected
No. of In- Probability of Probability of

State of Block- No. of block State block being acquired being acquired
Acquirer purchases (A) purchases (B) locally (B/A) locally
Alabama 3 0 0.00 0.64
Arizona 7 2 28.57 1.40
Arkansas 1 0 0.00 0.40
California 1 13 37 32.74 15.69
Colorado 14 2 14.29 2.92
Connecticut 26 l 3.85 2.62
Delaware 6 0 0.00 0.41
D. of Columbia 11 0 0.00 0.33
Florida 25 4 16.00 ‘ 5.29
Georgia 10 1 10.00 2.51
Idaho 4 0 0.00 0.22
Illinois 3 8 3 7.90 4.12
Indiana 6 0 0.00 1 .35
Iowa 2 0 0.00 0.54
Kentucky 3 0 0.00 0.60
Louisiana 2 1 50.00 0.68
Maryland 1 l l 9.09 1.80
Massachusetts 25 5 20.00 4.66
Michigan 6 1 16.67 2.00
Minnesota 18 7 38.89 2.98
Missouri 12 4 33.33 1.52
Nebraska 2 0 0.00 0.29
Nevada 6 l l 6.67 0.95
New Jersey 29 4 13.79 5.11
New Mexico 1 0 0.00 0.22
New York 179 21 11.73 9.76
North Carolina 5 l 20.00 1.65
Ohio 15 3 20.00 3.51
Oklahoma 6 2 33.33 0.91
Oregon 4 0 0.00 0.90
Pennsylvania 13 l 7.69 4.14

148

 

South Carolina 1 0 0.00 0.60
Tennessee 4 1 25 .00 1 . 16
Texas 53 16 30.19 8.92
Utah 3 1 33.33 0.99
Virginia 8 2 25.00 2.32
Washington 15 4 26.67 1.56
West Virginia 1 1 100.00 0.21
Wisconsin 9 1 11.1 1 1.28
Wyoming 1 0 0.00 0.10
Total 698 128 18.34 7.04

 

I49

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150

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