The Impacts of Takeover Protection on Firm Innovation Knowledge
Increase in Takeover Protection and Firm Knowledge Accumulation Strategy
WANG, Heli | ZHAO, Shan | HE, Jinyu
Strategic Management Journal, Vol. 37, 2016.
The threat of a takeover undoubtedly makes CEOs uneasy because they often lose their jobs if the threat is followed through. But the verdict on whether a threat is harmful to the firm itself is still out. Some argue that it acts like a market discipline on a CEO to perform in the best interest of the firm, others that it leads to higher managerial turnover and short-termism decision-making.
New research by Heli Wang, Shan Zhao and Jinyu He, however, finds that the threat may do more harm than good, a conclusion they reached after flipping the question around to ask what happens when a firm suddenly gets some protection against takeovers.
They had a real-life case to work with after the US state of Delaware introduced takeover protection legislation in 1995. Their argument was that takeover protection would make CEOs feel more secure and therefore motivate them to invest in strategies that support the accumulation of firm-specific innovative knowledge assets, in particular patents, which are critical to firm value in the long run.
Without protection, the CEO’s efforts would be more likely to focus on general knowledge resources, such as knowledge of patents that could be more readily transferred to another firm.
“An increase in takeover protection therefore could affect a firm’s shift toward accumulating firm-specific, as opposed to general, knowledge resources through its influence on top managers’ job security and incentives,” they said.
To show how this can happen, they analyzed 307 firms in Delaware when they filed for new patents between 1992 and 1999. They used the frequency with which a firm’s existing patents cite its own previous patents to indicate the degree to which the firm’s new knowledge is built on its own knowledge base and thus firm specific. The findings confirmed their suspicions: after the takeover protection was introduced, there was a 15.3 per cent increase in the mean degree of firm-specific knowledge assets accumulated.
The authors were also interested in the limits, or boundaries, of this effect, particularly given the argument that takeover protection weakens the disciplinary role of the market. They found that if managers were given incentives such as higher managerial ownership in the firm, their interests aligned with shareholders and this mitigated the downside of takeover protection. Firms with a higher value of managerial ownership saw a 29 per cent increase in the mean degree of firm-specific knowledge assets following takeover protection, while those with a low degree saw only a 3.7 per cent increase.
Managerial tenure also mattered. Managers with longer tenure had less incentive to invest in increasing their firm-specific knowledge since they had already acquired so much. Therefore, a high value of tenure was associated with only a 13 per cent increase in firm-specific knowledge assets following takeover protection, but a low value with a 20.3 per cent increase. “To some extent, high managerial tenure may be considered a substitute for takeover protection,” the authors said.
They added: “More generally, our study highlights the importance of human factors in generating competitive advantages from firm-specific resources, which is in accordance with other recent research examining the roles that managers and employees play in obtaining and developing firm resources and dynamic capabilities.”