Poison Puts: Corporate Governance Structure or Mechanism for Shifting Risk? Webinar October 5, 2015

Transcription

1 Poison Puts: Corporate Governance Structure or Mechanism for Shifting Risk? Webinar October 5,

2 Agenda Introductions Research Review IRRCi Perspective Q&A 2

3 Webinar Logistics! Attendees in listen only mode.! Questions encouraged. Type using the Question function, and we will answer following report overview.! You will receive with link to replay.! Report and all others available at! Share info on social media. Find Audio issues during webinar, contact

4 Speakers Fred Bereskin Report Author and Assistant Professor University of Delaware Helen Bowers Report Author and Associate Professor University of Delaware Jon Lukomnik Executive Director Investor Responsibility Research Center Institute 4

5 About the Investor Responsibility Research Center Institute Not-for-profit established in Funds, disseminates objective, unbiased research on range of issues at intersection of corporate responsibility, investors informational needs. Academic and practitioner research that examines the capital market context that impacts how investors and companies make decisions. Annual research award with two $10K awards More than 40 research reports available at no charge. 5

6 Broad Range of Research Environmental, Social and Governance Survey The Materiality of Human Capital to Corporate Financial Performance The Alignment Gap Between Creating Value, Performance Measurement, and Long-Term Incentive Design Nanotechnology and the S&P 500: Small Sizes, Big Questions The Impact and Future of High Frequency Trading What Investors Need To Know About Cybersecurity Informed Options Trading prior to M&A Announcements: Insider Trading? Board Oversight of Sustainability Issues Integrated Financial and Sustainability Reporting in the United States Controlled Companies in the Standard and Poor s 1500: A Ten Year Performance and Risk Review Executive Superstars, Peer Groups and Over-Compensation Voting Decisions at US Mutual Funds: How Investors Use Proxy Advisors Discovering Shale Gas: An Investor Guide to Hydraulic Fracturing Download at no cost at 6

7 Poison Puts: Corporate Governance Structure or Mechanism for Shifting Risk? 7

8 What is a Poison Put?! Bond covenant that gives bondholders right, but the obligation to redeem bonds if change in control occurs.! Also referred to as proxy puts, change in control or event risk covenants. 8

9 Triggers! Typical triggering events for poison puts " any person/group acquires 50% or more of voting stock " merger or consolidation of the company into another entity " the sale, in one or a series of related transactions, of all or substantially all of the company s assets " the adoption of a plan to dissolve or liquidate the company.! Some poison put covenants include a double trigger where the change in control event must be associated with a ratings downgrade! Deadhand " any time the majority of the board of directors ceases to be those who were directors at the time of issuance (continuing directors) or " directors whose election was approved by a majority of the continuing directors 9

10 Poison Puts Are Unique In Corporate Governance! Potentially unregulable means of entrenchment! Contract with bondholders! Do not typically require a shareholder vote! Dual motivation " Legitimate protection for bondholders or entrenchment device " Effectiveness as either is unclear! Unlike poison pills can cause severe harm to the firm : " Can create a liquidity crisis for the firm " Harm to the firm would affect both bondholders and shareholders 10

11 Recent Developments! Dramatic increase is use of poison puts since 2006 " Based on our sample use hovered around 10% between 1995 and 2005 " Since 2006 over 50% of bond issues contain poison puts! Poison puts have been the subject of litigation concerning the limits of the shareholders rights! Use and threats of use by boards during contested elections 11

12 Related Literature! Broader literature on creditors role in corporate governance, and how their involvement in governance occurs: " Board of directors (Santos and Rumble, 2006) " Information intermediation (Ivashina et al., 2009) " Financial distress (Baird and Rasmussen, 2006; Chava and Roberts, 2008; Ayotte and Morrison, 2009; Roberts and Sufi, 2009; Nini, Smith, and Sufi, 2012)! Original studies of poison puts in Crabbe (1991) and Cook and Easterwood (1994) " Evidence of reduced borrowing costs " Also of positive wealth effects for bondholders and negative wealth effects for shareholders 12

13 Related Literature! Billett, Jiang, and Lie (2010): Effects of poison puts on LBOs from " Positive announcement effect for issues with poison puts, negative for issues without poison puts " Also, reduced probability of being an LBO target " Consistent with prior studies (Asquith and Wizman, 1990; Billett, King, and Mauer, 2004)! Managerial entrenchment / covenants can mitigate the bondholdershareholder conflict (Chava, Kumar, and Warga, 2010; Qi, Roth, and Wald, 2011)! Other reasons can exist for poison puts for example, they can potentially help an incumbent firm extract more of a merger surplus (Hege and Hennessy, 2010) 13

14 Motivation for Our study! Investigate the association of poison puts " With corporate governance " Effects on acquisition activity.! We examine two, non-mutually exclusive motivations for the inclusion of the poison put covenants: " Potentially enhancing managerial entrenchment " Protect bondholders from the results of risk-shifting in changes of control which increase shareholder value (academic literature defines as efficient contracting)! We recognize that inclusion of poison puts could be motivated by bondholder protection with the unintended consequence of enhancing management entrenchment 14

15 Results Entrenchment! Firms with poison puts " Don t seem have weaker governance " Are less involved in M&A, either as acquirers or targets! We also find: Concerns about Risk-Shifting! Issues and firms with poison puts " Have some characteristics associated with risk-shifting " May be driven by increased shareholder protection Related to bondholders concerns of risk shifting or contracting " Firms are not opportunistically using poison puts to position themselves as acquirers 15

16 Resurgence in Use Of Poison Puts Since 2006 Percentage of Issues with Poison Puts The frequency of the use of poison puts we report are consistent with, but not directly comparable to Billett, Jiang and Lie (2010) because of differences in sample selection criteria. However, we agree with them that the there has been a striking increase in the use of (poison put) covenants. 16

17 Use of Poison Puts Varies by Industry 17

18 Poison Put Issues Are Predominantly Non-Investment Grade Percentage of Poison Put Issues by Credit Rating 18

19 All of a Firm s Debt Issues Have Poisons Puts Or None of the Firms Issues Have Poison Puts 19

20 Financial Characteristics Poison Put Firms vs. Non-poison put firms Average Revenue Poison put firms are smaller than non- poison put firms *** Poison put firms average revenue = $6.4 billion Non-poison put firms average revenue = 13.5 billion Debt Poison put firms are more highly levered *** Average book value of debt as a % of book value of assets 41% for poison put firms 31% for non-poison put firms Valuation Market value of assets/book value of assets is higher for poison-put firms *** Poison put firms average market-to-book ratio = 1.67 Non-poison firms average market-to-book ration = 1.48 *** Statistically significantly different at the 1% level. 20

21 Corporate Governance Characteristics Poison put firms vs. Non-poison put firms Institutional Ownership Delaware Incorporation Poison put firms have somewhat higher institutional ownership *** Poison put firms: Average = 55% Median = 64% Non-poison put firms: Average = 54% Median = 59% Poison put firms less likely to be incorporated in Delaware ** 42% for poison put firms 46% for non-poison put firms Poison Pill Poison put firms are less likely to have a poison pill *** 35% of poison put firms also have a poison pill 45% of non-poison put firms also have a poison pill Classified Board Poison put firms are just as likely as non-poison put firms to classified boards 51% for poison put firms 52% for non-poison put firms 21 *** Statistically significantly different at the 1% level; ** Statistically significantly different at the 5% level..

22 Regression Analysis of Bond Issues: Likelihood of an issue containing a poison put Increases with:! The number of other covenants! The number of restrictive covenants! The treasury spread of the issue! The size of the issue Decreases with:! The firm s sales! The firm s leverage! The days to maturity of the issue and! The ratio of market to book value of the firm s assets All results are statistically significant at the 1% level. We control for industry differences and events that occur over time that affect all firms equally. 22

23 Our Results for Individual Firms! Our regression analysis of firms, year-by-year, shows that a firm is more likely to include a poison put in at least one of its bond issues in a year " With increases in (1) the firm s leverage *** and (2) the percentage of institutional ownership *** " And with decreases in (1) the ratio of market to book value of the firm s assets ** (2) the firm s sales revenues ***! A firm incorporated in Delaware is more likely to have a poison put ***! Having a classified board or a poison pill does not seem to have any effect 23 *** Statistically significant at the 1% level; ** Statistically significant different at the 5% level..

24 Implications of These Results! These results are consistent with contracting concerns and contain no evidence that firms using poison put covenants have weaker shareholder protections. 24

25 Other Purposes Associated with Use of Poison Puts! The use of poison puts coincides with concerns with risk-shifting and related concerns (asset sales, cross-acceleration, etc.), and less with other types of concerns! Other covenants that are associated with poison puts are consistent with contracting concerns, e.g.: Covenants Also Present in Issues with Poison Puts Proportion Consolidation & merger 92.8% Sale of assets 92.6% Cross acceleration 80.7% Defeasance without tax consequences 76.2% Covenant defeasance without tax consequences 73.7% Negative pledge covenant 70.3% Sales leaseback 54.7% 25

26 Purposes Associated with Use of Poison Puts 26

27 Effects on M&A! Firms with poison puts are less involved in M&A, both as acquirers and as targets! We do not find any consistent evidence of riskshifting! Our regressions indicate that industry acquisition activity is positively associated with the use of poison puts 27

28 M&A Activity: During the previous five years firms with a bond issue with a poison put vs. those that did not Targets Poison put firms are less likely to be targets *** 15% of the poison put firms in our sample were acquisition targets 21% of the non-poison put firms in our sample were acquisition targets Acquirers Poison put firms are less likely to be acquirers *** 7% of the poison put firms in our sample were acquirers targets 10% of the non-poison put firms in our sample were acquirers *** Statistically significantly different at the 1% level. 28

29 M&A Sample Statistics Deal Hostile transactions accounted for 2% of the deals for both poison put and non-poison put firms Transaction Value: Non-poison put firms had a significantly higher average transaction value than poison put firms Acquirers Market to book: We found no significant difference in the market to book ratios for poison put and non-poison put acquirers Leverage: Leverage was not significantly different for poison put and non-poison put acquirers Earnings volatility: Non-poison put acquirers had significantly higher earnings volatility than poison put acquirers Targets Market to book: Non-poison put targets had significantly higher market-to-book values than poison put targets Leverage: Non-poison put targets had significantly more leverage than poison put targets Earnings volatility: Non-poison put targets had significantly higher earnings volatility than poison put targets 29

30 Regression Analysis: Effects of M&A Activity on Use of Poison Puts! Our regression analysis shows that industry acquisition activity, as either acquirers or targets is positively associated with a firm using poison puts! Earnings volatility is not significantly associated with the use of poison puts 30

31 Conclusions! Poison puts are prevalent, growing, and a continued focus of litigation.! They have the potential for significant managerial entrenchment, and are subject to less shareholder oversight than many other traditional means of entrenchment! Our study shows that their typical use is associated with bondholders concerns contracting 31

32 Conclusions (cont.)! However, there is an effect on managerial entrenchment, given the reduced M&A activity! We do not find evidence that these firms have weaker corporate governance, This can be interpreted in two ways: (1) Poison puts are one of the few means of entrenchment for firms otherwise resistant to other entrenchment mechanisms; (2) Poison puts are primarily driven by bondholders concerns and not with the goal of managerial entrenchment 32

33 From IRRCi s Viewpoint! Opaque, technical, overlooked and important.! Not easily parsed into pro/con, either/or. It s more of an and/but.! No evidence of other entrenchment devices at firms with poison puts, but the indentures themselves are entrenching.! Possible that other shareholder protections increase lenders unease, thereby encouraging poison puts in a classic unintended effect.! Hope study is useful to C-suite, Boards, investors, investment bankers, others figuring out optimal financing. 33

34 Type your question using the Question function. We will read questions aloud, speakers will respond. 34

35 Contacts Jon Lukomnik Executive Director IRRC Institute Fred Bereskin and Helen Bowers Report Authors University of Delaware