Paul H. Malatesta

Corporate Governance and Shareholder Initiatives: Empirical Evidence

Shareholder-initiated proxy proposals on corporate governance issues became popular in the late 1980s as corporate takeover activity declined. We find firms attracting governance proposals have poor prior performance, as measured by the market-to-book ratio, operating return, and sales growth. There is little evidence that operating returns improve after proposals. The proposals also have negligible effects on company share values and top management turnover. Even proposals that receive a majority of shareholder votes typically do not engender share price increases or discernible changes in firm policies.

The wealth effect of merger activity and the objective functions of merging firms

Abstract This paper studies the net effects of the long-run sequence of events leading to merger, and of merger per se, on shareholder wealth. The appropriate measure of the wealth effect is shown to be the abnormal dollar return cumulated over time. Using this measure, the long-run wealth effect of the event sequence culminating in merger is significantly negative for acquiring firms. For acquired firms, the effect is negative, but not significant. The immediate impact of merger per se is positive and highly significant for acquired firms but larger in absolute value, and negative for acquiring firms. The evidence also reveals that measured abnormal rates of return to acquiring firms are sensitive to a slight variation in model specification and dependent on firm size, with smaller firms earning significantly negative post-merger returns.

Earnings management, stock issues, and shareholder lawsuits

Abstract Abnormal accounting accruals are unusually high around stock offers, especially high for firms whose offers subsequently attract lawsuits. Accruals tend to reverse after stock offers and are negatively related to post-offer stock returns. Reversals are more pronounced and stock returns are lower for sued firms than for those that are not sued. The incidence of lawsuits involving stock offers and settlement amounts are significantly positively related to abnormal accruals around the offer and significantly negatively related to post-offer stock returns. Our results support the view that some firms opportunistically manipulate earnings upward before stock issues rendering themselves vulnerable to litigation.

Partially anticipated events: A model of stock price reactions with an application to corporate acquisitions

Abstract This paper presents a model of stock price reactions to partially anticipated events. The model formalizes the intuition that stock price reactions reflect both the economic importance of events and the extent to which events are surprises. Unbiased estimates of the economic importance of partially anticipated events must combine stock price reactions to events with stock price movements in periods when no event occurs. The model is used to estimate the value of acquisition attempts made by frequently acquiring firms. For a sample of thirty active acquirers, the evidence indicates that acquisition attempts were profitable investment projects.

The wealth effects of second-generation state takeover legislation

Abstract We examine the stock-price effects of all second-generation state takeover laws introduced from 1982 through 1987 for which we find press announcements. On average, the announcements are associated with a small but statistically significant decrease in the stock prices of firms incorporated in the state and of large firms headquartered in the state. The stock-price effects are concentrated in firms without preexisting firm-level takeover defenses. Firms with prior defenses have no significant stock-price reactions.

Earnings Management: IPO Valuation and Subsequent Performance:

We examine the role of earnings management by issuers prior to making initial public offerings (IPOs). Our results indicate that pre-IPO abnormal accruals are positively related to initial firm value. Entrepreneurs may seek to increase their offering proceeds, temporarily deceiving investors by opportunistically manipulating earnings through accruals management before going public. This would imply a negative relationship between abnormal accruals around the offer date and subsequent firm performance. Confirming earlier studies, we find that abnormal accruals during the offer year are significantly negatively related to subsequent firm stock returns. In addition, we find that abnormal accruals in the preceding year are also significantly negatively related to subsequent performance. Moreover, this result persists even for returns that are risk-adjusted using the multifactor CAPM of Eckbo, Masulis, and Norli (2000). Thus, it appears that aggressive pre-IPO earnings management both increases IPO proceeds and decreases subsequent returns to investors.

Firm Values and Sovereign Wealth Fund Investments

We analyze the impact of sovereign wealth fund (SWF) investments on firm values and provide evidence consistent with the tradeoff between the monitoring and lobbying benefits versus tunneling and expropriation costs of SWFs as blockholders. The data show significant positive (negative) returns to announcements of SWF investments (divestments). The returns are non-monotonic, first rising (falling) and then falling (rising) with the share sought (sold) for investments (divestments). Moreover, we find that SWFs are often active investors. Slightly more than half of the target firms experience one or more events indicative of SWF monitoring activity or influence.

State Takeover Legislation and Share Values: The Wealth Effects of Pennsylvania's Act 36

Proponents of state antitakeover legislation argue that previous empirical tests by financial economists of the wealth effects of Pennsylvanias 1990 antitakeover law are biased. We show that the proponents are correct. In particular, firm size, event-time clustering, and non- synchronous trading effects account for the wealth decreases in earlier studies. We also show, however, that both proponents and critics of the Pennsylvania legislation have ignored the earliest press release about it. The wealth effect associated with this announcement is negative, large, and statistically significant. These results therefore are consistent with the hypothesis that the Pennsylvania law decreased company values and with the hypothesis that the initial market reaction is an unbiased estimate of the laws effect on firm values.

Government Regulation and Structural Change in the Corporate Acquisitions Market: The Impact of the Williams Act

This paper presents evidence on how the Williams Act affected the corporate acquisitions market. The acquisition process is modeled and three hypotheses about the Acts effects are discussed. These hypotheses imply differing restrictions on how the Act changes the models parameters. Parameter changes are estimated but we are unable to reliably discriminate between two of the three hypotheses using the classical statistical testing approach, though the third hypothesis is reliably rejected. Bayesian analysis using a diffuse prior is employed to make formal probability comparisons among the hypotheses. The most probable hypothesis, according to the results, implies that the Williams Act reduced the expected gross present value of acquisition attempts.

Corporate Cultures and Fabricated Boards: Should Board Structure Be Regulated?

This study examines the effects of different corporate cultures on the efficacy of board independence as a corporate governance mechanism. We distinguish between two cultural types, manipulative versus non-manipulative firms, and focus on CEO dismissal events. In our empirical analysis, firms that are sued for financial misreporting are considered to have manipulative cultures and those that are not sued are considered to have non-manipulative cultures. Our findings show that the semblance of board independence in manipulative firms is unrelated to the likelihood or the promptness of CEO dismissal following the discovery of corporate wrongdoings. Banks and blockholders, on the other hand, both increase the likelihood and promptness of CEO dismissal. In underperforming non-manipulative firms, the presence of blockholders and bank borrowing has no effect on CEO turnover, but more independent boards increase the likelihood of CEO turnover. Corporate culture appears to be an important element in shaping the roles of governance mechanisms. Overall, these findings suggest that attempts to mandate effective corporate oversight by regulating the fraction of independent directors, crudely defined, on the board are unlikely to be successful in achieving their policy objectives.