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UI Researcher Finds CEO Merger Incentive Is To Diversify Wealth

New research by a University of Iowa business professor shows that many corporate mergers and acquisitions are driven as much by the desire of CEOs to diversify their personal stock holdings as they are by market opportunities, sometimes to the detriment of stockholders.

Anand Vijh, a professor of finance in the Tippie College of Business, said that this phenomenon is largely a response to the significant increase in the number of corporations that now pay their CEOs stock or stock options as part of their salary packages.

"While the acquisitions clearly increase the CEOs' own welfare, we are not sure whether these actions increase the welfare of all their shareholders," said Vijh.

A wave of mergers and acquisitions has again been washing over American publicly traded corporations recently. Just this week, Bank of New York announced it was buying Mellon Financial Corp. for $16.5 billion, and Iowa-based Bandag Inc. agreed to be bought out by Bridgestone for $1.05 billion.

Vijh and his co-researcher, Drexel University business professor and 2005 University of Iowa PhD alumnus Jie Cai, tracked more than 8,800 firms and 250 corporate acquisitions between 1993 and 2001, the years that corporations began to rely more and more on stock and stock options to pay their executives. Much of that reimbursement is not liquid so CEOs cannot sell it without severe restrictions. Mergers or acquisitions, however, give CEOs a one-time opportunity to sell their illiquid company stock and cash in their stock options.

Vijh's research found that many corporate acquisitions seem to be driven at least in part by the desire of one or both CEOs involved in the acquisition to convert their illiquid holdings to cash. The research found that CEOs who have more of their personal wealth tied up in company stock are more likely to acquire another company in order to diversify their investments.

"We also found that the CEOs seeking to merge with or acquire another firm often looked for undervalued targets outside their industries and tried to speed up the negotiating process by failing to bargain hard and paying a higher premium," Vijh said. "All of these are consistent with acquirer CEOs increasing their own welfare."

At the same time, the CEOs of companies with overvalued stock were more likely to allow their firms to be acquired in order to sell their overvalued personal holdings at a premium price, or to "cash out," he said.

Unfortunately, Vijh said, not all of these mergers and acquisitions benefit the shareholder. In some cases, the research showed CEOs are more likely to use their own overvalued stock to pay for the acquisition, a move that might increase the welfare of long-term shareholders but lower the value for short-term shareholders.

Vijh's and Cai's research paper, "Incentive Effects of Stock and Option Holdings of Target and Acquirer CEOs," will appear in a forthcoming issue of The Journal of Finance.


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