We investigate the extent to which managerial incentives, including golden parachute (GP) payments, have influenced target acquisition gains over the past two decades. We find that the use and scope of GP contracts expanded dramatically for a large sample of firms acquired from 1980 through 1995. To investigate the effect of managerial incentives on target acquisition gains, we estimate a regression of abnormal stock returns for acquisitions on variables including managerial incentives, the value of GP payments, and the interaction between GPs and management incentives. The regression results indicate that management incentives are positively associated with target acquisition returns and that GP payments serve to mitigate this influence. We do not, however, detect any direct association between the level of GP payments and target gains.

The lock-in effect proposes that capital gains taxes represent transaction costs that increase the reservation price for security owners and, ceteris paribus, reduce trading volume. Consistent with the lock-in effect, previous empirical research documents price and reactions to enacted changes in the capital gains tax rate. We investigate whether the volume hypothesis predicted by the lock-in effect extends to corporate acquisition activity. In particular, we analyze whether aggregate corporate acquisition activity is inversely associated with shareholder capital gains tax rates. We measure quarterly corporate acquisition activity from 1973 through 2001 using (1) the percentage of traded firms acquired in a calendar quarter and (2) the percentage of market value of traded firms acquired in a calendar quarter. In supplemental analysis, we measure acquisition activity at the industry level (i.e., as the percentage of firms and percentage of market value acquired by industry annually). In each analysis we model acquisition activity as a function of the maximum long-term capital gains tax rate for individuals and other macroeconomic factors previously hypothesized to be associated with acquisition activity. Consistent with a lock-in effect for corporate acquisitions, we find a significant negative association between corporate acquisition activity and the capital gains tax rate whether we measure acquisition activity in the aggregate or at the industry level. In addition, we find that this negative association is attributable to increased (decreased) taxable acquisition activity during periods of low (high) capital gains tax rates. These results suggest that, ceteris paribus, capital gains taxes represent significant transaction costs that influence the level of corporate acquisition activity.

We investigate whether quarterly earnings guidance by corporate takeover targets is associated with acquisition premiums. Regulators have expressed recurring concerns that quarterly guidance is associated with a misallocation of resources because it encourages management to focus on excessively short-term horizons. If so, firms providing quarterly guidance represent an acquisition opportunity for non-guiding firms because acquired resources can be redeployed towards more productive long-term uses. Based on prior research that finds value created by acquisitions accrues primarily to target shareholders, we predict that an expected increase in value from the termination of guidance will be observed in acquisition premiums. We find that, after controlling for the other determinants of acquisition gains, the premium paid for an acquired corporation is associated with the target's practice of issuing quarterly earnings guidance. Consistent with our prediction, we find that no incremental premium is paid to acquire guiding targets when the bidding firm also provides guidance.

This study investigates the effect of shareholder capital gains taxes on the structure of corporate acquisitions. We analyze a sample of large publicly traded firms acquired in taxable cash-for-stock and tax-free stock-for-stock acquisitions from 1975 to 2000. We model acquisition structure (i.e., taxable cash-for-stock acquisitions versus tax-free stock-for-stock acquisitions) as a function of target shareholder capital gains taxes and other economic factors believed to influence acquisition structure. Consistent with expectations, we find a positive association between the capital gains tax rate for individual investors and the use of tax-free stock-for-stock acquisitions. In addition, we find that the effect of the capital gains tax rate for individuals decreases with target institutional ownership (a proxy that represents the likelihood the price-setting shareholder is not subject to the individual capital gains tax rate). We reconcile our analyses with previous studies and identify a plausible explanation for the lack of results in prior research. In supplemental analysis, we also report evidence that corporations “time” the completion of taxable acquisitions around major tax rate changes to minimize shareholder capital gains taxes. In sum, results suggest that shareholder-level taxes have a significant effect on the choice of taxable cash-for-stock versus tax-free stock-for-stock acquisitions, and this effect varies with the tax status of target shareholders.

We exploit cross‐temporal differences in capital gains tax rates to test whether shareholder‐level capital gains taxes are associated with higher acquisition premiums for taxable acquisitions. We model acquisition premiums as a function of proxies for the capital gains taxes of target shareholders, taxability of the acquisition, and tax status of the price‐setting shareholder as represented by the level of target institutional ownership. Consistent with a lock‐in effect for acquisition premiums, results suggest a unique positive association between shareholder capital gains taxes for individual investors and acquisition premiums for taxable acquisitions, which is mitigated by target institutional ownership.