Corporate Governance5

7/31/2019 Corporate Governance5

1/16

Boards, Uncertainty, and the Use ofFairness Opinions

Melissa B. Frye* and Weishen Wang

ABSTRACT

Manuscript Type: EmpiricalResearch Question/Issue: We propose and test a new perspective on why the boards of some acquiring rms purchase afairness opinion (FO). Specically, we examine whether the boards knowledge explains the use of an FO and the marketreaction to the FO.Research Findings/Insights: We nd that FOs are more likely to be purchased when the acquiring rms board feelsuncertain about the deal. Specically, we nd that boards with more outside directors are more likely to use an FO, while boards whose directors hold more outside appointments (busy boards) are less likely to seek an FO. Moreover, we nd thatalthough the market reacts negatively to the FO, board characteristics both moderate and exacerbate the reaction. When anFO is used by a busy board, the market reacts more negatively to the merger announcement. In contrast, board indepen-dence and the average service years for directors seem to moderate the markets reaction to the FO.Theoretical/Academic Implications: The results of this study are consistent with the idea that a lack of knowledge andunderlying transaction uncertainty motivates the board to purchase an FO. In addition, our empirical evidence supports asophisticated market reaction, where the market recognizes the boards knowledge when assessing the necessity of the FO.Practitioner/Policy Implications: This study provides a new perspective on why boards use FOs. A board with moreoutside directors may be strong on monitoring, but may lack knowledge on the deal. This essentially provides an exampleof a cost associated with an independent board. Further, we show that the market can differentiate the types of boards thatuse an FO.

Keywords: Corporate Governance, Merger, Board Knowledge, Fairness Opinion, Market Reaction

INTRODUCTION

I n mergers and acquisitions, the boards of acquiring rmsand/or target rms often seek a fairness opinion (FO)from nancial advisors, usually investment banks. The FOindicates whether the deal, particularly the price, is fair totheir shareholders. It is essentially a professional opinion based on collected data with an unambiguous indication of whether the deal is fair. FOs are not mandatory; however,Kisgen, Qian, and Song (2009) report that 80 per cent of targets and 37 per cent of acquirers are willing to pay sub-stantial fees to obtain a third-party assessment of the merger.

Some studies suggest that directors seek such opinions toprovide legal protection as they may provide evidence of the boards due diligence (Bowers & Latham, 2006; Chen &Sami, 2007; Kisgen et al., 2009; Makhija & Narayanan,

2007). However, Ohta and Yee (2008) stress that this legalprotection or inoculation hypothesis cannot be the wholestory. Specically, they question why all rms do not usethem if they provide valuable protection as well as why theyare not boilerplate across all transactions. They highlight thatthe use of FOs did not increase following the Smith versusVan Gorkum case in 1985, where the Delaware SupremeCourt rebuked a board for failing to make an informed deci-sion. Ohta and Yee (2008) further highlight that there are nocases where a board has been held liable for failing to obtainan FO.

Moreover, extant studies that focus on the legal protectionhypothesis often present inconclusive or even puzzlingresults as to why a board would use an FO. Kisgen et al.(2009) do consider an alternative to the legal protectionhypothesis, which they label the transaction improvementhypothesis. Their results for acquirer FOs support bothhypotheses. Specically, they nd that deal premiums arelower for acquirers using an FO (consistent with the trans-action improvement hypothesis), while they also show that

*Address for correspondence: Department of Finance, College of Business Adminis-tration, University of Central Florida, Orlando, FL 32816-1400, USA. Tel: 407-823-3097;Fax: 407-823-6676; E-mail: [email protected]

48

Corporate Governance: An International Review, 2010, 18(1): 4863

2009 Blackwell Publishing Ltddoi:10.1111/j.1467-8683.2009.00773.x


2/16

deals with acquirer FOs are more likely to be completed andare associated with greater wealth losses (consistent with thelegal protection hypothesis). However, they assume thatacquiring rm announcement returns provide a more com-prehensive assessment, thus they conclude that FOs areused for legal protection.

In addition to these mixed results, Kisgen et al. (2009) ndthat smaller boards with more outside members are morelikely to use an FO, seemingly indicating that rms with better corporate governance structures are more likely to usean FO. This raises the question as to why a rm with bettergovernance would need more protection. In contrast,Bowers and Latham (2006) assume that rms with bettergovernance (measured by the Gompers, Ishii and Metricks,2003 governance index) would face lower litigation risk andthus would be less likely to obtain an FO. However, theynd no evidence that governance affects the demand forFOs. Makhija and Narayanan (2007) contend that captured boards with more insiders would seek the legal protection of an FO, but they nd no signicance in their empirical testswith acquirers. The inconclusiveness on this issue begs anew viewpoint.

In this paper, we propose and test a fresh perspective onacquiring rms use of FOs. We focus on acquiring rms forseveral reasons. Kisgen et al. (2009) note that there is morevariation in the use of FOs by acquiring rms, which raisesthe question as to why some rms purchase them whileothers do not. Second, most acquiring rms experiencesignicant losses in mergers, while targets often gain(Andrade, Mitchell, & Stafford, 2001). Moeller, Schlinge-mann, and Stulz (2005) stress the importance of understand-ing why announcement returns of acquirers are associatedwith large losses. Since an FO is an added expense to anevent that, on average, destroys shareholder wealth, themotivation behind the purchase seems timely and relevant.

Finally, the Kisgen et al. (2009) ndings on acquirer FOs arenot always consistent with their legal protection hypothesis.In our paper, we contend that FOs are more likely to be

purchased when the board has excessive uncertainty associ-ated with the deal. We maintain that some boards are moreknowledgeable about the value-creating potential of the dealthan others. Such boards will feel more certain about themerits of the merger and will be less likely to ask investment bankers whether the deal price is fair. Coles, Daniel, andNaveen (2008) and Kroll, Walters, and Wright (2008) empha-size the importance of board knowledge in both the moni-toring and advising functions of the board.

Under this new perspective, we also expect the market torecognize the uncertainty of the underlying transaction aswell as the knowledge of the board. We expect that the use of an FO will signal to the market that the board was unsureabout the synergies of the deal (or that the transaction wascomplex). Thus, the market will react more negatively todeals with an FO. However, we expect the market to temperthis reaction based on the underlying knowledge of the board. We note that prior studies have considered gover-nance as a determinant of the use of an FO (Bowers &Latham, 2006; Kisgen et al., 2009), but they do not examinewhether announcement returns are affected by characteris-tics of the board using the FO. Makhija and Narayanan(2007) examine the effect of low inside holdings and low

board independence only on target company announcementreturns.

Using multiple proxies for the boards knowledge as wellas a matched sample to control for the deal uncertainty, ourempirical results suggest that the boards uncertainty aboutthe value of the deal is an important determinant of the useof an FO by an acquiring rm. We nd that larger boards, ormore specically, those with more outside directors, aremore likely to obtain an FO. Outsiders to the board may feelless informed about the merger valuation and thus obtainthe FO as a means to gather information. We nd that boardswith busy directors are less likely to use an FO. Serving onmultiple boards may increase the directors knowledge baseand thus decrease the need to seek an FO. We also ndevidence that boards are more likely to use an FO whenthere is more uncertainty about the underlying transaction.In general, our results are consistent with Ohta and Yee(2008) and suggest that the boards knowledge is importantin explaining the use of an FO.

In terms of market reactions, we nd that overall themarket reacts negatively to the FO; however, board charac-teristics both moderate and exacerbate the reaction. Speci-cally, we nd that when an FO is used by a board with agreater percentage or number of outside directors or by a board whose members have long tenures with the rm, themarket reacts less negatively. Such boards are likely to haveless knowledge and the market appears to recognize thenecessity of the FO. However, when a busy board, whichshould be more knowledgeable, uses an FO, the marketreacts more negatively.

The contribution of our study is twofold. First, we providea new perspective on why boards use FOs. We show that a board with more outside directors may be strong on moni-toring, but may lack knowledge about the value-enhancingpotentials of the deal. This essentially providesan example of

a cost associated with an independent board. Our frameworkof uncertainty may provide a better explanation for the rela-tion between board characteristics and the use of anFO than that offered by previous studies, which seeminglyshow better governed rms need more legal protection(Kisgen et al., 2009).Also,our frameworkand results providean alternative explanation to the mixed ndings of Kisgen etal.(2009), where dealpremiumsare lower butannouncementreturns are negative for acquirers with an FO. The use of anFOmay lead to a bettertransaction (lower deal premium),butmay signal to themarket theboards lack of knowledge.Thus,our ndings may reconcile the results in Kisgen et al. (2009).Second, we show that the market does consider the charac-teristics of the board that uses an FO. An FO may signal to themarket that the board is unsure about the merger and subse-quently the market reacts negatively to the FO. However, themarket recognizes the necessity of an FO for boards lackingknowledge to perform their duciary duties.

BOARD KNOWLEDGE AND FAIRNESSOPINIONS (FOs)

The board has both an advisory and monitoring role, whichrequire extensive knowledge about the rm and its strategicenvironment. In the case of mergers and acquisitions, the

BOARDS AND FAIRNESS OPINIONS 49

Volume 18 Number 1 January 2010 2009 Blackwell Publishing Ltd


3/16

acquiring rms board needs to know not only their rm, butalso about the target rm and the potential synergies fromthe merger. Variation in board knowledge may affect the boards decision making process. For a knowledgeable board, it is likely to be easier for the board to decide whetherthe merger ts the rms strategy and the value of the targetrm to the acquiring rm. In this case, seeking an externalopinion may be unnecessary. However, with a less knowl-edgeable board, purchasing an FO may be required for board members to feel comfortable with the transaction.

We use several proxy variables to capture the boardsknowledge, including the percentage and number of outside(independent) directors on the board, the size of the board,the average years of director service, and the busyness of thedirectors. When the board has more outside directors, thesedirectors have less information about the rm simply because they are outsiders (Coles, Daniel, & Naveen,2008). Fama and Jensen (1983) note that outsiders are inde-pendent of the CEO but are less informed about the rmsprojects. The literature generally contends that an indepen-dent board may be more effective at monitoring (e.g., John &Senbet 1998). Johnson, Hoskisson, and Hitt (1993) and Judge and Zeithaml (1992) indicate that boards that are moreindependent are more likely to exercise greater inuenceover strategic decisions. However, a lack of knowledgeabout the rm coupled with a strong desire to monitor maypersuade the independent board to collect more informationto reduce their uncertainty about the deal. In Rahejas (2005)model, when the number of outsiders on the board is large,the costs to coordinate efforts and verify projects increase.She shows that outside directors can determine projectquality only if they incur costly verication. Seeking an FOfrom an investment bank is an example of such costly veri-cation. Thus, the percentage of outside directors on the board should be positively associated with the probability of

obtaining an FO.With respect to a merger, internal knowledge about therm may not be as important as the ability to assess thesynergies between the two companies. The managementliterature often suggests that independent directors gainknowledge from their work outside the rm and become better advisors (McDonald, Westphall, & Graebner,2008). While this may suggest that such directors would bemore knowledgeable about acquisitions, McDonald et al.(2008) point out that outside directors must balance boardduties with a variety of other professional responsibilities,suggesting time constraints may also make the FO moreappealing as they may not have time to adequately re-search and understand the transaction. Likewise, Good-stein, Gautam, and Boekers (1994) arguments suggest thatas the number of outsiders on the board increases, thechance of board factions and coalitions would also increaseand thus reduce knowledge transfers among directors. If knowledge is not exchanged, the board as a whole will beless informed and knowledgeable. Thus, we expect boardswith more outsiders to be more likely to seek an FO. Notethat we consider both the proportion of outside directorsas well as the interaction of the percentage of outside direc-tors and board size, in other words the number of outsidedirectors. This approach is consistent with Coles, Daniel,and Naveen (2008).

The size of the board may also measure of the boardsknowledge, or more specically, the knowledge exchangeamong members. Prior literature contends that larger boardssuffer from communication and coordination problems(Eisenberg, Sundgren, & Wells, 1998). This leads to lessinformation dissemination between board members, result-ing in a board that is less knowledgeable in an aggregatesense. In Goodstein, Gautam, and Boeker (1994), large boards become more factionalized into special interestgroups as the strategic decision becomes more complex andambiguous. This results in directors promoting their ownagendas and a decreased interest in sharing expertise.Goodstein et al. (1994) argue that this less cohesive boardessentially becomes a barrier to reaching a consensus onimportant decisions. Likewise, Jensen (1993) suggests thatlarger boards have less candid discussions among directors,again suggesting the aggregate knowledge of the board may be reduced. Thus, we expect larger boards to be more likelyto purchase an FO.

Our next proxy for board knowledge is the average direc-tors years of service with the rm. Vafeas (2003) notes thatlong tenured directors may have important internal (notnecessarily external) knowledge about the rm; however,such directors are more likely to be beholden to manage-ment and detrimental to shareholder interests. 1 Anderson,Mansi, and Reeb (2004) nd that as board tenure increases,managers are better able to sway director opinion, suggest-ing less oversight by the board and less open discussions inthe boardroom. Kaymak and Bektas (2008) conclude thatlong tenured directors have clouded judgment. Boone,DeBrabander, van Olffen, and van Witteloostuijn (2002) ndthat increased board tenure leads to poor decision making because such directors rarely challenge managers. Katz(1982) shows that extended tenure reduces intra-group com-munication, and isolates groups from critical information

sources both within and outside their organizations. Thus, a board with long-tenured directors may again suffer froma lack of communication, knowledge, and informationsharing, resulting in a less knowledgeable board overall.Finally, Rutherford and Buchholtz (2007) associate long board tenure with a greater likelihood of proactively seekinginformation to reduce asymmetric information. Thus, weexpect service years to be positively related to the use of anFO.

The nal proxy for board knowledge is the busyness of thedirectors, captured by the number of other directorshipsheld by the board. Several studies show that directorshaving additional appointments may provide benets to therm. Harris and Shimizu (2004) nd that over-boardeddirectors are important sources of knowledge and enhanceacquisition performances. Carpenter and Westphal (2001)show that additional directorships enhance the directorsability to contribute to strategic decision making. Thus, busydirectors may be more knowledgeable about mergers andsynergies, making them less likely to seek an FO. 2

In addition to looking at the use of an FO, we also examinemarket reactions. The purchase of an FO likely indicates alack of certainty on the part of the board and will result in anegative market reaction. However, we expect the degree of value loss to be moderated by board knowledge and thenecessity of an FO. Broadly speaking, we expect that if the

50 CORPORATE GOVERNANCE



4/16

board needed an FO to overcome a lack of knowledge, themarket should react less negatively to the FO. In contrast, if an FO is used by a board that essentially does not need theFO (or should already be knowledgeable), the marketshould react more negatively when an FO is used.

Specically, we expect a less negative reaction when an FOis used by a larger, more independent board and by boardswith long-tenured directors. Boards with more outsidedirectors may need the costly verication to ensure projectquality (Raheja, 2005), while larger boards may need to over-come communication problems that reduce informationexchange and thus overall board knowledge. Likewise, a board with long-tenured directors may have less informa-tion sharing and less access to critical information (Katz,1982). In a sense, the market should view the FO as neces-sary or justied under these conditions and thus react lessnegatively.

In contrast, we expect the negative response to the use of an FO to be stronger when the FO is purchased by a busy board. Essentially, the market may view an FO even morenegatively when purchased by a board that should not needan FO. In this case, the FO represents wasteful spending bya board that should have the expertise to evaluate themerger. In addition, a busy board, with presumably moreknowledge, that purchases an FO may signal that the dealuncertainty is extremely high. If a board with membershaving expertise is looking for additional information thatmay indicate very high levels of ambiguity associated withthe deal.

DATA AND METHODOLOGY

Data

To examine the role of board knowledge and the use of anFO, we start with director data maintained by the InvestorResponsibility Research Center (IRRC). The data cover theyears 19962003 and include 2,594 US rms and 11,579 rm-years. We obtain quarterly nancial and monthly stockreturn data for these rm-years from CRSP (Center forResearch in Security Prices) and Compustat. We obtain the4,103 merger deals that these 2,594 rms undertake asacquiring rms during the period from 1996 to 2004 from theSecurities Data Corporation (SDC) on-line Merger and Cor-porate Transactions database. Finally, we merge the dealinformation with the acquiring rms nancial (stock) infor-mation from the month prior to the deal and the rmsgovernance information. Our nal sample consists of 1,102mergers. 3 For each deal, SDC discloses whether the invest-ment banks used by the acquiring rm provided an FO. 4However, as Kisgen et al. (2009) note, relying on SDC datamay severely underestimate the actual incidence of FOs. Tocorrect this potential bias, we manually search SEC lingsfor the 580 deals in which SDC indicated a nancial advisorwas used. We nd 103 deals that use buy-side opinions. 5 Wealso randomly check another 300 deals that SDC does notstate that the acquiring rm used nancial advisors. We ndthat this characterization is accurate. That is, when SDCstates that there is no buy-side nancial advisor in the deal,we do not nd a buy-side opinion.

Consistent with Coles, Daniel, and Naveen (2008) andother studies, we use the natural logarithm of board sizeand the number of independent directors, as well as thepercentage of independent outside directors. 6 To computethe number of years of service, we use the average numberof years that all directors have served on the board.Director busyness is the average number of other rm boards on which directors sit. All board characteristics arefrom IRRC.We also control for variables documented by priorstudies on FOs, such as in Kisgen et al. (2009) and Bowersand Latham (2006). Board holdings are the total sharehold-ings of the directors on the board. Board holdings are oftenused as a measure of the rms internal governance oralignment of manager and shareholder interests. Firmswith low inside ownership should be more likely to seekan FO. As Kisgen et al. (2009) suggest, managers of theserms may be more likely to pursue dubious acquisitionsfor their own private benet. We also use deal features thatcapture the underlying risk, including the transaction value(size), whether the acquiring rm and target rm conduct business in close industries, whether the acquiring rmuses its stock as currency, the attitude of target rm man-agement to the deal (hostile or not), and whether the targetis publicly traded ( Public Target). Larger deals, deals paidfor with stock, deals in different industries, and friendlymergers are more likely to be complex. Publicly tradedtargets may be more complex, but they are usuallyacquired to enter new businesses (Capron & Shen, 2007).In addition, we control for the acquiring rms size andperformance before the deal announcement. In our marketreaction analyses, we include a dummy variable equal toone if the target rm uses an FO ( TFO). Makhija andNarayanan (2007) show that the market reacts less favor-ably to deals where the target company uses an FO. Con-

trolling for this allows us to separate the effects of acquirerFOs and target FOs.While our models include deal characteristics, it is pos-

sible that our results are biased since a relatively large pro-portion of our sample does not use an FO and our controlsmay not adequately capture the notion that an FO is morelikely to be used when uncertainty is high. To address thisand provide a robustness check, we construct a matchedsample. Specically, we match opinioned deals to non-opinioned deals based on industry (4-digit SIC code), size(acquirers market capitalization), and book-to-marketratio. 7 We are able to match 103 opinioned acquirers to 185non-opinioned rms.

The board and deal characteristics of the sample aregiven in Table 1. In terms of board characteristics, themedian board has 10 members, of which approximately sixare independent. Directors on average have served on theacquiring rm board for 8.2 years. Acquiring rm directorsserve on an average of .99 other boards. In terms of usingan FO, there are about 9 per cent deals in which the acquir-ing rm uses an FO, and about 26 per cent target rms usean FO. 8 The acquiring rms stock performance before theannouncement ( Pre-performance), computed as the averageabnormal monthly return of the acquiring rm against thesimple market model over the 24 months prior to themerger announcement, is 1 per cent. Same Industry is a




5/16

dummy variable used to capture whether the deal is asimple expansion in the same industry or diversicationacross different industries for the acquiring rm. In thesample, Same Industry has an average of .49, indicatingthat 49 per cent of deals in which the acquiring rmand target rm share the rst three digits of their mainSIC.

Hostile is a dummy variable used to capture whether thedeal is hostile or is welcomed by the target rm. Only 2 percent of deals are hostile. In 53 per cent of deals, the acquireruses stock as currency. The number of competing bidders is1.05 and the average premium paid by the acquiring rm(Premium) is 55 per cent in the sample. The abnormal returnsof the acquiring rms are - .8 per cent for the two-dayannouncement window.

MethodologyWe rst examine whether the boards knowledge and deal

characteristics are associated with the use of opinions byestimating the following logistic choice model:

Prob AFO Board Deali i j j( ) = + + + 1 (1)where AFO is a binary variable equal to 1 if the acquiringrm obtains at least one opinion in the deal and 0 otherwise;Board variables include board size, the percentage of outsidedirectors, the number of outside directors, the averagenumber of service years for directors, board busyness, and board holdings; Deal includes Log(Assets), Pre-performanceLog(Tran Value), Same Industry, Hostile, Stock Pay, Number oBidders, and Public Target.

TABLE 1Summary Statistics for Acquiring Firm

Variable N Mean Median Std Minimum Maximum

% of Outsiders 1,102 .63 .67 .18 .00 .92Board Size 1,102 10.53 10.00 3.81 4.00 25.00

Number of Outsiders 1,102 6.76 6.00 3.35 0 22.00Service Years 862 8.20 7.92 3.35 .88 23.17Busyness 862 .99 .89 .70 .00 3.56Board Holdings 998 7.33 2.00 13.74 .00 93.20Acquirer Fairness Opinion 1,102 .09 .00 .29 .00 1.00Target Fairness Opinion 1,102 .26 .00 .44 .00 1.00Assets 1,072 16,263.25 3,335.50 55,762.46 92.10 1,057,657.00Pre-performance 1,102 .01 .01 .03 - .09 .17Transaction Value 946 1,358.96 215.98 4,770.13 .01 89,167.72Same Industry 1,102 .49 .00 .50 .00 1.00Hostile 1,102 .02 .00 .13 .00 1.00Stock Pay 1,102 .53 1.00 .50 .00 1.00Number of Bidders 1,102 1.05 1.00 .25 1.00 4.00Public Target 1,102 .59 1.00 .49 .00 1.00Premium 529 55.23 44.44 103.82 - 86.28 1,937.04Acquirer Market Cap 1,102 20,047.40 3,689.78 50,895.80 44.90 571,197.28Acquirer Book to Market 1,102 .36 .31 .26 - .23 2.24CAR (- 1, 0) 1,102 - .8% - .5% 4.9% - 28.0% 16.7%

This table reports summary statistics for the sample. % of Outsiders is the percentage of outside independent directors on the board. BoardSize is the number of directors on the board. Numberof Outsiders is the number of outside directors on the board. Service Yearsis the averageyears that directors have served the company. Busyness is the average other company boards on which acquiring rm directors sit. Board Holdings is the number of shares held by the board members divided by the rms total number of shares. AFO is a dummy variable takinga value of 1 if acquiring rm uses fairness opinion and 0 otherwise. TFO is a dummy variable taking a value of 1 if target rm uses fairnessopinion and 0 otherwise. Assets are the acquiring rms total assets in deal announcement year. Pre-performance is the average abnormalmonthly return of the acquiring rm against the simple market model over the 24 months prior to the merger announcement. Transaction

Value is the transaction value of the merger. Same Industry is a dummy variable used to capture whether the deal is a simple expansionin the same industry or diversication across different industries for the acquiring rm. It takes a value of 1 if the acquiring rm and targetrm share the same rst three digits of their main SIC, and 0 otherwise. Hostile is a dummy variable equal to 1 if the target rm opposesthe deal and 0 otherwise. Stock Pay is a dummy variable taking a value of 1 if acquiring rm uses its stock as currency and 0 otherwise.Number of Biddersis the number of competitive bidders present before the result of the deal is disclosed (completed or withdrawn). PublicTarget is a dummy variable equal to 1 if target rm is a public rm and 0 otherwise. Premium is price paid for each target share relativeto the targets stock price four weeks before the announcement. Acquirer Market Cap is the market capitalization of the acquiring rm. Acquirer Book toMarket is the book to market ratio for the acquiring rm. CAR (- 1, 0) is the cumulative daily abnormal returns overwindow ( - 1, 0) for the acquiring rms.




6/16

We use abnormal returns around merger announcementsto capture short-term wealth effects. Abnormal returns arecomputed using a standard event study approach. The esti-mation period is the 255-day period ending 30 days prior tothe announcement date. The market is the CRSP valueweighted index of stocks traded on the New York StockExchange (NYSE), the American Stock Exchange (AMEX),and NASDAQ. Following Datta, Iskandar-Datta, and Raman(2001), we compute two-day ( - 1, 0) cumulative abnormalreturns (CARs) for acquirers in response to mergerannouncements.

We use the following regression model to investigate thewealth effects:

CAR TFO AFO Board AFO

Board Deal

i i

j j k k

= + + +

+ + +

1 2

2 (2)

where CAR is cumulative abnormal return over ( - 1, 0)window.

TFO in Equation (2) is a dummy variable, which has avalue of 1 if the target rm uses an FO and 0 if it does not.

AFO in Equation (2) is a dummy variable, which has a valueof 1 if the acquiring rm uses an FO and 0 if it does not. If anacquirer who uses an FO is different from an acquirer thatdoes not use an FO and the difference is not totally captured by presented variables, there will be a self-selection issue.Following Kisgen et al. (2009), we also compute a hazardrate l from the rst stage Probit model and add it to Equa-tion (2) to address this problem.

RESULTS

Using an Fairness Opinion

Table 2 presents differences in board and deal characteristicsfor mergers with and without an FO. In Panel A, we use theentire sample. In Panel B, we use the matched sample. Interms of board characteristics, service years are lower forrms with an FO in Panel A (t = - 1.63, p = .10), but the dif-ference is only marginally signicant when using a Wilcoxontest (z = - 1.65, p = .09). The signicance is lost using thematched sample. Other board characteristics are not statisti-cally different in Panel A or B. For deal features, FOs areused in larger transactions and when stock is used to pay forthe transaction. FOs are also more likely to be used when thetarget company is publicly traded. We nd that premiumsand announcement returns are signicantly lower for dealswith an FO, consistent with Kisgen et al. (2009).

Table 3 presents the results from the logistic regressionspredicting the likelihood that an acquiring rm uses an FOin a merger. We report several model specications. In par-ticular, we include each of our proxies for board knowledgeseparately with control variables (Models 16). We include board holdings in all model specications to be consistentwith Kisgen et al. (2009) and to control for the general align-ment of shareholder and director interests. Also, we includetwo specications where board knowledge proxy variablesare combined (Models 7 and 8).

Several measures of board knowledge are signicantlyassociated with the use of an FO. For instance, larger boards,

where knowledge exchange may be inhibited, are morelikely to use an FO. In Model 2, the natural log of board sizehas a coefcient of 1.24 (Wald = 12.13, p < .01). In Model 7,the coefcient is 1.07 (Wald = 7.03, p < .01). Interestingly, thepercentage of outside directors is not statistically signicant;however, the number of outside directors on the board ispositive and signicant. In Models 3 and 8, it has a co-efcient of .54 (Wald = 6.13, p < .05) and .56 (Wald = 5.34,p < .05), respectively. This result conrms our prediction that boards with more outside directors may feel less informedor suffer from less knowledge exchange and are thus morelikely to use FOs. We also note that the number of insidedirectors, which we include for completeness, is not statis-tically signicant (Models 4 and 8), so the number of outsidedirectors is not simply capturing board size. The coefcientestimates for service years are insignicant at traditionallevels. Models 6, 7, and 8 show that busy directors are lesslikely to obtain a costly FO (all signicant at the 10 percent level). Busy directors should be more educated aboutmergers and valuation (Harris & Shimizu, 2004). Throughtheir involvement on other boards, such directors shouldhave gained more knowledge and thus have less need for anFO.

While board holdings is generally insignicant, consistentwith Makhija and Narayanan (2007), we nd that many of the deal features are important determinants of the use of anFO and suggest that the underlying risk of the transaction isan important determinant. 9 Consistent with our hypothesisthat FOs are more likely to be used when the deal iscomplex, the size of the transaction is positively associatedwith obtaining an FO (p < .01 in all models). A large mergermay be difcult to integrate and therefore may have highrisk. Smaller rms and those with poor performance prior tothe merger are also more likely to obtain an FO. For largerrms, the transaction may be relatively less valuable in a

strategic sense, thus reducing the need for the FO. Boardsalso seem more likely to purchase an FO when stock is usedas currency, which may make the valuation more complex.While we have only a small number of hostile mergers in oursample, our ndings are consistent with Bowers and Latham(2006) and Kisgen et al. (2009). We nd that rms are morelikely to seek an FO for friendly deals. Kisgen et al. (2009)contend that friendly deals are more complicated and thus boards will be more likely to seek an FO. Bowers andLatham (2006) assert that friendly transactions are more con-ducive to self-dealing and thus increased litigation risk. Wealso nd that FOs are more likely to be purchased when thetarget company is publicly traded. Capron and Shen (2007)show that rms acquire public targets to enter new busi-nesses or businesses with high levels of intangible assets,suggesting greater risk. We also nd weak evidence that FOsare more likely to be used when the target is in a differentindustry.

Wealth Effects and Fairness OpinionsTo examine the wealth effect of a buy-side FO, we rstconduct two-factor analyses of variance ( anova ) to examinewhether FOs, board knowledge, and their interactions affectmarket reactions. Table 4 presents the results. Panels A, B, C,D, and E report how the percentage of outside directors,




7/16

TABLE 2Board and Deal Characteristics and the Use of an Fairness Opinion

Variable Opinioned Non-opinioned t-statistic Z-statistic

Panel A: All opinioned and non-opinioned dealsBoard characteristics

% of Outsiders .64 .63 .60 .37(.64) (.67) [.55] [.71]Board Size 10.49 10.53 - .08 .24

(10.00) (10.00) [.93] [.80]Number of Outsiders 6.80 6.76 .12 .69

(6.00) (6.00) [.901] [.49]Busyness 1.03 .99 .50 .40

(1.00) (.89) [.61] [.68]Service Years 7.61 8.26 - 1.63 - 1.65

(7.40) (8.00) [.10] [.09]Board Holdings 6.60 7.39 - .52 - 1.25

(1.40) (2.00) [.60] [.20]Deal characteristics

Assets 7,412.85 17,183.00 - 4.49** - 1.20(3,218.8) (3,352.00) [.00] [.23]

Pre-performance .02 .01 1.08 1.27(.01) (.01) [.28] [.20]

Transaction Value 5,060.31 911.64 3.64** 10.67**(1,778.11) (168.20) [.00] [.00]

Same Industry .49 .49 .19 .18(.00) (.00) [.85] [.85]

Hostile .01 .02 - .62 - .61(.00) (.00) [.53] [.53]

Stock Pay .89 .49 11.70** 7.79**(1.00) (.00) [.00] [.00]

Number of Bidders 1.08 1.04 .89 .99(1.00) (1.00) [.37] [.31]Premium 41.44 57.62 - 2.54* - 1.95

(38.52) (45.27) [.01] [.05]Public Target .92 .55 11.90** 7.20**

(1.00) (1.00) [.00] [.00]Acquirer Market Cap 12,370.90 21,640.90 - 1.67 - .73

(3,772.50) (4,018.30) [.09] [.46]Acquirer Book to Market .35 .36 - .57 - .01

(.32) (.32) [.56] [.99]CAR(- 1, 0) - 4.0% - .5% - 7.21** - 5.42**

(- 3.0%) (- .4%) [.00] [.00]Panel B: Matched sampleBoard characteristics

% of Outsiders 0.649 .61 1.31 1.07(0.64) (.63) [.19] [.28]

Board Size 10.49 10.40 .21 .30(10.00) (10.00) [.83] [.76]

# of Outsiders 6.80 6.47 .88 1.16(6.00) (6.00) [.37] [.24]

Busyness 1.02 .92 .97 1.00(1.00) (.77) [.33] [.31]

Service Years 7.61 8.21 - 1.28 - 1.26(7.40) (7.83) [.20] [.20]




8/16

board size, the number of outside directors, average serviceyears, and board busyness interact with the use of an FO,respectively.

In Panel A, the sample is equally divided into ve groups based on acquirer board independence. The F-test for theindependence overall effect is 2.03, which is marginally sig-nicant. The F-value of the FO overall effect is 55.50, signi-cant at 1 per cent level, indicating that the FO has a maineffect on CAR ( - 1, 0). The F-value for the interaction effect is2.23, signicant at the 10 per cent level, indicating that theFO interacts with the proportion of outside directors toaffect the acquirers CAR ( - 1, 0). For instance, in Quintile 5,the group with highest percentage of outside directors, theaverage CAR for opinioned deals is - 4.8 per cent. This is

lower than the average return of - .7 per cent for non-opinioned deals. In Quintile 1, the group with lowest boardindependence, the average CAR for opinioned deals is - 6.5per cent, which is lower than the average return of - .1 percent for non-opinioned deals. Thus, 4.1 per cent ( - 4.8 percent + .7 per cent) is the extra loss associated with an FOwhen the board is most independent while the extra loss is6.4 per cent ( - 6.5 per cent + .1 per cent) when the board isleast independent. Thus, the results in Panel A show that anFO used by a board with a larger percentage of outsidedirectors is associated with less value loss for shareholdersthan when an FO is used by a less independent board. Thisprovides evidence that the markets interpretation of the FOdiffers based on board characteristics. Boards with greater

TABLE 2Continued

Variable Opinioned Non-opinioned t-statistic Z-statistic

Board Holdings 6.60 9.03 - 1.18 - 1.40(1.40) (2.10) [.24] [.16]

Deal characteristicsAssets 7,412.85 11,759.40 - 1.24 .03(3218.80) (2667.60) [.21] [.98]

Pre-performance 0.01 .01 .89 1.26(0.01) (.01) [.37] [.21]

Transaction Value 5,060.31 976.64 4.27** 8.40**(1,778.11) (168.78) [.00] [.00]

Same Industry .49 .51 - .30 - .30(.00) (1.00) [.76] [.76]

Hostile .01 .01 - .09 - .08(.00) (.00) [.92] [.93]

Stock Pay .89 .45 8.10** 7.31**(1.00) (.00) [.00] [.00]

Num Bidders 1.07 1.05 .82 .57(1.00) (1.00) [.41] [.57]

Premium 41.44 71.78 - 1.27 - 1.88*(38.52) (47.62) [.20] [.06]

Public Target .92 .55 7.00** 6.48**(1.00) (1.00) [.00] [.00]

Acquirer Market Cap 12,370.90 19,607.11 - 1.22 .58(3772.50) (3157.43) [.22] [.55]

Acquirer Book to Market .34 .39 - 1.23 - .61(.31) (.32) [.21] [.54]

CAR(- 1, 0) - 4.1% - .3% - 5.47** - 4.73**(3.5%) (- .5%) [.00] [.00]

This table compares the board and deal characteristics for rms that use an FO (opinioned) with those that do not (non-opinioned). PanelA includes the entire sample, while Panel B includes a matched sample. The full sample consists of 1,102 deals of which 103 obtained anFO. For the matched sample, we match opinioned deals to non-opinioned deals based on industry (4-digit SIC code), size (acquirersmarket capitalization, and book-to-market ratio). We are able to match 103 opinioned acquirers to 185 non-opinioned rms. Variabledenitions are provided in Table 1. The t-statistics are from difference in means tests and the z-statistics are from Wilcoxon two-sampletests. Medians are in parentheses. P-values are in brackets under the t- and z-statistic columns.p < .10*p < .05**p< .01.




9/16

T A B L E 3

D e t e r m

i n a n t s o

f U s i n g a n

A c q u

i r e r

F a i r n e s s

O p

i n i o n

% o f o u t s i d e r s

B o a r d s i z e

N u m

b e r o f o u t s i d e r s

N u m

b e r o f i n s i d e r s

S e r v i c e y e a r s

B u s y n e s s

P o o l

P o o l

( 1 )

( 2 )

( 3 )

( 4 )

( 5 )

( 6 )

( 7 )

( 8 )

I n t e r c e p t

- 2 . 0 5 * *

- 3 . 2 9 * *

- 2 . 1 6 * *

- 1 . 7 2 * *

- 1 . 7 1 *

- 1 . 9 6 * *

- 3 . 0 2 * *

- 2 . 0 7 * *

( . 7 2 )

( . 7 9 )

( . 6 6 )

( . 6 2 )

( . 7 0 )

( . 6 8 )

( . 9 1 )

( . 7 3 )

L o g

( A s s e t s )

- . 5

8 * *

- . 8

0 * *

- . 6

8 * *

- . 6

1 * *

- . 5

5 * *

- . 5

4 * *

- . 7

3 * *

- . 6

9 * *

( . 0 8 )

( . 1 1 )

( . 0 9 )

( . 0 8 )

( . 0 8 )

( . 0 8 )

( . 1 2 )

( . 1 1 )

P r e - p e r

f o r m a n c e

- 6 . 1 3 *

- 5 . 4 8

- 5 . 8 7 *

- 6 . 1 7 *

- 6 . 7 1 *

- 6 . 5 7 *

- 6 . 2 9 *

- 6 . 5 7 *

( 2 . 7

9 )

( 2 . 8

8 )

( 2 . 8

3 )

( 2 . 7

9 )

( 2 . 8

6 )

( 2 . 8

8 )

( 3 . 0

1 )

( 3 . 0

0 )

% o f

O u t s i d e r s

. 5 0

. 1 1

( . 5 3 )

( . 5 9 )

L o g

( B o a r d

S i z e

)

1 . 2 4 * *

1 . 0 7 * *

( . 3 6 )

( . 4 0 )

L o g

( N u m

b e r o f

O u t s i d e r s )

. 5 4 *

. 5 6 *

( . 2 2 )

( . 2 4 )

L o g

( N u m

b e r o f I n s i

d e r s )

. 1 8

. 3 2

( . 1 6 )

( . 1 9 )

S e r v i c e

Y e a r s

- . 0

3

- . 0

3

- . 0

4

( . 0 3 )

( . 0 3 )

( . 0 3 )

B u s y n e s s

- . 2

8

- . 2

8

- . 2

9

( . 1 6 )

( . 1 6 )

( . 1 6 )

B o a r d H o l

d i n g s

- . 0

1

- . 0

1

- . 0

0

- . 0

1 *

- . 0

1

- . 0

1

- . 0

1

- . 0

1

( . 0 1 )

( . 0 1 )

( . 0 0 )

( . 0 1 )

( . 0 1 )

( . 0 1 )

( . 0 1 )

( . 0 1 )

L o g

( T r a n V a l u e )

. 7 2 * *

. 7 8 * *

. 7 4 * *

. 7 2 * *

. 6 9 * *

. 7 4 * *

. 7 9 * *

. 7 8 * *

( . 0 8 )

( . 0 8 )

( . 0 8 )

( . 0 8 )

( . 0 8 )

( . 0 8 )

( . 0 9 )

( . 0 9 )

S a m e I n d u s t r y

- . 2

9

- . 3

2

- . 2

9

- . 3

1

- . 2

1

- . 2

7

- . 3

2

- . 3

2

( . 1 6 )

( . 1 6 )

( . 1 6 )

( . 1 6 )

( . 1 7 )

( . 1 8 )

( . 1 8 )

( . 1 8 )

H o s t i l e

- 1 . 5 8 *

- 1 . 7 5 *

- 1 . 6 7 *

- 1 . 5 7 *

- 1 . 2 4

- 1 . 2 7

- 1 . 4 2 *

- 1 . 4 1 *

( . 6 5 )

( . 7 1 )

( . 6 7 )

( . 6 6 )

( . 6 7 )

( . 6 7 )

( . 7 2 )

( . 7 1 )

S t o c

k P a y

. 8 8 * *

. 9 1 * *

. 9 0 * *

. 8 7 * *

. 8 6 * *

. 8 0 * *

. 8 2 * *

. 8 1 * *

( . 2 3 )

( . 2 3 )

( . 2 3 )

( . 2 2 )

( . 2 4 )

( . 2 4 )

( . 2 5 )

( . 2 4 )

N u m

b e r o f B i d d e r s

- . 3

6

- . 4

1

- . 3

8

- . 3

8

- . 4

7

- . 4

4

- . 4

8

- . 4

9

( . 3 6 )

( . 3 7 )

( . 3 6 )

( . 3 6 )

( . 3 8 )

( . 3 8 )

( . 4 0 )

( . 4 0 )

P u

b l i c T a r g e t

. 6 4 *

. 7 2 * *

. 6 6 *

. 6 6 * *

. 5 4 *

. 5 3 *

. 6 3 *

. 6 2 *

( . 2 5 )

( . 2 7 )

( . 2 5 )

( . 2 5 )

( . 2 6 )

( . 2 6 )

( . 2 8 )

( . 2 8 )

Y e a r D u m m i e s

Y e s

Y e s

Y e s

Y e s

Y e s

Y e s

Y e s

Y e s

N

8 4 8

8 4 8

8 4 7

8 4 7

7 4 2

7 4 2

7 4 2

7 4 2

P s e u

d o R - s q u a r e

. 4 3

. 4 5

. 4 4

. 4 3

. 4 4

. 4 5

. 4 7

. 6 8

T h i s t a b l e r e p o r t s r e s u

l t s

f r o m

l o g i s t i c r e g r e s s i o n m o d e l s p r e

d i c t i n g t h e

l i k e l i h o o

d o f u s i n g a n A F O

. B o a r d a n

d d e a l c h a r a c t e r i s t i c v a r i a b

l e s a r e

d e n e d i n T a b l e 1 . S t a n

d a r

d e r r o r s

a p p e a r i n p a r e n t h e s e s .

p

Documents

Corporate Governance5