Bridge over ocean
1 April 2016 CFA Institute Journal Review

CEO Preferences and Acquisitions (Digest Summary)

  1. Gregory G. Gocek, CFA

To evaluate the impact of executives’ personal attributes on corporate financial decisions, the authors analyze how the inclination of CEOs to retire at age 65 significantly and systematically affects the choice to sell a public firm. Related areas of agency conflict in mergers and acquisitions, such as adoption of takeover defenses, are also considered.

What’s Inside?

A comprehensive regression analysis of the past two decades of US public company mergers indicates that managerial self-interest—as reflected by the retirement preferences of target firm CEOs—has a significant impact on takeover decisions. Bids are more likely to be successful when CEOs are close to age 65. These deals occur without adverse shareholder impacts in terms of reduced takeover premiums or target announcement returns. Better corporate governance is associated with more acquisitions of firms led by younger CEOs and with a smaller increase in deals at retirement age. CEO compensation systems appear to adjust for the potential private costs of truncated CEO tenures.

How Is This Research Useful to Practitioners?

Takeovers can have significant effects on investment performance at both micro and macro levels; the former is related to the stock price premiums paid to acquired firms, and the latter is related to waves of accelerated merger activity inflating market indexes. Any additional insights on related dynamics thus seem to be information worth knowing for investors. The focus of this research—the connection between CEO retirement decisions and mergers—potentially encompasses both of these effects. On the micro scale, acceptance of a bid will customarily end in a higher stock price. For the macro, a demographic bulge across companies that indicates an upcoming generational leadership change results in background conditions that favor a greater frequency of transactions. And the advantage of a retirement factor as an investment screen is its unambiguous and predictable character; that is, age is easily determined from publicly available descriptive data on corporate leaders. So, in principle, the authors’ findings could be useful in building an investment case for relevant opportunities.

How Did the Authors Conduct This Research?

The authors analyze data from (1) a comprehensive Compustat Research Insight panel of US public firm (more than $10 million in book assets) CEO information for 1989–2007, (2) the SDC US M&A database focused on 4,145 completed takeover bids, and (3) CRSP monthly stock returns. For tests of corporate governance, matching firm details are drawn from proxy statements in the Disclosure database. Over the entire sample, CEOs are, on average, 54.1 years old with 6.2 years in office, and the analysis is conducted on four partitioned age group subsamples (≤53, 54–58, 59–63, and 64–66).

Logit regression models test the effect of retirement age on takeovers, with a statistically significant sharp rise in successful bids at a retirement age of 65. An intra-period 1997–99 merger wave is shown to increase the frequency of pre-retirement age CEOs accepting bids, which is interpreted as being consistent with the hypothesis of lower personal costs for those CEOs to approve offers. Stronger corporate governance that prioritizes shareholder over management interests is shown to reduce the reluctance of younger CEOs to accept bids. Regressions gauging the effect of retirement age on stock price reactions to bids and takeover premiums reveal no reduction for deals involving the oldest CEOs, no anticipatory price run-ups in light of nearing retirements, and no tendency to settle for lower offers as retirement approaches. Alternative explanations for the age 65 merger spike are also tested (disciplinary takeovers, succession issues, CEO illiquidity, buyout wealth effects) and rejected. Overall, the evidence consistently supports the stated findings.

Abstractor’s Viewpoint

The usefulness of the findings is contingent on the identification of a genuine, rather than spurious or confounded, effect. Mergers can be driven by many factors, and the impending retirement of an important, but not necessarily exclusively definitive, decision maker may be only one of many contributions. The authors’ assertion of a strong finding, therefore, needs the confirmation of well-executed research, with its design discussed next.

Given career cost as a CEO decision driver, it would be informative to see how the phenomenon of decreasing average length of tenure for CEOs could alter the identified retirement age timing effect. Nonetheless, CEO birthdate is another corporate data point worth tracking.

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