Corporate Governance and Financing Policy: New Evidence

Transcription

1 Corporae Governance and Fnancng Polcy: New Evdence Lubomr P. Lov Sern School of Busness New York Unversy February 2, 2004 Absrac Pror research has ofen aken he vew ha enrenched managers end o avod deb. Conrary o hs vew, I fnd ha frms wh weak shareholder rghs, as measured by he Gompers e al. (2003) governance ndex, acually use more deb fnance and have hgher leverage raos. I provde an explanaon by showng ha enrenched managers choose conservave (safe) nvesmen polces and hus rade-off expeced bankrupcy coss wh ax shelds of deb a hgher leverage levels. Conssen wh hs, I fnd evdence ha frms wh weak shareholder rghs have lower bond yelds when ssung deb, enjoy hgher cred rangs, and have a hgher propensy o engage n conglomerang mergers. To address he poenal endogeney of he governance ndex, I use he exogenous shock o corporae governance generaed by he adopon of sae an-akeover laws and fnd ha managers ncrease leverage when hey are less vulnerable o akeovers. I am graeful o Heor Almeda, Yakov Amhud, Malcolm Baker, Mchael Herzel, Seven Kaplan, Jonahan Karpoff, Augusn Lander, Mchael Lemmon, Davd Mauer, Janpng Me, Paul Malaesa, René Sulz, Lawrence Whe, parcpans of he semnars a New York Unversy, Unversy of Washngon a Seale, Souhern Mehods Unversy, Unversy of Vrgna, he docoral semnar a he 2004 FMA Meengs, and especally my advsors, Kose John, Danel Wolfenzon, Jeffrey Wurgler, and Bernard Yeung, for valuable dscussons. I hank Davd Yermack for help wh Moody s rangs mgraon daase and Edwn Elon for help wh Lehman Brohers fxed ncome daabase. Ths sudy has been suppored by he Paul Wllensky fellowshp a he Leonard Sern School of Busness of New York Unversy.

2 I. Inroducon The queson of how agency coss mpac fnancng polcy has araced aenon a leas snce Jensen and Mecklng (1976). A prevalen vew n he exsng leraure s ha managers prefer less leverage han s opmal, for nsance o reduce her human capal rsk. Berger, Ofek, and Yermack (1997) show ha enrenched managers are more lkely o use equy usng a sample of 423 ndusral frms beween 1984 and They fnd lower leverage n frms run by CEOs wh long enure, low sensvy o performance, a large board, a low fracon of ousde drecors n he board, and no major sockholder. 1 Based on her evdence hey argue ha enrenched managers use less leverage. 2 In hs paper, I revs hese facs n a broad sample, movaed by he observaon ha a complee analyss of he mpac of governance mechansms on fnancng decsons requres an analyss of how governance mechansms affec boh shareholders and debholders. Whle he qualy of corporae governance s ofen defned n erms of s value o shareholders, a governance regme mgh be harmful o debholders by encouragng value-enhancng rsk-akng ha leaves debholders wh downsde rsk. Wh hs nuon n mnd, hs paper sudes how mproved governance mechansms affec frm fnancng. 1 Berger e al. (1997) recognze he presence of endogeney n her measures of enrenchmen. In parcular, hey nerpre low pay-for-performance sensvy as ndcaon ha he manager s enrenched. Hallman, Harzell, and Pearce (2004) re-examne hs nerpreaon, argung ha here s a subsuon effec beween ncenves (.e. payfor-performance) and monorng (hrea of dsmssal) such ha managers subjec o a lower hrea of dsmssal have a hgher pay-for-performance sensvy. 2 In a relaed ven, Garvey and Hanka (1999) es wheher managers reduce leverage when hey are shelded from akeovers. See also Frend and Lang (1988), who fnd ha he deb rao s negavely relaed o manageral ownershp. Kayhan (2003) exends he ess of Berger e al. for o a larger sample and concludes ha he amoun of ne deb ssues, however, does no appear o be nfluenced by enrenchmen, bu raher ha enrenched managers acheve lower leverage hrough reanng more profs and ssung equy more opporunscally. However, oher sudes suppor he vew of Jensen (1986) ha deb s a me-conssen opmal mechansm o dscplne self-servng managers. For example, Harvey, Lns, and Roper (2004) fnd ha acvely monored deb (syndcae loans) benefs frms wh hgh expeced manageral agency coss and wh overnvesmen problems resulng from hgh levels of asses n place or lmed fuure growh opporunes. They show ha equy holders value complance wh monored covenans, parcularly when frms are prone o overnves. 1

3 To proxy for manageral enrenchmen n a broad sample, I use he ndex recenly developed by Gompers, Ish, Merck (2003), whch s based on a coun of charer provsons ha reduce mnory shareholder rghs. 3 Among he mechansms ncluded n hs ndex are sae law provsons ha delay and/or make akeover aemps cosly, an-akeover provsons n he corporae charer, provsons ha nsulae managemen compensaon and perk consumpon from dsgrunled shareholders, and provsons ha lower shareholder vong power. The less proeced he managemen of a frm s, he lower he governance (enrenchmen) score s assgned. I refer o he Gompers e al. ndex as an enrenchmen ndex snce hgher values ndcae hgher levels of enrenchmen. 4 The man emprcal resul of he paper s ha frms wh srong shareholder rghs rely more on equy o mee her fnancng needs; frms wh weak shareholder rghs rely more on deb. Perhaps reflecng he cumulave oucome of he effec of governance mechansms on ncremenal fnancng decsons, I also fnd ha frms wh srong shareholder rghs have lower leverage raos. Thus, my resuls run couner o he exsng evdence ha bad governance s assocaed wh less leverage. Ths fndng s hghly robus. To address he poenal endogeney of he governance ndex, I also use he exogenous shock o corporae governance generaed by he adopon of he second-generaon sae an-akeover laws. I fnd ha afer he enacmen of hese laws, largely beleved o ncrease manageral enrenchmen, managers of frms ncorporaed n saes passng such blls use more deb fnance and have hgher leverage raos. 3 In hs arcle manageral enrenchmen, weak governance, and weak shareholder rghs are used nerchangeably. 4 Appendx Table 1 provdes a concse ls of he man componens of he Invesor Research Responsbly Cener sub-ndces and he Gompers e al. ndex self. The laer has 24 provsons. These nclude 22 frm-level provsons and sx sae laws (four of he laws are equvalen o four of he frm-level provsons). To conserve space, Appendx Table 1 repors solely he sx sae laws ( does no repor he four frm-level provsons whch are analogous o he correspondng four laws). Bebchuk, Cohen, and Ferrell (2004) aemp o refne he Gompers e al. (2003) ndex; I consder her verson n robusness checks. 2

4 Afer documenng he robusness of hese resuls, I provde a heorecal explanaon for he negave relaon beween frm governance and leverage. My explanaon s based on he endogenous choce of he rsk of he nvesmen polcy made by he managers as a funcon of he srengh of he corporae governance n place. The nuon s as follows. Well-monored (or well-governed) managers are more lkely o underake rsky (and value enhancng) projecs because s easer o dsngush beween bad manageral luck and bad manageral judgmen n a monored envronmen. Tha s, well-funconng corporae monorng mechansms reduce he managers human capal rsk and provde hem wh ncenves o ake value enhancng rsks. On he oher hand enrenched managers or frms wh weak corporae governance choose subopmally conservave nvesmen polces. Based on he rsk of her nvesmen polcy, frms would choose her opmal capal srucures radng-off expeced bankrupcy coss wh debrelaed benefs such as ax shelds. Frms wh rsker nvesmen polces would have lower levels of deb compared o frms wh safer nvesmen polces. In equlbrum beer governed frms would choose lower deb levels compared o badly governed frms. 5 As addonal suppor for hs explanaon, I offer several peces of evdence. I fnd ha weak governance frms have hgher long-erm cred rangs and face lower offer yelds and bond rangs n non-converble publc deb ssues. Frms wh srong shareholder rghs are eher less lkely o have such a cred rang assgned or have a lower cred rang when hey are raed. These facs reflec he percepons of cred rang agences and bond marke parcpans of frm rskness. These resuls are conssen wh he recen fndngs by Klock, Mans, and Maxwell 5 Hrshlefer and Thakor (1992) examne manageral conservasm and leverage. In her model wh dfferenal manageral ably, he ncenves for repuaon buldng make managers sub-opmally conservave. Rsk-shfng ncenves of leverage provde an offse whch mgh move manageral rsk-akng ncenves closer o he opmal nvesmen rsk choce. Takng hs offse no accoun shareholders choose leverage opmally o nduce nvesmen polcy close o he opmum. 3

5 (2004) and Chava, Derker, and Lvdan (2004). 6 I also fnd ha frms wh weak governance end o engage n more dversfyng mergers and acqusons whle frms wh srong governance end o engage n focusng ransacons. Ths s conssen wh evdence from he 1970s n Amhud and Lev (1981), whch suggess ha undversfed managers engage n rsk-reducng acves, such as conglomerang mergers, o reduce her human-capal rsk. I s also conssen wh Berand and Mullanahan (2003), who show ha enrenched managers enjoy he que lfe by engagng n rsk-reducng projecs upon he adopon of he an-akeover sae law provsons. In summary, I fnd ha he large-sample, cross-seconal relaonshp beween manageral enrenchmen and leverage s posve, no negave, and I offer some prelmnary evdence ha manageral rsk-akng and he relaed sockholder-bondholder conflcs may play an mporan role n undersandng hs relaonshp. 7 The remander of hs paper s organzed as follows. Secon wo presens he daa and he emprcal mehodology. Secon hree presens he prmary resuls. Secon four presens a dealed dscusson and furher evdence. Secon fve concludes. II. Mehodology and Daa In hs secon I descrbe he daa and he basc emprcal approach. A. Corporae Governance Snce corporae governance s a cenral explanaory varable n hs sudy, I sar wh s descrpon. I use he enrenchmen ndex nroduced by Gompers e al. (2003). Ther sudy focused on daa from surveys conduced by he Invesor Responsbly Research Cener (IRRC) 6 Klock e al. (2004) argue ha an-akeover provsons are vewed benefcally by bondholders, and Cremers e al. (2004) examne he jon effec of an-akeover provsons and srong shareholder conrol on reurns o bondholders. Cremers e al. fnd ha srong shareholder rghs are assocaed wh lower bond yelds when he frm s proeced from akeovers, and wh hgher bond yelds f he frm s no proeced from akeovers. Chava e al. (2004) show ha frms wh srong shareholder rghs pay hgher raes on bank loans. 7 Mauer and Sarkar (2004) analyze n a conngen clams framework he mpac of bondholder-sockholder conflc on capal srucure. They arrve a smlar predcons for he cos of deb and leverage. However, n her framework he conflc beween he bondholders and sockholders arses because he laer have ncenves o overnves. 4

6 n 1990, 1993, 1995, and Usng hese surveys, Gompers e al. defne a governance ndex (he G-ndex) o characerze he srengh of shareholder rghs across frms. Ths ndex s based on he coun of 24 an-akeover provsons across fve broad an-akeover provson caegores delayng a hosle akeover bd, offcer proecon, vong rghs, sae laws, and oher defenses. They compue her ndex by smply addng one for each presen defensve provson presen n he corporae charer. Ths coun s now avalable for cross-secons from 1990, 1993, 1995, 1998, 2000, and For he years beween surveys and for he years afer 2002, I assume ha he ndex score s he same as n he prevous (survey) year. I appears ha he Gompers e al. ndex s he bes avalable broad-sample ndex of manageral enrenchmen. 8 B. Compusa and CRSP Daa I sudy a large unbalanced panel of frms ha are covered by he IRRC daa and also have daa avalable from he CRSP/Compusa merged ndusral annual daabase (CCM) for The IRRC sample consss of 3,014 frms ncluded n an unbalanced panel over he survey years (for a oal of 21,310 frm-year observaons). The followng flers are mposed. Fnancng frms (SIC codes ), regulaed ules (SIC codes ), and frm-years when he frm s nvolved n major mergers and acqusons (Compusa foonoe codes AB) are excluded. 9 Also excluded are frm-year observaons ha repor cash flow daa usng forma codes (Compusa em #318) 4, 5, and 6 (4 and 6 are undefned by Compusa; 5 s he Canadan fle) or hose n whch he code s mssng. To lnk Compusa o CRSP, I use only records wh lnk ypes of 'LC', 'LN', 'LO', 'LS', 'LU'or 'LX'. I furher remove mssng observaons, oulers and ms-recorded daa for ceran varables. The oulers are removed by 8 My resuls do no depend on he assumpon ha he value of he enrenchmen ndex n-beween survey years s unchanged. In unrepored resuls based solely on daa from he survey years, I oban largely smlar resuls. 9 Emprcal ess on a sample ha does no exclude hese frm-years gve very smlar resuls o hose presened here. 5

7 wnsorzng he exreme observaons n he 1% lef or rgh al of he dsrbuon. 10 All varables are ranslaed n consan 1995 dollars usng he GDP deflaor. Even hough my daase s by far he mos comprehensve among he sudes of capal srucure and manageral enrenchmen, s sll subjec o an mporan bas ha sems from mssng observaons on frms aken prvae hrough leveraged buyous (LBO). Snce hese frms presumably have boh hgh leverage and close algnmen of managemen wh shareholders, one s lef o wonder wheher ncludng hese n my daase would weaken my prmary resuls. I argue ha would no. Even hough hese frms mgh appear o be shareholder-frendly, her managers may sll underake sub-opmally conservave (from he vewpon of shareholders) nvesmen polces, because of her concenraed ownershp sakes. Thus, would be opmal for hese frms o rely more on deb fnance because hey are more conservave n her nvesmen choces. In addon, he oal asses of LBO frms represen on average less han 1% of he oal asses of he frms n my daa sample 11 and hus are unlkely o have economcally sgnfcan mpac on my resuls. Summary sascs for he fnal sample are presened n Table 2. I spl he sample frmyear observaons by qunles of he enrenchmen ndex. I also presen smple sascs for he op and boom decles of he enrenchmen ndex (correspondngly he democracy and dcaorshp frms n Gompers e al. (2003)). The summary sascs mmedaely reveal a number of neresng paerns. Frs, book leverage, marke leverage, he second measure of ne change n leverage (defned below) all ncrease monooncally across he enrenchmen qunles. Second, frms wh more enrenched 10 Before any varables are rmmed, I follow Frank and Goyal (2003) n recordng as zero values for ceran varables whenever hey are mssng or combned wh oher daa ems n order o preserve he accounng denes; see he foonoe o Table 1 for a dealed ls of varables runcaed n hs manner. 11 Ths average s compued as he average annual rao of he annual sum of oal asses of leveraged buyous (from SDC Mergers and Acqusons daabase) o he annual sum of oal asses of all frms n my daase. 6

8 managemens end o be older: he dfference beween he average qunle age of he op and boom enrenchmen qunle porfolos s 15 years. Thrd, sze ncreases monooncally across he qunles. The dfference beween he average sze of he frms n he op and boom qunles s $822 mllon. Fourh, he marke-o-book rao decreases non-monooncally across enrenchmen qunles. Ffh, here appears o be no sysemac paern of he oal level of exernal fnancng across enrenchmen qunles. A smlar concluson apples for he nernal cash flow and profably of he frms. Fnally, here s a non-monoonc ncrease n ne deb ssues and non-monoonc decrease n ne equy ssues across enrenchmen qunles. C. Equy and deb ssuance I sudy he choce of clams ssued from several aspecs. The frs and mos mporan s based on he followng accounng deny: DEF, W, + DIV, + INV, CFLOW, = E, + D,, (1) where he componens n hs deny are ( ndexes frm, and ndexes fscal year): DEF, = Fnancal defc as defned n (1). W, = Change n workng capal, compued as he change n operang workng capal plus he change n cash and cash equvalens plus he change n curren deb. DIV, = Cash dvdends. INV, = Ne nvesmens, compued as he sum of capal expendures, ncrease n nvesmens, acqusons, oher use of funds ne of he sale of produc, plan and equpmen (PPE) and ne of he sale of nvesmen. CFLOW, = Cash flow afer neres and axes, compued as ncome before exraordnary ems, plus deprecaon and amorzaon, plus exraordnary ems and dsconnued operaons, plus deferred axes, plus equy n ne loss, mnus earnngs, plus oher funds from operaons, and plus gan (loss) from sales of PPE and oher nvesmens. 7

9 E, = Ne equy ssued, equal o sales of common sock mnus sock repurchases. D, = Ne deb ssued, equal o long-erm deb ssuance mnus long-erm deb reducon. Please refer o Table 1 for a dealed defnon of each of hese varables. To sudy fnancng polcy, I follow he approach of Shyam-Sunder and Myers (1999) and Frank and Goyal (2003). In parcular, I consder he followng regresson seup: D = a + bdef + ε, (2),,, where D, s he ne amoun of deb ssued and he fnancng defc, DEF,, s as defned above. I run hree versons of (2) o asceran robusness. Frs, I use he Fama and MacBeh (1973) approach o robus parameer esmaon. Second, I apply random year and frm effecs wh robus sandard errors (he Huber/Whe heeroscedascy conssen esmaor) and an AR(1) auocorrelaon n resduals correcon. Thrd, I apply fxed frm and year effecs. III. Emprcal Resuls A. Fnancng The resuls of regresson (2) are presened n Table 3. The panels of he able llusrae he hree regresson approaches. Sarng wh he Fama-MacBeh regressons n Panel A, noe he nearly monoonc ncrease n he coeffcen on DEF, across qunles. Noe also ha he explanaory power ncreases monooncally (as judged by he ncrease n average R 2 ) across enrenchmen qunles. Overall, he resuls sugges ha frms wh enrenched managemen are relyng more on deb fnancng. Ths resul, along wh he observaon of no dfference of nernal cash flow across enrenchmen qunles, suggess ha manageral moves raher han fnancal consrans may drve hese resuls. Fnally, noce ha he peckng order heory works beer for he enrenched frms, as he majory of her fnancng s conduced va deb ssues. 8

10 In Table 4, I nerac he enrenchmen ndex G wh he fnancng defc: F a + b + cdef, + dg, 1 edef, G, 1 fx + + +, ε,, (3), = where F, alernaely denoes ne equy ssues ( E, ), ne deb ssues ( D, ), and he change n long erm deb ( ), each scaled by oal asses. The vecor X, conans a se of conrol LD, varables based on Rajan and Zngales (1995), n parcular changes n Tangbly(), changes n Sze(), changes n Profably(), and changes n Marke-o-book(). I also nclude frm age(). 12 I repor resuls for specfcaons ha nclude frm and year fxed effecs. 13 Our prmary neres here s n he coeffcen e. The odd-numbered models n Table 4 esmae (3) whou conrols whle he even-numbered models nclude he conrols. Ne equy ssuance s negavely assocaed wh boh he neracon erm and wh he enrenchmen ndex. Conrollng for varous known capal srucure nfluences, Table 4 shows ha enrenched frms sll ssue less equy, and more ne or long-erm deb, o fnance ncremenal capal needs. These resuls show ha he paern uncovered n Table 3 s robus o varous conrol varables. B. Levels of leverage and changes n leverage Havng documened a srong lnk beween enrenchmen and fnancng polcy wh flow of funds daa, I nex examne balance-shee measures of leverage and changes n leverage. Book leverage s defned as book deb o oal asses. Marke leverage s defned as book deb dvded by marke value of asses (equal o oal asses mnus book equy plus marke equy; marke equy s shares ousandng (#25) mes prce (#199)). The lef panels of Table 5 presen leverage sored by sze and he enrenchmen ndex. A posve assocaon beween enrenchmen and leverage s apparen whn every sze qunle. Smlar abulaons by frm age and profably 12 The regresson s n dfferences snce he dependen varable s also a flow. 13 Robusness checks wh fxed year and ndusry effecs produce smlar resuls. 9

11 10 agan sugges a robus posve relaonshp beween leverage and enrenchmen. Alhough he relaon beween leverage and enrenchmen ndex s non-monoonc, -ess rejec he equaly of he mean of he op and boom enrenchmen qunle n every sze, frm age, and profably group. Double sors by marke-o-book and governance lead o smlar resuls. In Table 6, I sudy he relaonshp beween enrenchmen and changes n leverage. I use wo proxes for he ne change n leverage. The frs follows Berger e al. (1997) and s ne deb ssuance mnus ne equy ssuance scaled by oal asses:, A E D L,,, 1, =. (4) A second proxy for he change n leverage follows Garvey and Hanka (1999): 1, 1,,, 1,, 1, 2, =, A D E D A D D L (5) where 1, D s lagged book deb and 1, A s lagged oal asses. Table 6 presens resuls for levels of leverage and hese measures of changes n leverage n he followng specfcaon: ( ) A D c A c A EBITDA c A PPE c B M c G c b a L, 1, 5 1, 4 1, 3 1, 2 1, 1 1, 0, log ε = (6) The regressons are performed usng populaon-averaged random year and frm effecs. I correc for AR(1) resdual auocorrelaon and apply he Huber/Whe heeroscedascy-robus sandard error esmaor. The resuls agan pon o he concluson ha frms wh weak shareholder rghs use more deb fnance. Panels A and B use dfferen ses of conrol varables bu oban very smlar coeffcens on he enrenchmen varable, suggesng he robusness of he relaon beween

12 leverage and he Gompers e al. ndex. In Panel A, a one-sandard-devaon ncrease n he enrenchmen ndex (roughly, he addon of abou hree new provsons n he corporae charer) s assocaed wh a 3.16 % above-he-mean ncrease n book leverage, a 2.25% above-he-mean ncrease n marke leverage, 24% above-he-mean ncrease n and a 20% above-he-mean L 1,, ncrease n. L 2,, C. Conrol varables Tables 4 and 6 nclude a varey of conrol varables prevously argued o be deermnans of he capal srucure. Dealed varable defnons are gven n Table 1. Here I brefly dscuss he sgns and sgnfcance of hese esmaes. Consder models (3) and (4) of Table 4. These coeffcens are as expeced: ne deb ssuance ncreases when angbly ncreases, when profably decreases, when marke-o-book decreases, and when sze ncreases. These relaons apply also for long-erm deb ssuance excep for he fac ha long-erm deb ssuance s ncreasng when oal asses are decreasng. Consder now models (1) and (2) n Table 6. In general, he coeffcens on he conrol varables are smlar o hose n earler research, ncludng Rajan and Zngales (1995), Berger e al. (1997), Fama and French (2002), and Baker and Wurgler (2002). D. Robusness One feaure of he Gompers e al. (2003) ndex s ha he ndvdual componens of he ndex (akeover delay provsons, sae-law an-akeover provsons, vong rghs provsons, managemen proecon provsons see Appendx Table 1 for bref descrpon) are all equally weghed whn he overall coun. However, each sub-ndex mgh have a somewha dfferen effec on fnancng polcy. Thus one drecon n whch o examne robusness s o consder he ndvdual sub-componens of he ndex. In Appendx Tables 2 and 3, I fnd ha he resuls are 11

13 robus o hree of he four sub-ndces: he sae-law an-akeover provsons ndex; he offcer proecon ndex; and he ndex of charer provsons geared a delayng akeover aemps. The posve relaonshp beween enrenchmen and he use of deb, however, does no appear f one uses an ndex of enrenchmen based purely on he vong rghs of shareholders. I also examne he effec of redefnng enrenchmen usng he sub-ndex of Bebchuk, Cohen, and Ferrell (2004). 14 The resuls are smlar o hose ha oban wh he ndex of Gompers e al., bu are generally less sgnfcan. I also examne he robusness of he man resuls o alernave proxes for shareholder rghs. Whn a subsample of dual-class frms, I fnd resuls smlar o hose n he full sample (unrepored). Ths s neresng snce he presence of dual-class socks s synonymous wh he presence of hgh benefs of prvae conrol. Tables reporng he above ess are avalable upon reques. Fnally, resuls appear robus o varous sample selecon flers. For example, hey are robus o he excluson of he frm-year observaons of he frs record for a frm n Compusa. E. Causaly Causaly s obvously a major concern n he sudy of leverage and corporae governance; leverage self may be an effcen mechansm for governance (Jensen (1986)) and as such may mpac he choce of oher governance mechansms. Furhermore, could be ha he relaonshp I observe beween leverage and governance mechansms s due more o a spurous correlaon nduced by he mpac of he 1980s akeover pressure on boh, raher han any causal lnk. Whle here are lms o wha one can say on hs score, I sudy he regressons (1) and (2) n Table 6 n dfferences n an effor o address hs concern. Snce survey daa for he 14 Ther ndex s based on he followng sx provsons: saggered boards, lms o shareholder bylaw amendmens, supermajory requremens for mergers, supermajory requremens for charer amendmens, poson plls and golden parachues. 12

14 enrenchmen ndex s avalable only for 1990, 1993, 1995, 1998, 2000, and 2002 I sudy he regresson n cumulave changes across hese years. The resuls of hs baery of ess generally conform o hose presened earler, bu sascal sgnfcance ends o be low. To address causaly quesons descrbed n hs subsecon, I am able o denfy and sudy an even ha represens an exogenous shock o he manageral saus. 15 For ha purpose I use he varaon n corporae governance generaed by he adopon of he second generaon sae an-akeover laws and examne changes n manageral preferences for deb fnancng upon he nroducon of hese laws. The frs pece of an-akeover legslaon was he Wllams Ac of 1968, a federal saue ha provded measures o proec arge shareholders durng he ender offer process, ncludng srngen dsclosure requremens. In he 1970s, ndvdual saes exended he provsons of he Wllams Ac n wha s known as he frs-generaon anakeover laws. However, he Supreme Cour deemed hese laws unconsuonal n 1982 (Edgar vs. Me Corp.) due o her cross-sae jursdconal reach. Followng ha rulng, saes began o pass second-generaon an-akeover laws (SGAT), whch were deemed consuonal by he Supreme Cour n 1987 (CTS Corp. v. Dynamcs Corp. of Amerca). These laws ook prmarly hree forms: busness combnaon laws, far prce laws, and conrol share acquson laws. Researchers beleve ha her mpac has been o ncrease he enrenchmen saus of he ncumben managers. Snce no all saes passed such laws, he SGAT represen an exogenous 15 Anoher concern ha necessaes addonal ess s ha he one of he mos sgnfcan lnks beween he governance ndex and leverage s conaned n he offcer proecon sub-ndex (see Appendx Table 2). Indeed, ha may help reconcle my fndngs wh he convenonal wsdom ha enrenched managers dslke deb. If manageral perk consumpon s proeced n conngences rggered by fnancal dsress or bankrupcy (.e. provsons ha place perks beyond he reach of credors such as secular rus penson plans, severance packages, and golden parachues) managers would be more wllng o le her frms assume hgher level of deb, parly snce here s advanage o deb n erms of ncreased frm value (hgher ax shelds), as long as here exss some lnkage beween manageral conracual compensaon and frm value. Ths complemenary nerpreaon does no nvolve nvesmen polcy dsoron and could provde a drec explanaon why offcer proecon sub-ndex appears mos sgnfcan among all governance sub-ndces. I am able dsprove hs hypohess n sudyng he secondgeneraon an-akeover laws nroducon s mpac on leverage. 13

15 shock o he enrenchmen saus of he manager ha allows us o sudy he effec of enacmen of hese laws on frms ncorporaed n saes passng such blls, n comparson o frms from saes no passng such blls. 16 I use he sample perod of o sudy he mpac of he SGAT laws adopon on leverage (Table 1 n Berrand and Mullanahan (2003) provdes a ls of he even years). I follow he approach of Cheng, Nagar, and Rajan (2004) n sudyng he mpac of he frs law n he second-generaon an-akeover legslaon ha s passed n a frm s sae of ncorporaon (usually he busness combnaon laws), snce, he passage of subsequen laws s faclaed by he passage of he frs. Unvarae resuls on he SGAT expermen are presened n he las wo columns of Table 2. Indeed boh marke and book leverage ncrease afer he enacmen of hese laws. I nex use a dfferences-n-dfferences (DID) panel daa esmaor 17 o sudy he mpac of hese laws on leverage. Ths mehodology has been prevously used by Berrand and Mullanahan (1999, 2003). I provdes an effcen use of he panel naure of he daase, and does no resrc he sample o sae laws passed n he same year (as n Garvey and Hanka (1999)). I esmae he followng equaon L = a + b + claw AFTER, + dx +, ε,, (7), 16 Frms were gven he opporuny o op ou of hese laws. However, snce he decson o op ou s endogenous, I do no exclude hese frms from my sample (dong so would ncur a selecon bas). 17 Ths esmaor could be easly llusraed wh an example. Suppose we are neresed n sudyng he mpac of he New York Sae SGAT law adopon n 1985 on he leverage of frms ncorporaed n New York Sae. We would esmae he average leverage before s adopon n 1985 and afer o compue he dfference. However, economywde and frm-specfc facors oher han he SGAT mgh have mpaced leverage before and afer Thus we need a conrol group of frms from a sae no passng such blls, for example Calforna. We would compare he dfferences n frm leverage n New York Sae, pre- and pos-1985 wh he dfferences n frm leverage n Calforna pre- and pos The esmaor hen sudes he dfference n dfferences beween he reamen (New York) and conrol (Calforna) frm groups. Techncally, we compue he esmae n a regresson. For furher deals, see Berrand and Mullanahan (1999). Heckman and Hoz (1989) and Gruber (1989) dscuss he sascal properes of he DID esmaor. Several sudes used DID esmaors o sudy he mpac of SGAT laws adopon on: manageral ownershp (Cheng, Nagar, and Rajan (2004)), execuve compensaon (Berrand and Mullanahan (1999), and manageral rsk-akng ncenves (Berrand and Mullanahan (2003)). 14

16 where ncluded are boh frm and year fxed effecs, where ndexes frms, ndexes years, LAW s a reamen effec, equal o 1 f he frm s ncorporaed n a sae passng an-akeover law, and zero oherwse, and AFTER, s a dummy varable ha equals 1 for he years afer he nroducon of he SGAT, and zero oherwse. The coeffcen c n ha regresson s nerpreed as he mean effec of he enacmen of SGAT laws on leverage. Ths esmaor explos fully he panel naure of he daase and furher allows ha laws are passed a dfferen mes. Resuls from hese ess are presened n Table 7 and appear o be boh hghly sascally and economcally sgnfcan. Usng he resuls n Panel A, book leverage has ncreased wh 5.4% afer he SGAT laws adopon. 18 My resuls dffer from hese of Garvey and Hanka (1999). A poenal explanaon for s he dfferen, more resrcve sample selecon procedure he laer employ. They consder only frms wh complee Compusa and CRSP records n whch resuls n a sample of 1,203 frms (for example, any frm esablshed n ha perod, such as Mcrosof, would be excluded). Furher excluded are frms from saes ha passed SGAT laws pror o 1987, such as New York Sae. Ths nduces selecon bas ha may have mporan ramfcaons for he robusness of her fndngs. IV. Dscusson A. Re-examnng convenonal wsdom Wha can be drvng he posve relaonshp beween manageral enrenchmen and leverage ha s documened n he prevous secon? Whle I acknowledge ha hs relaonshp 18 Book leverage and marke leverage abulaons across sze, frm age, and profably dependen sors corroborae hese resuls. In addon, sudyng he mpac of he SGAT laws adopon on he share of ne deb ssuance used o fnance he fnancng defc, I also fnd ha afer he even here s an ncrease n deb fnancng. These resuls are omed o conserve space and are avalable upon reques. 15

17 s, n pracce, undoubedly he oucome of many complex nfluences, I oulne here hree smple heorecal channels ha mgh be behnd a posve relaonshp. The frs channel emphaszes how manageral rsk-akng ncenves (or agency coss of deb) may affec fnancng polcy (Hrshlefer and Thakor (1992), Leland (1998), Mauer and Sarkar (2004)). In a world wh beer monorng (and consequenly lower enrenchmen of frm managemen) value-enhancng rsk-akng s encouraged snce drecors of well-governed frms can easly ell bad manageral luck from bad manageral judgmen (good corporae monorng mechansm acs as a rsk-sharng devce for he human capal of he manager). Thus, s opmal for such safe frms o assume hgher leverage n order o benef from ax shelds. 19 Fgure 1 llusraes hs rade-off. In relaed work John, Lov and Yeung (2004) buld a heorecal model ha predcs ha enrenched managers ndeed choose sub-opmally conservave nvesmen polces. 20 The second hypohess nvolves a volunary pre-commmen o deb monorng by enrenched managers (Jensen (1986, 1993)) as an explanaon for he man resuls. Whle somewha sraned, hs hypohess suggess ha enrenched managers mgh pre-comm o deb monorng o avod beng aken over or because of he hgh equy fnancng coss assocaed 19 Smlar concluson s reached n a dfferen lne of argumen by Hrshlefer and Thakor (1992). In her model wh dfferenal manageral ably manageral repuaon buldng ncenves make managers o choose sub-opmally conservave nvesmen polces. Rsk-shfng ncenves of leverage provde an offse whch mgh move manageral rsk-akng ncenves closer o he opmal nvesmen rsk choces. Takng hs offse no accoun shareholders choose leverage opmally o nduce nvesmen polcy close o he opmum. Thus, n equlbrum wh asymmerc nformaon on nvesmen choces, mgh be ex ane benefcal o shareholders o comm no o monor he manager so ha he frm can assume hgher leverage. However her paper generaes predcons for akeovers ha are exacly he oppose of mne. In her model when he probably of akeovers reduces, manageral conservasm goes down and a lower level of deb s opmal. Ths predcon s somehng I es drecly usng he SGAT laws adopon and fnd resuls oppose o. 20 In he framework of John, Lov, Yeung (2004), he manager knows he opmal amoun of perks ha he would wan o consume when cashflows are realzed. In a sub-game perfec equlbrum conex, when he akes he nvesmen polcy decson (a me zero) he would be nfluenced by he fac ha he wll no be able o consume hs opmal amoun n he very bad cash-flow saes of he projec. Hs ncenves a me zero would hen be somorphc o ha of a senor deb holder whose promsed paymen s equal o he opmal amoun of perks ha he would consume f here s enough projec cash. In hs sense hs nvesmen polcy would be more conservave, he larger hs opmal perks are (whch are hgher he worse he governance s). 16

18 wh hgh prvae benefs of conrol (as n Myers (2000) and Shlefer and Wolfenzon (2002)). Or, hey mgh manan an opaque nformaon envronmen o faclae her dverson of corporae resources; 21 hs could furher lead o cosly equy fnancng n a peckng order seup, where enrenched managers would frs ap nernal resources for fnancng nvesmen, and when hese run ou, ap deb markes. 22 Thus he need for some exernal capal may force enrenched managers o pre-comm o deb monorng. The free-cash flow argumen has been refned by Sulz (1990), who pons ou ha deb consrans overnvesmen bu also consrans undernvesmen. A hrd hypohess, or relaed se of hypoheses, nvolves he sraegc use of deb o rean corporae conrol. Harrs and Ravv (1988) and Sulz (1988) show ha managers whose conrol s beng challenged may use deb o nflae her relave vong rghs, e.g. by ssung shor-erm deb and usng he proceeds o buy shares from non-conesng shareholders. Deb can also serve as a me-conssen pre-commmen devce o avod neffcen fuure nvesmen and hereby dscourage poenal bdders (Zwebel (1996), Novaes (2003)). Mueller and Panunz (2004) propose ha deb can dscourage a rader from aempng a akeover, snce raders ofen conduc boosrap akeovers n whch he akeover aemp s fnanced wh deb ha s collaeralzed wh he asses of he arge. Ths n urn creaes ncenves for he arge managemen o pledge s asses pror o he ender offer. Clearly, despe he fac ha a posve enrenchmen-leverage relaonshp s somewha counernuve, here s noneheless no shorage of heores ha have he poenal o shed lgh 21 Pero and von Thadden (2003) buld a model o sudy he mpac of dfferen governance srucures on dffuson of nformaon. Ther model predcs ha lender-domnaed frms wll dscourage nformave prces, as hs would endogenously deerorae he value of lender clams hrough he channel of rsk-akng. 22 Snce monorng dffers across ypes of deb clams, s an open queson wheher enrenched managers would prefer prvae or publc deb. Denns and Mhov (2003) documen a negave relaonshp beween manageral equy ownershp and he lkelhood of publc deb ssue bu do no dscuss he above ssue. 17

19 on, and hey are dffcul o es. 23 In lgh of hs fac, my goal s no o deermne whch of he above heores s correc, bu s somewha less ambous. My goal here s smply o provde some affrmave suppor ha he posve enrenchmen-leverage relaonshp drven a leas n par by he frs channel above, he manageral rsk-akng ncenves channel, whch makes several relavely sraghforward esable predcons. B. Evdence from he cos of deb ssuance To es he hypohess ha deb provders vew enrenched managers as less lkely o engage n asse subsuon, I sudy how percepons of frm credworhness vary wh he Gompers e al. ndex. In parcular, I examne he gross underwrng spreads, cred rangs, and offer yelds he sample frms pay when ssung deb clams n publc markes. 24 The source for hese coss of deb proxes s he non-converble publc deb ssues daa n SDC Global Issues. The daa s compled from regulaory flngs, news sources, company releases and prospecuses. I exclude all converble deb ssues. Alhough he daabase does no conan he unverse of all raded deb, I can see no reason o suspec a sysemac reporng bas. 25 The daa provdes nformaon on he ssue daes of varous deb clams, her maury, 23 For nsance, he second channel suggess ha frms wh weak governance suffer hgher coss of equy. Unforunaely, measurng he cos of equy s a noorously delcae ask. In unrepored resuls I am able o documen a posve relaon beween measures of equy ssuance coss (underprcng, dscounng and underwrer spreads n seasoned equy offerngs) and enrenchmen ndex. These however have low sascal sgnfcance. In addon equy ssuance coss by naure are sunk coss, and may no be relevan for he equy ssuance decsons snce equy s an nfnely lved secury. 24 I choose o sudy deb ssue coss nsead of deb coss because he laer could vary no only because of demand sde facors (such as bondholders percepon of credworhness) bu also because of facors relaed o he supply sde (manageral preferences for deb fnancng). Tha s, a frm may be rsky echnologcally and sll have low cos of deb, e.g. because s managemen dslkes deb. Thus, I consder he cos of deb condonal on he corporae decson o ssue publc deb. I do no sudy prvae deb ssued by he sample frms, snce Chva, Lvdan, and Derker (2004) have already done so. However, prvae deb mgh be relavely more mporan for frms n hs sample. Also, I do no address deb covenans n any deal, bu agan hese could be major deermnans of he cos of deb. For nsance, Blle, Kng, and Mauer (2004) wre ha frms use resrcve covenans o conrol sockholder-bondholder conflcs over he exercse of growh opons, and ha shor-erm deb and resrcve covenans are subsues n conrollng such conflcs and ha resrcve covenans help aenuae he negave effec of growh opporunes on leverage. 25 Km, Pala, and Saunders (2003) also use he SDC Global Issues daabase o sudy he long-erm behavor of deb underwrng spreads. The daase however s no free of errors; for 233 of he deb ssues he fnal maury dae s 18

20 varous measures of he cos of deb, and fees charged by nvesmen banks for specfc ssues. As a proxy for he overall cos of deb I use he gross underwrng spread and he offer yeld for he non-converble deb ssues of he frms n he IRRC sample. The bond yeld s he offer yeld o maury n percenage pons, whch nvesors wll receve f he secury s held (and no defauled on) o he frs maury dae. The gross underwrng spread s he oal fee pad o he nvesmen bankng group ha placed he deb ssue. The approach I ake s o relae hese cos-of-deb ndcaors o he enrenchmen ndex, conrollng for varous frm and ssue-specfc characerscs. Among he frm characerscs I conrol for are company profably as measured by he reurn on asses, leverage, and sze. The secury-specfc characerscs nclude he log of he deb s maury (n years), he deb ssue s sze relave o he sze of he frm, and he unscaled log of he sze of he deb ssue. I also consder separae specfcaons ha nclude or exclude ssue-specfc cred rangs provded by Sandard & Poor s and Moody s, snce cred rang agences mgh ncorporae par or all of he provsons n he enrenchmen ndex (drecly or ndrecly) n her evaluaons. From he nal oal of 39,325 ssues n he sample perod, I drop company-year observaons on fnancal frms and regulaed ules as well as all offerngs of less han $10 mllon. 26 Ths leaves 5,478 deb ssues. I merge hese wh he frm sample from IRRC and oban 3,642 maches, represenng 533 frms whch have an average of 6.8 bond offerngs across he sample perod of Frms ssung deb have an average enrenchmen ndex of 9.7 whle non-ssuers have an average of 8.9. A nonparamerc Wlcoxon rank-sum es rejecs he equaly of hese means a he 1% level. recorded mproperly. For hese, I have manually checked he daa wh Bloomberg daa feed and have correced maury daes accordngly. 26 The resuls are no sensve o hs bound on ssue proceeds. 19

21 Nex I consder he relaonshp beween he enrenchmen ndex and he cos of deb proxes. There are 2,663 offerngs wh daa on he offer yeld, he gross underwrng spread, and conrol varables. The average offer yeld for hese ssues s 7.01% and he average gross underwrng spread s 0.74%. Regressons of hese varables on he enrenchmen ndex are presened n Table 8. I use fxed year and ndusry effecs (a he 3-dg SIC code) snce a Hausman es sascs for random effecs rejecs her presence of 1% level. Offer yeld and gross underwrng spreads are presened n percenage pons of oal proceeds, whle yeld spread s presened n erms of bass pons. Table 8 provdes some ndcaon ha, conssen wh he asse subsuon sory, enrenched-frm managers can ssue deb a a lower cos. Conrollng for a varey of frm and ssue characerscs, boh he underwrng spread and he offer yeld s lower for ssues by enrenched managers. These resuls renforce oher recen sources of evdence ha enrenched managemens enjoy lower coss of deb. For nsance, Anderson, Mans and Reeb (2004a,b) fnd ha foundng-famly ownershp, a hgh proporon of ndependen drecors on he board, and a large board sze s assocaed wh a lower cos of deb. An alernave explanaon of my resuls on he lnkage beween cos of deb ssuance and corporae governance s ha arge bondholders dslke akeovers snce n hese nsances hey could be expropraed. Ths conjecure however s no borne by he daa as Blle, Kng, and Mauer (2003) fnd ha average akeover announcemen bond reurns for arges are sgnfcanly posve whle hese for acqurers are sgnfcanly negave (her sample perod s 1980s and 1990s). Thus s appears ha ndeed frm rskness s wha drves he lnkage beween cos of deb ssuance and corporae governance presened n hs subsecon. 20

22 C. Evdence from cred rangs Nex I consder cred rangs. Graham and Harvey (2001), Faulkender and Peersen (2003), and Ksgen (2003) argue ha cred rangs have a drec mpac on fnancng decsons. My approach here s o examne wheher he long-erm cred rangs of frms vary accordng o he enrenchmen ndex. I use he long-erm ssuer cred rang assgned by Sandard & Poor s. Ths rang reflecs he company s overall credworhness raher han he ably o repay specfc oblgaons. In parcular, ams o measure he ably and readness of a debor o mee s long-erm fnancal commmens (maures of more han one year) when due. I ranges from AAA (srong ably o pay fnancal oblgaons) o CC (vulnerable). These rang varables are assgned a sx-way code classfcaon, 1 hrough 6, wh 1 beng he lowes cred rang; hese correspond accordngly o S&P s bond rangs of B or below, BB, BBB, A, AA, and AAA (for Moody s bond rangs, he sx groups would be B or below, Ba, Baa, A, Aa, and Aaa). Of he sample of 23,204 frm-year observaons n he IRRC daa, a oal of 9,442 have S&P long-erm cred rangs assgned. Afer removng ules and fnancal frms, 6,699 frmyear pars, correspondng o a oal of 788 frms wh cred rangs, reman (he oal number of IRRC frms s 3,133). The average enrenchmen ndex for frms whou any rang s 8.81, whle hose wh a rang average A Wlcoxon rank-sum es rejecs he equaly of hese means a he 1% level. The ordered prob regresson repored n he lef sde of Table 9 s as follows: ( w) = Φ( G + α L + α ROA α Sze ) Prob Cred Rang, where { 1,2,3,4,5,6 } and (.) = 1, 1 2, 1 3, 1 + 4, 1 α, (8) Φ denoes he sandard normal dsrbuon cumulave densy funcon. As conrols I nclude leverage, profably and sze (o conserve space, hese 21

23 coeffcens are suppressed). 27 Table 9 shows ha as enrenchmen ncreases, bond rangs ncrease, even conrollng for several varables ha should drecly nfluence bond rangs. I also repor resuls of regressons n whch I nclude dcaorshp and democracy dummy varables, and repor he dfference beween he wo coeffcens. These regressons gve a smlar mpresson. 28 The assumpon of normaly of he underlyng prob model mgh be volaed n he daa. To address hs, I perform a regresson where I manage o ransform he dscree dependen varable (he cred rangs) no a connuous one and hus perform OLS panel daa regressons free of he underlyng assumpon of normaly. To do hs I aach o each rang caegory he spread beween ha cred rang yeld and he Treasury noe wh same maury. Snce I use he long-erm S&P cred ssuer rangs, I accordngly assgn o hese he average yelds on he Lehman Brohers annual long-erm corporae noes. I have rereved hese for ssuer rangs of AAA, AA, A, BBB, BB, B, CCC and below for from Daasream. Resuls are repored n Panel B. Indeed, he resuls n panel A are robus o he assumpon of normaly underlyng he prob model I use. D. Evdence from mergers and acqusons As suggesed by Jensen (1993), Gompers e al. (2003), and many ohers, one venue for neffcen nvesmens s acquson acvy. Amhud and Lev (1981) and Morck, Shlefer, and Vshny (1990) argue ha enrenched managers may engage n dversfyng mergers, perhaps pursung unrelaed conglomeraon o dversfy her human capal rsk. Even f downszng mgh be more profable n expecaon, enerng a new lne of busness mgh ncrease he 27 In unrepored resuls I also nclude a conrol for he probably of defaul, Alman s Z-score, as n MacKe-Mason (1990). The enrenchmen ndex coeffcen remans unchanged. 28 IRRC added new frms o he daase afer he survey n 1998,.e. from 2000 onwards. Thus he sample ncreases subsanally n recen years. Noce he concurren ncreased sensvy of he S&P cred rang o he enrenchmen ndex. 22

24 survval probably of he frm. Or, f he frm performed poorly las perod, he manager mgh ry o acqure a new lne of busness, one n whch he manager mgh perform beer. I use he SDC Mergers and Acqusons daabase o oban daa on acquson acvy. Beween 1/1/1990 o 12/31/2003, here are a oal of 51,861 acqusons compleed by US publc frms n whch he arge s also a US frm (publc or prvae). Excludng buybacks, recapalzaons and exchange offers reduces he sample o 48,665 ransacons. Of hese, here are 11,829 acqusons accomplshed by he sample frms. Afer droppng fnancal and regulaed frms as before, 8,837 ransacons reman. Of hese I classfy all acqusons as nondversfyng f he arge and he acqurer are n he same ndusry (o defne ndusry groups I use he Fama and French (1997) 48 ndusry porfolo defnons). By hs defnon, here are a oal of 4,427 dversfyng and 4,410 synergsc mergers. These correspond o 1,429 publc arges and 7,408 prvae arges. The frs es s smply o regress he number of acqusons per frm-year on he enrenchmen ndex. Snce frms may no have acqusons n a gven year, I use a Posson regresson o address he censorng of he dependen varable. The panel Posson regresson s: Pr,, z ' β [ Coun = j] =, j = 0,1,2,3,..., E [ Coun ] λ, = e, e λ j λ j!, =, (9) whch ncludes as conrol varables he book-o-marke rao, he reurn on asses, he sze of he frm, Fama-French (1997) ndusry dummes, and year dummes. Noce ha he sze of he sample for he frs model s 16,040, snce when here s no acquson I assgn a coun of zero. More neresngly, I perform a Posson regresson whch couns only dversfyng mergers, and compare o one n whch I coun only non-dversfyng mergers., 23

25 The resuls srongly ndcae ha frms wh enrenched managers are more lkely o conduc dversfyng mergers. Conversely, frms wh srong shareholder rghs are more lkely o engage n focused mergers han hose wh nsulaed managers. In he rgh columns of Table 10, I presen he resuls of he regresson of he acquson rao on he conrol varables and he enrenchmen ndex. The acquson rao s defned as he sum of he value of all corporae acqusons durng he sample perod scaled by he average of he marke value a he begnnng and end of he year he acquson occurred. Frs I presen ob esmaes of he acquson rao for he enre sample on he enrenchmen ndex, conrol varables (as above) and random ndusry and year effecs. Tob regresson s approprae because of he censorng; he acquson rao s very ofen zero. Ineresngly, based on he enre sample here s no sgnfcan relaon beween governance and he acquson rao. However, ha s due o he offseng effecs of governance on he propensy o engage n dversfyng and synergsc mergers. Conssen wh he dea ha enrenched managers seek lower nvesmen rsk, enrenched-managers frms are more lkely o buy unrelaed arges. E. Sae an-akeover laws adopon and frm rskness Even hough he evdence of he mpac of SGAT laws adopon on leverage s congruen wh he one based on Gompers e al. enrenchmen ndex, s no clear wheher hgher leverage afer he SGAT laws passage s due o he nvesmen rsk dsoron I descrbe above. To corroborae my saemen on hs coun, I refer o he evdence presened n Berrand and Mullanahan (2003). The laer documen ha upon he passage of he SGAT laws, he desrucon of old plans falls, bu he creaon of new plans also falls... overall producvy and profably declne n response o hese laws. Ths s conssen wh he hypohess ha he ncrease n he manageral enrenchmen as a resul of he passage of he SGAT laws s ndeed assocaed wh sub-opmally conservave nvesmen polces. 24

26 V. Concluson In hs paper, I fnd ha frms whose managers are more enrenched, as measured by he Gompers e al. (2003) ndex of an-akeover provsons, use more deb o fund fnancng defcs and manan hgher leverage raos overall. Ths large-sample relaonshp runs couner o he radonal nuon ha enrenched managers prefer less deb. Ths resul s hghly robus. I verfy ha he poenal endogeney of he governance ndex I use does no drve he observed emprcal paern. For ha purpose, I sudy an exogenous shock o corporae governance generaed by he adopon of second generaon sae anakeover laws, largely beleved o have ncreased manageral enrenchmen. Usng he varaon n corporae governance generaed by he nroducon of hese laws, I fnd largely smlar resuls. Afer oulnng several heorecal channels ha could lead o hs relaonshp, I fnd emprcal suppor for an explanaon based on he dea ha frms wh weak shareholder rghs assume sub-opmally conservave ( safe ) nvesmen polces and as such would benef from hgher leverage. Specfcally, because he frms wh enrenched managers are safer, hey would rade-off expeced bankrupcy coss wh ax shelds of deb a hgher leverage levels. Conssen wh hs nerpreaon, I show ha boh bondholders and cred rang agences vew frms wh weak shareholder rghs as less rsky: n parcular, deb ssues by enrenched frms have (conrollng for varous frm- and ssue-specfc nfluences) hgher rangs, lower offer yelds, and lower gross underwrng spreads. I also fnd ha enrenched-frm managers are more lkely o engage n dversfyng mergers, conssen wh a desre o reduce nvesmen rsk. The resuls hus provde surprsng new evdence on he drecon and he mporance of he lnkage beween corporae governance mechansms and fnancng decsons. 25

27 References Aggarwal, R., A. Samwck, 2003, Why do managers dversfy her frms? Agency reconsdered, Journal of Fnance, Vol. 58: Alınkılıç, O., R. Hansen, 2003, The dscounng and underprcng of seasoned equy offers, Journal of Fnancal Economcs, Vol. 69: Amhud, Y., B. Lev, 1981, Rsk reducon as a manageral move for conglomerae mergers, Rand Journal of Economcs, Vol. 12: Anderson, R., S. Mans, D. Reeb, 2004a, Foundng famly ownershp and he agency cos of deb, Journal of Fnancal Economcs, forhcomng. Anderson, R., D. Reeb, 2003, Foundng-famly ownershp, corporae dversfcaon, and frm leverage, Journal of Law and Economcs, Vol. 46: Anderson, R., S. Mans, D. Reeb, 2004b, Board characerscs, accounng repor negry, and he cos of deb, Journal of Accounng and Economcs, forhcomng. Baker, M. and J. Wurgler, 2002, Marke mng and capal srucure, The Journal of Fnance, Vol. 57: Bebchuk, L., A. Cohen, A. Ferrell, 2004, Wha maers n corporae governance? Workng paper, Harvard Law School. Berger, P., E. Ofek, D. Yermack, 1997, Manageral enrenchmen and capal srucure decsons, The Journal of Fnance, Vol. 52: Berrand M., S. Mullanahan, 1999, Corporae governance and Execuve Pay: Evdence from Takeover Legslaon, workng paper, MIT. Berrand M., S. Mullanahan, 2003, Enjoyng he que lfe? Corporae governance and manageral preferences, Journal of Polcal Economy, Vol. 111: Blle, M., T. H. Dolly Kng, D. Mauer, 2004, Bondholder wealh effecs n mergers and acqusons: new evdence from he 1980s and 1990s, Journal of Fnance, Vol. 59: Blle, M., T. H. Dolly Kng, D. Mauer, 2004, The effec of growh opporunes on he jon choce of leverage, maury and covenans, workng paper, Souhern Mehods Unversy. Cheng, S., V. Nagar, M. Rajan, 2004, Idenfyng Conrol Moves n Manageral Ownershp: Evdence from Anakeover Legslaon, Revew of Fnancal Sudes, forhcomng. Chva, S., M. Derker, D. Lvdan, 2004, Do shareholder rghs affec he cos of bank loans? Workng paper, Unversy of Houson. Cremers, M. V. Nar, C. We, 2004, The mpac of shareholder conrol on bondholders, workng paper, New York Unversy. Denns, D., V. Mhov, 2003, The choce among bank deb, non-bank prvae deb, and publc deb: evdence from new corporae borrowngs, Journal of Fnancal Economcs, Vol. 70:

28 Fama, E., K. French, 1997, Indusry coss of equy, Journal of Fnancal Economcs, Vol. 43: Fama, E., K. French, 2002, Tesng rade-off and peckng order predcons abou dvdends and deb, Revew of Fnancal Sudes, Vol. 15: Fama, E., J. MacBeh, 1973, Rsk, reurn, and equlbrum: emprcal ess, Journal of Polcal Economy, Vol. 81: Faulkender, M., M. Peersen, 2003, Does he source of capal affec capal srucure? Workng paper, Norhwesern Unversy. Fazzar, S., R.G. Hubbard, B. Peersen, 1988, Fnancng consrans and corporae nvesmen, Brookngs Papers on Economc Acvy, Vol. 1: Frank, M., V. Goyal, 2003, Tesng he peckng order heory of capal srucure, The Journal of Fnancal Economcs, Vol. 67: Frank M., V. Goyal, 2004, Capal srucure decsons: Whch facors are relably mporan? Workng paper, Unversy of Brsh Columba. Garvey, G., G. Hanka, 1999, Capal srucure and corporae conrol: The effec of anakeover saues on frm leverage, Journal of Fnance, Vol. 54: Gompers, P., J. Ish, A. Merck, 2003, Corporae governance and equy prces, Quarerly Journal of Economcs, Vol. 118: Gompers, P., J. Ish, A. Merck, 2004, Incenves vs. conrol: An analyss of U.S. dual-class companes, workng paper, Harvard Unversy. Graham, J., C. Harvey, 2001, The heory and pracce of corporae fnance: Evdence from he feld, Journal of Fnancal Economcs, Vol. 60: Gruber, J., 1994, The ncdence of mandaed maerny benefs, Amercan Economc Revew, Vol. 84: Hallman, G., J. Harzell, C. Parsons, 2004, Carros and scks: The hrea of dsmssal and ncenve compensaon, workng paper, Unversy of Texas a Ausn. Harvey, C., K. Lns, A. Roper, The effec of capal srucure when expeced agency coss are exreme, Journal of Fnancal Economcs, forhcomng. Heckman, J., V. Joseph Hoz, 1989, Choosng among alernave nonexpermenal mehods for esmang he mpac of socal programs: he case of manpower ranng, Journal of he Amercan Sascal Assocaon, Vol. 84: Hrshlefer, D., A. Thakor, Manageral Conservasm, Projec Choce, and Deb, Revew of Fnancal Sudes, Vol. 5: Jensen, M., 1986, Agency cos of free cash flow, corporae fnance, and akeovers, Amercan Economc Revew, Vol. 76: Jensen, M., 1993, The modern ndusral revoluon, ex, and he falure of nernal conrol sysems, Journal of Fnance, Vol. 48:

29 Jensen, M., W. Mecklng, 1976, Theory of he frm: Manageral behavor, agency coss and ownershp srucure, Journal of Fnancal Economcs, Vol. 3: John, K., L. Lov, B. Yeung, 2004, Corporae governance and manageral rsk-akng ncenves: heory and evdence, workng paper, New York Unversy. Kayhan, A., 2003, Manageral enrenchmen and he deb-equy choce, workng paper, Unversy of Texas a Ausn. Km. D., Pala, D., A. Saunders, 2003, The long-run behavor of deb and equy underwrng spreads, workng paper, New York Unversy. Ksgen, D., 2003, Cred rangs and capal srucure, workng paper, Unversy of Washngon - Seale. Klock, M., S. Mans, W. Maxwell, 2004, Does corporae governance maer o bondholders? Journal of Fnancal and Quanave Analyss, forhcomng. Leland, H., 1998, Agency coss, rsk managemen, and capal srucure, Journal of Fnance, Vol. 53: Leuz, C., D. Nanda, P. Wysock, 2003, Invesor proecon and earnng managemen: an nernaonal comparson, Journal of Fnancal Economcs, Vol. 69: MacKe-Mason, J.K., 1990, Do frms care who provdes her fnancng? Journal of Fnance, Vol. 45: Mauer, D., S. Sarkar, 2004, Real opons, agency conflcs, and opmal capal srucure, Journal of Fnance, forhcomng. Modglan, F., M. Mller, 1958, The cos of capal, corporaon fnance, and heory of nvesmen, Amercan Economc Revew, Vol. 48: Morck, R., A. Shlefer, R. Vshny, 1990, Do manageral objecves drve bad acqusons? Journal of Fnance, Vol. 45: Mueller, H., F. Panunz, 2004, Tender offers and leverage, Quarerly Journal of Economcs, forhcomng. Myers, S., 2000, Ousde equy, Journal of Fnance, Vol. 55: Myers, S., and M. Majluf, 1984, Corporae fnancng and nvesmen decsons when frms have nformaon ha nvesors do no have, The Journal of Fnancal Economcs, Vol. 13: Myers, S., L. Shyam-Sunder, 1999, Tesng sac radeoff agans peckng order models of capal srucure, Journal of Fnancal Economcs, Vol. 51: Novaes, W. 2003, Capal srucure choce when managers are n conrol: enrenchmen versus effcency, Journal of Busness, Vol. 76: Parrno, R., M. Wesbach, 1999, Measurng nvesmen dsorons arsng from sockholderbondholder conflcs, Journal of Fnancal Economcs, Vol. 53:

30 Pero, E., E.-L. von Thadden, 2003, Sraegc ransparency and nformed radng: Wll globalzaon force convergence of corporae governance? Journal of Fnancal and Quanave Analyss, Vol. 38: Shvdasan, A., 1993, Board Composon, ownershp srucure, and hosle akeovers, Journal of Accounng and Economcs, Vol. 16: Shlefer, A. D. Wolfenzon, 2002, Invesor proecon and equy markes, Journal of Fnancal Economcs, Vol. 66: Sen, J., 2003, Agency, nformaon and corporae nvesmen, Chaper 2 of he Handbook of he Economcs of Fnance, Elsever Scence B.V.: Amserdam. Warga, A., I. Welch, 1993, Bondholder losses n leveraged buyous, Revew of Fnancal Sudes, Vol. 6: Zwebel, J., 1996, Dynamc capal srucure under manageral enrenchmen, Amercan Economc Revew, Vol. 86:

31 Fgure 1. Opmal leverage for frms wh weak and srong corporae governance. The former are deemed safer snce managemen of frms wh weak corporae governance assume sub-opmally conservave nvesmen polces. Thus expeced bankrupcy coss rade-off wh frm ax shelds a hgher deb levels for such frms. In he fgure V STRONG denoes he value of frms wh srong corporae governance and V WEAK he value of frms wh weak corporae governance. Frm Value Hgh Rsk Technology V STRONG Low Rsk Technology V WEAK L STRONG L WEAK Leverage 30

32 Table 1: Varable Defnons. Varable Descrpon Source Man Varables Ne equy ssues Ne deb ssues Change n workng capal Invesmen Cash dvdends Inernal cash flow Fnancng defc 29 Gross deb ssued E Sale of common & preferred sock (Compusa daa em #108) purchase of common & preferred sock (#115) dvded by asses (#6). The, resulng varable s wnsorzed a 1% n boh al of he dsrbuon. Compusa. D Long-erm deb ssuance (#111) long erm deb reducon (#114) dvded by asses (#6). The resulng varable s wnsorzed a 1% n boh al of, he dsrbuon. Compusa. W For frms reporng forma code 1, he change n workng capal equals he sum of ems #236+#274+#301. For frms reporng forma codes 2 and, 3, he change n ne workng capal s #236+#274-#301. For forma code 7, he value s gven by #302-#303-#304-#305-#307+#274-#312-#301. Compusa. The resulng varables are scaled wh oal asses and hen wnsorzed a 1% n boh al of he dsrbuon. INV, For frms reporng forma codes 1 o 3, nvesmens s equal o #128+#113+#129+#219-#107-#109. For frms reporng forma codes 7, Compusa. nvesmens s equal o #128+#113+#129-#107-#109-#309-#310. The resulng varables are scaled wh oal asses and hen wnsorzed a 1% n boh al of he dsrbuon. DIV, Represened by daa em #127 n Compusa. The resulng varable s scaled wh oal asses and hen wnsorzed a 1% n boh al of he Compusa. dsrbuon. CFLOW, For frms reporng forma codes 1, 2 and 3, equals #123+#124+#125+#126+#106+#213+#217+#218. For frms reporng forma code 7, Compusa. equals #123+#124+#125+#126+#106+#213+#217+#314. The resulng varable s scaled wh oal asses and hen wnsorzed a 1% n boh al of he dsrbuon. DEF, The sum of he cash dvdends, nvesmens and change of workng capal mnus nernal cash flow. The sum s furher wnsorzed a 1% n boh als of he dsrbuon. Compusa. GRD Long-erm deb ssuance (#111) scaled by oal asses (#6) as of end of fscal year. The varable s wnsorzed a 1% n boh al of he dsrbuon. Compusa., Change n deb rao Book equy Book deb Book leverage Marke leverage Ne change n leverage, I Ne change n leverage, II Governance Varables Enrenchmen ndex Change n he long-erm deb (#9) o oal asses (#6) as of he end of he curren fscal year. The varable s wnsorzed a 1% n boh al of he Compusa. dsrbuon. Toal asses (#6) oal lables (#181) preferred sock (#10) + deferred axes (#35) + converble deb (#79) as of he end of he curren fscal Compusa. year; f preferred sock s mssng, hen I subrac he redempon value of preferred sock (#56). If redempon value s also mssng hen I subrac he carryng value (#130). In hs compuaon, f deferred axes are recorded as mssng or combned wh oher ems, I record hem as 0. D Book deb, defned as oal asses (#6) book equy, boh as of he end of he curren fscal year. Compusa. LD, BE,, BL Book deb (, D ) o oal asses (#6) a he end of he curren fscal year. The varable s furher wnsorzed a 1% n boh als of he dsrbuon. Compusa., ML Book deb dvded by: [oal asse (#6) book equy + oal shares ousandng (#25) * prce (#199)]. The resulng varable s wnsorzed a 1% n, boh als of he dsrbuon. L 1,, Measure of leverage defned as D, 1 + D, D, where, 1 D s book deb and L, A s oal asses a he end of he curren fscal year., 1,, = A, 1 + D, + E, A, 1 The resulng measure s wnsorzed a he 1% n boh als of he dsrbuon. L 2,, L 2,, = ( D, E, ) A, where D s book deb and,, A s oal asses a he end of he curren fscal year. Measure II s smlar o he one n, Berger, Ofek, Yermack (1997), whle measure I s smlar o he measure appled by Garvey, Hanka (1999). The resulng measure s wnsorzed a he 1% n boh als of he dsrbuon. G, An ndex ha couns he presence of 24 an-akeover, vong, compensaon-relaed and an-akeover sae law provsons presen n he corporae charer of a frm. The ndex s nroduced by Gompers, Ish, Merck (2003). Compusa. Compusa. Compusa. Invesors Responsbly Research Cener (IRRC). 29 In he compuaon of he fnancng defc componens, I follow Frank and Goyal (2003) n recordng as zero he followng ems when hey are eher mssng or combned wh oher daa ems (Compusa daa em s shown n brackes): deprecaon and amorzaon (# 125), oher funds from operaon (defned as #124 + #126 + #106 + #213 + #217; I have recorded as zero all ndvdual componens f mssng or combned wh oher em), accouns recevable (#302), nvenory (#303), accouns payable and accrued lables (#304), ncome axes-accrued (#305), ne change n asse & lables (#307), ncrease n nvesmens (#113), sale of nvesmen (#109), capal expendure (#128), sale of propery plan and equpmen (#107), acqusons (#129), shor erm nvesmen change (#309), nvesng acves-oher (#310), purchase of common and preferred sock (#115), cash dvdend (#127), long-erm deb reducon (#114), changes n curren deb (#301), oher fnancng acves (#312), exchange rae effec (#314), oher sources of funds (#219), workng capal change (#236). 31

33 Democracy dummy Dc, Dummy varable ha equals one f he enrenchmen ndex 5 G, and zero oherwse. Based on IRRC. Dcaorshp dummy Demc, Dummy varable ha equals one f he enrenchmen ndex G 14, and zero oherwse. Based on IRRC. Conrol Varables Marke-o-book ( M B ), The rao of he marke value of asses o he book value of asse. The marke value s calculaed as he sum of he book value of asses and he Compusa. marke value of common sock less he book value of common sock and deferred axes, [Toal asses (#6) book equy + marke equy], where are componens are as of he end of he curren fscal year. The resulng varable s wnsorzed a 1% n boh als of he dsrbuon. Asse angbly ( PPE A) Equals ne propery, plan and equpmen (#8) dvded by oal asses as of he curren fscal year. The resulng varable s wnsorzed a 1% n boh Compusa. als of he dsrbuon. Profably ( EBITDA A ), Equals EBITDA (#13) dvded by oal asses as of he curren fscal year. The resulng varable s wnsorzed a 1% n boh als of he Compusa. dsrbuon. Frm sze log A, Equals he naural logarhm of oal asses (#6) as of he end of he fscal year. The varable s wnsorzed a 1% n boh als of he dsrbuon. Compusa. Earnngs before ax o ( ET A), Equals earnngs before neres and ax (#18+#16) dvded by oal asses n he curren fscal year dvded by asses a he end of he curren fscal Compusa. asses year. The varable s wnsorzed a 1% n boh als of he dsrbuon. Dvdend/ book equy ( Dv BE), Common sock dvdends (#21) scaled by book equy as of curren fscal year. The varable s wnsorzed a 1% n boh als of he dsrbuon. Compusa. Dvdends/ marke equy ( Dv ME ), Common sock dvdends (#21) dvded by marke equy as of end of fscal year. The varable s wnsorzed a 1% n boh als of he dsrbuon. Compusa. Deprecaon/ asses ( Dp A ), Deprecaon expense (#14) n he curren fscal year dvded by oal asses a he end of fscal year. The varable s wnsorzed a 1% n boh als Compusa. of he dsrbuon. R&D/ asses ( RD A ), Research and developmen expense (#46) n he curren fscal year dvded by oal asses a he end of fscal year. If research and expenses are Compusa. mssng (.e. no maeral) I record he em as 0. The varable s wnsorzed a 1% n boh als of he dsrbuon. Frm Age Age, Frm age measured as he dfference beween he curren year and he year when he frm has frs appeared on he CRSP ape. CRSP monhly sock fle. Cos of Deb Varables Sandard and Poor s long SPRLT, Long erm ssuer cred rang assgned by he Sandard & Poor s. The rang ndcaes he ably and readness of a debor o mee s long-erm Compusa erm ssuer cred rang fnancal commmens (maures of more han one year) when due. Ths ndcaor ranges from AAA (srong ably o pay fnancal oblgaons) o CC (vulnerable). The numercal code ransformaon of he leer rangs ranges from 1 hrough 6, wh 1 beng he lowes cred rang; hese Rang Spread Yeld spread Offered bond yeld Gross underwrng spread Moody s Bond Rang S&P s Bond Rang SPREADR, YIELD, OFRYIELD, GSPREAD, MRATING, SPRATING, correspond o bond rangs closes o: B or below, BB, BBB, A, AA, and AAA. Compued by aachng o each annual S&P long-erm ssuer cred rang he correspondng annualzed rang spread of he Lehman Brohers longerm corporae noes (e.g. AAA, AA, AA, BBB, BB, B, C and below) over a correspondng maury Treasury noes. The daa for hese aggregae ndces s from Daasream for The spread over reasury noes wh he same maury s he dfference (n bass pons) beween he yeld on he bond and he yeld on a comparable maury reasury bond. SDC Global Issues daabase repors hs em only for fxed rae, non-converble deb ssues. The bond yeld s he offer yeld o maury n percenage pons a he me of ssuance, whch nvesors wll receve f he secury s held o he frs maury dae. The oal compensaon o he nvesmen-bankng group. The dollar gross spread s he dfference beween he prce a whch he underwrng syndcae obans he bonds from he ssung frm and he offer prce a whch sells hem. I consss of managemen fee, sellng concesson and underwrng fee. The varable s n percenage pons from he oal proceeds. Moody s rang of he deb ssue a he me of he offer provded by SDC Global Issues daabase. The rang varables are assgned a sx-way code classfcaon from 1 hrough 6, wh 1 beng he lowes cred rang; hese correspond accordngly o bond rangs of: B or below, Ba, Baa, A, Aa, Aaa. S&P s rang of he deb ssue a he me of he offer provded by SDC Global Issues daabase. Codes as he S&P long-erm ssuer cred rang above. Daasream and Lehman Brohers Fxed Income daabase. SDC Global Issue daabase SDC Global Issue daabase SDC Global Issue daabase SDC Global Issue daabase SDC Global Issue daabase Mergers and Acqusons Measure of relaedness Acquson Rao Acquson Coun RELDUMMY, A dummy varable equal o one f boh he arge and he bdder belong o he same Fama, French (1997) 48 ndusry porfolo, and zero oherwse. Ken French s webse; SDC M&A daabase. ACQR, The sum of he value of all corporae acqusons accomplshed by he company durng he calendar year scaled by he average of he company SDC M&A daabase. marke value a he begnnng and end of he calendar year. ACQC The number of acqusons he frm accomplshed durng a gven calendar year. SDC M&A daabase., 32

34 Table 2: Summary sascs by enrenchmen ndex qunle. All varables are scaled by oal asses and wnsorzed a he 1% n boh als of he dsrbuon. The daa ems noaon corresponds o he Compusa code or s defned n Table 1. Top & Boom Enrenchmen Index Qunle Decles Daa em 1 (Low) G 6 2 G = 7,8 { } 3 G = 9,10 { } 4 G = 11,12 { } 5 (Hgh) G 13 Democracy G 5 Dcaorshp G 14 Pre-SGAT laws nro Pos-SGAT laws nro Number of observaons 2,515 2,720 2,870 2,404 1,522 1, ,115 14,516 Asses + Cash # Shor erm nvesmens # Recevables-oal # Invenores # Curren asses - oher # = Curren asses - oal # Ne propery plan and equpmen # Invesmens & advances - equy mehod # Invesmens and advances oher # Inangbles # Asses - oher # = Toal asses # Lables + Deb n curren lables # Accoun payable # Income axes payable # Curren lables-oher # = Curren lables - oal # Long-erm deb - oal # Lables - oher # Deferred axes and ITC # Mnory neres # = Lables - oal # Preferred sock -carryng value # Common equy - oal # = Toal lably & sockholders'equy # = Toal asses # Book Leverage Marke Leverage Ne change n leverage, I Ne change n leverage, II Profably BL, ML, L 1,, L 2,, ( EBITDA A) Marke-o-Book Rao ( M B ), Sze (Logarhm of Toal Asses) Frm Age Cash Dvdends Invesmens Change n workng capal Inernal cash flow Fnancal defc Ne deb ssues Ne equy ssues log A, Age, DIV, I, W, CFLOW, DEF, D, E,

35 Table 3: Fnancng polcy and manageral enrenchmen. Esmaes of equaon (2) by enrenchmen ndex qunles, usng he Fama-McBeh procedure n panel A; random year and ndusry effecs wh correcons for AR(1) auocorrelaon and wh Huber/Whe heeroscedascy-robus sandard errors n panel B; and fxed frm and year effecs n panel C. I repor he average of he effecs as he nercep n panel B. The equaon = +, s esmaed for each qunle of D a bdef + e he enrenchmen ndex wh he dependen varable beng ne deb ssuance. Panel A presens he resuls for he enre sample, panel B presens he resuls only for he frms n he dcaorshp and democracy porfolos defned as n Gompers e al. (2003). Refer o Table 1 for dealed varable defnons. Fnancng defc componens, equy ssuance, and deb ssuance are wnsorzed a 1% on each sde of he dsrbuon. Snce he enrenchmen ndex s a caegorcal varable, he qunles based on have uneven szes. Enrenchmen qunles are based on ndex values as of he begnnng of he year. The boom qunle represens frms wh he leas-enrenched managemen rankng. The rank-sum es of equaly of means of he op and boom qunle s presened a he boom of each panel. Enrenchmen Qunle (-1) Panel A: Fama-McBeh Esmaes, (Low) (Hgh) Democracy Dcaorshp G 6 G = { 7,8} G = { 9,10} G = { 11,12 } G 13 G 5 G 14 Inercep sa (0.51) (0.79) (0.53) (1.19) (0.72) (0.29) (0.61) Fnancng Defc () sa (3.09) (5.56) (6.78) (6.60) (6.25) (2.55) (4.54) Observaons (per year) Average R-squared sa 50.0% 59.3% 61.1% 63.7% 70.0% 51.8% 70.5% T-sa for [5]-[1] [3.03] [2.39] Panel B: Random Year and Company Effecs wh Robus Sandard Errors & AR (1) Correlaon Correcon 1 (Low) (Hgh) Democracy Dcaorshp G 6 G = { 7,8} G = { 9,10} G = { 11,12 } G 13 G 5 G 14 Inercep sa (2.57) (3.63) (2.49) (5.46) (3.36) (0.98) (2.32) Fnancng Defc () sa (8.75) (14.29) (14.66) (14.59) (13.7) (5.83) (14.63) Observaons 2,201 2,328 2,274 1,861 1,277 1, Ch-squared sa T-sa for [5]-[1] [3.60] [2.58] Panel C: Fxed Year and Frm Effecs 1 (Low) (Hgh) Democracy Dcaorshp G 6 G = { 7,8} G = { 9,10} G = { 11,12 } G 13 G 5 G 14 Inercep sa (2.62) (5.93) (6.13) (10.21) (6.91) (0.32) (4.58) Fnancng Defc () sa (45.49) (57.19) (64.2) (60.64) (58.88) (35.7) (39.12) Observaons 2,460 2,659 2,767 2,326 1,490 1, Ch-squared sa 43.6% 54.4% 56.8% 58.7% 69.2% 45.0% 68.7% T-sa for [5]-[1] [7.67] [3.91] 34

36 Table 4: Fnancng polcy and manageral enrenchmen: Robusness ess. Regressons of ne equy, ne deb ssuance and change n long erm-deb ssuance versus fnancng defc, enrenchmen ndex, neracon of fnancng defc and he enrenchmen ndex, and conrol varables. The generc equaon esmaed and shown n hs able s F a + b + cdef, + dg, 1 edef, G, 1 fx + + +, ε,, where he dependen varables F, are: ne equy, = E, ), ne deb ssues ( D, ssues ( ), and he change n long erm deb ( LD, ) and he conrol varables change n PPE, change n sze, log A 1, change n profably, ( EBITDA A) 1, change n marke-o-book,, and frm age. Refer o Table 1 for dealed varable defnons. Regressons are performed usng fxed year and angbly, ( A) 1 ( M B) 1 frm effecs (no repored). Ne Equy Issues Ne Deb Issues Change n LT Deb Varable (1) (2) (3) (4) (5) (6) Fnancng Defc () (23.18) (21.58) (32.81) (34.15) (9.32) (9.95) Enrenchmen Index (-1) (-2.38) (0.26) (1.97) (-0.69) (1.25) (0.05) Enrenchmen Index (-1)* Fnancng Defc () (-7.00) (-5.15) (7.43) (5.67) (4.68) (4.43) ( PPE A) (-8.47) (6.18) (11.51) log A (-1.47) (2.59) (-2.47) ( EBITDA A) (12.39) (-11.11) (-7.79) ( M B) (6.61) (-5.55) (-4.19) Age, (-5.61) (6.22) (2.01) Observaons 11,803 11,449 11,702 11,349 12,185 11,877 R-squared sa 35.38% 31.87% 54.38% 53.69% 13.47% 15.62% 35

37 Table 5: Levels of leverage and manageral enrenchmen. Tabulaons of marke leverage (panel A) and book leverage (panel B) by sze, frm age, and profably qunles. Tess for he sgnfcance of he dfference beween he leverage of frms n he frs and las enrenchmen qunle (and beween dcaorshp and democracy porfolos) whn every sze, frm age, and profably qunle are shown n brackes. Refer o Table 1 for varable defnons. Panel A: Marke leverage abulaon (%) Sze Rank Frm IPO Age Rank Profably Rank Enrenchmen Index 1 (Low) (Hgh) 1 (Low) (Hgh) 1 (Low) (Hgh) 1 (Low), G , G = { 7,8} , = { 9,10} 4, = { 11,12 } G G (Hgh), G sa (Qunle 1 - Qunle 5) [6.73] [3.03] [4.95] [4.10] [1.43] [5.74] [2.57] [5.73] [3.16] [2.14] [5.56] [3.05] [6.09] [8.87] [10.07] Democracy Frms ( G 5 ) Dcaorshp Frms ( G 14) sa (Dcaorshp - Democracy): [3.63] [2.52] [2.68] [2.69] [0.36] [2.52] [2.16] [2.12] [2.56] [1.41] [3.13] [1.11] [5.79] [5.58] [8.61] Panel B: Book leverage abulaon (%) Sze Rank Frm IPO Age Rank Profably Rank Enrenchmen Index 1 (Low) (Hgh) 1 (Low) (Hgh) 1 (Low) (Hgh) 1 (Low), G , G = { 7,8} , = { 9,10} 4, = { 11,12 } G G (Hgh), G sa (Qunle 1 - Qunle 5) [6.05] [2.83] [5.40] [4.42] [2.54] [6.36] [4.59] [4.44] [7.97] [4.46] [5.19] [4.81] [7.72] [7.85] [10.65] Democracy Frms ( G 5 ) % 49.2% 51.3% 52.3% 58.0% Dcaorshp Frms ( G 14) % 56.8% 53.0% 58.5% 64.0% sa (Dcaorshp - Democracy): [3.20] [0.55] [3.22] [2.29] [0.14] [3.20] [3.20] [1.42] [3.21] [1.97] [2.90] [1.01] [5.99] [4.31] [7.14] 36

38 Table 6: Levels of leverage, changes n leverage and manageral enrenchmen. Regressons of book leverage, marke leverage, and measures of changes n leverage on he enrenchmen ndex and conrol varables. Refer o Table 1 for varable defnons. Panel A uses he conrol varables n Rajan and Zngales (1995). Panel B uses he conrol varables n Fama and French (2002). All varables are wnsorzed a he 1% level n boh als. Regressons n boh panels use random frm and year effecs. Panel A: Rajan and Zngales (1995) conrol varables BL, Varable (1) (2) (3) (4) Enrenchmen Index (-1) (4.98) (2.95) (2.40) (2.20) ( M B) (-1.90) (-25.93) (0.90) (5.50) ( PPE A) (2.53) (5.72) (-0.10) (1.10) ( EBITDA A) (-21.47) (-26.12) (18.20) (14.70) log A ( ) 1 (8.58) (18.75) (3.20) (1.40) ( D A) (-7.80) (-6.10) Observaons 11,907 11,902 5,994 5,994 Ch-squared sa , Panel B: Fama and French (2002) conrol varables BL, Varable (1) (2) (3) (4) Enrenchmen Index (-1) (4.51) (3.19) (2.62) (2.32) M ( B) 1 (-3.75) (-22.49) (2.28) (5.53) ( ET A) (-27.96) (-28.44) (12.53) (10.25) ( Dv BE) (17.71) (-6.09) (5.82) (6.69) ( Dv ME) (-9.00) (14.91) (-5.62) (-5.35) ( Dp A) (0.43) (-7.59) (2.92) (2.76) ( RD A) (-5.80) (-11.80) (-7.13) (-4.93) log ( A ) (9.39) (16.18) (2.36) (0.87) D ( A) 1 (-7.73) (-6.29) Observaons 11,914 11,909 5,990 5,990 Ch-squared sa ML, ML, L 1,, L 1,, L 2,, L 2,, 37

39 Table 7: Levels of leverage, changes n leverage and manageral enrenchmen. Regressons of book leverage, marke leverage, and measures of changes n leverage on he enrenchmen ndex and conrol varables. LAW s a dummy effec equal o 1 f he frm s ncorporaed n a sae passng an-akeover law, and zero oherwse. AFTER, s a dummy varable ha equals 1 for he years afer he nroducon of he SGAT, and zero oherwse. Panel A uses he conrol varables n Rajan and Zngales (1995). Panel B uses he conrol varables n Fama and French (2002). All varables are wnsorzed a he 1% level n boh als. Regressons n boh panels use fxed frm and year effecs. Panel A: Rajan and Zngales (1995) conrol varables BL, ML, L 1,, L 2,, Varable All frms All frms All frms All frms LAW AFTER, (22.0) (25.55) (1.75) (2.96) ( M B) (-7.54) (-28.32) (-5.15) (-5.42) ( PPE A) (9.91) (12.17) (-6.09) (-6.65) ( EBITDA A) (-31.13) (-30.6) (3.93) (4.49) log ( A ) (6.93) (33.32) (-1.73) (3.07) ( D A) (-16.15) (-25.47) Observaons 31,518 31,396 17,972 17,972 R-squared sa 6.8% 16.1% 3.1% 6.5% Panel B: Fama and French (2002) conrol varables BL, ML, L 1,, L 2,, Varable All frms All frms All frms All frms LAW AFTER, (18.29) (23.21) (2.42) (3.39) ( M B) (-5.52) (-25.26) (-4.65) (-4.84) ( ET A) (-34.19) (-31.93) (2.85) (3.98) ( Dv BE) (-0.87) (-8.18) (1.73) (-0.23) ( Dv ME) (0.01) (10.81) (-2.32) (-0.43) ( Dp A) (12.78) (10.47) (-0.28) (2.03) ( RD A) (-1.92) (-4.85) (-6.71) (-2.99) log ( A ) (11.01) (36.06) (-2.63) (2.73) ( D A) (-15.8) (-24.93) Observaons 31,503 31,381 17,956 17,956 R-squared sa 9.79% 18.01% 3.30% 6.16% 38

40 Table 8: Cos of deb capal and manageral enrenchmen. Regressons of gross underwrng spread and offer yeld on he enrenchmen ndex. See Table 1 for dealed varable defnons. Conrol varables nclude he log of frm sze, book leverage, he reurn on asses, S&P bond rang, Moody s bond rang, and bond maury n years. The regressons nclude random year and ndusry effecs (ndusry a 3-dg SIC code level) (no repored). Varable Gross Underwrng Spread Offer Yeld (1) (2) (3) (4) (1) (2) (3) (4) Enrenchmen ndex (-1) (-2.88) (-2.18) (-2.50) (-3.25) (-2.96) (-3.02) Lowes enrenchmen qunle (-1) (-0.63) (2.33) Hghes enrenchmen qunle (-1) (-3.02) (-1.00) log A, (0.44) (1.12) (-4.71) (-4.26) (-8.77) (-8.44) (-11.74) (-11.69) ( D A) (5.92) (6.08) (12.96) (13.03) (4.86) (4.86) (8.69) (8.62) ROA (-4.67) (-4.78) (-8.61) (-8.30) (-5.92) (-5.88) (-8.49) (-8.41) Relave sze of proceeds () (11.33) (11.45) (13.05) (13.39) (4.04) (4.01) (5.19) (5.26) S&P rang code () (19.57) (10.12) Moody s rang code () (19.23) (9.66) Maury lengh n years () (22.54) (22.57) (19.08) (19.08) (16.50) (16.42) (15.31) (15.26) Observaons 2,678 2,678 2,681 2,681 2,696 2,697 2,700 2,700 R-squared sa 38.8% 39.1% 31.4% 31.3% 30.1% 29.7% 26.0% 25.9% 39

41 Table 9: Cred rangs and manageral enrenchmen. Panel A presens an ordered prob for he S&P long-erm ssuer cred rangs on he enrenchmen ndex and conrol varables. The rangs are coded from 1 hrough 6, wh 1 beng he lowes cred rang; hese correspond o S&P s bond rangs closes o B or below, BB, BBB, A, AA, and AAA. The conrol varables are profably, leverage, and log of frm sze (all lagged; no shown). The second par of panel A repors he esmaes of he ordered prob regresson of S&P cred rang on he dfference beween he dcaorshp and democracy dummy, and he same conrols. Panel B repors an OLS regresson of he spread above reasury noes wh correspondng maury of bonds wh cred rangs closes o B or below, BB, BBB, A, AA, and AAA. The -sascs are based on Huber/Whe heeroscedascy conssen sandard errors. The las row presens he Fama-MacBeh esmaes as he esmaes of an OLS regresson of he ndvdual annual coeffcens on a consan. The -sascs s he -sasc on he consan n ha regresson. Panel A: Sx-way classfcaon of bond rangs Dcaorshp (-1) Enrenchmen Index (-1) Democracy (-1) Panel B: Rangs spread dfferences Dcaorshp (-1) - Enrenchmen Index (-1) Democracy (-1) Coeffcen T-sa Coeffcen T-sa Coeffcen T-sa Coeffcen T-sa (8.56) (6.46) (-4.72) (-3.78) (1.14) (0.29) (-2.66) (-2.06) (1.32) 0.02 (0.25) (-2.61) (-1.95) (0.65) (-0.20) (-2.49) (-1.80) (1.52) (0.33) (-2.90) (-1.91) (1.82) (0.66) (-3.14) (-2.15) (1.44) (0.28) (-0.56) (0.05) (1.00) (0.13) (-1.66) (-1.18) (1.42) (0.25) (-2.10) (-1.62) (2.70) (2.91) (-1.11) (-2.37) (3.35) (3.28) (-2.80) (-3.13) (4.42) (4.03) (-3.46) (-3.57) (4.18) (4.19) (1.14) (1.12) (4.39) (4.72) (-4.99) (-5.03) Leas Squares Mean Leas Squares T-sa (6.18) (3.18) (-3.95) (-3.63) 40

42 Table 10. Choce of nvesmen rsk and manageral enrenchmen. The lkelhood of relaed and dversfyng mergers by enrenchmen. In he lef columns, he acquson coun s relaed o he enrenchmen ndex for he enre sample, and for he sub-samples wh dversfyng acqusons, and he sub-sample wh focusng acqusons. A merger s focusng f boh acqurer and arge belong o he same Fama-French (1997) ndusry. The resuls are he coeffcen esmaes from a Posson regresson ncludng random year and ndusry effecs (no shown). In he rgh columns, I presen coeffcen esmaes from ob regressons wh fxed year and ndusry effecs (no shown) across he enre sample, and he sample of dversfyng acqusons and synergsc acqusons. Panel A: Acquson Coun Panel B: Acquson Rao Dversfyng Non-Dversfyng All Dversfyng Acqusons Acqusons Acqusons Acqusons (1) (2) (3) (4) (5) (6) All Acqusons Non-Dversfyng Acqusons Enrenchmen ndex (1.65) (3.59) (-1.15) (-0.04) (2.49) (-2.99) log A, (38.39) (31.29) (23.02) (12.85) (9.95) (11.11) ROA (12.88) (10.68) (7.98) (-3.25) (1.8) (-3.98) B M (-0.71) (-0.69) (-0.25) (-1.23) (-0.85) (-1.05) ( ) 1 Observaons 16,040 16,040 16,040 13,806 13,806 13,806 Ch-square sa

43 Appendx Table 1: Componens of he Invesor Research Responsbly Sub-Indces and Gompers e a. (2003) ndex. The laer has 24 provsons. These nclude 22 frm-level provsons and sx sae laws (four of he laws are equvalen o four of he frmlevel provsons). To conserve space, Appendx Table 1 repors solely he sx sae laws ( does no repor he four frm-level provsons whch are analogous o he correspondng four laws: an-greenmal, far prce, supermajory approval for mergers, drecor dues). Provsons Delay Proecon Vong Oher Sae Laws Blank Check Preferred Sock Saggered Board Lms o Call Specal Meengs Compensaon Plan Lms o Amend Bylaws Penson Parachue Recapure of Profs Laws (Drecor) Lms o Amend Charer Slver Parachue Busness Indemnfcaon Combnaon Laws conracs Golden parachue Cumulave Vong Poson Pll Cash Ou Laws Lms for Wren Consen Severance Secre Ballo Far Prce Laws Drecor Indemnfcaon Unequal Vong Conrol Share Acquson Laws Drecor Lably Drecor Dues Laws Appendx Table 2: Alernave proxes for manageral enrenchmen. Regressons are as n Table 6 wh random ndusry and year effecs. The conrol varables are ncluded, bu no shown here. BL, Varable (1) (2) (3) (4) Sub-Index Proecon (-1) (3.32) (1.80) (1.96) (1.70) Sub-Index Index Delay (-1) (2.58) (1.37) (1.57) (1.71) Sub-Index Index Sae Laws (-1) (0.85) (0.66) (-1.42) (-1.35) Sub-Index Vong (-1) (0.02) (1.98) (0.22) (0.40) Bebchuk e al. Enrenchmen Index (-1) (3.22) (3.47) (0.79) (1.49) Appendx Table 3: Alernave proxes for enrenched managemen and he cos of deb ssuance. The resuls presened n Tables 8 and 9 for varous proxes for enrenchmen. The regressons nclude random year and 3-dg SIC code effecs. Underwrng Spread Offer Yeld Cred Rangs Spread Varable (1) (2) (3) Sub-Index Proecon (-1) (-2.18) (-3.18) (-4.03) Sub-Index Index Delay (-1) (-1.68) (-4.00) (0.01) Sub-Index Index Sae Laws (-1) (-1.59) (-1.74) (-3.43) Sub-Index Vong (-1) (-2.08) (0.39) (1.20) Bebchuk e al Enrenchmen Index (-1) (-3.25) (-3.13) (-1.39) ML, L 1,, L 2,, 42