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Study Finds Managers Make Frequent Large Investments if Insulated from Takeover Threat

Corporate executives whose jobs are protected from takeover bids are apt to make more frequent investments of their company's money, according to a new study from The University of Iowa's Tippie College of Business.

According to the study by finance professors Jon Garfinkel and Matt Billett, executives who are insulated from takeovers and have access to capital make significant investments every 3.6 years. The study found that executives who were not insulated make significant investments only every 4.6 years, or a full year later.

Garfinkel and Billett looked at spikes in investment for companies between 1990 and 2007. Garfinkel said the spikes were anything that could be identified as a capital expenditure, such as a manufacturer building a new factory, or a transportation company buying a new fleet of trucks.

They then looked at the number of anti-takeover amendments in the firm's charter. Garfinkel said such amendments are a useful proxy to measure how insulated a company's executive team is, particularly its chief executive officer. The more anti-takeover amendments a board approves generally means the executives feel freer to make investments, even if those investments aren't always the most efficient, because they are less worried about losing their jobs if the investments don't work out. In particular, underperforming investments hold back share price and make the company a more tempting takeover target, and if the company is taken over, the executives could be fired. But with more anti-takeover amendments, executives are less worried about poorly performing investments leading to their own unemployment.

But fewer anti-takeover amendments usually restrain an executive from making inefficient investments because too much poor performance could lead to a takeover and the loss of their jobs.

"We observed that less insulated executives tend to wait longer between large investments," Garfinkel said.

As might be expected, the study also found that access to investment capital is crucial. Those executives who were insulated from takeovers but lacked financing made investments every 4.2 years, which is the same span of time as uninsulated executives who lacked financing.

It was those companies with less constrained executives that made investments 13 percent more frequently than executives who are not constrained.

"Given the fact that executives who could lose their job if they made a bad investment invested only every 4.6 years, this suggests that more frequent investing is less efficient," he said. "Moreover, the group of most-insulated firms with access to capital and lower stock-based incentive pay not only invested more frequently, their stocks underperformed the benchmark significantly over the next 3 years. This contrasts with the other firms in the sample, whose stocks performed as well as the benchmark."

The paper was co-authored with Yi Jiang of California State University-Fullerton.


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