Bond‐blockholders and corporate acquisitions

• Published date: 01 May 2024
• Author: Chune Young Chung,Sunghoon Joo,Sanggyu Kang
• Date: 01 May 2024
• DOI: http://doi.org/10.1111/corg.12546

ORIGINAL ARTICLE

Bond-blockholders and corporate acquisitions

Chune Young Chung

1

| Sunghoon Joo

2

| Sanggyu Kang

3

1

School of Business Administration, College of

Business and Economics, Chung-Ang

University, Seoul, South Korea

2

Department of Accounting, Finance, and

Economics, California State University,

Dominguez Hills, Carson, California, USA

3

Division of Advanced IT, Baekseok University,

Cheonan, South Korea

Correspondence

Chune Young Chung, School of Business

Administration, College of Business and

Economics, Chung-Ang University,

84 Heukseok-ro, Dongjak-gu, Seoul 06974,

South Korea.

Email: bizfinance@cau.ac.kr

Abstract

Research Question/Issue: We examine whether bond-blockholders provide addi-

tional, distinct monitoring roles in merger and acquisition (M&A) processes beyond

those of equity-blockholders. Using a sample of 4309 M&A deals reported between

2001 and 2010, we shed new light on the monitoring spillover effects of bondholders

to shareholders in the context of M&As.

Research Findings/Insights: Our findings demonstrate a positive relationship

between the presence of bond-blockholders (or a change in their position) and

acquiring firms' abnormal return announcements, which supports the monitoring

spillover effects from bondholders to shareholders in M&A processes. Our subsample

analyses indicate that bond-blockholders are better monitors of (1) overconfident

CEOs engaging in M&As, (2) CEOs exhibiting risk-taking behavior in M&As, and

(3) entrenched managers participating in M&As. Moreover, we discover a positive

association between the previous quarter's changes in “monitoring”bond-block-

holders' positions and the acquiring firms' 3-day cumulative abnormal returns

(CARs).

Theoretical/Academic Implications: In corporate finance literature, equity-

blockholders have long been recognized as effective monitors. Despite the

importance of debt as most firms' primary funding source, the benefits of debt for

monitoring the efficiency of managers and their organizations have been largely over-

looked in the existing literature. Thus, this study provides evidence on the additional

and distinct monitoring roles of bond-blockholders beyond those of equity-

blockholders in M&A processes and the impact of bond-blockholders on share-

holders' wealth around M&A announcements.

Practitioner/Policy Implications: This study offers insights to policymakers inter-

ested in enhancing the legitimacy of corporate governance on the monitoring spill-

over effects of bondholders to shareholders in the context of M&As. In addition, our

findings suggest that bondholders can have a long-term perspective beyond the

limited time horizon of bond maturity and influence M&A processes positively. Thus,

this study has significant implications for managers and practitioners interested in

which investors positively affect M&As.

KEYWORDS

agency problem, bank loan contracting, corporate governance, institutional blockholders,

mergers and acquisitions

Received: 18 November 2022 Revised: 20 May 2023 Accepted: 22 May 2023

DOI: 10.1111/corg.12546

Corp Govern Int Rev. 2024;32:391–407. wileyonlinelibrary.com/journal/corg © 2023 John Wiley & Sons Ltd. 391

1|INTRODUCTION

Mergers and acquisitions (M&As) are vital corporate investments that

have far-reaching effects on a firms' ongoing and future operations.

The traditional rationale for firms to engage in M&As is to generate

synergistic gains that increase the value of the combined firm (Bradley

et al., 1988). Large shareholders (hereinafter referred to as “equity-

blockholders,”defined as institutional shareholders who own over 5%

of a firm's common stocks) play significant roles in major corporate

events as effective monitors who produce corporate gains

(Chang, 1998; Chen et al., 2007; Maug, 1998; Shleifer &

Vishny, 1986). While equity-blockholders may be incentivized to

increase monitoring and disciplining efforts on entrenched manage-

ment for the benefit of shareholders and bondholders, large equity

stakes may also enable equity-blockholders to exert control over

managers to act exclusively in the shareholders' best interests, to the

detriment of bondholders. In the agency framework of shareholder–

debtholder conflicts, debtholders with fixed claims are susceptible to

borrowers' opportunistic behaviors because shareholders, as residual

claimants, are incentivized to encourage managers to invest in risky

projects (Jensen, 1986; Jensen & Meckling, 1976). Hence, depending

on the relative intensity of the conflicts between shareholders and

managers, bondholders and managers, and shareholders and bond-

holders, a complex interplay may arise between various contracting

parties (i.e., shareholders, bondholders, and corporate managers)

(Amiri-Moghadam et al., 2021).

Prior research highlights the prevalence of equity-blockholders in

US firms (Dlugosz et al., 2006; Holderness, 2009) and their corporate

governance role as effective monitors in M&As; however, little is

known about the monitoring roles of bond-blockholders in M&A pro-

cesses and the resulting impact on shareholder wealth. This study

aims to fill this literature gap by shedding new light on the monitoring

spillover effects of bondholders to shareholders around M&A

announcements. Among other major corporate events, we focus on

M&As, because they reorganize ownership and control rights. There-

fore, conflicts of interest may be particularly acute in M&A processes,

thus providing a unique empirical setting for demonstrating the role of

bondholders clearly.

This study examines whether bond-blockholders (institutional

investors holding over 5% of a firm's outstanding bonds) provide

additional, distinct monitoring roles in M&A processes beyond those

of equity-blockholders. Specifically, using a sample of 4309 M&A

deals reported between 2001 and 2010, we analyze the monitoring

spillover effects from bond-blockholders to shareholders. We argue

that the presence of bond-blockholders impedes the ability of

equity-blockholders to exert power over corporate executives and

boards of directors for personal gain. Through effective monitoring,

bond-blockholders also enhance corporate governance by prevent-

ing managers from excessive risk-taking and value-destroying

M&As. Our findings reveal a positive relationship between the pres-

ence of bond-blockholders (or a change in their position) and the

acquiring firms' 3-day cumulative abnormal returns (CARs), which

supports the monitoring spillover effects from bondholders to

shareholders in M&A processes. Additionally, our subsample ana-

lyses indicate that bond-blockholders are stronger monitors of

(1) overconfident CEOs engaging in M&As, (2) CEOs exhibiting

risk-taking behavior while conducting M&As, and (3) entrenched

managers participating in M&As.

According to Chen et al. (2007), only large equity holdings by

independent long-term institutional investors are positively related to

post-merger performance. We posit that large bond holdings by

bond-blockholders are likewise positively correlated with the abnor-

mal returns of acquiring firms. First, the greater the bond holdings, the

more effective the threat of exit via a substantial bond sell-off, which

may lead to an increase in a firm's cost of debt (Hasan et al., 2013).

Thus, bond-blockholders with large bond holdings can likely conduct

effective monitoring. In this instance, bond-blockholders behave simi-

larly to passive institutional investors who adhere to the “Wall Street

Walk”rule. Second, because large bond holdings are typically rolled

over, bond-blockholders who are content with a firm's current man-

agement will reinvest their bonds at maturity and thereby hold them

for a longer period (Ye et al., 2021). Bond-blockholders are more likely

to monitor investee firms because they benefit from monitoring

efforts. Effective monitoring by bond-blockholders results in positive

abnormal returns for acquirers in M&A.

To better understand the monitoring effects of bond-

blockholders on M&A outcomes, we analyze whether bond-

blockholders focus monitoring efforts on the holdings with the

greatest weight in their portfolios. Similar to Fich et al. (2015), we

define “monitoring”bond-blockholders as those whose holding value

of a firm's bond is among the top 10% of their bond portfolio. We dis-

cover a positive relationship between the previous quarter's changes

in ownership of “monitoring”bond-blockholders and the acquiring

firms' 3-day CARs. We anticipate that the “monitoring”bond-

blockholders who invested in the most recent quarter may be

long-term bond-blockholders. Hasan et al. (2013) contend that bond-

holders are heterogeneous and have varying investment horizons.

Using the portfolio turnover ratio, they categorize bond-blockholders

into long and short term ones. While long-term bondholders typically

have a positive impact on the firms where they invest, short-term

bondholders may be transient and thus have negative impacts.

Further, we examine whether the value of cash-financed deals

increases when bond-blockholders increase their bond holdings in

acquiring firms. In the literature on M&As' payment methods, inves-

tors consider that a stock payment indicates an overvaluation of the

acquiring firm. The acquirer's managers tend to offer stock exchanges

for the deal when they believe their shares are overvalued. However,

the acquiring firm uses cash as a payment method when the target's

value is higher and the acquirer's share is undervalued. According to

the information asymmetry hypothesis, a cash payment conveys a

positive signal to the market, which causes shareholders to enjoy posi-

tive market reactions whereas those in stock-financed M&As face

adverse market reactions. We find that changes in bond-blockholdings

in the preceding quarter are positively related to a greater portion of

cash-financed deals, where acquirers are approximately 73% more

likely to make payments where more than half is in cash. This finding

392 CHUNG ET AL.