Institutional Ownership, Tender Offers, and Long-Term Investments

8/14/2019 Institutional Ownership, Tender Offers, and Long-Term Investments

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3 5007 00475441 6

A Study

by

The Off ice of th e Chief EconomistSecu r i t i e s and Exchange Commission450 5th S t r e e t , N.W.Washington, D.C. 20549

Apri l 19 , 1985

I n s t i t u t i ona l Ownership, Tender Offer s ,and Long-Term Inves tments

The views expressed here in a re those of the Off ice of th eChief Economis t only . The Commission has expressed no viewon t h i s s tudy .


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PERSONS TOCONTACT

Ins t i tu t iona l Ownersh ip , Tende r Offers ,and Long-Term Investments

Gregg A. Ja r re l l - 272-7104Ken Lehn - 272-7147Wayne Marr - 272-7640One of the pr inc ipa l arguments made by cr i t i c s of host i le

tender offers is tha t the threa t of a host i le tender offerpreoccupies co rpo ra te execu ti ve s with propping up short-termearnings, a t the expense of investing in long-cerro projects ,such as research and development. 1/ Although th is argument,hereafter referred to as the ~ s h o r t - t e r m a r g u m e n t ~ , hasat t rac ted a sympathetic audience, no e v i d e ~ c e has yet beenadvanced i i t s support . This study empir ical ly examines theargument and concludes tha t i t is not supported by s ta t i s t i ca levidence eresented here.The Short-Term Argument

Central to the short- term argument is the observationtha t ins t i tu t iona l investors (e .g . , pension funds, mutual funds)have come to dominate the ownership of corporate equi ty. In .contrast to the t rad i t iona l i nd iv idual sha reholde r, i t isargued that ins t i tu t iona l investors have short- t ime horizons,and regularly "churn t he ir p or tf oli os . This procl iv i ty tochurn supposedly der ives from two sources: the f iduciaryresponsibil i ty of fund managers, and the in tensely competitivemarket for money managers th at res ul ts in quar ter - to-quar termonitoring of the i r performance.

This behavior of large ins t i tu t iona l shareholders purportedlyfac i l i ta tes host i le tender offers - ins t i tu t iona l investors


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- 2 -stand ready to tender the i r shares to any b i d d e r ~ f f e r i n geven a small premium o v ~ r market pr ice . To stave o ff h os ti letakeover at tempts , corporate managers supposedly t ry to propup stock prices by increasing shor t- te rm earn ings , even a t theexpense of abandoning otherwise profi table long-term investmentprojects in which present expend iture s are incurred inant ic ipat ion of future earnings. According to proponentsof the short- term argument, th is induced myopia i s ubiquitousamong corpora te execu tives and i t i s eroding our country 'sabi l i ty to compete in the in ternat ional economy. ~

On conceptual grounds, many economists are cr i t i ca l of, the s h o r t - t ~ r m argument. 1/ Impl ic i t in the short- termargument is the view tha t the capi ta l market systematical lyunderva lues expected ea rn i nqs, The argument assumes , tha tinvestors are pers is tent ly fooled by firms that reduceexpenditures on economically viable long-term investmentprojects in order to inf la te present earnings. Economistsargue tha t the arbitrage poss ib i l i t i e s presented by systematicmispricing of secur i t i es creates strong f inancial incentivesfor se l f -correc t ion in the stock market. This occurs assoph i st ica ted investor s bid up (down) the price of undervalued(ovc rvaLued ) securi t ies unt i l the price of a securi ty equalsan unbiased estimate o f i t s "true" value. The economists ' view does not deny tha t under some circumstances, corporatemanagers may have incentives to ar t i f ica l ly inf la te earningsin ways tha t are costly for investors to monitor. Infla t ing


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s h o r t - t e r m earnings by reducing expendi tures-on o t h e r w i s ep r o f i t a b l e investment p r o j e c t s , however, i s too v i s i b l e ,p a r t i c u l a r l y to s b p h i s t i c a t e d i n v e s t o r s such as i n s t i t u t i o n a lfunds . Firms t h a t fol lowed t h i s p r a c t i c e , according t o theseeconomists , would unfavorably a f f e c t t h e i r s t o c k p r i c e ,t he re by r en de rin g t h i s s t r a t e g y i n e f f e c t i v ~ i n s t a v i n g o f fh o s t i l e t e n d e r o f f e r s .

, Although economists have not d i r e c t l y examined ther e l a t i o n s h i p between i n s t i t u t i o n a l owner$hip, h o s t i l e tendero f f e r s , and investment i n long- te rm p r o j e c t s , t h e r e i $ ' anabundance o f i n d i r e c t evidence t h a t i s i n c o n s i s t e n t withthe s h o r t - t e r m argument. There i s , f o r example, c o n s i d e r a b l es t o c k p r i c e e V i d e ~ c e showing t h a t t ~ market e f f e c t i v e l y .v a l u e s t i m e - d ~ s c o u n t e d cash 'f l ows , not ~ i m p l y c u i r e n t reportede a r n i n g s . For example, the market does n o t ' d e v a l u e companiest h a t switch t h e i r inventory v a l u a t i o n from f i r s t - i n , f i r s t o u t (FIFO) t o l a s t - i n , f i r s t - o u t (LIFO), even though t h i saccount ing change i s supposed t o reduce r e p o r t e d e a r n i n g sduring p e r i o d s o f p o s i t i v e i n f l a t i o n ~ a t e s . ! / ' Al s o , the f a c tt h a t p r i c e - e a r n i n g s r a t i o s vary widely a c r o s s f i rms i n d i c a t e st h a t the market does d i s c r i m i n a t e in a s s e s s i n g the f u t u r ep r o s p e c t s of f i rms. 1/ . In a d d i t i o n , received wisdom holdst h a t the p r i n c i p a l sources o f f inancing f o r v e n t u r e c a p i t a lf i rms a r e i n s t i t u t i o n a l i n v e s t o r s , which seems t o damage thearg 'ument t h a t i n s t i t u t i o n a l , i n v e s t o r s a r e a t t r a c t e d only tof irms' with r e l a t i v e l y high s h o r t- te r m e a r n i n g s .


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- 4 -Testable Implications of the Short-Term A r g u m e n ~

Besides this abundance of i n d i r e c t evidence, which isi n c o n s i s t e n ~ with the short- term argument, no evidence thatdirect ly addresses the short- term argument has yet beenpresented by .ei ther i t s proponents or i t s c ri t i c s . / Giventhe p r o f o u ~ d implications of ' accepting t h i s a r g ~ m e n t , it isimportant ~ h a t i t be subjected to rig orous empirical t es t ing .In our view, the short- term argument has the following testableimplications:

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An inverse relat ionship should ex i s t b e t w e e ~ thepercentage of a f i rm's equity held by ins t i tu t iona linvestors and the leve l of the f i rm's investmentin long-term prqjec ts , such as R&D ( i . e . , thegrea ter the ins t i tu t iona l holdings, the lower isR&D) Target fi rms in ' tender offers should exhibi t highspending on ,l ong - t e rm i n v e ~ t m e n t projects . re la t iveto t h e i r ' ~ a s t experience, ~ n re la t ive to other firmsin the same industry ,The percentRge of equity held by ins t i tu t iona linvestors in t a rge t firms of tender offers shouldbe higher than the corresponding figure for nont a rge t firms in the same industry, preceding the i rtakeover.

o The public announcement by firms tha t they areembarking on a new long-term investment projectshould resu l t in a negative stock price react ion,ref lect ing the market 's expec ta ti on tha t short-termearnings wil l be adversely affected.The remainder of th i s study reports the ' resul t s from anempirical invest igat ion of these and related implicationsof the short-term argument.Empirical Results

Ins t i tu t ional Holdings and Investments in R&DThe short-term argument makes a testable predict ion


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about the re la t ionsh ip between the percentage_of a firm=sequi ty held by i n s t i t u t i ons and i t s investment in long-termp ro j e c t s . Since t h i s a r g u ~ e n t s t a t e s t ha t the growth oEi n s t i t u t i ona l ownership i s inducing myopia among corpora teexecu t i ves , we should observe r e l a t ive ly low (high) Lnve s tmen tin long- te rm pro jec t s by companie s h av ing a l a rge (smal l )percentage of equi ty held by i n s t i t u t i ons .

To examine the re la t ionsh ip between i n s t i l u t i ona lownership o f corpora te equi ty a n investment in long-termpro j ec t s , we col lec ted da ta fo r 324 f i rms represent ing ac ross sec t ion of indus t r i e s including aerospace , appl i ances ,automobi les , chemicals , drugs , e l e c t r i c a l , fue l , informat ionp ro c es si ng , i ns tr umen ts , l e i su re , farm machinery, paper ,personal and home care p ~ o d u c t s , semiconductors , s t e e l , t e l e -communications, food and b e v e r a g e s ~ and t i r e s and rubber .This sample cons is t s of a l l f irms in these indus t r i e s whichwere l i s t ed in th e Busin ess Week "R&D Scoreboard" fo r each ofthe yea r s , and fo r which we were able to obta in da ta oni n s t i t u t i ona l o w n e r s h i p ~ For each of these f i rms we col l ec tedthe fol lowing data fo r each of years 1980-1983: the opercentageof common equi ty held by i n s t i t u t i ons th at repo rt to the SECunder Rule 13F ( i . e . , i n s t i t u t i ona l funds with combined equi tyas se t s in excess of $100 m il l io n) , to ta l revenues , ne t incomebefore ext raord inary i temsoor discont inued opera t ions , andcompany sponsored R&D expendi tures , which i s our proxy fo r thecompanies ' investment in long-term pro jec t s . The f i rms vary


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widely in s i ze , ranging from Gelman Sciences with-1983 revenuesof $40 mil l ion to Exxon with 1983 revenues of S89 b i l l i on .

In sho r t , these data tend to re fu te the shor t - t e rm argument.Table 1 shows t h a t i n s t i t u t i ona l ownersh ip, as a percentageof common equ i ty , has s tead i ly increased from an average of30.0 in 1980 to 38.0 in 1983. Concomitant with t h i s increasehas been a s teady increase in the average ra t io of R&D torevenues , from 3.38% in 1980 to 4.03% in 1983. I n the aggregate ,then, i n s t i t u t i ona l ownership has been increas ing , but therei s no evidence tha t corpora te managers have become increas inglymyopic by . inves t ing more in shor t - t e rm pro j ec t s . Indeed, the

o p p o ~ i t e i s ~ r u e , according to these da ta .Since the l eve l of a f i rm ' s R&D expendi tures i s determined

by many ~ a c t o r s , it i s usefu l to probe behind t h aggregate~ a t a to de tec t the incrementa l impact of i n s t i t u t i ona l ownership .on R&D expendi tures . Table 2 conta ins r e su l t s from es t imat ionof a regress ion equat ion in which the average R&D to revenuesr a t io .(1980-1983) fo r each of the firms i s regressed on: i ) tneaver:age percentage of equi ty held by i n s t i t u t i ona l i nves to r sin the firm over the same . per iod , and i i ) a se r i es of indus t rydummy var iab les . These r e su l t s r evea l , holding indus t rye f E e ~ ~ s cons t an t , tha t there i s a d i r e c t and s t a t i s t i c a l l ys ign i f i can t r e l a t ionsh ip between i n s t i t u t i ona l ownership andR&D expendi tures . This means t ha t the higher the i n s t i t u t i ona lholdings in a f i rm, the higher i s i t s R&D ac t iv i t y . Althoughthese r e su'Lcs do not es tab l i sh t ha t higher i n s t i t u t i ona l


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7 -ownership causes high R&D expendi tures , they ao s t ronglysuggest t ha t i n s t i t u t i ona l inves tors a re not deter red frominves t ing in firms with high R&D expendi tures .

The causa l re la t ionsh ip between i n s t i t u t i ona l , ownershipand R&D expendi tures can be ~ n v e s t i g a t e d empi r i ca l ly byexam in ing w hat hap pen s to R&D expendi tures in f i rms t ha texperience changes in the percentage of i t s equi ty heldby i n s t i t u t i ona l i nves to r s . In many of the 324 f i rms in oursample, there were s izeable changes in the percentage o fequi ty held by i n s t i t u t i on s , ranging from a decl ine of 29percentage poin ts in MatteI , to an inc rease of 48 percentagepoin t s in Outb oard M a rin e. The shor t - t e rm argumentpred ic t s tha t companies such as Outboard Marine wi l l becomemore vulne rable to hos t i l e t a k e o v e r s ~ 'As a r e s ~ l t , thesecompanies wi l l become i nc reas ing ly more preoccupied withshor t - te rm earn ings , which should manifes t i t s e l f in ' r educ t ionsin R&D expendi tures . By the same log ic , companies exper iencingsubs tan t i a l reduc t ions in i n s t i t u t i ona l o w n e ~ s h i p wi l l fee ll ess threa tened by a hos t i l e takeover , which should r e s u l t inan increase in t he i r R&D expendi tures .

Tables 3 ~ n 4 list r e su l t s which 6 o n t r a ~ i c t the predic t ionof the s h o r t ~ t e r m argument . In Table 3 , we list th e av eragechanges , in the r a t i o o f R&D out lays to sa l e s from 1980 ' t o,1983 for f i rms t h a t experienced , a decl ine in i n s t i t u t i ona lownership and fo r groups of f i rms t ha t experienced progress ive lyla rg er in cr ea se s in i n s t i t u t i ona l ownership. The average


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- 8 -change in R&D-sales ra t io for the firms experiencibg a declinein ins t i tu t iona l ownership was 0.67%. The correspondingchange for firms experiencipg an in crease in ins t i tu t iona lownership was almost ident ical , 0.65%. Furthermore, nodiscernib le pat tern in R&D changes exis t s among firm s w ithincreasingly l a rger pos i t ive changes in ins t i tu t iona l holdings.

Table 4 con ta in s r eg re ss ion resul ts from ~ equation inwhich the change in . .R&D-revenue ra t io for each of the 324 firmsis regressed on the change in ins t i tu t iona l hoidings and a se tof industry dummy ' variables . These resul ts indicate tha t a posi t ive , but s t a t i s t i ca l ly ins igni f icant re la t ionship exis t sbetween changes in ins t i tu t iona l holdings and changes in R&Dexpenditures. .I n sho t t , Tables j and 4 do not provide empiricalsupport for the . argument that an increase in ins t i tu t iona lownership causes corporate managers to become myopic.R&D Activi ty and Ins t i tu t iona l Ownership inTarget Firms of Tender Offers

Another testable p r o p o ~ i t i o n of the short- term argument isthe contention tha t firms which inves t in long-term projectswi l l suffer decl ines in the .market value of the i r equi ty , andpossibly a takeover. This proposi t ion implies tha t R&Dexpentiitures in t a rge t firms of tender offers should be highre la t ive to the f i rm's pas t experience and re la t ive to anindustry control g r ~ u p of non ta rg et firms.

To t e s t th i s proposi t ion, we consulted the pre- tender offer ,lO-K reports of a l l target firms in successful tender offers during


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- 9 -the period 1981-1984. Of t h 217 t a r g e t f i rms i n t h i s sample ,160 f i rms r e p o r t e d t h a t t h e i r R&D e x p e n d i t u r e s were "not m a t e r i a l " .This high percentage 'of a c t u a l t a r g e t s not r e p o r ti n g m a t e r i a lR&D o u t l a y s s su g g e s ts t h a t ' it i s i n c o r r e c t t o i d e n t i f y a c t u a lt a r g e t s with i n t e n s i v e R&D a c t i v i t y . For the remaining 57f i rms in the sample 'having m a t e r i a l R&D o u t l a y s , we c a l c u l a t e dthe R&D-to-revenue r a t i o i n the y e a r immediate ly preceding thet e n d ~ r o f f e r , and. i n the t h r e e p r i o r y e a r s . For t h e samey e a r s , we a ls o c a l c u l a te d t h e s e r a t i o s f o r the i n d u s t r i e s in'wh i ch t h e s e f i rms competed.

Table 5 shows t h a t , c o n t r a r y t o the s h o r t - t e r m argument ,the value weighted R&D-revenue r a t i o f o r t a r g e t f i r m s ~ 0.77%, wasl e s s than o n e - h a l f t h a t o f the i n d u s t r y c o n tr o l groups, 1.66%, .i n the, year immedia t e l y p r e ced Lnq the t e n d e r , o f f e r . Furthermore,these d a t a were not s i g n i f i c a n t ly d i f f e r e n t from th e correspondingd a t a in the t h r e e previous y e a r s : 0.75% f o r t a r g e t f i rms and1.49% f o r the i n d u s t r y c o n t r o l groups. These d a t a s t r o n g l ysuggest t h a t inves tment i n long-term p r o j e c t s , such as R&D doesnot make a firm v u l n e r a b l e to t a k e o v e r s .

We c a u t i o n , however, a g a i n s t drawing tne tp.mpting i n f e r e n c et h a t t a r g e t f i rms t y p i c a l l y " u n d e r i n v e s t " in R&D. As Table 6shows, these t a r g e t f i rms were s i g n i f i c a n t l y , s m a l l e r than t h e i ri n d u s t r y c o u n t ~ r p a r t s . Median revenue f o r the 57 t a r g e t f i rms inthe year immediate ly preceding the t e n d e r o f f e r was ~ 3 l 2 m i l l i o n ,as , compa r ed with a corresponding m e d ~ a n of $1382.6 m i l l i o n f o r--the i n d u s t r y c o n t r o l groups . S i m i l a r l y , the average revenue f o r


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the two s e t s of f i rms was 51731.5 mil l ion and $2>92.1 mil l ion ,r .espect ive ly. To the ex ten t t h a t economies of sca le ex i s t inR&D, which i s a common and sens ib le be l i e f , it i s na tu ra l to~ x p e c t smal le r f i rms to have smal le r R&D-revenue r a t i o s thanl a rger . f i rms . Non eth ele ss , th e da ta do not suppor t thepropos i t ion t h ~ t t a rg e t . f i rms tend to "over inves t" in R&Dpco jec t s .

The shor t - t e rm argument a lso p re dic ts tha t i n s t i t u t i ona lownership in t a rg e t f i rms i s higher than i n s t i t u t i ona l ownersnip. i n non ta rg et f irm s. Table 7 l i s t s the average percentage ofequi ty held by . i n s t i t u t i ona l i nves to r s ( tha t repor t to the SECunder 13F) ~ 177 t a rg e t f i rms (1981-1984) in the quar t e rimmediate ly preceding the tender of f e r . Also l i s t ed i s the.c o ~ r ~ s p o n d ~ n g a ~ e r a g ~ fo r 177 i n d ~ s t r y cont ro l groups. T h data show t h a t i n s t i t u t i ona l ownership in the t a rg e t f i rms,19.3%, was ac tua l ly ' .ower, than it was, 33.7%, in the indus trycon t ro l groups . Given tha t t a r g e t f i rms t yp ica l ly are smal lerthan t he i r indust ry counterpar t s , th i s di f fe rence may be a t t r i -buted to s ize d i f f e rences . These da ta do, however, suggestt h a t it i s not high i n s t i t u t i ona l ownership per se t h a t fue lstender of f e r s .

Stock Pr ice React ion to R&D AnnouncementsFina l l y , the. short - term argument unambiguously p re dic ts th at

the s tock market d ev alu es firm s which inves t in p ro je cts th atimpair t h ~ i r s hor t- te rm ea rn ing s, even i f these pro jec t s have apos i t ive ne t presen t va lue . To t e s t th is pred ic t ion , we examined


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the s tock pr i ce reac t ion to 62 Wall S t r e e t Journa l announcementst ha t f irms were embarking on an R&D p ro j e c t . These announcemen tswere co l l ec t ed by in s t ruc t ing NEXIS, the news r e t r i eva l system, toprovide us with a l l Wall S t r e e t Journa l a r t i c l e s conta ining thewords - research and developent" during the period 1973-1983.Using the convent ional even t s tudy methodology, 2/ we es t imatedthe ne t- of -ma rk et s to ck re turns to shareholders of the 62 f i rmsaround the da te on which they announced t he i r R&D p r o j e c t s ~

Table 8 conta ins the r e su l t s from th i s exper iment . On the. announcement day, Day 0, these f irms e xp er ie nc ed an averageabnormal re turn of pos i t i ve 0.45%, fol lowed by an add i t i ona l

. .0.35% abnormal re turn on the next t rad ing day. The twa-dayannouncement re turn o f 0.80% i s s t a t i s t i c a l l y s i gn i f i c an t( t - s t a t i s t i c 2.5) and r ep resen t s a subs tan t i a l ne t -of -marke tin crease in the value 'o f the f i nn ' s equi ty . During the 20 t radingdays a f t e r the . announcement, . th e c umulative ne t -of -marke t re turnincreases to 1.8%.

This evidence s t rongly r e fu t e s the propos i t ion tha t thes tock market values only shor t - t e rm ea rn ings , and no t expectedfu ture ea rn ings . A l og ica l in fe rence to be drawn from th i sevidence i s th a t it i s fu t i l e fo r co rp ora te managers to t ry tof o r e s t a l l a hos t i l e takeover by pumping up shor t - te rm earn ingsa t the expense of in ves tin g in long-term pro jec t s with pos i t i venet p re se nt v alu es .


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ConclusionThe evidence repor ted in t h i s s tudy uniformly con t r ad ic t s

t he shor t - t e rm a r g u m e n t ~ This ev id en ce shows:o

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For a sample o f 324 f i rms in a dive rse s e t ofi ndu s t r i e s , th e percentage 'o f equi ty held byi n s t i t u t i ona l i nves to r s ( t h a t r epor t to . theS E under Rule 13f) increased from 30% in 1980to 38% in 1983. During th i s same pe r iod , th eaverage R&D-revenue r a t i o fo r these f i rms a lsoi nc reased from 3.38% to 4.03%. These aggrega tedata do no t supp ort the argument t ha t the growthin . i n s t i t u t i ona l ownership of corpora te equi tyi$ fo rc ing corpora te managers to 'be c ome moremyopic. (See Table 1 . ) .Regress ion ana lys i s revea l s t ha t , holdingindus t ry e f f e c t s cons t an t , i n s t i t u t i ona l i nves to r sac tua l ly seem to favor firm s w ith high R&D-revenuer a t i c s . (See 'Tab le 2 .)

0" In our sample o f 324 f i rms , 88 f i rms exper ienceda . decl ine in i n s t i t u t i ona l ownership during t h i speriod and 236 f irm s e xp erie nc ed an in c rea se ini n s t i t u t i ona l o ~ n e r s h i p . The average qhange in"R&D- r e ve n ue r a t i o fo r the two groups of f i rms ,however, was almost i d en t i c a l - 0.67% fo r theformer group and 0.65% fo r the Lat t e r group.These da ta re fu te the argument t h a t i nc r ea se sin i n s t i : u t i ona l ownership cause managers tofocus more on the shor t - t e rm. (See Table 3 .)

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Regress ion ana lys i s revea l s tha t , holding indus t rye f f e c t s cons t an t , changes in i n s t i t u t i ona l holdingsa re not cor re l a t ed with changes in R&D a c t i v i t y .(See Table 4 .)Examination o f da ta on R&D expendi tures fo r 57t a r ge t f i rms (1981-1984) revea l s t h a t t hese f i rmshad an average R&D-sales r a t i o , 0.77%, which wasl ess than one-ha l f of t h a t , 1.66%, fo r an indus t rycon t ro l group in the year i ~ e d i a t e l y precedingthe t ender of f e r . These data s t rongly sugges tt h a t investment in long-term pro j ec t s qoes no tinc rease a f irm 's v u ln e ra b il ity to a t akeover . Iti s a l so noteworthy t h a t an add i t i ona l 160 t a rg e tf i rms dur ing th i s period reported ( in t he i r 10-R's)t ha t t h e i r R&D expend i tu res were "no t mate r i a l " .We caut ion aga ins t drawing the i n fe rence t ha t


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. o

o

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these f irms became vulnerable t o a t akeover becausethey were under inves t ing in R&D a c t i v i t y . Targe tf i rms are sm alle r than t he i r indus t ry counterpar t s ,and to the ex t en t there a re economies of sca l e inR&D, it i s na tu ra l to f ind lower R&D-sales r a t iosfo r t a rg e t f i rms. (See Table 6 .) In add i t ion , thet a rg e t f i rms ' R&D-revenue ra t io in the year immediately.p r e c e d i n g the t ende r o ffe r is not s i gn i f i c an t l yd i f f e r en t from the corresponding r a t i o , 0.75%, in theprevious th ree yea r s .The average p e r c e n t a g ~ of equi ty held by i n s t i t u t i ona linves tors in 177 t a r ge t f irms ( 1 9 8 1 ~ 1 9 8 4 ) fo r which wewere ab le to obta in ownership da t - was 19.3% in thequa r te r immediate ly preceding the tender of fe r , ascompared with a corresponding average of 33.7% fo r f i r ms in an in d us tr y c on tr ol group o f nontarge t f i rms.These da ta seem to con t r ad ic t the a sse rt io n th at heavyi n s t i t u t i ona l ~ w n e r s h i p per se gives r i s e to hos t i l et akeovers . (See Table 7 .)Stock pr ice . evidence revea l s t h a t the cap i t a l marketpos i t ive ly values companies t h a t announce t h a t theya re embarking on an R&D p ro j e c t . The ne t -of -marke tinc rease in the equi ty value . of 62 f i rm s making such.announcements (1973-1983) was 0.80% over the twodays fo l lowing the announcement, and .t h i s increasei s s t a t i s t i c a l l y s i gn i f i c an t . This e ~ i d e n c e rebukesthe argument t ha t the market penal i zes companies tha ti nves t in long term pro jec t s and thereby makes themcandida tes fo r - hos t i l e takeovers .

Col l ec t iye ly , t h i s evidence seems to re fu te the shor t - t e rm argument.We welcome comments and su gg estio ns fo r improving the s tudy fromboth proponents and c r i t i c s ~ t h i s argument.


15/23

1/

2/

FOOTNOTES

This argument h as appeared f requent ly in t h husinesspres s , including "Andrew Sig le r : Rules fo r the TakeoverGame", Financ ie r (March 1985) , pp. 15-20: Pe t e r Drucker ,"Taming the Co rpor at e Takeove r" , Wall S t r ee t Journa l(October 30, 1984) : A llan S loan , "Why i s No One Safe?" ,Forbes (March 11, 1985) , pp. 134-140: "Wilt Money ManagersWreck the Economy?", Business Week (August 13, 1984) , pp.86-91. This argument a lso has surfaced in Congress ionalprop osa ls to regula te hos t i l e takeovers . See, fo r . example,Mart in L ip to n 's p ro po sa l, "The Shareholder Protec t ion andEliminat ion of Takeover Abuses Act of 1985" November 20,1984.proponents of the shor t - t e rm argument f requent ly contendtha t t akeover f ea r is ~ r o d i n g our compet i t ive pos i t i onvi s -a -v i s Japan. I n t e r e s t i ng ly , however, the percentage ofequi ty owned by i n s t i t u t i ona l inves tors in Japan has increaseds i gn i f i c an t l y during the pa s t 32 years from 38.6% in 1980 to71.9% in 1982. (Source: Secur i t i e s Markets in Japan 1984(Tokyo:. Japanese Secur i t i e s Research I n s t i t u t e ) , 1983) Onescholar even a t t r i bu t e s . the fa rs igh tedness of corpora temanagement in purported Japan to the dominant ownershipoos i t i on of i n s t i t u t i ona l inves tors : "In Japan , where~ i r t ~ a l l y a l l e q ~ i t y i s held by banks . and l ~ r g e inves tmentf i rms , the concern fo r s h o r t - t ~ r m performance i s no t near lyas acu te fo r longer- term prospec t s . As a r e su l t , Japanesefirms a re not as co ncern ed as Western firm s about shor t - te rmp ro fi t s o r, for tha t mat te r , pro f i t s in gene ra l . " (See C. CarlPege ls , Japan vs . the West (Kluwer-Ni jhoff) , 1984.)See , fo r example, the test imony o f P ro fe ss ors Harold Demsetz,Michael Bradley , and Michael Jensen in the t r ansc r i p t forthe SEC Economic Forum on Tender Offers , February 20, 1984.See, fo r example, Shyam Sunder, "Stock Pr ice and R isk R elatedto Accounting Changes in Inventory Valu atio n" , J ou rn al ofAccounting Research (Apr i l 1975), pp. 305-313.These poin t s were made by the economists a t the SEC BconomicForum on Tender Offe r s , February 20, 1985. See footnote 3.pre l iminary f indings. from t h i s emp iric al in q uir y were sent toSEC Chairman John S.R. Shad in two memos, dated January 22,1985 and February 20, 1985.For a discussion of th i s methodology, see William Schwe rt,"Using Financ ia l Data to Measure Effec t s of Regul i t ion" ,Journal o f Law and Econom ics (Apri l 1981), pp. 121-158.


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TABLE 1

Average Ins t i tu t iona l Holdings (As Percent ofCommon Equity) and Average R&D/Revenuefor 323 Corporations, ~ 9 8 0 - 1 9 8 3

1980198119821983

Average Ins t i tu t iona lHoldings

30.031.234.338.0

AverageR&D ExpendituresAs .Percentage of Revenue

3.38%3.583.984.03


17/23

TABLE 2

OLS Est imate of Average R&D/Revenue, 19801983, as Function of Average I n s t i t u t i ona l. Holdings , and Indus t ry Var iab les( t - s t a t i s t i c s in paren theses )

In t e rcep tI n s t i t u t i ona l HoldingsChemicalsDrugsAerospaceAppliancesAutomobilest.e Lsu reFuelPaperStee lElec t r i ca l 'Horne CareTires and RubberIns trurnen t sHi Tech*Food

0.03( 6.6)0.0002(2 .9 ) .-0 .01(2 .4)0.04( 5 .7)-0 .005(0 .7)-0 .02(2 .2)-0 .005( 0 .4)-0 .009(1 .1)-0 .04( 4.4 ) - 0 . 0 3( 4 .0)-0 .03( 2 3 )-0 .03( 3 . 9 )-0 .02( 2 .3)-0.03( 2 .7 )0.003( 0 .7 )0.02( 4.5 )-0 .02( 3 . 9 )

3240.4113.1

ch i nc lude s i nforma ti on process ing , of f i ce equipment,onductors and te lecommunicat ions .


18/23

TABLE 3

Average Change in I n s t i t u t i ona l Holdings (as .Percen t of Common Equi ty ) , 1980 -1983 and AverageChange in R&D/Revenue, 1980-1983 fo r Firms withNegative and Increas ing ly Pos i t ive Changes

in In s t i t u t i ona l Holdings

Group of FirmsAverage Change inIn s t i t u t i ona l Holdings1980-1983

Averagein R&D asPercentage of

. ~ v e n u e , 1980-1983

88 Firms with a Decl inein I n s t i t u t i on a lHoldings

236 Firms with Increasein I n s t i t u t i on a lHoldings

79 Firms w i t b ~ m a 1 1 e s t. Inc rease inIn s t i t u t i ona lHoldings

77 Firms withMedianIncrease inI n s t i t u t i on a lHoldings

80 Firms with Larges tIncrease inI n s t i t u t i on a lHoldings

-5 .53

13.02

3.84

10.67

24.33

0.67%

0.65

0.89

0.41

0.64


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TABLE 4

OL5 Est imate of Change in R&D/Revenue,1980-1983 as Function of Change inIn s t i t u t i ona l Holdings , 1980-1983and Indus t ry Variables( t - s t a t i s t i c s in p are nth ese s)

In t e r cep tChange in I n s t i t u t i on a lHoldingsChemicalsDrugs ..AerospaceAppliancesAutomobilesLeisureFuel .PaperStee lElec t r i c a lHomecareTires and RubberIns trume n t sHiTech*Food

0.006. . (2 .3)0.00005(0 .6)-0.0008(0 .2)0.01(2 .9)-0.0002( 0 0 )-0.005( 0 .8 )-0.01(1 .6)0.001(a.2 )-0.005(0.9) '-0.005( 1 a)-0.003(a.4 )-0.002(a .5 )-0.004(a .9 )-0.0008(0 .1)0.0009(0 .3)0.003(1.1 )-0 .002(0 .5)3240.071.4

1 Tech ~ n c l u d e s in format ion process ing , of f i ce equipment ,iC9nductors , and te lecommunicat ions .


20/23

TABLE 5

R&D a s P ercen ta ge of R e v e n u e fo r 57 Targe t F i r m san d t h e i r Indus t ry G r o u p s in Y e a r Pr i o r toT e n d e r Offe r a n d t h e T h r e e Previous Y e a r s

Gro u p o f F i r m s

T a r g e t F i r m sIndus t ry G r o u p

R&D a sPercentage . of R e v e n u e

in Y e a r p r e c e ~ i n gT e n d e r Offe r

0.77%1 . 6 6

. R&D a spercentage of Rev en u eD u r i n g P r e v i o u sT h r e e Y e a r s

0.75%1 .49 '


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TABLE 6

Median Revenue and Average Revenue in Year pr io rto Tender Offer fo r 57 Targe t Firms andTheir Indus try Groups

Group o f Firms

Targe t FirmsIndus t ry Group

Median Revenue inYear PrecedingTender Offe r( in mil l ions)$ 312.01382.6

Average Revenue ir iYear precedingTender Offe r( in m i ll io n s)$1731.52592.1


22/23

TABLE 7

percentage of Equity Held by 13 In s t i t u t i onsin 177 Target Ficms of Tender Offers andThe i r Indus t ry in Quar ter Pr io r toTender Offec

Group of Firms

Target Firms

Indus t ry Group

AveragePercentage o f EquityHeld by 13f In s t i t u t i ons

19 .. 3%

33.7


23/23

TABLE 8

Abnormal Returns o f NYSE and Amex Lis ted .compa nLe at ha t Announced Research and Development Budget /CentersDuring January 1 , 1973 through December '31 , 1983.Event Day a i s the announcement day . ----

Da.ilyAbnormal Cumulat ive Daily Percent Number ofR e ~ u r n Abnormal Return Negat ive Firms

20 0.10 0.10 50.0 6219 -0 .27 -0 .17 . 64.5 6218 0 ~ 1 4 -0 . 03 . 51.6 6217 -0.23 -0 .25 . 50.0 6216 - 0 ~ 1 8 -0 .43 45.2 6215 0.12 -0 .32 56.5 6214 0.03 -0 .29 53.2 6213 -0 .08 -0 .37 58.1 6212 0.33 -0 .04 53.2 6211 -0 .70 ; -0 .74 61.3 6210 -0 .24 ' -0 .98 62.9 62-9 0.03 -0 .95 48.4 62:-.8. -0 .50 -1 .45 59.7 62-7 0.11 -1 .35 51.6 62-6 0.07 -1 .27 51.6 62-5 -0 .18 -1 .45 59.7 62-4 0.37 -1 .08 37.1 62-3 0.37 -0 .71 43.5 62-2 -0 .10 -0 .81 61.3 62-1 -0 ..29 -1 .10 58.1 620 0.45 -0 .65 37.1 621 0.35 -0 .30 46.8 622 0 .31 0 .02 46.8 623 -0 .01 .0.01 45.2 624 0.09 0.10 45.2 625 '0 . 3 6 0.46 50.0 626 -0 .15 0.31 48.4 627 0.29 0.60 43.5 628 0.12 0.72 50.0 629 0.26 0.97 54.8 6210 0.29 1.26 41.9 6211 0.38 1.65 45.2 6212 0.14 1.79 51.6 6213 0.16 1 ~ 9 5 50.0 62"

~ 0 . O 2 1.93 50.0 625 0.26 2.19 48.4 62'0 .15 2.34 46.8 62-0 .27 2.07 51.6 62-0 .31 1.76 58.1 62

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Institutional Ownership, Tender Offers, and Long-Term Investments