Taking advantage of investor inattention
Companies pursue more M&A activity when shareholders are looking the other way, and the returns are poorer, research suggests.
Source: Kempf et al., 2016
The researchers analyze corporate takeovers because those involve executive decisions to make large discretionary investments. Their results suggest that the likelihood of a company announcing a merger is higher when shareholders are distracted, and that acquisitions that diversify a company’s business are nearly twice as likely to happen as compared with general deals.
A diversifying acquisition, expanding the products and services of the merged company, is considered to disproportionately benefit management “for reasons of empire building or job security through more stable cash flows,” according to the researchers. When investors are distracted, managers tend to tilt their budgets toward diversifying acquisitions, which turn out to be value destroying. Kempf, Manconi, and Spalt find that “bidders with distracted shareholders experience substantially negative abnormal returns over the 36 months following the deal.”
The underperformance of firms with distracted shareholders relative to firms with less-distracted shareholders isn’t confined to M&A announcements. The researchers sort all stocks in the Center for Research in Security Prices database into a low-distraction portfolio (below-median distraction measure in a given industry and month) and a high-distraction portfolio (above median). They find a significant underperformance in companies with distracted shareholders, but no abnormal performance for companies whose shareholders are less distracted. This relative underperformance amounts to 15 basis points per month, suggesting that managers engage in value-reducing actions, beyond M&A, on an economically significant scale when their investors aren’t paying attention.
The findings are consistent with the view that managers actively try to take advantage of investor inattention, to the harm of their shareholders. Unmonitored managers are more likely to cut dividends and design merger financing so that a shareholder vote isn’t required, and they are less likely to be fired during periods when the firm’s shareholders are distracted by outside events.
Understanding managers’ behavior in environments where shareholder attention is limited could “significantly improve our understanding of value creation in firms,” write the researchers. Perhaps the best advice to a distracted shareholder is to assume that management is misbehaving when no one is looking.
More from Chicago Booth Review
We want to demonstrate our commitment to your privacy. Please review Chicago Booth's privacy notice, which provides information explaining how and why we collect particular information when you visit our website.