Board Composition, ownership structure, and hostile takeovers

Anil Shvdasani
Journal of Accounting and Economics

Whenever there is a sole owner-manager in the firm and he later decides to sell off
some portion of his firms shares to outsider, there will be a conflict of interest between
owner-manager and outside shareholder due to certain behaviour or decisions by the ownermanager. This problem is called agency problem which leads to agency cost that is nothing
but decrease in valuation of the company and also monitoring and bonding costs put to
monitor the behaviour of the owner-manager.
To mitigate such agency problem this owner manager can simply takeover the firm and
can offer a takeover bid. If the owner-manager accepts the bid at one go it will be called as a
friendly takeover and if the owner-manager rejects the bid offer at first place but still the
shareholder manages to takeover, this is called as hostile takeover.

Objective of the paper

Objective of this paper is to study the impact of board composition and ownership structure
on the likelihood of hostile takeover by comparing board composition and ownership
structure of hostile targets and non targets.

Board-composition
CEO and other inside directors
Outside directors
Board composition can have impact on probability of hostile takeover. One variable to be
considered is number of outside directors. Outside directors are to be in the board of the
company as per the legal norms. It is said that these outside directors will have less incentives
to monitor the firm because they are outsiders and thus there will be more agency problem
and more chances of hostile takeover. These outside directors can be affiliated and
unaffiliated to the firm. Affiliated means they have certain personal ties with the firm.
Affiliated ones will again have less incentives to monitor the firm and in these cases there
will be more chances of hostile takeover. However, this study also considers ownership by

the outside directors. More the ownership by outside directors more the incentives to monitor
the firm and less chances of hostile takeover should be there.
Next variable is No. of directorships by the outside directors. More the number
directorships in other firms by the outside directors, it means the outsider directors are more
reputed in the market and serve as good monitors. So one expected relationship would be
more the proportion of directorship less the likelihood of takeovers and reputed well
experienced directors will control the managers.
However there is also another thought that more the no. of directorship; less effective
will be the outside director due to time constraints and in this case more the no. of
directorship more will be the chances of hostile takeover.

Ownership Structure
Fraction of shares held by CEOs, inside directors other than CEOs, blockholders, and outside
directors are also considered.
More the shares held by directors and blockholders more the incentives to monitor the firm
due to their personal wealth invested and less agency cost and less likelihood of hostile
takeovers.
However, there can be affiliated and unaffiliated blockhoders. Affiliated means they would
have special ties with the management and infact can be management itself. So higher the
shares held by affiliated ones, more their incentives aligned with the management and also
more would be the takeover cost to the bidder.

Data
Sample of hostile targets and non targets is constructed by examining 1158 firms by Value
Lune Investment Survey during the fourth quarter of 1981. The Wall Street Journal Index,
Wall Street Journal, and Dow Jones News Retrieval Service are used to identify firms that
received takeover bids during 1980 to July 1988.
Of 1988 firms, 247 received hostile bids. 248 friendly takeovers and 653 no
takeover bids
Hostile if bid rejected by board white knight etc defences

 Comparing equal proportions sample of hostile targets and non targets

For each hostile target, a nontarget from the same industry whose market value
of equity most closely matched that of target firm one year prior
Final Sample 214 hostile targets and 214 size - industry matched non target
firms

Results
Number of outside directors has no significant impact on hostile takeover likelihood. But
ownership stake by outside director and number of directorship have relationship with
likelihood of hostile takeovers- unaffiliated directors having more ownership stakes &
directorship will reduce the likelihood of hostile takeovers as they have more incentives to
monitor the firm and also they are highly experienced and reputed in the market due to more
number of directorship they hold.
Also ownership by unaffiliated block-shareholders have impact on probability of hostile
takeovers; More ownership by unaffiliated shareholders more monitoring and less chances
of hostile takeovers.