Corporate governance dynamics and wealth effects: evidence from large loss acquisitions and large gain acquisitions in the USA

• DOI: https://doi.org/10.1108/CG-05-2018-0168
• Pages: 353-371
• Published date: 13 November 2018
• Date: 13 November 2018
• Author: Seung Hee Choi,Samuel H. Szewczyk,Maneesh Chhabria
• Subject Matter: Corporate governance,Strategy

Corporate governance dynamics and

wealth effects: evidence from large loss

acquisitions and large gain acquisitions in

the USA

Seung Hee Choi, Samuel H. Szewczyk and Maneesh Chhabria

Abstract

Purpose –When major reallocations of the firm’s assets are strategically necessary, the corporation’s

decisionsystem is perhaps put to its severest test. This paper aims to argue that a relevantbalance in the

corporate governance structure is highly important to assure those strategic decisions taken are

successfuland economically beneficial to shareholders’wealth.

Design/methodology/approach –This study examines US firms making major acquisitions resulting in

large losses or large gains and identify weaknesses and strengths in their respective governance structures.

Findings –Firms making large loss acquisitions demonstrate a balance in the corporate governance

structure that heavily favors the CEO. Firms making large gain acquisitions present a more efficient

balance in the configurationtheir corporate governance dynamics.Finally, the authors present evidence

that making a major acquisitiontriggers rebalancing of the corporate governancedynamics to increase

the effectivenessof monitoring the implementation of the acquisition.The authors find firms making large

loss acquisitionsmake more extensive changesin the professional expertise on their boards.

Originality/value –This study provides a broadunderstanding of the role of corporate governanceby

examining overallgovernance dynamics and offers how one corporate governancestructure does not fit

all firms, at all times, in all circumstances. Instead, timely imbalances within the configurations of

corporate governancedynamics over the major strategic acquisitionprocess can be consistent with the

goal of increasingshareholders’ wealth.

Keywords Board of directors, Compensation, CEO, Chief executives, Corporate governance,

Equity ownership

Paper type Research paper

1. Introduction

The corporate decision system consists of decision management and decision control. To

exercise decision management, managers are authorized to initiate and implement

proposals for strategic resource allocation. To practice decision control, boardsof directors

are granted the right to ratify and monitor these proposals. Fama and Jensen (1983)

emphasize the importance of separation and balance between decision management and

decision control to builda value increasing corporate decision system.

The goal of corporate governance is to ultimately hold managers responsible for their

decisions and obligate boards of directors to effectively monitor and incentivize managerial

decision-making to maximize shareholders’ wealth. However, Choi and Szewczyk (2018)

observe a distinct imbalance in the configuration of corporate governance elements

favoring the CEO in firms making major strategic decisions. In the context of strategic

Seung Hee Choi is based at

the Department of Finance,

School of Business, The

College of New Jersey,

Ewing, New Jersey, USA.

Samuel H. Szewczyk is

based at the Department of

Finance, Lebow College of

Business, Drexel

University, Philadelphia,

Pennsylvania, USA.

Maneesh Chhabria is the

Principal of Naeil LLC.,

Lancaster, Pennsylvania,

USA.

JEL classif‌ication –G30, G32,

G34

Received 4 May 2018

Revised 30 July 2018

Accepted 28 September 2018

DOI 10.1108/CG-05-2018-0168 VOL. 19 NO. 2 2019, pp. 353-371, ©Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 353

decision-making, this imbalanceis not necessarily inconsistent with shareholders’ interests.

For example, creating an environment that encourages necessary but risky strategic

decision-making can require shielding managers, in some degree, from the potential

negative outcomes of their strategic decisions. On the other hand, an imbalance can also

be skewed to make it easier for the CEO to gain acceptance of major strategic proposals

that are hubris driven or self-servingwith respect to the interests of the CEO.

We examine the proposition that while an imbalance in corporate governance dynamics

may be necessary to encourage CEOs to initiate needed strategic change, the strategic

decision will exhibit disparate impacts on shareholders’ wealth depending of the

configurations of the governance structures creating the imbalance. Firms can effect major

strategic change internally through product development and through restructurings such

as divestitures and spinoffs, but, most dramatically, externally, through major acquisitions.

Major strategic acquisitions are significant reallocations of the firm’s resources conducted

to improve the firm’s prospects. These strategic decisions will redefine the firm’s future in

the market either positively or negatively.

In this paper, we examine the balance in corporate governance elements and strategic

decision-making by considering firms that ratify and implementmajor strategic acquisitions.

To gain a better understanding of an imbalance favoring CEOs in firms making major

strategic decisions and its relationship to shareholders’ wealth, we identify “large loss”

major acquisitions and “large gain” major acquisitions and use these acquisitions to screen

the corporate governance elements that increase shareholders wealth through major

strategic acquisitions from the ones that destroy shareholders’ wealth. We examine the

dynamics of the corporate governance elements in the context of CEO characteristics,

internal monitoring, externalmonitoring and CEO compensation[1].

Our analyses show that, for firms making a large loss acquisition, the balance in the

corporate governance structure heavily favors the CEO. The likelihood of large loss

acquisitions increases whenCEOs are more entrenched and new CEOs are brought in from

outside, when boards are busier, and their committees are less independent, and when

compensation is more sensitive to sales expansion and when lower proportions of total

compensation consists of bonuses for performance. We find, for firms making large gain

acquisitions, while the balance may favor the CEO, the decision control function is more

efficient. The likelihood of makinglarge gain acquisitions is increased when boards are less

busy and committees more independent and when total compensation has lower

proportions of options.

When a firm finds it necessary to make major reallocations of its assets, a balance favoring

the CEO can be a necessary condition for planning and initiating major strategic moves.

However, once the major acquisition proceeds to the implementation stage, effective

monitoring of the implementation and subsequent performance of the acquisition becomes

important. We present evidence that major strategic acquisitions trigger a post-acquisition

rebalancing in the configuration of corporate governance elements in a direction consistent

with increasing the effectiveness of the board’s monitoring function. Having made major

strategic acquisitions, these firms increase the independence of their boards and raise the

level of expertise on the board over the subsequent three years. We find the firms making

large loss acquisitions show significantly larger changes in the level of expertise on their

boards.

By analyzing firms making major large loss acquisition and major large gain acquisitions to

identify the imbalance in corporate governance structure and its impact on shareholders’

wealth, this study makes several contributions to the literature. We propose a broader

understanding of the role of corporate governance by examining overall governance

dynamics, rather than binary relations between individual governance factors and the

corporate decision-making process. We show how one corporate governance structure

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