Authors: Dirk Jenter (Stanford University and National Bureau of Economic Research) and Katharina Lewellen (Dartmouth University)
Publisher: Rock Center for Corporate Governance at Stanford University, Working Paper No. 105
Date Published: December 2011
Thinking about making a run at a company? You might get a better deal if you wait until the target’s chief executive turns 65. That’s the conclusion of this paper, which finds that firms are more likely to receive takeover bids when the CEO reaches retirement age than when the CEO is younger — and they are more likely to accept those later bids at prices that are less than ideal to shareholders.
The CEO is at the heart of a firm’s decisions about mergers and acquisitions, and once a takeover bid is lodged, the authors note, the chief executive takes the lead in shaping the firm’s responses. The influence of a CEO’s age on those decisions, they found, has largely escaped scrutiny.
But because CEOs usually lose their jobs during or just after a takeover, and studies have shown that departing CEOs often don’t find a comparable job at a public firm, many departing CEOs are pushed into early retirement. Thus, a takeover can be costly for a CEO’s career, notwithstanding the fact that compensation contracts often contain golden parachutes and special bonuses for CEOs in case their firm is sold.
The authors hypothesized that career costs represent a potential conflict with shareholders’ interests, because CEOs may want to stave off a takeover even if the timing and price of the deal are quite favorable to the company. Conversely, these potential costs should become less important to CEOs as they conclude their careers, and that may then open the door to deals that are not optimal for shareholders.
To test the hypothesis, the authors analyzed whether CEO retirement age —typically 65 — affected the frequency, pricing, and outcomes of takeover bids.
Combining several U.S. databases and excluding interim CEOs, the authors collected data on 5,841 CEOs and nearly 1,000 takeover bids from 1992 through 2008. In a regression analysis, they found that the likelihood of a takeover bid increased sharply when the targeted CEO reached 65. After controlling for CEO and firm characteristics, the authors determined that the probability that a firm would be the target of a takeover bid was close to 4 percent per year for CEOs younger than the retirement age. However, the likelihood increased to 6 percent for the retirement-age group, or those 65 and older, representing a 50 percent increase in the odds of receiving a bid.
“The increase in takeover activity appears abruptly at the age-65 threshold, with no gradual increase as CEOs approach retirement age,” the authors write. “These results show that bidders are more likely to target firms with retirement-age CEOs, possibly due to these CEOs’ weaker expected resistance against takeover bids.”
The authors next examined the effect of decisions by retirement-age CEOs on how much their shareholders gained from selling off the company. The attitude of CEOs toward a takeover bid is shaped by several factors, the authors say: how much they stand to lose in terms of their career prospects, how much that loss might be offset by a golden parachute, and the overall impact on shareholder value — something that is always of interest to the board, which has the final say.
When CEOs reach retirement age and have less to lose in a takeover, they will settle for deals that result in smaller gains for shareholders, the authors found. Their evidence: Takeover premiums — the difference between the estimate of a target firm’s value before the deal and the actual purchase price — and stock increases related to the takeover announcement are significantly lower when CEOs are 65 or older.
After controlling for firm, CEO, and deal specifics, the researchers found that the takeover premium is 8 to 10 percentage points lower, on average, when the targeted firm is run by a retirement-age CEO. Similarly, the gain in a targeted firm’s stock price on the day after a takeover announcement is on average 10 percentage points lower for companies run by retirement-age CEOs.
One possible explanation, the authors say, is that outside investors might view takeovers of firms as more likely when they are helmed by retirement-age CEOs, an assessment that could drive up valuations ahead of the bid. But another reason, they argue, is that target CEOs who are ready to step away might not haggle as forcefully over a deal and as a result might capture fewer benefits for their firms.
Several implications emerge. The authors recommend that boards be sensitive to the influence that a CEO’s age may play on merger and takeover decisions. In particular, boards could adjust the terms of CEO compensation contracts, especially golden parachutes, to take into account career concerns that change with age.
If those concerns “cause younger CEOs to be too reluctant to sell their firms, then boards can mitigate this problem through explicit monetary incentives,” the authors write. But when CEOs reach retirement age and career concerns lessen, the parachutes may have to be trimmed in size and restricted in scope. Otherwise, they could themselves serve as incentives to spur the wrong kind of deal.
CEOs may be reluctant to see their firms sold in a merger or acquisition deal because of the impact on their career prospects and future earnings. But reaching retirement age mitigates this factor and reduces CEO resistance to takeover bids, with the result that shareholders often gain less from the deals.