Internal corporate control and the dynamics of post-acquisition boards: Evidence of U.S. life insurers.
Xie, Xiaoying ; Cai, Wanke ; Lu, Weili 等
ABSTRACT
We study the role of target insurer boards and the post-acquisition
retention of target directors in U.S. life insurer mergers and
acquisitions. Our results indicate that board characteristics affect the
likelihood of acquisition. Smaller boards, boards with better
reputations and boards without CEO dominance are more likely to agree to
acquisition. Boards with a larger proportion of outside directors are
less likely to agree to acquisition, especially when firms perform well.
In terms of post-acquisition director retention, we find that outside
directors are more likely to lose their seats after acquisition,
especially when firms underperform. Directors holding more directorships
in other firms or having experience as top management are more likely to
be retained. Outside directors are less likely to be retained if they
are from a firm with CEO duality, and inside directors are more likely
to be replaced if the takeover is disciplinary.
JEL Classifications: G22, G30, G34
Keywords: mergers and acquisitions: board of directors; life
insurers
I. INTRODUCTION
A large number of mergers and acquisitions (M&As) have been
observed in the U.S. insurance industry in the past decade. In general,
these transactions are found to enhance the value and improve the
efficiency of target firms (Cummins et al., 1999; Cummins and Xie, 2008,
2009; Boubakri et al., 2008). Meanwhile, the literature on corporate
governance shows that directors of target firms face board seat loss and
a negative financial impact after M&As (Kini et al., 1995; Becher
and Campbell, 2005; Harford, 2003). This raises questions about the role
and fate of target firm boards in the M&A process. What types of
boards are more likely to agree to value enhancing takeovers? Are
certain types of directors more likely to be retained in
post-acquisition firms than others? Despite the rich literature on
takeover and corporate governance, few studies tackle the retention of
post-acquisition boards, and none focus on the insurance industry in
particular.
Unlike non-financial firms that are solely monitored by
non-regulatory groups, insurance companies are monitored by both
regulators and non-regulatory groups. (1) It then becomes interesting to
examine whether the non-regulatory groups monitor insurance companies in
the same way as they do non-financial firms. In particular, we study the
role of target boards in acquisition decision making and the
post-acquisition dynamics of these boards in the U.S. life insurance
industry. We first investigate whether the corporate governance of a
company affects its likelihood of being acquired. We then examine the
characteristics of target company directors and whether these
characteristics will determine their retention after a takeover.
This study contributes to the M&A and corporate governance
literature in several important ways. First, the study improves the
understanding of the role played by the board of a target company during
the M&A process in the insurance industry Despite the importance of
a board's role in an M&A, surprisingly little research has been
conducted to examine that role in the insurance industry, with the
exception of Boubakri et al. (2008), which examines the influence of
corporate governance on the long run performance of bidders in the
property and liability insurance industry. Our study investigates the
influence of the target company board on the likelihood of successful
acquisition. Since hostile takeovers in the insurance industry are rare
and difficult to carry out due to regulatory hurdles, (2) the role of
corporate governance in the target company may be different from that of
other industries (Shivdasani, 1993), further contributing to the
significance of this study. Additionally, using homogenous insurance
companies as our sample allows us to investigate the role of corporate
governance without cross-industry contaminations, avoiding possible
spurious correlations caused by unobservable differences across
industries.
Second, our study enriches the understanding of the determinants of
post-acquisition director retention. Most previous research discusses
the impact of corporate governance on acquisition performance and the
influence of M&A on CEOs, with very little research investigating
the factors affecting the retention of directors. For example, Allen and
Cebenoyan (1991) and Subrahmanyam et al. (1997) examine the effect of
management incentive and corporate governance variables on bidder
returns in bank acquisitions. Lehn and Zhao (2006) investigate the
effect of corporate governance on the relationship between the
likelihood of CEO turnover and bidder returns after M&A. Cotter et
al. (1997) examine the impact of the target firm's independent
outside directors on takeover premiums during takeover attempts by
tender offers. Only a few papers examine post-merger individual board
members. Among them, Harford (2003) investigates the influence of
M&A on the board of directors in relationship to its financial
effect and the loss of board seats for a sample of targets that were in
the Fortune 1000, and McLaughlin and Ghosh (2008) examine the factor of
expertise in director retention for a sample of large mergers. Our paper
is the first that studies the post-acquisition retention of directors in
the insurance industry.
Third, this study examines both public and private targets, while
the existing literature on corporate governance and M&A focuses
mainly on public targets. In the U.S. life insurance industry, a
significant number of M&A transactions involve private targets.
Therefore covering both public and private targets in the sample
provides a more complete picture of the M&A process in this
industry.
Our results provide evidence that board characteristics affect the
likelihood of acquisition in the life insurance industry. Boards of
smaller size, better reputation, and separation of CEO and chairman
roles are more likely to accept acquisition offers. Boards with a higher
proportion of outside directors are less likely to accept a takeover
offer, and this is especially true for good performance firms. In terms
of post-acquisition director retention, we find that outside directors
are more likely to lose their seats after the acquisition, especially in
poor performance firms. Holding more directorships in other firms or
having experience as a CEO will increase the chance of retention. In
addition, directors are more likely to lose their seats after
acquisition if a target firm has a powerful CEO (e.g., the CEO is also
the chairman) or if the takeover is disciplinary.
The remainder of the paper proceeds as follows: in Section II we
briefly review the relevant literature and develop hypotheses; in
Section III we discuss the sample and the data; in Section IV we present
corporate governance and the likelihood of acquisition; in Section V we
examine the determinants of post-acquisition director retention; and in
Section VI we conclude.
II. LITERATURE REVIEW AND HYPOTHESES
A. Literature on M&A in the Insurance Industry
While many studies in recent years (e.g., Chamberlain and Tennyson,
1998; Cummins et al., 1999; Akhigbe and Madura, 2001; Cummins and Xie,
2008, 2009; Cummins, Klumpes, and Weiss, 2015) have examined various
aspects of the M&A process in the insurance industry, few of these
have investigated corporate governance issues in M&A events, with
the exception of Chamberlain and Tennyson (1998) and Boubakri et al.
(2008).
Chamberlain and Tennyson (1998) study M&A transactions in the
U.S. property-liability insurance industry during 1980-1990, and find
that financial synergies were important motivations for M&As in that
period. They also investigate the replacement of top management (CEO or
president) in target firms and conclude that replacing management at
target firms is not a major objective of acquisition. Using a sample of
177 M&A transactions from 1995 to 2001, Boubakri et al. (2008)
provide evidence for the impact of corporate governance on value
creation in the U.S. property-liability insurance industry, and find
that CEO ownership is negatively related to the long run performance of
bidders, but board independence positively affects bidders' long
term performance.
Concerning M&As in the U.S. life insurance industry, Cummins et
al. (1999) examine the relationship between M&As and the efficiency
of targets, and find that acquisitions in this industry are mainly
driven by economic considerations and lead to improvements in efficiency
and productivity. However, they do not address the role of corporate
governance in acquisition decisions or post-acquisition dynamics of the
board.
In the global insurance industry, Cummins, Klumpes, and Weiss
(2015) examined the value created by M&As between 1990-2006 and
found that M&As increased the value of target firms significantly
M&As also increased the value of acquirer firms slightly, but only
if they were acquiring other insurance firms. Again, they do not assess
the impact of corporate governance or board dynamics on M&A events.
Our paper fills the gap in M&A research in the insurance
industry by highlighting the role of target insurer boards and the
post-acquisition retention of target directors. We develop hypotheses
regarding these two questions from the literature on corporate
governance and M&A.
B. Corporate Governance and M&A
Numerous studies have examined the effectiveness of the board
around M&A decisions made by both targets and acquirers, and the
results are mixed. The literature can be classified into three
categories: (1) corporate governance and post-acquisition performance
(e.g., Lehn and Zhao, 2006; Brown and Maloney, 2008; Cotter et al.,
1997; Franks and Mayer, 1996; Allen and Cebenoyan, 1991; Subrahmanyam et
al., 1997; and Cornett et al., 2003); (2) corporate governance and the
likelihood of acquisition (e.g., Hadlock et al., 1999; Mikkelson and
Partch, 1989; Song and Walkling, 1993; Shivdasani, 1993; Khorana et al.,
2007); (3) and (3) the dynamics of post-merger management and the board
(e.g., McLaughlin and Ghosh, 2008; Becher and Campbell, 2005; Davidson
et al., 2004; Harford, 2003; Franks and Mayer, 1996). Since this paper
focuses on the effect of corporate governance on the likelihood of firm
acquisition and the post-acquisition retention of the board, we rely on
the literature in the latter two categories to develop our hypotheses.
1. Corporate governance and the likelihood of acquisition
Jensen (1988) and Shleifer and Vishny (1988) set the foundation on
the relationship of takeover and corporate governance with the argument
that takeover is an efficient means to replace inefficient managers of
target companies (the corporate control hypothesis). Kini et al. (1995)
and Harford (2003) find that the effect of a completed takeover on
target executives and directors is generally negative (the penalty
hypothesis). This is consistent with the argument that outside takeover
breaks the internal corporate control mechanism and devaluates the human
capital of directors and executives. It is therefore important to
investigate empirically whether the internal control mechanism affects
takeover probability. We look at the common structures of a board: board
size, proportion of outside directors, reputation (the average number of
directorships held by its directors), and CEO duality (CEO is also
chairman of the board).
a. Board size
Lipton and Lorsch (1992) and Jensen (1993) argue that larger boards
can be less effective than smaller boards because of coordination costs
and director free-riding issues. Supporting this view, Eisenberg et al.
(1998) provide evidence that larger boards are associated with lower
firm value, and Yermack (1996) find that smaller boards are more likely
to initiate CEO turnover following poor performance. If board size is
related to effectiveness, we expect that firms with smaller boards are
more likely to make value-maximizing decisions: i.e., smaller boards
will be more likely to seek or approve a takeover deal rather than
resist it if they perceive that the deal will enhance firm value,
especially when the target firm performs poorly.
b. Board independence
The effectiveness of corporate governance is correlated with the
independence of a board. The literature shows that more independent
boards are more likely to serve shareholder interests and provide more
effective monitoring (e.g., Baysinger and Butler, 1985; Weisbach, 1988;
Cotter et al., 1997). (4) It is also argued that takeover markets and
(effective) outside directors can serve as substitute control mechanisms
(Shivdasani, 1993, Mayers et al., 1997; Fama and Jensen, 1983). In
addition, Harford (2003) suggests that target directors, and outside
directors in particular, are unlikely to be retained on the new board
following a successful merger; they also tend to hold fewer
directorships in other firms following a completed merger. The penalty
of losing board seats cannot be offset by financial gains from the
takeover transaction. In this case, it is no longer clear whether
outside directors would align themselves with target shareholders during
a takeover offer. As a result, we expect that firms with a higher
proportion of outside directors, particularly firms with good
performance, will be more resistant to takeover offers out of concern
for directorship loss and potential financial loss.
Alternatively, Harford (2003) shows that if a poorly performing
firm blocks a takeover offer, the outside directors may face the loss of
other directorships in the future, while directors of poorly performing
firms who support takeover transactions do not suffer loss of
directorships in other firms. Therefore, the probability of takeover
could be positively related to the proportion of outside directors for
poorly performing firms (for which the takeover market is the
"court of last resort" to replace ineffective management
(Jensen, 1986)), due to outside directors' concern for their
reputations.
c. Dual role of CEO and chairman (CEO duality)
Some financial economists challenge the ability of outsiders to
make independent judgments on management decisions, arguing that outside
directors are mainly appointed by the CEO or President, and board
independence is related to the CEO's bargaining power over the
board-selection process (e.g., Vancil, 1987; Hermalin and Weisbach,
1998). Fama and Jensen (1983) argue that combining the role of decision
management and decision control in one individual reduces a board's
effectiveness in monitoring top management. Jensen (1993) and Goyal and
Park (2002) provide similar arguments and empirical evidence that it is
more difficult for a board to perform critical functions without the
direction of an independent leader; for example, combining the CEO and
chairman roles makes it difficult for the board to remove poorly
performing CEOs.
If the dual role of CEO and chairman leads to higher agency costs
in making value-maximizing decisions for shareholders, we expect that a
company with CEO duality is more resistant to takeover offers. The
effect will be particularly significant for poorly performing firms
where the CEO is more likely to be replaced after the acquisition
(Martin and McConnell, 1991; Krug and Hegarty, 1997).
d. Board reputation
A board composed of directors with more directorships in other
companies is considered more effective because holding more
directorships indicates higher ability and accomplishment (Ferris and
Jagannathan, 2001; Ferris et al., 2003). The potential disadvantage of
holding more directorships is that the director may be less attentive to
any one company's affairs; however this is not supported in the
literature (Ferris and Jagannathan, 2001).
In the context of mergers and acquisitions, the reputation cost of
directors resulting from an improper decision regarding a takeover
strategy may force them to better align their interests with the
shareholders (Harford, 2003). As a result, we predict that a company
with more reputable directors is more likely to be acquired, ceteris
paribus.
In summary, based on previous research, we hypothesize that boards
of smaller size, with better reputations, a higher proportion of
outsiders and no CEO dominance are more likely to accept acquisition
offers after controlling for firm performance and other financial
characteristics.
2. Post-acquisition retention of target board members
Several empirical studies have investigated determinants of target
director retention after acquisition, such as Kini et al. (1995),
Harford (2003), Davidson et al. (2004), Becher and Campbell (2005), and
McLaughlin and Ghosh (2008). Factors examined by these studies include
M&A transaction characteristics, director characteristics, and
target and acquirer firm characteristics.
a. Inside directors vs. outside directors
When a board of directors does not effectively perform the
monitoring role, the internal corporate control mechanism may fail,
leading to poor firm performance and making the firm a potential target
of takeover (Jensen, 1986). As a penalty, directors will lose their
directorships on the target board after acquisition. Consistent with the
penalty hypothesis, Harford (2003) finds that target directors, and
outside directors in particular, are less likely to be retained on the
new board following a successful merger. The paper argues that the
higher retention of insiders than outsiders may represent either
continuation of target management or firm-specific knowledge possessed
by the insiders that is valuable to the new board. The paper also shows
that the retention of outside directors is not affected by
pre-acquisition performance, but inside directors are more likely to be
retained following good performance.
b. Top management experience of directors
The literature shows that the market responds more positively to
the appointment of outside directors with CEO experience than to those
without CEO experience (Fich, 2005). In the context of takeover, Harford
(2003) and McLaughlin and Ghosh (2008) find that inside directors
working as CEOs are more likely to be retained in a surviving board.
This evidence suggests that experience as top management is granted high
human resource value. In particular, inside directors with top
management experience are more knowledgeable about the firms. As a
result, we expect that directors with CEO experience (past or current)
are more likely to be retained after takeover, ceteris paribus.
c. Disciplinary takeover
When the acquirer intends to replace inefficient management teams
of targets (a disciplinary takeover), the target board is assumed to
have failed to effectively monitor and control the management.
Therefore, the target board is very likely to be disciplined as well.
Kini et al. (1995) provide evidence for this argument and find that the
replacement of directors is more pronounced in disciplinary takeovers,
i.e., those with CEO turnover.
d. Director's reputation
Previous studies show that directors who have multiple board seats
often serve on the boards of large corporations that perform well
relative to their peers who serve on a single board (Li and Ang, 2000;
Ferris and Jagannathan, 2001; Ferris et al., 2003; Harris and Shimizu,
2004). McLaughlin and Ghosh (2008) find that inside directors with more
than two additional directorships are more likely to be retained after
takeover. Based on these findings, we expect that target directors with
multiple board seats are more likely to be retained in a
post-acquisition board.
e. Other characteristics
Other characteristics, such as those of the target and acquiring
firms, as well as the M&A transactions, are also suggested to be
related to the retention of directors. For example, Davidson et al.
(2004) examine stock-for-stock mergers and find that the retention of
target directors in the combined firm is positively related to the
relative size of the firms and to the proportion of inside directors of
the target firm, and they provide weak evidence that directors from
targets with good pre-merger performance are more likely to be retained.
Becher and Campbell (2005) examine how CEO and non-CEO directors
increase their own benefit in banking merger negotiations, and also find
that the retention of non-CEO target directors is positively related to
the relative size of the targets and acquirers, and is not related to
pre-merger firm performance.
McLaughlin and Ghosh (2008) examine post-merger board construction
by including more variables that are potentially related to the
retention of directors from both targets and bidders. In addition to
director characteristics, they find that a cash acquisition will reduce
the likelihood of inside director retention. The likelihood of retention
of outside directors is found to be lower if a merger deal is financed
by stock, if the target has a relatively smaller size or if the outside
directors have less CEO experience. The paper also finds that the tenure
of directors, CEO duality, board independence and pre-merger performance
have no impact on both outsider and insider retention.
In this paper, we include in the retention analysis the payment
method (cash vs. other), target size, target pre-acquisition operating
performance (industry-adjusted), target board independence and CEO
duality. Since the effects of these variables are mixed in the
literature, we make no clear cut prediction about them.
III. DATA AND SAMPLE
This paper focuses on the U.S. life insurance industry. The M&A
data used in this study are from SNL DataSource compiled by SNL
Financial. We study merger and acquisition transactions between 1998 and
2006. The demographic and financial information about firms is obtained
from the National Association of Insurance Commissioners
(NAIC)--Life-Health insurance database. Data from 1996-2006 are used.
The corporate governance information is collected from NAIC and
Best's Insurance Reports, and data from 1997-2008 are utilized.
We conduct analysis at the individual insurance company level. If a
target is a group or holding company under common ownership, we break it
down into individual companies. We consider a company as a target if it
was successfully acquired and if the acquisition resulted in changes in
ownership control. We also create a control sample of
"non-target". A company is defined as a non-target if it does
not have the same NAIC group code as a target or an acquirer during the
period t-2 to t+2, that is, it was not involved in any takeover
activities during t-2 to t+2, where t represents the year of
acquisition. We eliminated firms with unusual characteristics such as
zero or negative net worth or assets.
According to these criteria, 316 targets and 6,837 non-targets are
identified in the final sample during 1998-2006 (see Table 1). The
majority of target firms are affiliated firms (insurers with group
affiliation). We perform analysis of post-acquisition retention on 2,218
directors identified from the boards of these 316 target firms.
IV. CORPORATE GOVERNANCE AND THE LIKELIHOOD OF ACQUISITION
To examine whether internal corporate control affects the
likelihood of acquisition, we regress a target dummy (target=l if a firm
is successfully acquired, and 0 otherwise) on corporate governance
variables, pre-acquisition performance (return on assets), and other
control variables (such as firm size, business mix, diversification,
group affiliation, and organizational form) that have been expected to
affect the likelihood of being targets in the literature (Cummins et
al., 1999). The summary statistics on these variables are presented in
Table 2, and the probit analysis is presented in Table 3.
Table 2 above shows that the average board size (number of
directors on a board) of target firms is 7.022, while the average board
size of non-targets is 7.257. Target firms on average have a smaller
proportion of outside directors (0.461 vs. 0.489). (5) We use the
average number of directorships held by the board members in other
insurance companies as a proxy to measure target board ability or
reputation. The directors of target boards on average hold 2.222 seats
in other insurance companies, while the directors of the non-target
boards on average have 1.064 seats, suggesting that target boards on
average have a better reputation. Table 2 also shows that in life
insurance companies it is common for a CEO to also hold the position of
chairman of board (duality). About 67 percent of target firms and 74
percent of non-targets combine the position of CEO and chairman. The
difference between the two groups is significant. (6)
Summary statistics on other variables are largely consistent with
the findings in the literature for non-financial firms. Target firms are
bigger than non-targets based on total assets. They are also financially
vulnerable, with a lower surplus to asset ratio than non-targets (0.328
vs. 0.420). Target insurers on average underperform significantly
compared to non-target insurers (with ROA 0.006 vs. 0.023). Targets tend
to underwrite more business in individual annuities and group annuities
and are more geographically diversified than non-targets. The premium
growth rate of targets averages 0.043, much lower than that of the
non-targets (0.125). Only a small percentage of target firms are
unaffiliated single firms (firms without group affiliation) (16.1
percent), but the percentage is higher for non-target firms (38.3
percent). Targets and non-targets alike are mostly composed of stock
companies, but the percentage of stock firms is slightly higher for
targets (95.3 percent vs. 90.3percent).
Table 3 presents the probit regression analysis of the likelihood
of being a target. To control for the structural difference of board
behavior in good performance and poor performance firms, separate
regressions are conducted for firms that perform better than the
industry median and for those that perform worse than the industry
median, as measured by return on assets. (7) A likelihood ratio test is
conducted and rejects the equality of coefficients of the two
regressions, suggesting that factors affecting the likelihood of being a
target differ between good performance and poor performance firms.
We find that in general firms with smaller boards are more likely
to be involved in takeover activities regardless of firm performance,
suggesting that smaller boards are more likely to agree to acquisition
decisions. This is somewhat consistent with Lipton and Lorsch (1992) and
Jensen (1993), who find that a smaller board is more effective in
maximizing firm value. Table 3 also shows that boards with more
reputable directors are more likely to accept takeover offers, which
holds for both good performance and poor performance samples.
Consistent with the penalty hypothesis (Harford, 2003; Jensen,
1986), our results show that boards with a higher proportion of
outsiders are less likely to be acquired; the result is significant for
good performance firms only. A possible explanation is that directors of
good performance companies are more likely to avoid the uncertainties
inherent in M&As.
Consistent with the predictions, we find an inverse and significant
relationship between the CEO duality and the likelihood of an
acquisition, regardless of firm performance. This indicates that the
dual CEO-chairman role tends to reduce the independence of the board,
which may make the board less effective when making M&A decisions.
This also complements the findings of Shivdasani (1993), that the
presence of a powerful CEO on the board lowers the probability of a
hostile bid. (8)
Results for non-governance variables are mostly consistent with the
existing literature in non-financial firms. Overall, firms with lower
return on assets are more likely to be acquired. For firms that
underperform in comparison to the industry median, those with relatively
lower premium growth rate and stock organizational form are more likely
to be acquired, however the likelihood of acquisition is lower for
unaffiliated single firms. For firms that perform better than the
industry median, the likelihood of acquisition decreases with their
return on assets. Consistent with Cummins et al. (1999), firms that are
more geographically diversified are more attractive to acquirers, and
this effect holds for both good performance and poor performance firms.
In addition, life insurers with a higher percentage of business in
annuity products are more likely to be acquired.
V. POST-ACQUISITION RETENTION OF TARGET DIRECTORS
Table 4 provides descriptive statistics of characteristics for both
retained directors and non-retained directors. A director is considered
"retained" if the director continues to serve on the surviving
board of a target (if the target maintains its independence after being
acquired) or starts to serve on the acquirer's board (if the target
loses its independence after being acquired) in the year when the
acquisition is complete.
Out of 2,218 directors of target firms, 1,118 directors are
retained and 1,100 directors leave the board after their firms are
acquired. About 46.2 percent of retained directors are outside
directors, while 53.8 percent of retained directors are insiders,
suggesting that outside directors are more likely to lose their seats
after takeover. On average, retained directors hold 2.577 board seats in
other insurance companies before acquisition, which is significantly
higher than non-retained directors (average 1.872 seats). About 41.1
percent of retained directors have experience working as a CEO in the
life insurance industry, while the number for non-retained directors is
only 28.4 percent. This disparity is significant and indicates that
directors working as CEOs (past or current) are more likely to be
retained after acquisition because of their experience as decision
makers.
Table 4 also summarizes target characteristics and transaction
characteristics. On average, the majority of non-retained directors come
from smaller firms, firms with a higher proportion of outside directors,
firms whose CEO also holds the position of chairman, firms with
disciplinary CEO turnover (CEO is replaced within two years after
acquisition) and firms that receive cash financing.
We run several probit regressions to examine the determinants of
director retention after acquisition. To address the concern that
observations from the same target firm are not independent, we run the
probit regression specifying that the standard errors allow for
intragroup correlation. The dependent variable is a dummy variable
indicating retention (=1) or departure (=0) from a post-acquisition
board. The independent variables include characteristics of individual
directors such as director reputation, status as insider or outsider,
CEO experience in the target or other insurance firms; target firm
characteristics, such as pre-acquisition performance, size of targets,
CEO duality, the proportion of outside directors of a board, and whether
the CEO of the target experiences disciplinary turnover after
acquisition; and transaction characteristics such as the payment method
(cash vs. stock and other payments). Organizational form and group
affiliation are also included in the regression. (9)
Differences in determinants of retention between outside and inside
directors are discovered by running regressions based on two sub-samples
that consist of insiders or outsiders only. In addition, to control for
structural differences between firms with good performance and poor
performance, we conduct separate regressions for firms that perform
better than, and worse than, the industry median. The results are
reported in Table 5.
The overall sample shows that outside directors are less likely to
be retained after acquisition. Directors with better reputations and
experience as top management are more likely to be retained, but
directors from targets that experience disciplinary CEO turnover after
acquisition are less likely to be retained. In general, these findings
are consistent with the predictions from our hypothesis section.
Furthermore, we find that directors from firms that combine the position
of CEO and chairman or have a larger proportion of outside directors are
less likely to be retained. This suggests that the takeover market
penalizes boards with extremely powerful figures and less effective
directors, or boards with more independent directors whose value is
depreciated in the post-acquisition firm. Target firm size is not a
significant determinant of director's retention. (10)
When comparing the regressions for insiders and outsiders, we find
that holding more directorships in other insurers, which is a measure of
director's reputation, matters more for insiders than for
outsiders. This suggests that acquirers value both the reputation and
inside knowledge of the directors of target firms when deciding
retention. Top management experience is also an important factor in
retention for both insiders and outsiders. CEO duality has a negative
impact on the retention of outsiders, but no effect on the retention of
insiders, suggesting a heavier "penalty" for outside directors
who are less capable of performing effective independent monitoring
duties. Inside directors are less likely to be retained if the takeover
is disciplinary; however the retention of outside directors is not
affected by this factor. Consistent with Becher and Campbell (2005) and
McLaughlin and Ghosh (2008), pre-acquisition performance (industry
adjusted) has no significant impact on the retention of either inside or
outside directors. Cash financing of acquisitions deals is negatively
related to target firms' director retention, but not statistically
significant after adjusting intragroup correlation in the regression.
We also compare the determinants of retention for directors from
good performance firms and poor performance firms, benchmarked by the
return on assets of the industry median firm. We find that outside
directors are less likely to be retained if they are from poor
performance firms, while the result is not significant for good
performance firms. This suggests that if the outside directors fail to
work as effective monitors, resulting in poor performance, they are more
likely to be dismissed than the insiders. Director reputation helps a
director to be retained in a good performance firm, but not if the firm
perform poorly. For both types of firms, top management experience are
important for retention, which is in line with the findings of
McLaughlin and Ghosh (2008) and Harford (2003), suggesting that
acquirers prefer directors with better reputations and CEO experience,
i.e. those with more valuable human and social capital. Directors of
poor performance firms with CEO duality are more likely to lose their
directorships, indicating that these directors are more dispensable
because of their limited and poor contribution to management monitoring.
For poor performance firms, directors are less likely to be retained if
the takeover is disciplinary.
VI. CONCLUSION
The board of directors is considered to have a monitoring role,
overseeing the decisions of management in order to protect the interests
of the firm and the shareholders. In this paper, we study the U.S. life
insurer mergers and acquisitions between 1998 and 2006 to understand the
role of target insurer boards in acquisition decisions and the
post-acquisition retention of target directors.
We find evidence that board composition does affect the likelihood
of acquisition in the life insurance industry, and boards from firms
with good and poor performance behave differently. A smaller board is
more likely to accept takeover, and boards with a larger fraction of
outside directors are more resistant to takeover, especially when their
firms perform well. Firms with more reputable boards are more likely,
while firms with CEO/chairman duality are less likely, to be acquired,
regardless of performance. The results suggest that boards of insurance
firms react rationally regarding acquisition decisions.
We also investigate target director retention after acquisition.
Outside directors are less likely to be retained than insiders in
general, especially if firms underperform in comparison to the industry
median, because they are considered ineffective monitors and therefore
dispensable. For outside directors, those with CEO experience are more
likely to be retained, suggesting acquirers value effective decision
makers; while those from firms with CEO dominance are more likely to be
removed. For inside directors, experience as CEO or holding
directorships in other insurance companies more often results in
retention after acquisition. Serving firms with post-acquisition
disciplinary CEO turnover tends to reduce the likelihood of retention
for insiders.
For directors from targets that perform better than the industry
median, better reputation and experience as top management increases
chances of retention, but the likelihood of retention is negatively
related to the proportion of outsiders on a board. We find no evidence
that outsiders are more likely to leave in good performance firms.
Directors from poor performance targets are less likely to be
retained if they are outsiders, if CEO duality exists, or if the
takeover is disciplinary. This suggests that directors are punished if
they are ineffective monitors and are held responsible for a firm's
poor performance. Having top management experience increases the chances
of retention.
In conclusion, our paper finds that the takeover market is an
effective way to enhance corporate governance of firms even in the
heavily regulated U.S. life insurance industry. Directors with good
reputations, strong executive experience, and rich inside knowledge of
the target firm are more likely to be retained post acquisition, whereas
directors without these qualities are less likely to be retained.
ENDNOTES
(1.) Mutual companies also exhibit a different organizational
structure than stock firms, which further differentiates the insurance
industry and its governance (Boubakri, 2011).
(2.) For example, the NAIC model law on Insurance Holding
Companies, which has been adopted by the majority of U.S. states,
stipulates that when mergers or acquisitions are being considered,
acquirers are required to file documents for approval that include all
details of the transaction (called Form A filings). For a transaction to
be valid, approvals must be obtained in multiple states where the
involved parties have operations.
(3.) A significant number of papers focus on the relationship of
management ownership and the likelihood of acquisition; however, we are
not able to obtain data on management ownership for this study, so we do
not look at ownership in the paper.
(4.) In contrast, Masulis, Wang, and Xie (2012) found that
independent directors based in foreign countries may provide less
oversight since they are more likely to miss board meetings. They found
that firms with foreign independent directors are associated with higher
CEO compensation, higher chance of financial fraud, and slower
replacement of poorly performing CEO's.
(5.) The proportion of outside board members is calculated as the
number of outside directors divided by board size. Similar to He and
Sommer (2011), we define an outside director as a director who is not
one of the current or former officers or their family members. Since a
large percentage of firms in our sample are private companies, we are
unable to obtain more detailed information about the directors, such as
whether they are the friends of officers, consultants, or business
partners of the firms.
(6.) The literature often includes a director's tenure in the
analysis; however, we are only able to identify the tenure for a small
subset of directors in our sample. The result shows that directors of
target firms on average have a shorter tenure than the directors of
non-target firms.
(7.) The sample size of regression is smaller than the number
reported in table 1 because of missing observations of some explanatory
variables. If an insurer's ROA is exactly on the industry median,
the firm is excluded from the subsample regression.
(8.) In a subsample of firms with director tenure available, we run
the probit regression with the average director tenure, and find that
the variable is negatively related to the takeover likelihood, which is
significant in the regressions of entire sample and poor performance
firm sample. This result is consistent with the argument that directors
with longer tenure may have more firm-specific human capital, which
makes them more likely to spurn an acquisition offer (Hadlock et al.,
1999).
(9.) We also run probit analyses on a subsample where we can
identify a director's tenure. The result shows that outside
directors with a longer tenure are less likely to be retained. The
result is not significant for inside directors.
(10.) The literature also uses the relative size of target to
acquirer as one explanatory variable. However, because our analysis is
at the individual firm level with private targets included, we are not
able to calculate accurately the relative size. Nonetheless, we
conducted a robustness test using two alternative definition of relative
size: (1) target size at (t-l)/size of lead firm of acquirer at (t-1);
(2) target size at (t-l)/acquirer size at (t-1) if target is an
unaffiliated single firm or a sold subsidiary of a seller; target group
size at (t-l)/acquirer size at (t-1) if the whole target group is
acquired. The result of this variable is not significant and is
therefore dropped from the regression.
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Xiaoying Xie (a), Wanke Cai (b), Weili Lu (c) Laura Yue Liu (d),
Aaron Takumi (e)
(a) Professor of Finance, Mihaylo College of Business and Economics
California State University, Fullerton, CA 92831
xxie@fullerton. edu
(b) Senior researcher, Fixed Income Investment Department Pacific
Asset Management Co., Ltd.
caiwanke@cpic. com.cn
(c) Professor of Finance, Mihaylo College of Business and Economics
California State University, Fullerton, CA 92831
wlu@fullerton. edu
(d) Assistant Professor of Finance, Mihaylo College of Business and
Economics California State University, Fullerton, CA 92831
yueliu@fullerton. edu
(e) Senior Financial Analyst, Herbalife, Ltd. 990 West 190th
Street, Torrance, CA
aaront@herbalife. com
Table 1
Number of target and non-target firms, 1998-2006
Year Target Non-target
Affiliated Unaffiliated Affiliated Unaffiliated
companies companies companies companies
1998 44 11 563 409
1999 60 11 504 391
2000 45 6 484 337
2001 28 3 497 314
2002 11 6 472 304
2003 15 5 405 257
2004 24 0 457 271
2005 35 7 400 157
2006 3 2 438 177
Total 265 51 4220 2617
Note: "Affiliated companies" refer to insurance companies with group
affiliation; "Unaffiliated companies" refer to insurance companies that
have no group affiliation.
Table 2
Summary statistics on targets and non-targets
Target
Variables Mean Std. dev
Observations 316
Size and Financial Ratios
Size: Ln(assets) 18.794 2.493
Surplus / assets 0.328 0.301
Operating Performance
Return on assets 0.006 0.077
Business Mix and Diversification
Proportion of premiums in individual annuities 0.195 0.298
Proportion of premiums in group annuities 0.056 0.175
Geographic Herfmdahl, premiums written 0.358 0.357
Premium Growth Rate
Change in premiums, t-1 to t 0.043 0.465
Group Affiliation and Organizational Form
Unaffiliated insurer dummy 0.161 0.368
Stock insurer dummy 0.953 0.213
Corporate Governance
Board size 7.022 3.079
Proportion of outside directors 0.461 0.287
Board reputation 2.222 2.189
CEO is chairman 0.671 0.471
Non-target
Variables Mean Std. dev
Observations 6837
Size and Financial Ratios
Size: Ln(assets) 17.625 2.712
Surplus / assets 0.420 0.301
Operating Performance
Return on assets 0.023 0.085
Business Mix and Diversification
Proportion of premiums in individual annuities 0.118 0.243
Proportion of premiums in group annuities 0.031 0.134
Geographic Herfmdahl, premiums written 0.571 0.401
Premium Growth Rate
Change in premiums, t-1 to t 0.125 0.491
Group Affiliation and Organizational Form
Unaffiliated insurer dummy 0.383 0.486
Stock insurer dummy 0.903 0.296
Corporate Governance
Board size 7.257 3.681
Proportion of outside directors 0.489 0.299
Board reputation 1.064 1.338
CEO is chairman 0.740 0.438
Difference
Variables Target - Non-target
Observations
Size and Financial Ratios
Size: Ln(assets) 1.169 (***)
Surplus / assets -0.092 (***)
Operating Performance
Return on assets -0.017 (***)
Business Mix and Diversification
Proportion of premiums in individual annuities 0.077 (***)
Proportion of premiums in group annuities 0.025 (**)
Geographic Herfmdahl, premiums written -0.213 (***)
Premium Growth Rate
Change in premiums, t-1 to t -0.082 (***)
Group Affiliation and Organizational Form
Unaffiliated insurer dummy -0.222 (***)
Stock insurer dummy 0.050 (***)
Corporate Governance
Board size -0.235
Proportion of outside directors -0.028 (*)
Board reputation 1.158 (***)
CEO is chairman -0.069 (***)
Note: (*) Significant at the 10% level. (**) Significant at the 5%
level. (***) Significant at the 1% level. The asterisks illustrate
whether the difference between targets and non-targets is significant
based on T-test. Board size: the number of directors on a board. Board
reputation: average number of directorships held by the directors of
the board in other insurance companies. Proportion of outside
directors: the number of outsiders divided by the board size. Similar
to He and Sommer (2011), we define an outside director as a director
who is not a current or former officer or their family members. "CEO is
chairman" is a dummy variable equal to 1 if a CEO is also the chairman
of a board, and 0 otherwise.
Table 3
Probit analysis--likelihood of targets
Variables Whole Good
Sample Performance
Board size -0.023 (**) -0.028
[0.011] [0.019]
Board reputation 0.130 (***) 0.242 (***)
[0.017] [0.032]
Proportion of outside directors -0.199 -0.338 (*)
[0.130] [0.199]
CEO is chairman -0.288 (***) -0.354 (***)
[0.071] [0.110]
Firm Size: Ln(assets) -0.007 0.002
[0.021] [0.033]
Return on assets -0.952 (**) -1.503 (*)
[0.465] [0.793]
Surplus / assets -0.191 -0.084
[0.163] [0.237]
Geographic Herfindahl -0.524 (***) -0.512 (***)
[0.110] [0.163]
Proportion of premiums in annuities 0.291 (**) 0.396 (*)
[0.118] [0.221]
Premium growth rate -0.294 (***) -0.130
[0.080] [0.113]
Stock insurer 0.285 (**) 0.250
[0.125] [0.231]
Unaffiliated insurer -0.183 (**) -0.021
[0.085] [0.128]
Observations 5529 2742
Pseudo R-square 0.146 0.201
Likelihood ratio test on equality LR chi2(20)= 33.13
of coefficients
P-value Prob > chi2 = 0.0448
Variables Poor
Performance
Board size -0.019
[0.015]
Board reputation 0.087 (***)
[0.021]
Proportion of outside directors -0.095
[0.176]
CEO is chairman -0.257 (***)
[0.095]
Firm Size: Ln(assets) -0.024
[0.028]
Return on assets -0.555
[0.711]
Surplus / assets -0.271
[0.239]
Geographic Herfindahl -0.572 (***)
[0.156]
Proportion of premiums in annuities 0.262 (*)
[0.150]
Premium growth rate -0.468 (***)
[0.121]
Stock insurer 0.307 (**)
[0.151]
Unaffiliated insurer -0.273 (***)
[0.118]
Observations 2776
Pseudo R-square 0.125
Likelihood ratio test on equality
of coefficients
P-value
Note: Dependent variable is target dummy (target=l if a firm is
successfully acquired, and 0 otherwise). Independent variables take
value one year prior to the acquisition. Constant term and year
dummies are not reported. (*) Significant at the 10% level. (**)
Significant at the 5% level. (***) Significant at the 1% level.
Standard errors in brackets.
Board size: the number of directors on a board. Board reputation:
average number of directorships held by the directors of the board in
other insurance companies. Proportion of outside directors: the number
of outsiders divided by the board size. Similar to He and Sommer
(2011), we define an outside director as a director who is not a
current or former officer or their family members. "CEO is chairman" is
a dummy variable equal to 1 if a CEO is also the chairman of the board,
and 0 otherwise. A firm is considered as "good performance" if its
return on assets (ROA) is higher than the industry median ROA, and as
"poor performance" otherwise.
Table 4
Summary statistics on target director retention
Retained Non-retained
Directors Directors
Variables Mean Std. dev Mean Std. dev
Director Characteristics
Number of observations 1118 1100
Director - outside director 0.462 0.499 0.566 0.496
Director - inside director 0.538 0.499 0.434 0.496
Director reputation 2.577 3.467 1.872 2.668
Director - top management experience 0.411 0.492 0.284 0.451
Target or Transaction Characteristics
CEO is chairman 0.569 0.495 0.725 0.446
Proportion of outside directors 0.490 0.288 0.539 0.282
Pre-acquisition operating performance -0.001 0.047 -0.003 0.062
Disciplinary CEO turnover 0.572 0.495 0.802 0.399
Cash payment 0.453 0.498 0.495 0.500
Target size: In(asset) 19.472 2.400 18.929 2.582
Difference
Variables Retained -
Non-retained
Director Characteristics
Number of observations
Director - outside director -0.104 (***)
Director - inside director 0.104 (***)
Director reputation 0.705 (***)
Director - top management experience 0.127 (***)
Target or Transaction Characteristics
CEO is chairman -0.156 (***)
Proportion of outside directors -0.049 (***)
Pre-acquisition operating performance 0.002
Disciplinary CEO turnover -0.230 (***)
Cash payment -0.042 (**)
Target size: In(asset) 0.542 (***)
Note: (*) Significant at the 10% level. (**) Significant at the 5%
level. (***) Significant at the 1% level. "Director - outside director"
equals 1 if a director is an outsider, and 0 otherwise.
"Director - inside director" equals 1 if a director is an insider, and
0 otherwise. "Director Reputation" is measured by the number of
directorships held by a director in other insurance companies.
"Director - top management experience" is a dummy variable equal to 1
if a director had CEO experience before acquisition, and 0 otherwise.
"CEO is chairman" is a dummy variable equal to 1 if a target firm's CEO
is also the chairman of the board, and 0 otherwise. "Proportion of
outside directors" is the proportion of outsiders in a target board,
calculated by the number of outsiders divided by the board size.
Pre-acquisition operating performance is the industry-adjusted average
return on assets for the two years prior to the acquisition.
"Disciplinary CEO turnover" is a dummy variable equal to 1 if the CEO
of a target loses the CEO position within two years after acquisition,
and 0 otherwise. "Cash payment" equals 1 if the acquisition is financed
by cash, and 0 otherwise.
Table 5
Probit analysis-likelihood of target director retention
Whole Outside
Variables Sample Directors
Director - outside director -0.134 (**)
[0.055]
Director reputation 0.033 (*) 0.009
[0.019] [0.029]
Director - top 0.242 (***) 0.299 (***)
management experience [0.062] [0.109]
CEO is chairman -0.406 (***) -0.567 (***)
[0.145] [0.192]
Proportion of outside -0.429 (*) -0.620
directors [0.241] [0.405]
Pre-acquisition operating 0.318 -0.482
performance [1.054] [1.425]
Disciplinary CEO turnover -0.598 (***) -0.332
[0.151] [0.203]
Cash payment -0.066 -0.043
[0.137] [0.182]
Target size: ln(assets) 0.032 0.025
[0.031] [0.040]
Stock company -0.141 -0.141
[0.289] [0.350]
Unaffiliated company 0.043 0.061
[0.209] [0.262]
Constant 0.317 0.417
[0.796] [1.107]
Observations 2,019 1,048
Pseudo R-square 0.082 0.067
Inside Good
Variables Directors Performance
Director - outside director -0.118
[0.081]
Director reputation 0.047 (*) 0.046 (*)
[0.025] [0.025]
Director - top 0.226 (***) 0.190 (*)
management experience [0.080] [0.101]
CEO is chairman -0.227 -0.204
[0.152] [0.227]
Proportion of outside -0.281 -0.993 (***)
directors [0.278] [0.376]
Pre-acquisition operating 1.059 -2.248
performance [1.167] [1.867]
Disciplinary CEO turnover -0.971 (***) -0.313
[0.156] [0.229]
Cash payment -0.151 -0.189
[0.142] [0.205]
Target size: ln(assets) 0.038 0.028
[0.033] [0.045]
Stock company -0.157 -1.012
[0.356] [0.635]
Unaffiliated company -0.012 0.073
[0.223] [0.337]
Constant 0.349 1.296
[0.815] [1.207]
Observations 971 812
Pseudo R-square 0.120 0.086
Poor
Variables Performance
Director - outside director -0.146 (*)
[0.080]
Director reputation 0.036
[0.027]
Director - top 0.290 (***)
management experience [0.078]
CEO is chairman -0.519 (***)
[0.189]
Proportion of outside -0.065
directors [0.321]
Pre-acquisition operating 0.867
performance [1.486]
Disciplinary CEO turnover -0.794 (***)
[0.190]
Cash payment 0.033
[0.183]
Target size: ln(assets) 0.047
[0.044]
Stock company 0.07
[0.324]
Unaffiliated company 0.052
[0.279]
Constant -0.268
[1.076]
Observations 1,207
Pseudo R-square 0.119
Note: (*) Significant at the 10% level. (**) Significant at the 5%
level.(***) Significant at the 1% level. Standard errors allowing for
intragroup correlation are in brackets. "Director - outside director"
equals 1 if a director is an outsider, and 0 otherwise.
"Director - inside director" equals 1 if a director is an insider, and
0 otherwise. "Director reputation" is the number of directorships held
by a director in other insurance companies. "Director - top management
experience" is a dummy variable equal to 1 if a director had CEO
experience before acquisition, and 0 otherwise. "CEO is chairman" is a
dummy variable equal to 1 if a target firm's CEO is also the chairman
of the board, and 0 otherwise. "Proportion of outside directors" is the
proportion of outsiders in a target board, calculated by the number of
outsiders divided by the board size. Pre-acquisition operating
performance is the industry-adjusted average return on assets for the
two years prior to the acquisition. "Disciplinary CEO turnover" is a
dummy variable equal to 1 if the CEO of a target loses the CEO position
within two years after acquisition, and 0 otherwise. "Cash payment"
equals 1 if the acquisition is financed by cash, and 0 otherwise.
