Does Transparency Increase Takeover Vulnerability?

Takeovers and especially models predicting takeovers have been of interest to academics and practitioners.  In essence, our paper studies how transparency affects takeover probability and stock returns over 25 years of takeover data.  Economic intuition suggests that if higher firm-level transparency lowers uncertainty with respect to synergies and valuations of potential target firms, then it should facilitate takeovers.  We argue therefore that a better information environment increases takeover vulnerability, such that it has an incrementally important impact on estimates of takeover likelihood, which is consistent with recent research.  To the best of our knowledge, however, this is the first paper to examine empirically whether transparency affects takeover vulnerability and potentially stock returns too.  

Our paper augments a baseline logit model, which contains known variables to proxy a firm’s takeover likelihood, with variables that measure a firm’s transparency level.  For example, accrual quality is one proxy for transparency; a lower value of accrual quality indicates a more transparent information environment.  To ensure our results are robust to different measures of transparency, we consider two alternative proxies: namely, forecast error and forecast dispersion that are based on analysts’ earnings forecasts.  Our paper’s analysis first establishes that our augmented model with transparency variables improves the predictive power of a firm’s takeover likelihood relative to the baseline logit model without transparency variables in various ways.  Second, we study the relation between takeover probability and stock returns.  We find that firms with higher takeover likelihood are generally associated with higher stock returns over the sample period of 1991 to 2016.  Third, a number of robustness tests differentiate more the pricing ability of our augmented takeover factor from the baseline takeover factor and also assess further the quantitative relevance of the takeover premium from the augmented model relative to the baseline model.

Overall, our results reveal transparency is crucial for external governance mechanisms, such as takeovers.  Future researchers could consider its relation to internal governance mechanisms, such as activist investors or institutional ownership.  A few questions that could emerge from such research are whether more transparent firms are more likely to have institutional shareholders (e.g., pension funds), and whether they are more likely to have activist campaigns.