Corporate Governance and Diversification*

Kimberly C. Gleason
Dept of Finance
Florida Atlantic University
kgleason@fau.edu
Inho Kim
Dept of Finance
University of Cincinnati
Inho73@gmail.com
Yong H. Kim
Dept of Finance
University of Cincinnati
kimyh@uc.edu
Young Sang Kim**
Haile/US Bank College of Business
Northern Kentucky University
kimy1@nku.edu
This version: Nov 10, 2011

JEL classification: G34, G32

Keywords: Corporate Governance; Mergers and Acquisitions; Diversification Discount

* We thank seminar participants at the Bowling Green State University, Florida Atlantic
University, Northern Kentucky University, the 2006 Financial Management Association meetings,
2006 Global Finance Conference meetings, the Sixth International Conference on Asia-Pacific
Financial Markets, 2011 for helpful comments to improve the paper. We gratefully acknowlege
the best paper award in capital market at the 13th annual meeting of Global Finance Conference,
Brazil, 2006.
** Correspondence Address: Young Sang Kim, Associate Professor of Finance, Haile/US Bank
College of Business, Northern Kentucky University, Highland Heights, KY 41099, Tel: (859)
572-5160, Fax: (859) 572-6177, Email: kimy1@nku.edu

Corporate Governance and Diversification

Abstract

In this paper, we investigate the relation between corporate governance and returns to
bidders and targets, using 1,640 observations of completed acquisitions from 1996 to
2003. We find that the cumulative abnormal returns for acquirers are significantly
negative upon announcement of acquisitions for the full sample and for the related and
diversifying sub-samples. However, we find that diversifying acquisitions, when
conducted by firms with a higher percentage of outsiders on the board, improve returns.
Furthermore, we separately examine high-tech and non high-tech firms to test the relation
between board characteristics and announcement returns in different information
asymmetry environments. We also find that diversifying acquirers with independent
boards perform better than those with insider dominated boards and the results are
especially pronounced for high-tech firms. Taken together, the results suggest that firms
with better incentive alignment will be more likely to be perceived by the market as
stronger performers in acquisitions. In sum, we find that corporate governance plays an
important role in determining wealth creation for our sample of acquiring firms.
JEL classification: G34, G32
Keywords: Corporate Governance; Mergers and Acquisitions; Diversification Discount

Corporate Governance and Diversification

I. Introduction
Following corporate governance scandals involving numerous U.S. firms,
regulators took action to reduce the scope for corporate misbehavior. The Sarbanes-Oxley
Act of 2002 imposed new restrictions on the structure of the board of directors, in the
hope that independent outside directors would be more impartial in assessing managerial
decisions than inside directors, who may have conflicting interests and hence, loathe
disciplining top level managers. The Sarbanes-Oxley Act requires that boards have audit
committees that consist only of independent outside directors, and encourages firms to
adopt smaller boards, which may provide better (or more careful) oversight than large
boards.
The role of board is to monitor and advise managers on important decisions, such
as mergers and acquisitions. If the board is structured effectively so that sufficient
monitoring takes place, proposals by managers that may lead to personal perquisite
consumption or entrenchment, such as diversifying acquisitions, will be voted down.
Alternatively, the proposal may not be initiated in the first place if it is clear that the
board will provide disciplinary action when confronted with agency behavior by
managers.
To examine the effectiveness of the board as a monitor of the firm, many studies
have investigated top management turnover, which is attributed to actions taken by the
monitors of the firm, such as boards, and the market for corporate control (see, e.g.,
Mikkelson and Partch, 1997; Huson et al., 2004; Goyal and Park, 2002). Bhagat et al.
(2006) indicate that share ownership by directors impacts the ability of the board to

discipline management. While effective corporate governance provides a higher ex-ante

threat of dismissal, using top management turnover detects only those firms where the
threat is ex-post exercised. Thus, it is necessary to investigate the monitoring mechanisms
providing ex-ante impact on crucial investment decision. The examination of the relation
between corporate governance and mergers and acquisitions provides important insights
of ex-ante monitoring role. In addition, it is important to incorporate the impact of a
broader set of governance quality indicators such as percentage of independent directors,
board size, percentage of director shares, CEO/Chair duality, and institutional block
holdings when we investigate the relation between mergers and acquisitions and
corporate governance.
In this paper, we empirically investigate whether board structure and outside
blockholdings affect acquisition announcement returns, using 1,640 observations of
completed acquisitions from 1996 to 2003. A large body of literature provides insights
into wealth destruction and diversification1, but there is no clear consensus regarding the
relationship between governance and the performance of diversification. We document a
link between corporate governance and diversification, while diversifying acquisitions
are value-destructive for the sample as a whole, the negative impact is modified when
firms have strong independent boards2 and effective governance monitors such as outside
blockholders, so that managerial incentives are aligned with shareholders interests. Thus,
our results imply that high quality governance firms make appropriate diversification
decisions, in support of the monitoring hypothesis, which indicates that managers of firms
1

Several studies find negative announcement returns for diversifying takeovers (see, e.g., Morck, Shleifer,
and Vishny, 1990; Moeller, Schlingemann, and Stulz, 2005).
2
We define strong independent as a board comprised of at least 50% of outsiders. Also we use the average
value of the percentage of independent board in our sample period as an alternative definition for strong
board.

that have independent board and outside blockholdings are better monitored and hence,
make value enhancing investment decisions.
Our study contributes to the literature in four ways. First, we provide additional
evidence that diversifying acquisitions are viewed by shareholders as value destructive,
though a high percentage of independent directors on diversifying firms boards mitigate
the negative abnormal returns. This suggests that for firms with strong boards,
diversification proposals that are not in the shareholders interest may not be initiated by
managers or may not be approved by the board. This result may shed light on the puzzle
of the empirically observed negative relationship between board composition and firm
value. The effective board can reduce potential agency conflicts by prohibiting value
destructive proposals in an earlier stage (ex-ante). Our results imply that internal controls
provided by boards add value when it comes to mergers and acquisitions.
Secondly, by designing our empirical test using event study method with
announcement returns as the proxy for firm performance, we reduce the potential
endogenous problems associated with typical corporate governance studies that analyze
firm value differences. Our results indicate that corporate governance plays an important
role in the shareholders perception of the valuation effects of diversifying mergers and
acquisitions. Consistent with earlier studies (e.g., Morck et al., 1990; Lang and Stulz,
1994; Berger and Ofek, 1995; Moeller et al., 2004; and Hoechle et al., 2011) we show
that diversifying mergers and acquisitions reduce firm value as measured by cumulative
abnormal returns upon announcement of the acquisition bid. However, in regression
specifications with an interaction variable between diversification and internal controls,
we show that diversifying firms with higher board independence experience less of a

wealth decline after controlling other factors: CEO age and duality, deal characteristics
(i.e., multiple bids, method of payment, deal size, target organizational form),
institutional ownership, and firm characteristics (i.e., size, leverage, and growth
opportunities). This result provides evidence of a positive relationship between properly
structured boards and firm value, and is consistent with other studies which indicate
empirically that outside directors have reputation and human capital incentives to
maximize shareholder wealth (Coles and Hoi, 2003; Brickley et al., 1999; Harford, 2003).
As a result, outsider dominated boards lead to better performance (Hermalin and
Weisbach, 1991). Third, we examine high-tech firms and non high-tech firms separately.
Denis and Sarin (1999) and Lasfer (2004) segment their samples into high and low
growth firms, and find significant differences in the relation between board structure and
performance, and attribute these differences to a necessity of stronger monitoring of firms
with high information asymmetry (such as technology firms). Accordingly, we observe
that for firms in non high-technology industries, there is a weak relationship between the
percentage of the board comprised of independent directors and announcement returns,
while for firms in high-technology industries, there is a strong relationship between
independent dominated boards and firm value.
Raheja (2005) argues that for firms that are more difficult to verify, such as
technology firms, private benefits are lower, and there is less of a need for outsiders. For
firms that are easier to verify, private benefits increase, and more outsiders are optimal.
Our results provide further empirical evidence on this issue. Consistent with Raheja
(2005), we find that insiders play an important role for high-tech firms engaging in
related acquisitions, and independent directors do not add value. For diversifying

acquisitions in high-technology industries, however, independent directors play an

important role and add value.
Fourth, to our knowledge, our paper is the most comprehensive study thus far to
analyze the relation between various aspects of corporate governance and diversifying
acquisitions. Earlier studies are limited in terms of sample size and scope in examining
this issue. 3 Notably, a recent study by Masulis et al. (2006) examines the impact of
firms anti-takeover provisions and the shareholder wealth effects of its acquisitions.
They find that firms with higher anti-takeover provisions are more likely to make value
destructive diversifying acquisitions. This result complements our findings of a relation
between corporate governance and firm value.
The rest of the paper is organized as follows. The testable hypotheses regarding
the relation between corporate governance and diversification are presented in Section II.
Section III describes the sample selection. Section IV provides evidence concerning the
characteristics of firms engaging in value enhancing versus value destructive corporate
diversification. Section V provides empirical tests of our hypotheses. Section VI
summarizes the conclusions.
II. Corporate Governance and Performance
Several studies point towards a paradoxical insignificant or negative relationship
between corporate governance quality, as proxied by the percentage of outside directors
on the board, and firm value. Morck et al. (1988), Hermalin and Weisbach (1991) and
Bhagat and Black (2001) find no significant relationship between board independence
and firm value (using Tobins q as a proxy for firm value). Coles et al. (2006) examine

For example, Bradley, Desai, and Kim (1988), Byrd and Hickman (1992), Bhagat and Black (2001) and
others examine with small sample size.

the relationship between board structure and firm value, and find that one board size or
composition does not provide the same monitoring benefits for all firms. Furthermore,
Hermalin and Weisbach (1991), Mehran (1995), Klein (2000), and Bhagat and Black
(2001) find an insignificant relationship between board independence and accounting
performance. Agrawal and Knoeber (1996) find that Tobins q decreases with an increase
in the proportion of outside directors. Thus, the evidence regarding the merits of
independent boards is inconclusive. We attempt to shed more light on this issue by
examining the relationship between corporate governance and acquisition returns to
bidders and targets.
II.1. Monitoring and Scope for Value Destruction
The scope for value destruction of mergers and acquisitions is well documented in
the finance literature. Roll (1986) asserts that hubris may play a role in value destructive
acquisitions; managers may overestimate synergies generated by the merger and hence,
overvalue takeover targets. Jensen (1986) argues that managers have an inherent conflict
with shareholders due to the separation of ownership and control, and when they have
large stocks of free cash flows, they tend to make value destructive managerial decisions.
Thus, it can be anticipated that in the absence of proper internal controls, managers will
make decisions that benefit themselves at the expense of shareholders. We demonstrate
that internal controls via independent boards and outside blockholdings are alterative
mechanisms for disciplining managerial decision regarding mergers and acquisitions. Our
paper attempts to evaluate these two theoretical arguments of hubris and free cash flow,
and to empirically demonstrate their interactions with various monitoring mechanisms of
corporate governance.

II.2. The Diversification Discount and Wealth Losses from Diversifying Acquisitions
Several studies have revealed that diversified firms suffer from a diversification
discount (e.g., Berger and Ofek, 1995; Lang and Stulz, 1994; Servaes, 1996; and Denis et
al., 1997) where a conglomerate firm is worth less than the sum of imputed value of its
segment components, measured by multipliers of the comparable industry focused firms.
Comment and Jarrell (1995) and Berger and Ofek (1999) find that firms that begin
refocusing programs are able to improve value by reversing costly prior diversification.
Lins and Servaes (1999) find evidence of a diversification discount in the U.K. and Japan,
while German firms do not exhibit a diversification discount, arguably due to high inside
ownership in Germany that aligns incentives. In essence, these studies show that
diversifying acquisitions destroy shareholder wealth, and hence, are met with disapproval
from the market. Specifically, Berger and Ofek (1999) show that abnormal returns to
bidding firms diversifying into new product markets are significantly negative.
However, there is some debate over whether diversification is value destructive.
Bodnar et al. (1999) find that the losses due to product market diversification are offset
somewhat by positive gains from geographic diversification, and argue that the losses to
diversification have been overstated. Graham et al. (2002) find that a large percentage of
excess value occurs because firms acquire already discounted business units, not because
diversification is value destructive per se. Mansi and Reeb (2002) find that diversified
firms are less risky than non-diversified firms, and that losses to diversified firm
shareholders are offset by gains to diversified firm bondholders. Also, utilizing
Heckmans (1979) two-stage estimator to control for the propensity to diversify,
Villalonga (2004) reports no diversification discount in her sample. Whited (2001) argues

that the diversification discount documented in earlier studies is misleading, due to a

miscalculation of Tobins q. Finally, Campa and Kedia (2002) argue that firms selfselection explains the diversification discount.
Thus, the debate over the relationship between diversification and firm value is
ongoing. However, no studies to date have examined whether it may be the case that
firms that diversify have poorly structured boards which drive this result. Anderson et al.
(2000) examine the structure of corporate governance in diversified firms. However, they
fail to find evidence that governance characteristics explain the value discount from
diversification.4 In this paper, we contribute to the literature by demonstrating that proper
governance may reverse the losses observed in prior studies from diversification
activities.
II.3. Corporate Governance and Acquisitions
The role of the board of directors is to ensure that managers make shareholder
value maximizing decisions, and to discipline managers if they fail to do so. Agency
theory and the free cash flow hypothesis indicate that managers have incentives to
consume perquisites at the expense of shareholders (Jensen and Meckling, 1976).
Mergers and acquisitions are important managerial decisions that require vetting from the
shareholders and the board of directors, and the potential for value destructive decision
making is great. Moeller et al. (2004) find that conglomerate firms destroyed on average
$25.2 million of wealth per year upon announcement between 1980 and 2001 and a total
loss of $240 billion from 1998 to 2001.

In a recent paper by Hoechle et al. (2011) examine the relation between diversification discount and
corporate governance. They find the discount disappears entirely after controlling for governance variables
in dynamic panel GMM regression. This finding is also consistent with our results.

10

Several studies examine the link between corporate governance, decision making
regarding acquisitions, and post-acquisition performance. Paul (2006) examines that
firms with independent boards are more likely to withdraw acquisition bids, following a
negative market response. She attributes this to independent boards being more willing to
facilitate the correction of managerial mistakes. Masulis et al. (2006) find that firms with
anti-takeover provisions in place are more likely to make diversifying acquisitions. They
attribute this to the anti-takeover provision value destruction- hypothesis, which posits
that as the disciplinary capabilities of the market for corporate control are removed,
managers have more scope for engaging in wealth destruction, because they do not
perceive their human capital to be at risk. Masulis et al. (2006) find negative abnormal
returns upon announcement of diversifying acquisitions, and note that this effect is
particularly strong for firms with weak shareholder rights. These results suggest that
firms that are not properly governed may be more likely to make value destructive
decisions. Byrd and Hickman (1992) provide evidence regarding the relationship between
board of director characteristics and bidder returns. They find that bidders with
independent boards (where independent is defined as a board comprised of at least 50%
of outsiders) experience higher abnormal returns than those that do not have independent
boards. 5 Li and Srinivasan (2011) compare board with founder-director firms and
nonfounder firms on their CEO compensation, CEO retention policies, and M&A
decisions. Board with founder-director firms is more independent, less agency problems
and more pay-for-performance sensitive than board with nonfounder firms. They report

However, Byrd and Hickman (1992) find no evidence that board independence is relevant when it is
defined as the percent of the total board comprised of outside directors, a measure traditionally used in the
literature.

11

that founder-director firms represent higher three-day M&A announcement returns than
nonfounder firms.
In another empirical analysis, Malmendier and Tate (2005) find support for the
Jensen (2003) view, that overconfident managers are more likely to undertake
acquisitions, and that the negative market reaction is significantly stronger for
overconfident managers as opposed to rational managers.
II.4. Board Structure
Prior research on the effectiveness of board indicates that certain board qualities
enhance board performance. Yermack (1996) finds that as board size increases, the
ability to monitor the firm declines, and argues that smaller boards are more effective at
monitoring than larger boards. However, Coles et al. (2006) find that not all firms are
best served by small boards. Their research indicates that for high-tech firms (i.e., R&D
intensive firms), a larger fraction of insiders on the board leads to better performance. We
investigate whether the board size and board structure affects the share price response to
acquisitions differently for high-tech firms and non high-tech firms. High-tech firms, in
general, have a substantial amount of information asymmetry, and thus the verification
costs by boards are higher. Thus, we expect that the effect of board composition on
announcement returns would differ for high-tech and non high-tech firms. In a similar
vein, Cicero et al. (2011) show that firms tend to change the structure of board by
changes in underlying firm characteristics.
II.5. Blockholders Impact on Gains from Diversification
Several studies assert that blockholders - outside entities that hold five percent or
more of the firms stock - provide a significant monitoring role, while others argue that

12

blockholders are able to extract private benefits of control. Shleifer and Vishny (1989)
argue that large blockholders have an incentive to monitor management and the power to
influence the board and managers. Other studies indicate that pay per performance
sensitivity is affected by the presence of large blockholders (Mehran, 1995; Gillan et al.,
2003). Further evidence on the disciplinary mechanism of blockholders is provided by
Denis and Serano (1996), who find that outside blockholders are likely to take the
initiative to fire poorly performing managers. Even if blockholders do not directly
discipline management, they are able to vote with their feet and provide a credible
threat to management by selling their shares (Parrino et al., 2003). Evidence from the
acquisitions literature also suggests that stock transactions are value enhancing because
they introduce a new blockholder group which will provide additional monitoring (Chang,
1998). Thus, we anticipate finding that the percent of outside blockholdings positively
affects managerial decision making, and hence, diversifying acquisitions of firms with
high external blockholdings should be value enhancing, as blockholders will be more
likely to take an activist role in governing the firm (and overseeing acquisition decisions).
However, other research (i.e., Barclay and Holderness, 1989) indicates that blockholders
may have a better ability to obtain private benefits from managerial decisions. Further,
the evidence suggests that some blockholders provide better monitoring than others;
pressure-insensitive blockholders lead to improved operating performance (Saunders et
al., 2003). We incorporate pressure-insensitive institutional investors using a variable that
measures pension plan holdings. Our paper is the first to examine the relationship
between outside blockholdings and the efficacy of diversification decisions, as well as the
impact of pressure insensitive versus pressure sensitive investors.

13

II.6. Technology
Consider a small entrepreneurial venture in the biotechnology industry. It is often
the case that scientists who work for large companies (such as the pharmaceutical sector,
in drug development) decide to leave and pursue independent research, and so they create
start-up firms together. Having worked together closely for a long time on a certain,
specialized kind of technology, they form a management team knowledgeable in the
technology, so that they can pursue product development. However, the technology of the
venture is not widely understood by the public; when the firm goes public and structures
its board, it may be beneficial to put people on the board who also understand that
specific technology, and these are often people who worked for the large pharmaceutical
firm. In that case, where technology is specialized and few people have these specialized
skills, it is often useful to have a higher percentage of directors who are insiders.
II.7. Control variables
The literature finds that abnormal returns are lower for acquisitions by firms with
low leverage (Maloney et al., 1993), low Tobins q (Lang et al., 1989; Servaes, 1996),
low managerial ownership (Lewellen et al., 1985), and large capitalization (Moeller et al.,
2004). In addition, the existence of competing bids (Bradley et al., 1988) and deal size
relative to bidder size are relevant determinants of abnormal returns (Asquith et al., 1983).
Recently, Bradley and Sundaram (2005) argue that while acquirer size does matter
larger acquirers realize greater losses the effects of the medium of exchange, the
organizational type of target, and the relative size of the target are also relevant. Finally,
Chang (1998) finds that while returns to shareholders of acquisitions of publicly traded
companies are negative, abnormal returns to bidders of privately held firms are

14

significantly positive when they are paid for with stock. We incorporate these control
variables in our analysis.
III. Data
We investigate a sample of acquisitions constructed from the Securities Data
Company's (SDC) U.S. Mergers and Acquisitions Database. We obtain the initial sample
of 5,429 acquisitions from SDC from year 1996 to 2003. In addition, the sample meets
the following criteria: (1) The announcement date is in the 1996 to 2003; (2) The
acquirer controls less than 50% of the shares of the target at the announcement date and
obtains 100% of the target shares; (3) The deal value is equal to or greater than $1
million;6 (4) Data on acquirer stock prices and accounting variables are available from
CRSP and Compustat Research Insight, respectively.
To investigate the effectiveness of corporate governance and internal control
issues of impacting managerial decision making, we obtain the following data from
Investor Responsibility Research Center (IRRC): board size, board composition (percent
of insiders versus outsiders), CEO duality, CEO age, and director share ownership. The
IRRC database provides details on the structure and practices of the boards of directors at
a large number of U.S. companies from 1996 to 2003.
Furthermore, we obtain institutional blockholdings and pension fund holdings
data from Cremers and Nair (2005). 7 Blockholdings are defined as the percentage
shareholding by largest institutional blockholder, which owns at least 5% of the firms
outstanding shares. Pension fund holdings are defined as the percentage of shares held by

The deal value corresponds to 10%, 5%, and 1% of the market value of the assets of the acquirer (defined
as the book value of assets minus the book value of equity plus the market value of equity). We report
results for the 1% threshold but our conclusions hold for the more restrictive samples.
7
We thank Cremers and Nair for providing their institutional ownership data.

15

the 18 largest public pension funds, which are generally more distant from conflicts of
interest and corporate pressure than other institutional shareholders (i.e., pressure
insensitive blockholders). Accounting data is collected from Compustat Research
Insight. After all of the above restrictions and requirements, we finally obtain 1,640
mergers and acquisitions from 1996 to 2003.
IV. Sample Characteristics
Table 1 provides descriptive characteristics of sample deals. Panel A shows the
sample breakdown by year, indicating the deal size and method of payment for the
sample transactions. Panel B parses the sample into related transactions and diversifying
transactions, and provides cumulative abnormal returns, percent of independent directors,
and board size by year.
[Table 1 About Here]
Table 1, Panel A indicates that the mean (median) deal size of the sample period
was $1,167.81 ($185.54) million. The year with the largest deals was 1999, with a mean
(median) size of $1,625.04 (260.52) million. The year with the smallest average
transaction size was 1997, with a mean (median) value of $550.23 (171.20) million.
About 29.5% of the deals were financed with cash only; 47.01% were financed with
stock only, with the remaining being financed with a combination of considerations. The
most frequent year for stock deals was 1997, with 57.89% of transactions financed with
stock. Stock transactions declined substantially following the collapse of the internet
bubble in 2001, to only 18.42% of deals in 2003. Cash payment was most frequent in
2003, when 51.31% were financed with cash.

16

Table 1, Panel B parses the data by related and diversifying acquisitions

transaction. We use the Fama-French (FF) 49 industrial categorization to identify the
relatedness of the acquisition.8 We define related acquisitions as those where the bidder
and target are in the same FF49 industry, while diversifying acquisitions occur when a
firm acquires a target in a different FF49 industry. The results indicate that for the 1,007
related transactions, the mean (median) deal size was $1,492.09 ($217.80) million. The
633 diversifying deals tended to be smaller on average, with a mean (median) of $651.93
($150.00) million. Table 1, Panel B also indicates that the average percentage of
independent directors is higher for diversifying transactions than for related transactions,
although the median (66.67%) is the same for both. Mean board size for related
transactions (10.96) exceeds that of diversifying transactions (9.87), though the medians
are the same (10.0).
Finally, Panel B provides cumulative abnormal returns by year for diversifying
and related transactions. We calculate the cumulative abnormal returns (CAR) over the
three-day window (-1, +1) surrounding the mergers and acquisitions announcement date.
We use standard event study methodology of Brown and Warner (1985). The parameters
for the market model are estimated over 200 days before the event date [-210, -11].9 We
use the CRSP equally weighted market index and the significance levels are computed
using time series and cross-sectional variation of abnormal returns.
Mean (median) CARs for the [-1,+1] window for related transactions are -1.227%
(-0.671%). For diversifying transactions, mean (median) cumulative abnormal returns
8

We also examine 2 digit SIC code to identify the relatedness, and the results (not reported) are similar to
our findings in this paper. We obtain FF49 industry from Kenneth French website,
http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html
9
We also use various estimation periods such as 120 days, and 150 days. The results are qualitatively
similar to the results reported in this paper.

17

appear smaller, but less negative than for related transactions, a finding inconsistent with
previous literature. It can be explained by the issues of corporate governance and market
for corporate control becoming more important in the sample period or other confounding
factors need to be control for better explanation. For related transactions, CARs were
highest in 1996 (0.258%) and lowest in 2000 (-3.424%) and for diversifying transactions,
the highest CARs were in 1997 (0.818%) and lowest for 2001 (-1.972%).
Table 2 provides summary statistics on the characteristics of sample firms. The
mean (median) percent of independent directors was 63.33% (66.66%). The mean
(median) number of independent directors was 6.80 (6.00). Mean (median) board size
was 10.54 (10). This is comparable with Coles et al. (2006). They find mean (median)
board size is 10.4 (10) from 1992-2001 for Execucomp firms. The percent of shares held
by directors was a mean (median) of 8.629% (3.047%). The mean (median) CEO age is
53.59 (54.0). CEOs of 69.57% of firms were also chairmen of their boards. Institutional
pension fund holding is 2.59%, and blockholdings overall comprise a mean (median) of
6.631% (6.621%) of shares outstanding.
Mean (median) deal size for related acquisitions was $1167.81 million ($185.53
million). Mean (median) relative deal size is 8.58% (2.56%) of bidders market value.
About 1.83% of the transactions had multiple bidders. Private targets constituted about
36.3% of the transactions. Total assets of the mean (median) firm was $17,684 ($4,398.0)
million. Mean (median) Tobins q was 2.62 (1.66). Leverage, as proxied by long term
debt to total assets, was 21.35%. Operating cash flow to total assets had a mean (median)
of 7.30% (6.43%).
[Table 2 About Here]

18

Table 3 provides univariate results for governance characteristics, deal

characteristics, and firm characteristics by diversifying versus related acquisition.
[Table 3 About Here]
Table 3 indicates that the percent of independent directors for firms engaging in related
diversification is insignificantly different from those engaging in diversifying
acquisitions. Furthermore, both mean and median board size is significantly larger for
firms announcing related transactions than for firms engaging in diversifying transactions.
The percentage of shares owned by directors is significantly higher for firms engaging in
related transactions than diversifying transactions.

However, CEO age and duality do

not differ for firms doing related versus diversifying transactions. Nor was pension fund
shareholding for firms doing related transactions significantly greater than for
diversifying firms. Surprisingly, diversifying firms had significantly greater blockholder
participation than firms engaging in related acquisitions. However, these blockholders
may be primarily pressure-sensitive, due to relationships with the firm, given that pension
fund shareholding was not significantly different across the two groups.
Table 3 also provides univariate tests of differences in deal characteristics. Deal
size was significantly larger for related than diversifying transactions, and the relative
size of related deals exceeds those of diversifying transactions. Significantly more related
transactions were paid for with stock; significantly fewer were paid for with cash. Private
targets were more prevalent in diversifying acquisitions than related acquisitions.
Finally, we examine characteristics of firms engaging in related versus
diversifying acquisitions. Firms doing related deals were significantly larger in terms of
total assets. Firms doing related deals had a significantly lower mean (median) Tobins q

19

than those doing diversifying transactions. Leverage was insignificantly different for
firms announcing related versus diversifying transactions. The ratio of operating cash
flows (OCF) to total assets was significantly larger for diversifying firms than for those
doing related acquisitions.
V. Empirical Results
V.1. Univariate Analysis
Moeller et al. (2005) find that diversifying acquisitions are value destructive,
especially those conducted between 1998 and 2001. However, we argue that independent
boards and outside blockholdings may improve the returns to bidders. We present event
study results that investigate this issue in Table 4 (for bidder returns) and Table 5 (for
value-weighted combined acquirer-target returns).
[Table 4 About Here]
Further, Table 4 indicates that mean and median bidder cumulative abnormal
returns are significantly negative upon announcement of acquisitions for both the related
(-1.227%) and diversifying (-0.790%) subsamples. However, only the mean overall
abnormal returns for each category are significantly negative; and the difference between
related versus diversifying acquisitions is insignificant. In Table 4, Panel A shows that
bidders with insider dominated boards have abnormal returns that are less negative
(though insignificantly so) than for those with outsider dominated boards. Moeller et al.
(2005) show the large losses of acquiring firms, which are mainly driven by a small
number of extremely large losses. In our sample, deal size is significantly larger in related
acquisitions than in diversifying acquisitions. Size effect may drive the smaller (i.e., more
negative) CARs in related acquisitions.

20

Table 4 also indicates that for bidders with insider dominated boards, related
acquisitions result in higher mean abnormal returns than for those engaging in
diversifying acquisitions, but lower median abnormal returns (neither the mean nor
median difference is significant). For bidders with outsider dominated boards,
diversifying acquisitions result in less negative abnormal returns than those that engage in
related acquisitions, and the mean and median differences are significant at the 5% level.
In Table 4, Panel B, we segment the sample by blockholding of greater than 5%
and less than 5%. CARs (-1, +1) for bidders of firms with high blockholdings are higher
than for those with low blockholdings (i.e., -0.697% versus -1.669%, respectively), and
the difference is statistically significant.
To summarize, bidders for diversifying acquisitions with independent boards
experience higher abnormal returns than those for related acquisitions. Furthermore, for
both high and low blockholding firms, bidders engaging in related acquisitions
experience larger negative cumulative abnormal returns than do firms announcing
diversifying acquisitions, though the difference is insignificant. However, for high
blockholding firms, abnormal returns are significantly higher than for low blockholding
firms in both related and diversifying acquisitions. Interestingly, bidder returns are
highest in diversifying acquisition with high blockholdings. This result suggests that
diversifying acquisitions may be less value destructive if appropriate monitoring
mechanisms are put into place. This is consistent with the monitoring hypothesis, and
suggests that governance quality affects the markets perception of the potential for
wealth creation through mergers and acquisitions.

21

In order to examine the wealth generated by diversifying and related acquisition

activity for both the bidders and targets combined, we present the combined CARs in
Table 5.
[Table 5 About Here]
Table 5, Panel A shows the combined value weighted acquirer-target abnormal
returns by level of board independence. Mean (median) overall combined abnormal
returns for all categories of bidder-target combinations are 0.618% (0.525%). This
combined abnormal return is smaller than that of Moeller et al. (2005). It is possible that
our data include higher frequency of larger firms because of corporate governance data
requirements. However, we also observe increase in wealth to the shareholders of both
firms when we take into account the value created for the target as well as for the bidder.
Given the mean abnormal return to the bidder-target combination, the average of total
dollar value of wealth generated in each acquisition is approximately $15.51 million
since the average of market value of equity in combined firm based on the fiscal year end
value before the announcements is $2,509 million.
Overall, the returns to firms engaging in diversification are positive; for related
acquisitions, abnormal returns are insignificant. Furthermore, the abnormal returns for
diversifying firms are higher than those for related firms, but the difference is not
significant. For diversifying acquisitions, firms with independent boards experience
greater abnormal returns than those of insider dominated boards. The results for the
diversifying acquirers are consistent with the monitoring hypothesis, namely, that
outsider boards can ensure that managers do not engage in activities that will destroy
shareholder wealth.

22

Table 5, Panel B shows the comparisons of CARs by institutional blockholdings.

Consistent with the monitoring hypothesis, firms with greater blockholdings exhibit a
higher (and statistically significant) combined abnormal return than those with low
blockholdings. This suggests that governance quality affects the markets perception of
the potential for wealth creation through mergers and acquisitions. Firms with high levels
of blockholding experience positive and significant combined CARs, regardless of
whether the transaction was related or diversifying. For firms with both low and high
levels of external monitoring (as proxied by blockholdings), diversifying acquisitions
result in higher combined abnormal returns than those for related acquisitions.
Overall, our results suggest that when both bidder and target abnormal returns are
taken into consideration, acquisitions involving greater blockholdings and independent
boards are wealth enhancing, and significantly more so than firms that have less stringent
corporate governance controls in place. However, caution with the interpretation of the
univariate results should be taken, since other factors are not controlled for.
V.2. Multivariate Analysis
We next investigate the relationship between board characteristics, blockholding
and cumulative abnormal returns in a multivariate framework.10 The results are shown in
Table 6.
[Table 6 About Here]
For the full sample of merger and acquisition transactions, Model 1 indicates that
the coefficient of the diversification variable is negative, but statistically insignificant.

10

We report the result of OLS regression model to test the hypothesis. Also we try to use Heckman two
stage treatment models to test our hypothesis. The result of Heckman selection model provides the similar
result on the main interaction variable in this paper and coefficient of inverse mills ratio is not statistically
significant.

23

Hence, diversification per se does not lead to the markets perception of value destruction.
Furthermore, the results indicate that the percent of the board comprised of independent
directors is insignificant in determining abnormal returns, as is the log of board size.
Multiple bidders do not appear to affect cumulative abnormal returns. However, cash
deals are significantly and positively related to CARs. This reflects higher liquidity, and
the result is consistent with Asquith et al. (1983). Size of the firm (log of total assets) and
relative deal size are negatively and significantly related to abnormal returns, and Tobins
q is significantly and positively related to CARs, indicating that firms with higher growth
options are expected to make more value enhancing acquisitions than low Tobins q firms.
Leverage is not significantly related to abnormal returns, nor is duality, the ratio of
operating cash flow to total assets, and director ownership.
Model 2 incorporates an interaction term between diversification and board
independence. As with Model 1, the results indicate that diversifying acquisitions are
significantly and negatively related to abnormal returns. This is consistent with prior
evidence of wealth destruction and the diversification discount. However, and more
importantly, the interaction term between the percent of independent directors and
diversification is positive and significant.11 This means that when boards are structured
so that they are independent, diversifying acquisitions contribute positively to abnormal
returns; outside directors do a better job of ensuring that managers do not engage in
wealth destruction, consistent with our monitoring hypothesis (i.e., diversification may
not necessarily be value destructive if managers are monitored appropriately). Other
11

We also use a dummy variable equal to 1 if independent director is higher than 50%, instead of
percentage of independent director and interaction variable, as per the Byrd and Hickman (1992) analysis.
The results are very similar to our results. However, an interaction variable with board size is not
statistically significant, implying that board composition is a more important determinant of announcement
returns than board size.

24

control variables retain the signs from in Model 1. Model 3 incorporates the public status
of the target as a control, and the result indicates that announcements of acquisitions of
private targets yield significantly higher abnormal returns than public targets. Further,
Model 4 indicates that the interaction between private target and stock deal is
significantly and positively related to abnormal returns. This result is consistent with
Chang (1998), and supports the internal control hypothesis whereby when the private
entity becomes a shareholder of the acquirer, a new monitoring group is introduced.
The result of Model 5 is consistent with previous results. All other variables retain
their signs and significance, with the addition of blockholding in Model 5, which is
significant and positively related to CARs. This result suggests that blockholders, as well
as independent board of directors, provide an effective monitoring role that ensures that
diversification decisions will be made wisely and in accordance with shareholder wealth
creation. In Model 5, the presence of a pension plan is negatively related to CARs. This
result is consistent with Wahal (1996), Gillian, Hartzell, and Starks (2003), and Karpoff
et al. (1996), who find that monitoring by public pension funds does not increase
shareholder wealth.
In all five models, diversification has a negative and significant coefficient; but
the interaction term between diversification and the percentage of outside directors is
significant and positive. Hence, our results show that diversifying mergers are, on
average, value destructive. However, independent boards facilitate a lesser wealth
destruction. Thus, our results suggest that it is board quality that determines whether a
diversifying acquisition will be wealth enhancing or wealth destructive.
V.3. High- Tech vs. Non high-Tech Firms

25

As previously discussed, high-tech firms are characterized by substantial

information asymmetry, as their lines of business are often difficult to understand.
Because they have proprietary technology, these firms are better served by having boards
with inside directors (who understand the technology well). Because the characteristics
and optimal board structure of high-tech firms may differ from those of non high-tech
firms, we next run regressions on cumulative abnormal returns for high-tech and non
high-tech separately, as motivated by (Raheja, 2005). These results are shown in Table 7.
[Table 7 About Here]
We present three models for both non high-tech and high-tech firms. For the non
high-tech firms, Model 1 indicates that the diversification variable is negative but
insignificant. Thus, for non high-tech firms, diversifying acquisitions do not appear to
significantly destroy wealth. The percentage of independent directors is also insignificant.
This implies that the structure of the board whether insider or outsider dominated
does not impact abnormal returns. The log of board size, multiple bid deals, and stock
deals are insignificant determinants of abnormal returns. However, cash transactions are
significantly and positively related to abnormal returns, indicating that the market views
more liquid firms favorably when they engage in acquisitions. Relative deal size is
significantly and negatively related to CARs, indicating that larger deals destroyed more
wealth than smaller deals, consistent with Moeller et al. (2004). Firm size, as measured
by the log of total assets, is significantly and negatively related to abnormal returns. CEO
age is a negative and significant determinant of abnormal returns for non high-tech firms.
None of the other control variables, including Tobins q, leverage, market value, percent
of director ownership, or duality are significant.

26

Model 2 introduces the interaction variable between diversification and board

independence, which is insignificant in determining abnormal returns. The interaction
variable is positive but insignificant. All other variables retain their sign and significance
from Model 1. Model 3, again for non-high tech firms, is consistent with Models 1 and 2,
with the exception of the stock transaction variable, indicating that stock financed
transactions are viewed by the market as wealth destructive. The institutional holding of
pension plans and blockholdings do not contribute significantly to abnormal returns.
Regression results are next shown for the subsample of high tech firms. Model 4
indicates that diversification is positive but insignificantly related to abnormal returns.
Percent of independent directors is insignificant in determining abnormal returns, as are
board size, multiple bid deals, and stock payment. Cash transactions have significantly
higher abnormal returns than stock transactions, consistent with the results for non hightech firms. Furthermore, larger transactions reduce wealth significantly. For high-tech
firms, unlike non high-tech firms, Tobins q is a significant positive determinant of
abnormal returns, most likely because these are firms in nascent industries with high
growth options. The other control variables (leverage, operating cash flow to total assets,
director shareholdings, duality, and CEO age) are all insignificant determinants of
abnormal returns.
In Model 5, we examine the relationship between board structure and abnormal
returns. We find a negative and statistically significant coefficient for independent
directors, implying that the percentage of inside directors are more effective for
governing high tech firms in related acquisitions, consistent with Boone et al. (2006) and
Raheja (2005). The evidence indicates that the advisory role of insider directors is more

27

important for high tech firms than for non high-tech firms, because insiders understand
complex technology well. Further, Model 5 introduces the interaction variable of
diversification and percentage of the board consisting of independent directors. Unlike
for non high-tech firms, the interaction term is positive and significant in determining
abnormal returns, though the coefficient of diversification is negative and significant.
This result suggests that for high-tech firms, diversifying acquisitions are less value
destructive so long as the board is structured in a way that facilitates proper review of
managerial decisions. Thus, the independent dominated board plays an important role in
determining wealth creation for high-tech firms in diversifying mergers and acquisitions.
As with non high-tech firms, relative transaction size is a significant and negative
determinant of abnormal returns, with the same sign as in Model 4. Furthermore, leverage
is significant and positive; indicating that high-tech firms that are more closely monitored
by bondholders and have less free cash flow will have higher announcement returns.
Model 6 is consistent with Model 5, and introduces pension plan and
blockholding variables. The results suggest that while pension plans are insignificant in
determining abnormal returns, blockholding is significant, a deviation from the results
found for non-high tech firms. Thus, monitoring plays a stronger role in determining
whether firms will make value enhancing or value destructive decisions for high tech
firms. This is consistent with Denis et al. (1997) and Shleifer and Vishny (1986), who
demonstrate that outside blockholders may have an influence on managers, preventing
them from making value destructive diversification decisions. Since insider-dominated
boards experience positive abnormal returns, perhaps blockholders and creditors act as
additional monitors, and counteract any misbehavior on behalf of the insider dominated

28

board. All model specifications are significant at the 1% level of significance, as

illustrated by the F-statistic.
V.4. Combined Bidder and Target CARs
We next examine the determinants of combined bidder and target abnormal
returns upon the announcement of acquisitions. Table 8 provides the results of these
regressions. Models 1 and 2 pertain to the full sample, while Models 3 and 4 segment the
sample into non high-tech and high-tech, respectively.
[Table 8 About Here]
Model 1 (for the full sample) indicates that diversifying acquisitions lead to lower
abnormal returns, though not significantly so. Cash deals are positively and significantly
related to abnormal returns, and firm size is a negative determinant of CARs. Leverage, a
proxy for creditor monitoring, is significantly and positively related to CARs (at the 10%
level). Pension plan shareholdings appear to negatively affect abnormal returns. Model 2
incorporates the diversification and percent independent director interaction dummy,
which is significant and positive for the full sample. In this specification, diversification
is significant and negative. Thus, for the overall sample, the results indicate that
combined bidder and target gains are a function of board quality, and that independent
boards assist managers in making value enhancing decisions. Both Models 1 and 2 are
significant at the 5% level, as illustrated by the F statistics.
The next two models, Hi-Tech=0 and Hi-Tech=1, indicate that the full sample
results for diversification and for the interaction term are mainly driven by the high-tech
sample. For non high-tech firms, diversifying acquisition is negative and insignificant,
and the interaction of the diversifying and percent independent director variable is

29

insignificant and positive. Apparently, for non high-tech firms, independent board
monitoring does not translate into wealth creation for bidders and targets. Perhaps when
the value of assets is easier to ascertain by shareholders, there is less of a need for
reliance on internal controls. For non high-tech firms, bidder size is significant in
explaining combined wealth gains, and is negatively related to abnormal returns.
Furthermore, Tobins q is significant and positive. The F-statistic for the non high-tech
firms regression indicates that the model is not significant at conventional levels.
In contrast, for high-tech firms the model is significant at the 1% level, as
illustrated by the F-statistic. While diversifying M&A is significantly negative, the
interaction term between diversifying and percent independent directors is significant and
positive. These results indicate that high-tech firms are able to generate wealth, even with
diversifying acquisitions, when governance quality is high. Cash deals and Tobins q are
significant and positive as well. Leverage is also significant and positive, indicating that
high-tech firms benefit from creditor monitoring and the accompanying reduction in free
cash flow. Blockholding is also significantly and positively related to combined returns,
consistent with Denis et al. (1997).12 This is consistent with Raheja (2005), in that hightech firms may find insider dominated boards more beneficial because of information
costs.
Further, these results support our monitoring hypothesis, in that other contractual
agents here blockholders and creditors help to mitigate information asymmetry, and

12

Further regressions for robustness are examined where an independent board is defined as a dummy
where equal to one when the percentage of outsiders greater than the mean, and a corresponding interaction
term between the independent board dummy and diversification. The results from these regressions are
consistent with those reported in Table 5. Further robustness checks removing firms in the financial
services sector provide results consistent with those reported in Tables 5, 6, and 7. The windsorizing at 1
percent level of the sample shows qualitatively similar results.

30

can compensate for any potential agency problems arising from an insider dominated
board.
VI. Conclusions
In this paper, we empirically investigate whether corporate governance affects
diversification decisions and the gains from diversification. A large body of literature
provides insights into wealth destruction and diversifying mergers and acquisitions, but
there is no clear consensus regarding the relationship between governance and the
outcomes of diversification decisions. In this paper, we document a link between
diversification and governance, namely, that while diversifying acquisitions are valuedestructive, and this impact is moderated for firms with independent boards. In other
words, our results indicate that diversifying acquisitions are only value destructive when
they lack strong boards or external monitoring. In addition, we separately examine hightech and non high-tech firms to test the role of board structure and size in different firm
characteristics. We find that for high-tech firms (in contrast to non high-tech firms)
diversification itself is negatively related to bidder abnormal returns. However, insiderdominated boards moderate this effect in related acquisitions. Further, alternative
monitoring mechanisms moderate the effect of diversification. More importantly,
diversifying acquisitions with higher percentage of independent directors exhibit
significantly higher abnormal returns in high-tech firms. This suggests that firms that
have better incentive alignment will be more likely to experience positive abnormal
returns. Thus, taken together, our results suggest that corporate governance plays an
important role in determining wealth creation in acquisitions, and imply that high

31

governance quality firms make appropriate diversification decisions, in support of the

monitoring hypothesis.

32

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36

Table 1. Sample Descriptive Statistics by Announcement Year

This table provides descriptive statistics for the sample of 1,640 acquiring firm-year observations from
1996 to 2003. Panel A shows the number of M&A, Deal size, and method of payment by year. M&A deal
characteristics are obtained from SDC M&A database. In panel B, we report the number of M&As,
percentage of independent directors, board size, and CAR [-1,+1]. Governance characteristics variables are
collected from IRRC database. CAR [-1,+1] is calculated based on traditional market model event study
methodology (Brown and Warner, 1985). Medians are reported in parenthesis.
Panel A.
Year
No. M&A
Deal Size
Cash Only
Stock Only
700.02
18.99%
55.30%
1996
179
(134.12)
N= 34
N= 99
550.23
22.00%
57.89%
1997
209
(171.20)
N= 46
N= 121
1350.57
22.78%
57.53%
1998
259
(161.94)
N= 59
N= 149
1625.41
29.59%
52.43%
1999
267
(260.52)
N= 79
N= 140
1598.54
25.54%
53.24%
2000
278
(311.40)
N= 71
N= 148
1099.96
32.39%
34.09%
2001
176
(174.72)
N= 57
N= 60
892.29
50.00%
21.67%
2002
120
(111.47)
N= 60
N= 26
960.96
51.31%
18.42%
2003
152
(142.09)
N= 78
N= 28
1167.81
29.51%
47.01%
Total
1640
(185.54)
N= 484
N= 771
Panel B.
Related M&A

Diversify M&A

# of
Firms

Deal Size

% of
Indep Dir.

Board
Size

CAR
(-1, +1)

# of
Firms

Deal Size

% of
Indep Dir.

Board
Size

CAR
(-1, +1)

1996

108

687.65
(151.36)

64.71%
(66.67)

11.30
(11.0)

0.258%
(0.512)

71

718.82
(114.69)

59.42
(62.50)

9.78
(9.00)

0.041%
(0.024)

1997

117

676.55
(187.85)

64.39
(64.28)

11.78
(11.0)

-1.014
(-0.680)

92

389.58
(149.42)

61.01
(62.02)

9.92
(10.0)

0.818
(0.009)

1998

173

1643.03
(173.20)

61.07
(63.16)

11.19
(10.0)

-0.554
(-0.348)

86

762.26
(127.81)

63.07
(63.63)

9.76
(9.50)

-0.250
(0.201)

1999

162

2202.29
(255.34)

60.68
(63.63)

11.28
(10.0)

-0.471
(-0.249)

105

735.35
(260.52)

67.21
(71.43)

10.44
(10.0)

-0.789
(-0.229)

2000

164

2103.76
(377.27)

60.89
(66.67)

10.40
(9.00)

-3.424
(-1.925)

114

871.73
(198.08)

63.14
(66.67)

9.41
(9.00)

-1.889
(-1.551)

2001

97

1484.85
(241.38)

63.45
(66.67)

10.76
(9.00)

-2.538
(-1.569)

79

627.37
(114.10)

66.18
(66.67)

9.89
(10.0)

-1.972
(-2.276)

2002

87

1099.18
(135.73)

65.84
(66.67)

10.29
(9.00)

-0.218
(0.623)

33

346.88
(57.00)

64.51
(66.67)

9.82
(9.00)

-0.585
(-0.155)

2003

99

1246.72
(160.00)

66.87
(66.67)

10.39
(10.0)

-1.476
(-1.545)

53

427.18
(110.00)

67.48
(70.00)

9.92
(9.00)

-1.579
(-0.150)

1492.09
Total 1007 (217.80)

62.97
(66.67)

10.96
(10.0)

-1.227
(-0.671)

633

651.93
(150.00)

63.89
(66.67)

9.87
(10.0)

-0.791
(-0.216)

37

Table 2. Summary Descriptive Statistics

This table provides summary statistics for the sample of 1,640 acquiring firm-year observations from 1996
to 2003. Governance characteristics variables are collected from IRRC database and institutional holding
data are obtained from Cremers and Nair (2005). Deal characteristics are obtained from SDC M&A
database. CAR [-1,+1] is calculated based on the traditional market model event study methodology
(Brown and Warner, 1985). Firm characteristics are collected from COMPUSTAT database. We report
mean, standard deviation, 1st quartile, median, and 3rd quartile of sample distribution.
Mean

Std

Q1

Median

Q3

Governance Characteristics
Percent of Independent
directors (%)
No of Independent directors

63.33

17.84

50.00

66.66

77.77

6.80

3.40

9 (Max 20)

Board size

10.54

3.85

10

12 (Max 24)

Percent Director shares (%)

8.629

13.28

1.157

3.05

9.78

CEO Age

53.59

7.36

49

54

59 (Max 83)

Duality

0.695

0.460

1141 obs

Pension Plans (%)

2.590

1.540

1.972

2.465

3.129

Block holdings (%)

6.631

6.913

0.000

6.621

9.738

1167.81

4522.72

59.08

185.53

Relative deal size (Mkteq)

0.086

0.235

0.006

0.026

608.97
(Max 89,167)
0.084

Multiple Bid

0.018

0.134

0.00

0.00

30 obs

Private Target

0.363

0.481

0.00

0.00

596 obs

17684.3
2.616
0.213
0.073

54443.5
2.188
0.171
0.060

1150.3
1.180
0.072
0.031

4398.0
1.660
0.202
0.064

15374.5
3.050
0.311
0.104

Deal Characteristics
Deal Size

Firm Characteristics
Total Asset
Tobins q
Debt/Total Asset
OCF / Total asset

38

Table 3. Univariate Analysis of Mergers and Acquisitions

This table provides summary statistics for the sample of 1,640 acquiring firm-year observations from 1996
to 2003 by types of M&As. We use Fama-French 49 industrial identification to separate the sample into
related and diversifying M&A. We define related M&A when a firm acquires the target in the same
industry. Governance characteristics variables are collected from IRRC database and institutional holding
data including Pension Plans and Block holdings are obtained from Cremers and Nair (2005). Deal
characteristics are obtained from SDC M&A database. CAR[-1,+1] is calculated based on traditional
market model event study methodology (Brown and Warner, 1985) and stock returns are collected from
CRSP. Firm characteristics are collected from COMPUSTAT database. We report mean, median, mean
difference test statistics, and Wilcoxon nonparametric test statistics.
Related = 1007
Mean
Median

Diversify = 633
Mean
Median

62.97

66.66

63.89

66.66

-1.02

-0.85

Board size

10.96

10.00

9.87

10.00

6.09***

3.66***

Percent Director share (%)

9.378

3.352

7.383

2.608

2.66***

2.70***

CEO age

53.4

53.8

-0.79

0.697

54.0
1.00
(N=439)

-1.10

Duality

54.0
1.00
(N=702)

0.15

0.15

Pension Plan (%)

2.542

2.431

2.666

2.499

-1.54

-1.39*

Blockholdings (%)
Deal Characteristics

6.354

6.361

7.062

7.096

-1.95*

-2.14**

1492.09

217.80

651.93

150.00

4.46***

4.19***

Relative size

0.097

0.067

2.70***

0.506

3.74***

3.71***

Cash deal only

0.253

-4.61***

-4.69***

Private Target

0.325

0.022
0.000
(N=261)
0.000
(N=229)
0.000
(N=268)

2.94***

Stock deal only

0.0291
1.00
(N=510)
0.00
(N=255)
0.00
(N=328)

-3.97***

-4.00***

19745.8

5091.2

14404.9

3630.2

3.15***

3.09***

Tobins q

2.478

1.503

2.834

1.868

-3.16***

-5.97***

Debt/Total Asset

0.210

0.201

0.218

0.203

-0.86

-0.52

OCF/Total asset

0.068

0.054

0.080

0.074

-3.87***

-6.12***

Governance Characteristics
Percent of Independent
directors (%)

Deal size

0.693

0.412
0.361
0.423

T-stat

Z-stat

Firm Characteristics
Total Asset

***, **, * significant at the 1%, 5%, and 10% levels, respectively.

39

Table 4. Bidder Cumulative Abnormal Returns of M&A Announcements

This table provides CARs surrounding M&A announcements for the sample of 1,640 observations from
1996 to 2003 by acquisition characteristics, board structure, and blockholder ownership. We use the FamaFrench 49 industrial identification to separate the sample into related and diversifying M&A. We define a
related M&A as when a firm acquires a target in the same industry. CARs are calculated based on
traditional market model event study methodology (Brown and Warner, 1985). We report mean, median,
and the number of observations. The Wilcoxon signed rank test is used for the test of median abnormal
returns.

Panel A. CAR (-1,+1) by Board Structure

Related M&A

Diversifying
M&A

t-test
Z-score

Board Structure

Percent of Independent
Directors < Sample Mean
(63.33%)

-0.876% a
[-0.523%]
(466)

-1.052% b
[-0.323%]
(272)

0.33
-0.12

-0.940% a
[-0.405%]
(738)

Percent of Independent
Directors > Sample Mean
(63.33%)

-1.529% a
[-0.702%]
(541)

-0.594% c
[-0.164%]
(361)

-2.14**
-1.64**

-1.155% a
[-0.552%]
(902)

1.54
1.32*

-0.84
-0.18

-1.227% a
[-0.670%]
(1007)

-0.790%a
[-0.216%]
(633)

t-test
Z-score
Types of M&A

0.64
0.90
-1.29
-1.27

-1.058% a
[-0.504%]
(1640)

Panel B. CAR (-1,+1) by Institutional Blockholdings

Institutional Blockholdings
< 5%

Institutional Blockholdings
>= 5%
t-test
Z-score

Related M&A

Diversifying
M&A

t-test
Z-score

Institutional
Blockholdings

-1.833% a
[-1.110%]
(389)

-1.383% a
[-0.397%]
(221)

-0.80
-0.68

-1.669% a
[-0.958%]
(610)

-0.846% a
[-0.403%]
(618)

-0.473%
[-0.153%]
(412)

-0.89
-1.00

-0.697% a
[-0.274%]
(1030)

-2.18**
-2.26***

-1.70*
-1.82**

***, **, * significant at the 1%, 5%, and 10% levels, respectively.
a,b,c
significant at the 1%, 5%, and 10% levels, respectively, and test for difference from zero.

40

-2.79 ***
-2.93 ***

Table 5. Combined Bidder and Target Cumulative Abnormal Returns

This table provides CARs surrounding M&A announcements for the sample of 1,640 observations from
1996 to 2003 by acquisition characteristics, board structure, and blockholder ownership. We use the FamaFrench 49 industrial identification to separate the sample into related and diversifying M&A. We define a
related M&A as when a firm acquires a target in the same industry. CARs are calculated based on
traditional market model event study methodology (Brown and Warner, 1985). We report mean, median,
and the number of observations. The Wilcoxon signed rank test is used for the test of median abnormal
returns.

Panel A. CAR (-1,+1) by Board Structure

Related M&A

Diversifying
M&A

t-test
Z-score

Board Structure

Percent of Independent
Directors < Sample Mean
(63.33%)

0.882%c
[0.508%]
(227)

0.997%
[0.055%]
(113)

-0.10
0.40

0.920% c
[0.296%]
(340)

Percent of Independent
Directors > Sample Mean
(63.33%)

0.037%
[0.479%]
(306)

1.093%b
[0.857%]
(158)

-1.85*
-1.29*

0.397%
[0.570%]
(464)

t-test
Z-score
Types of M&A

1.41
0.99

-0.08
-0.70
1.053%b
[0.707%]
(271)

0.397%
[0.508%]
(533)

1.01
-0.38
-1.12
-0.67

0.618%b
[0.525%]
(804)

Panel B. CAR (-1,+1) by Institutional Blockholdings

Institutional Blockholdings
< 5%

Institutional Blockholdings
>= 5%
t-test
Z-score

Related M&A

Diversifying
M&A

t-test
Z-score

Institutional
Blockholdings

-0.329%
[-0.149%]
(203)

0.602%
[-0.086%]
(102)

-0.81
-0.32

-0.017%
[-0.139%]
(305)

0.844% b
[0.768%]
(330)

1.325% b
[1.227%]
(169)

-0.76
-1.15

1.007% a
[0.849%]
(499)

-2.01**
-1.77**

-0.62
-2.43**

***, **, * significant at the 1%, 5%, and 10% levels, respectively.
a,b,c
significant at the 1%, 5%, and 10% levels, respectively, and test for difference from zero.

41

-1.83*
-2.89***

Table 6. Regression Analysis of Announcement Returns for Bidders

The dependent variable is CAR [-1,+1] of the bidding firm. Cumulative abnormal returns are surrounding M&A
announcements for the sample of 1640 observations from 1996 to 2003. CARs are calculated based on traditional
market model event study methodology (Brown and Warner, 1985). We use the Fama-French 49 industrial
identification to separate the sample into related and diversifying M&A. We define related M&A when a firm acquires
the target in the same industry. Governance characteristics variables are collected from IRRC database and institutional
holding data are obtained from Cremers and Nair (2005). Deal characteristics are obtained from the SDC M&A
database. Firm characteristics are collected from the COMPUSTAT database. The reported statistics are obtained using
White (1980) robust standard errors to account for potential heteroskedasticity. The P-value is reported in parenthesis.

Sign
Intercept
Diversifying M&A

Diversifying Pct
Independent Director

Pct Independent Director

Log (Board Size)

Multi-bid

Stock Deal

Cash Deal

Relative deal size

Log (Total asset)

Tobins q

Debt /Total asset

OCF / Total asset

Pct of Director share

Duality

CEO Age

Private Target

Private Target Stock

Deal

Pension Plan
Blockholdings
F-stat
Adj-R square
Observations

Model 1
-0.480
(0.864)
-0.381
(0.363)

0.113
(0.930)
1.067
(0.125)
0.173
(0.905)
-0.427
(0.475)
2.011***
(0.000)
-5.490**
(0.025)
-0.419***
(0.003)
0.291***
(0.008)
2.457
(0.129)
-3.476
(0.419)
0.001
(0.952)
-0.009
(0.984)
-0.013
(0.667)

Model 2
0.511
(0.854)
-3.724**
(0.020)
5.202**
(0.027)
-1.735
(0.237)
1.081
(0.119)
0.061
(0.966)
-0.496
(0.407)
1.964***
(0.000)
-5.498**
(0.022)
-0.400***
(0.005)
0.287***
(0.009)
2.418
(0.130)
-3.964
(0.356)
0.001
(0.919)
0.000
(0.999)
-0.013
(0.689)

Model 3
-1.203
(0.677)
-3.507**
(0.028)
4.698**
(0.045)
-1.865
(0.202)
1.231*
(0.077)
0.350
(0.810)
-0.534
(0.370)
2.044***
(0.000)
-5.089**
(0.028)
-0.303**
(0.037)
0.279**
(0.011)
2.608*
(0.100)
-3.339
(0.436)
-0.002
(0.892)
0.155
(0.738)
-0.013
(0.683)
1.429***
(0.002)

Model 4
-0.758
(0.744)
-3.524**
(0.024)
4.765**
(0.042)
-1.950
(0.198)
1.323*
(0.074)
0.307
(0.837)
-1.224**
(0.050)
2.021***
(0.000)
-5.102***
(0.000)
-0.326**
(0.039)
0.256**
(0.012)
2.542**
(0.041)
-3.840
(0.285)
-0.003
(0.856)
0.224
(0.622)
-0.014
(0.682)
0.582
(0.326)
1.881**
(0.025)

7.03***
0.0656
1203

6.91***
0.0687
1203

***, **, * significant at the 1%, 5%, and 10% levels, respectively.

42

7.14***
0.0755
1203

7.03***
0.0786
1203

Model 5
0.695
(0.826)
-3.540*
(0.054)
5.215**
(0.049)
-1.617
(0.325)
1.308*
(0.086)
0.689
(0.626)
-0.467
(0.450)
2.110***
(0.000)
-5.452***
(0.000)
-0.415***
(0.006)
0.285**
(0.012)
3.541**
(0.023)
-5.049
(0.253)
-0.000
(0.978)
0.063
(0.897)
-0.025
(0.476)

-0.276*
(0.057)
0.058**
(0.018)
6.38***
0.0763
1107

Table 7. Regression Analysis of Announcement Returns by High-Technology Firms

The dependent variable is CAR [-1,+1] of the bidding firm. Cumulative abnormal returns are surrounding M&A
announcements for the sample of 1640 observations from 1996 to 2003. CARs are calculated based on traditional
market model event study methodology (Brown and Warner, 1985). We use the Fama-French 49 industrial
identification to separate the sample into related and diversifying M&A. We define related M&A when a firm acquires
the target in the same industry. High-Tech equals 1 if a firm is in High-tech industry based on Fama-French industry
identification. High-Tech = 0 if the firm is in a non high-tech industry. Governance characteristics variables are
collected from IRRC database, and institutional holding data including Pension Plans and Block holdings are obtained
from Cremers and Nair (2005). Deal characteristics are obtained from the SDC M&A database. Firm characteristics are
collected from the COMPUSTAT database. The reported statistics are obtained using White (1980) robust standard
errors to account for potential heteroskedasticity. The P-value is reported in parenthesis.

Model 1
**

Intercept
Diversifying M&A

Log (Board Size)

Multi-bid
Stock Deal
Cash Deal
Relative deal size
Log (Total asset)
Tobins q
Debt /Total asset
OCF / Total asset
Pct of Director share
Duality
CEO Age

**

1.906
(0.262)
-0.262
(0.732)
0.930
(0.640)
-0.914
(0.151)
1.408**
(0.020)
-7.340***
(0.000)
-0.482***
(0.006)
0.120
(0.490)
-0.664
(0.707)
-3.188
(0.456)
0.000
(0.999)
-0.173
(0.741)
-0.074*
(0.088)

8.362
(0.011)
-3.210
(0.189)
4.066
(0.238)
0.553
(0.734)
-0.311
(0.685)
0.737
(0.712)
-0.984
(0.125)
1.363**
(0.024)
-7.246***
(0.000)
-0.438***
(0.000)
0.125
(0.468)
-0.798
(0.655)
-3.559
(0.399)
0.003
(0.888)
-0.157
(0.764)
-0.074*
(0.085)

4.76***
0.0800
607

4.59***
0.0815
607

7.697
(0.027)
-0.593
(0.270)

Diversifying Pct
Independent Director
Pct Independent Director

High-Tech = 0
Model 2
Model 3
**

8.531
(0.021)
-3.901
(0.143)
5.025
(0.177)
0.731
(0.678)
-0.115
(0.892)
1.714
(0.406)
-1.406**
(0.037)
0.987
(0.118)
-7.331***
(0.000)
-0.364*
(0.051)
0.196
(0.283)
-1.661
(0.375)
-2.270
(0.602)
0.019
(0.464)
0.014
(0.979)
-0.093**
(0.035)
-0.231
(0.259)
0.038
(0.298)
4.14***
0.0861
567

Pension Plan
Blockholdings
F-stat
Adj-Rsquare
Observations

***, **, * significant at the 1%, 5%, and 10% levels, respectively.

43

Model 4
-1.642
(0.664)
0.068
(0.919)

High-Tech = 1
Model 5

-2.749
(0.165)
0.227
(0.872)
-0.303
(0.891)
0.296
(0.776)
3.167***
(0.001)
-4.793*
(0.068)
-0.365
(0.112)
0.485***
(0.004)
4.348
(0.105)
-3.581
(0.588)
-0.006
(0.809)
0.171
(0.820)
0.020
(0.672)

0.323
(0.932)
-4.803**
(0.026)
7.671**
(0.019)
-5.758**
(0.019)
0.183
(0.895)
-0.272
(0.900)
0.223
(0.830)
3.164***
(0.002)
-4.833*
(0.058)
-0.376
(0.102)
0.499***
(0.003)
4.417*
(0.090)
-3.883
(0.558)
-0.010
(0.698)
0.184
(0.807)
0.021
(0.665)

4.09***
0.0677
596

4.12***
0.0728
596

Model 6
0.842
(0.846)
-4.194*
(0.094)
7.308**
(0.049)
-6.270**
(0.026)
0.251
(0.867)
0.087
(0.968)
0.846
(0.444)
3.924***
(0.000)
-4.736*
(0.064)
-0.462*
(0.057)
0.522***
(0.003)
7.660***
(0.001)
-5.538
(0.423)
-0.036
(0.245)
0.249
(0.759)
0.009
(0.864)
-0.294
(0.132)
0.085***
(0.008)
4.33***
0.0949
540

Table 8. Regression Analysis of Combined Announcement Returns for Bidder and Target
The dependent variable is CAR [-1,+1] of the value weighted average of bidder and target abnormal return. CARs are
calculated based on traditional market model event study methodology (Brown and Warner, 1985) and stock returns are
collected from CRSP. We use Fama-French 49 industrial identification to separate the sample into related and
diversifying M&A. We define related M&A when a firm acquires the target in the same industry. Hi-Tech = 1 if the
firm is in a high-tech industry based on Fama-French industry identification. Hi-Tech= 0 if the firm is in a non hightech industry. Governance characteristics variables are collected from IRRC database and institutional holding data are
obtained from Cremers and Nair (2005). Deal characteristics are obtained from the SDC M&A database. Firm
characteristics are collected from the COMPUSTAT database. The statistics reported with White (1980) robust
standard errors to account for potential heteroskedasticity. P-values are reported in parenthesis.

Sign

Model 1

Model 2

**

Hi-Tech =1

12.512
(0.031)
-3.733
(0.366)
4.132
(0.445)
0.065
(0.981)
0.279
(0.811)
0.506
(0.884)
-1.317
(0.148)
1.238
(0.163)
-2.208
(0.371)
-0.807***
(0.003)
-0.442**
(0.034)
-2.237
(0.440)
-2.881
(0.634)
0.016
(0.700)
0.887
(0.262)
-0.058
(0.360)
-0.226
(0.403)
-0.003
(0.951)
1.44

1.786
(0.737)
-7.560**
(0.028)
11.181**
(0.023)
-3.672
(0.359)
-2.402
(0.300)
0.838
(0.708)
1.809
(0.147)
4.816***
(0.000)
0.444
(0.593)
-0.207
(0.610)
0.455*
(0.086)
10.395***
(0.000)
1.244
(0.873)
-0.021
(0.673)
-0.070
(0.943)
0.022
(0.749)
-0.413
(0.108)
0.152**
(0.046)
2.10***

F-stat

1.616
(0.427)
0.755
(0.453)
0.428
(0.803)
-0.033
(0.962)
2.202***
(0.002)
-0.558
(0.600)
-0.589***
(0.010)
-0.066
(0.720)
3.497*
(0.079)
-1.954
(0.703)
-0.008
(0.774)
0.496
(0.423)
0.002
(0.952)
-0.337*
(0.085)
0.027
(0.576)
1.89**

2.877
(0.457)
-4.787*
(0.066)
6.399*
(0.076)
-0.406
(0.862)
0.755
(0.448)
0.371
(0.828)
-0.119
(0.867)
2.123***
(0.003)
-0.578
(0.573)
-0.556**
(0.015)
-0.072
(0.696)
3.397*
(0.089)
-2.346
(0.647)
-0.000
(0.987)
0.445
(0.470)
0.001
(0.985)
-0.352*
(0.078)
0.036
(0.453)
2.00**

Adj-Rsquare

0.0250

0.0295

0.0238

0.0709

Observations

558

558

311

247

Intercept
Diversifying M&A
Diversifying Pct Independent
Director
Pct Independent Director
Log (Board Size)
Multi-bid
Stock Deal
Cash Deal

Relative deal size

Log (Total asset)

Tobins q

Debt /Total asset

OCF / Total asset (Market

Value)

Pct of Director share

Duality

CEO Age

Pension Plan
Blockholdings

1.647
(0.660)
-0.572
(0.357)

Hi-Tech = 0

***, **, * significant at the 1%, 5%, and 10% levels, respectively.

44