Stock Market Valuation and Acquisitions: An Empirical Test of One Component of Managerial Utility

Abstract

BETWEEN I948 and 196I, 735 public companies quoted on the London Stock Exchange were taken over by other quoted companies, or one-quarter of the original population. There also appears to have been two or three hundred unsuccessful bids during this period. It is the object of this paper to examine the effects the threat of take-over may exert on a firm's behaviour within the theoretical constructs of the managerial theories of the firm. The behavioural revisions to the theory of the firm, recognizing the importance of the separation of ownership and control in modern corporations, have attempted an examination of managerial motivations in order to explain the firm's behaviour. There is, however, little agreement to be found in the literature as to the nature of the ingredients in the objective function which are to replace the profit maximization assumption. For example, Baumol' believed managers sought to maximize dollar sales; Marris2 saw the primary motivation in terms of an attempt to maximize the growth rate of the firm; while Williamson3 included a variable for pecuniary and non-pecuniary emoluments and staff size in the objective function. In all approaches, however, managers are seen as constrained from making decisions which could lead to loss of employment or bankruptcy because of a competing desire for security. Baumol and Williamson impose this security constraint by requiring that profits do not fall below some minimum level which satisfies the owners in terms of dividends and provides for financial safety. Marris, on the other hand, views the constraint as being imposed directly by the firm's valuation on the stock market which reflects not only shareholder approval of the firm's financial policies (by way of both satisfactory dividends and capital gains), but also affects the likelihood that the firm will receive a take-over bid. Since it is usual for all or part of the existing manage-