Top management quality, corporate finance, and corporate innovation

Chemmanur, Thomas J.; Simonyan, Karen A. Working Paper Top management quality, corporate finance, and corporate innovation ADBI Working Paper, No. 780 Provided in Cooperation with: Asian Development Bank Institute (ADBI), Tokyo Suggested Citation: Chemmanur, Thomas J.; Simonyan, Karen A. (2017) : Top management quality, corporate finance, and corporate innovation, ADBI Working Paper, No. 780, Asian Development Bank Institute (ADBI), Tokyo This Version is available at: https://hdl.handle.net/10419/179236 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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Chemmanur and Karen Simonyan No. 780 September 2017 Asian Development Bank Institute The Working Paper series is a continuation of the formerly named Discussion Paper series; the numbering of the papers continued without interruption or change. ADBI’s working papers reflect initial ideas on a topic and are posted online for discussion. ADBI encourages readers to post their comments on the main page for each working paper (given in the citation below). Some working papers may develop into other forms of publication. Suggested citation: Chemmanur, T. J. and K. Simonyan. 2017. Top Management Quality, Corporate Finance, and Corporate Innovation. ADBI Working Paper 780. Tokyo: Asian Development Bank Institute. Available: https://www.adb.org/publications/top-management-quality-corporate- finance-and-corporate-innovation Please contact the authors for information about this paper. Email: chem[email protected], [email protected] We thank Lei Kong, Karthik Krishnan, Harshit Rajaiya, Xuan Tian, and Qianqian Yu for helpful comments and discussions. We alone are responsible for any errors or omissions. Thomas J. Chemmanur is professor of Finance and a Hillenbrand Distinguished Fellow at the Carroll School of Management, Boston College. Karen Simonyan is associate professor of Finance at the Sawyer Business School, Suffolk University. The views expressed in this paper are the views of the author and do not necessarily reflect the views or policies of ADBI, ADB, its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms. Working papers are subject to formal revision and correction before they are finalized and considered published. Asian Development Bank Institute Kasumigaseki Building, 8th Floor 3-2-5 Kasumigaseki, Chiyoda-ku Tokyo 100-6008, Japan Tel: +81-3-3593-5500 Fax: +81-3-3593-5571 URL: www.adbi.org E-mail: [email protected] © 2017 Asian Development Bank Institute ADBI Working Paper 780 Chemmanur and Simonyan Abstract In this paper, we review the theoretical and empirical literature on measuring the top management quality of firms, and its relation to various aspects of corporate financial policies and corporate innovation, and draw policy implications for enhancing corporate innovation. First, we discuss how management quality has been measured in the recent empirical literature. Second, we address theoretical models of the effect of the top management quality of a firm on its corporate financial and investment policies, and on corporate innovation. Third, we consider the recent empirical literature on the relationship between top management quality and the financial and investment policies of a firm, and how these affect the firm’s inputs into innovation, its innovation outputs, and innovation productivity. Fourth, we review the literature on the relationship between a firm’s top management quality, the anti-takeover provisions incorporated into its corporate charter, and corporate innovation. Fifth, we discuss the relationship between venture capital investments in entrepreneurial firms, their top management quality, and innovation by these firms. Sixth, we review the literature on the relationship between top management quality, the going public decisions of entrepreneurial firms, and the innovation outputs from these firms. We conclude with a discussion of the lessons from the theoretical literature and US evidence on corporate innovation for policymakers in various countries in Asia and elsewhere, and draw implications for public policy aimed at enhancing corporate innovation in these countries. JEL Classification: J24, O31, O32, O33, O38 ADBI Working Paper 780 Chemmanur and Simonyan Contents 1. INTRODUCTION ......................................................................................................... 1 2. HOW IS MANAGEMENT QUALITY MEASURED? ..................................................... 2 3. THEORETICAL MODELS OF THE RELATIONSHIP BETWEEN TOP MANAGEMENT QUALITY, CORPORATE INVESTMENT, AND INNOVATION ........ 6 4. MANAGEMENT QUALITY, INVESTMENT AND FINANCIAL POLICIES, AND INPUTS IN CORPORATE INNOVATION ........................................................... 9 5. MANAGEMENT QUALITY AND THE PRODUCTIVITY OF CORPORATE INNOVATION .............................................................................. 12 6. MANAGEMENT QUALITY, ANTI-TAKEOVER PROVISIONS, AND CORPORATE INNOVATION ........................................................................... 14 7. VENTURE CAPITAL BACKING, MANAGEMENT QUALITY, AND CORPORATE INNOVATION ........................................................................... 20 8. MANAGEMENT QUALITY, THE GOING PUBLIC DECISION OF ENTREPRENEURIAL FIRMS, AND CORPORATE INNOVATION .................... 22 9. LESSONS FROM THE LITERATURE AND IMPLICATIONS FOR PUBLIC POLICY IN ASIAN COUNTRIES ........................................................ 23 REFERENCES ..................................................................................................................... 26 APPENDIX A: DESCRIPTIONS OF THE FIRM-LEVEL ANTI-TAKEOVER PROVISIONS IN CORPORATE CHARTERS ANALYZED IN TABLE 4 ............................... 28 ADBI Working Paper 780 Chemmanur and Simonyan 1. INTRODUCTION It is now well-recognized that innovation is an important ingredient in generating the competitive advantage and long-term growth of nations, ultimately affecting their economic development (see, e.g., Porter, 1992). Schumpeter (1942: 83) viewed innovation as “a process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” It has been argued that since innovation is a process involving great uncertainty and a high risk of failure (see, e.g., Holmstrom 1989), the drivers of innovation may differ significantly from those of more routine tasks. Manso (2011) argues that motivating innovation needs significant tolerance for failure in the short term and reward for success in the long term. Given the increasing recognition of innovation as an important driver of economic development, there has been considerable interest in the determinants of innovation, not only in the corporate sector, but among policymakers around the world. One important aspect of firms and other organizations (such as non-profit institutions) that may significantly affect their ability to achieve high-quality innovation outcomes is the human capital or “quality” of the top management teams of these entities. Thus, the effectiveness of a firm’s top management team in selecting, investing in, and implementing innovative projects may determine the long-term success of the firm. Indeed, it is well known that venture capitalists and other early-stage investors analyze the top management quality of a private firm before investing in that firm. Given that a significant fraction of cutting-edge innovation is undertaken by small private firms, this underscores the importance of top management quality as a determinant of corporate innovation. However, finance researchers have, until recently, stayed away from analyzing the relationship between top management quality and innovation, perhaps because of difficulties in quantifying top management quality and the lack of theories regarding precisely how top management quality affects corporate financial policies and corporate innovation. This, in turn, has led to a paucity of research on the relationship between the top management quality of a firm and various aspects of its innovation activities. However, several recent studies have attempted to measure top management quality and analyze its effects on various aspects of a firm’s organization, governance, financial and investment policies, and innovation activities. In this paper, we review the theoretical and empirical literature on measuring the top management quality of firms, and its relation to various aspects of corporate financial policies and corporate innovation, and draw policy implications for enhancing corporate innovation. First, we discuss how management quality has been measured in the recent empirical literature. Second, we address theoretical models of the effect of the top management quality of a firm on its corporate financial and investment policies and on corporate innovation. Third, we consider the recent empirical literature on the relationship between top management quality and the financial and investment policies of a firm and how these affect the firm’s inputs into innovation and its innovation outputs and innovation productivity. Fourth, we review the literature on the relationship between a firm’s top management quality, the anti-takeover provisions incorporated into its corporate charter, and corporate innovation. Fifth, we discuss the relationship between venture capital investments in entrepreneurial firms, their top management quality, and innovation by these firms. Sixth, we review the literature on the relationship between top management quality, the going public decisions of entrepreneurial firms, and the innovation outputs from these firms. We conclude with a discussion of the lessons from the theoretical literature and the US evidence on corporate innovation for policymakers 1 ADBI Working Paper 780 Chemmanur and Simonyan in various countries in Asia and elsewhere, and draw implications for public policy aimed at enhancing corporate innovation in these countries. The rest of this paper is organized as follows. Section 2 describes how management quality is measured. Section 3 discusses theoretical models of the relationship between management quality, corporate investment, and corporate innovation. Section 4 addresses the empirical literature on the relationship between top management quality, investment and financial policies, and firm inputs in innovation. Section 5 reviews the empirical literature on the direct relationship between management quality and the productivity of corporate innovation. Section 6 discusses the empirical literature on the relationship between management quality, anti-takeover provisions, and corporate innovation. Section 7 reviews the empirical literature on the relationship between venture capital backing, top management quality, and corporate innovation. Section 8 discusses theoretical models, as well as the empirical literature on the relationship between top management quality, the going public decision of private firms, and corporate innovation by private and public firms. Section 9 concludes with a discussion of the lessons learned from the existing literature and suggests implications for public policy aimed at enhancing corporate innovation by firms in Asia and elsewhere. 2. HOW IS MANAGEMENT QUALITY MEASURED? Several recent studies have used different methodologies to measure and quantify the management quality of a firm. One of these methodologies makes use of several observable individual proxies of top management team quality capturing the human, knowledge, experiential, and educational resources available to the top management team, the uniformity/heterogeneity in the tenures of top management team members and their relative importance to the team, and the reputation and visibility of top management team members in the business community. To derive a single measure of top management team quality, these individual proxies of top management team quality are aggregated using common factor analysis. In particular, the following individual proxies of a firm’s top management team’s quality have been used in several recent studies making use of this methodology: the top management team size (the number of executive officers with the rank of vice president or higher on the top management team), the percentage of top management team members with master in business administration (MBA) degrees, the percentage of top management team members who are certified public accountants (CPAs), the percentage of top management team members who have served as top executive officers at other companies before joining the firm, the percentage of top management team members who have served as law and accounting partners prior to joining the firm, the chief executive officer (CEO) dominance (the ratio of CEO compensation over the average compensation of other management team members), the percentage of top management team members in core functional areas (operations and production, sales and marketing, finance, and research and development [R&D]), the average tenure of top management team members (the average number of years top management team members have worked for the firm), the heterogeneity in the tenures of top management team members (the coefficient of variation in top management team members’ tenures), the number of top management team members serving on the boards of non-profit organizations, and the number of top management team members serving on the boards of other firms. Larger values of these proxies indicate higher management quality. 2 ADBI Working Paper 780 Chemmanur and Simonyan Given that each of the above individual observable proxies of top management team quality may have unique limitations in measuring the underlying unobservable construct, common factor analysis is conducted on these individual top management team quality proxies and one single measure (factor) of top management team quality is derived. To ensure that individual proxies of top management team quality capture management quality only and not firm quality, before conducting the common factor analysis, individual management quality proxies are adjusted for firm quality measures, such as firm size, firm age, and industry dummies. This adjustment is performed by regressing individual top management team quality proxies on firm quality measures, and the residuals from the regressions are used as firm size-, firm age-, and industry dummies-adjusted individual top management team quality proxies in the common factor analysis. Common factor analysis generates several factors that account for common variance (correlation) between individual top management team quality proxies. Harman (1976) suggests that the number of factors necessary to approximate the original correlations between the individual measures is equal to the number of summed eigenvalues needed to exceed the sum of communalities (a communality of an individual management quality proxy is the squared multiple correlation obtained from the regression of that management quality proxy on other management quality proxies used in common factor analysis). To provide an example of the practical implementation of this methodology, we can refer to Chemmanur, Paeglis, and Simonyan (2011), who study the effect of management quality on the prevalence of anti-takeover provisions in the corporate charters of firms going public. They conduct common factor analysis using six individual proxies of top management team quality: the top management team size, the number of MBAs in the top management team, the number of CPAs in the top management team, the number of management team members who served as executive officers at other firms prior to joining the initial public offering (IPO) firm, the number of management team members who served as law and accounting partners prior to joining the IPO firm, and CEO dominance (the ratio of CEO compensation over the average compensation of other management team members). These six individual proxies of top management team quality are adjusted for firm size before conducting the common factor analysis. The average tenure of management team members and the heterogeneity in such tenures are excluded from the common factor analysis given that these two individual proxies of top management quality have negative loadings in the common factor analysis.1 Instead, these two proxies as used as control variables in multivariate regressions. The common factor analysis generates six factors. The first factor from the common factor analysis of the six individual proxies of top management team quality is retained to be used as a single measure of top management team quality. This is because the sum of the communalities of the individual proxies is equal to 0.62, which is less than the eigenvalue of the first factor (0.80) from the common factor analysis. Thus the first factor on its own is enough to explain parsimoniously the intercorrelations between the 1 The negative loadings of the average tenure of management team members and the heterogeneity in their tenures in the common factor analysis is driven by the fact that these two top management team quality proxies have negative correlations with other top management team quality proxies (such as the percentage of management team members with prior managerial experience and the percentage of management team members with MBA degrees) used in the common factor analysis. These negative correlations can be explained by the fact that those managers who have longer tenures with their firms are likely to have grown internally within the firm rather than being invited from outside, and are likely to have acquired their managerial skills internally within the firm rather than at an educational institution. 3 ADBI Working Paper 780 Chemmanur and Simonyan individual proxies of top management team quality. Table 1 shows the summary statistics of the individual proxies of top management team quality, as well as the top management team quality factor (first factor) generated as a result of the common factor analysis in Chemmanur, Paeglis, and Simonyan (2011). Table 2 presents the summary statistics on the common factor analysis from the same study, namely, estimated communalities of the six individual proxies of top management team quality, eigenvalues of the reduced correlation matrix, and correlations between the first common factor (used as a single measure of top management team quality) and the six individual proxies of top management team quality. The top management team quality common factor has positive correlations with the six individual proxies of management quality and by construction has a mean of zero. The larger values of the management quality common factor correspond to higher top management team quality. Table 1: Summary Statistics of Management Quality Variables for the Sample of IPO Firms in 1993−2000 N Mean Median Minimum Maximum St. Dev. TSIZE 719 5.424 5.000 1.000 15.000 2.223 PMBA 719 0.075 0.000 0.000 0.800 0.145 PCPA 719 0.118 0.077 0.000 0.833 0.141 PFTEAM 719 0.381 0.333 0.000 1.000 0.277 PLAWACC 719 0.031 0.000 0.000 0.750 0.088 FCEO 711 1.381 1.259 0.000 5.425 0.584 TENURE 719 6.482 5.000 1.000 30.500 5.239 TENHET 718 2.172 0.940 0.000 22.854 2.911 MQFACT 711 0.000 –0.099 –1.311 3.132 0.703 TSIZE is the size of a firm’s management team, defined as the number of executive officers and vice presidents on a firm’s management team. PMBA is the percentage of a firm’s management team with MBA degrees. PCPA is the percentage of a firm’s management team who are CPAs. PFTEAM is the percentage of a firm’s management team having served as executive officers and/or vice presidents prior to joining the IPO firm. PLAWACC is the percentage of a firm’s management team having previously been partners in a law or accounting firm. FCEO is the ratio of CEO salary and bonus to the average salary and bonus of other management team members in the fiscal year preceding the IPO. TENURE is the median number of years that management team members have been with a firm. TENHET is the coefficient of variation of the team members’ tenure. MQFACT is the management quality factor score. Table 2: Common Factor Analysis of Six Measures of Management Quality for the Sample of IPO Firms in 1993−2000 Panel A: Estimated Communalities of Six Management Quality Measures TSIZE MBA CPA FTEAM LAWACC FCEO 0.2320 0.0394 0.0756 0.1941 0.0666 0.0136 Panel B: Eigenvalues of the Reduced Correlation Matrix Factor 1 Factor 2 Factor 3 Factor 4 Factor 5 Factor 6 0.79795 0.23436 0.05479 -0.02431 -0.17019 -0.27131 continued on next page 4 ADBI Working Paper 780 Chemmanur and Simonyan Table 3: Seemingly Unrelated Regressions of Leverage, Dividend Payout Ratio, Investment, and R&D Levels on Management Quality and Reputation, and Other Control Variables Dependent Variable 1 2 3 1 2 3 LEVER TRF TSF DIVID TRF TSF Intercept –1.062 (–8.22)*** –0.849 (–3.57)*** –0.142 (–0.79) –0.063 (–2.69)*** –0.520 (–2.23)** –0.172 (–0.96) BOARDS –0.002 (–0.45) 0.001 (1.60) LNBVA 0.080 (18.35)*** 0.062 (7.39)*** 0.004 (0.67) 0.003 (3.29)*** 0.036 (4.73)*** 0.006 (1.03) LFAGE –0.020 (–3.79)*** –0.066 (–6.28)*** 0.016 (2.05)** 0.003 (2.65)*** –0.055 (–5.15)*** 0.010 (1.26) ODIR –0.000 (–0.16) –0.004 (–0.90) –0.007 (–1.95)* 0.002 (3.45)*** –0.001 (–0.25) –0.007 (–2.00)** TOBINQ –0.021 (–8.47)*** 0.002 (0.31) –0.001 (–0.20) 0.000 (0.16) 0.009 (1.75)* 0.001 (0.28) ROA –0.052 (–5.81)*** –0.025 (–1.40) 0.036 (2.70)*** 0.001 (0.81) –0.006 (–0.31) 0.036 (2.56)** LEVER –0.340 (–6.82)*** –0.027 (–0.71) DIVID –1.293 (–5.06)*** 0.027 (0.14) INVEST RD RETSD –0.258 (–0.56) TRF –0.088 (–6.79)*** –0.013 (–5.09)*** TSF –0.020 (–1.15) –0.001 (–0.17) R2 0.4422 0.1359 0.0929 0.1309 0.1313 0.0856 N 1,528 1,528 1,528 1,504 1,504 1,504 Dependent Variable 1 2 3 1 2 3 INVEST TRF TSF RD TRF TSF Intercept 0.724 (5.28)*** –0.686 (–2.91)*** –0.131 (–0.72) 0.801 (4.77)*** –0.975 (–3.27)*** 0.129 (0.60) BOARDS 0.005 (0.99) 0.012 (2.14)** LNBVA –0.027 (–6.06)*** 0.042 (5.49)*** 0.005 (0.87) –0.046 (–8.12)*** 0.052 (5.13)*** –0.006 (–0.77) LFAGE –0.024 (–3.80)*** –0.051 (–4.82)*** 0.011 (1.32) –0.000 (–0.04) –0.060 (–4.42)*** 0.023 (2.32)** ODIR –0.003 (–0.96) –0.003 (–0.58) –0.009 (–2.42)** 0.011 (2.92)*** –0.013 (–1.98)** –0.004 (–0.94) TOBINQ 0.001 (0.45) 0.008 (1.71)* 0.000 (0.03) 0.008 (2.61)*** 0.004 (0.61) –0.006 (–1.38) ROA –0.042 (–4.45)*** 0.013 (0.82) 0.020 (1.56) –0.266 (–17.91)*** 0.170 (5.65)*** 0.035 (1.64) continued on next page 11 ADBI Working Paper 780 Chemmanur and Simonyan Table 3 continued Dependent Variable 1 2 3 1 2 3 INVEST TRF TSF RD TRF TSF LEVER DIVID INVEST 0.311 (7.17)*** –0.089 (–2.64)*** RD 0.559 (9.96)*** –0.123 (–3.02)*** RETSD TRF 0.104 (6.97)*** 0.175 (9.73)*** TSF –0.040 (–2.08)** –0.056 (–2.23)** R2 0.3168 0.1296 0.0881 0.5597 0.1042 0.0868 N 1,518 1,518 1,518 938 938 938 LEVER is the ratio of the long-term debt plus debt in current liabilities to the long-term debt plus debt in current liabilities plus the book value of common equity. DIVID is the ratio of the sum of common and preferred dividends to earnings before depreciation, interest, and taxes. INVEST is the ratio of capital expenditure to the book value of assets. RD is the ratio of R&D expenses to the book value of assets. TRF is the team resources factor score obtained using common factor analysis on TSIZE, PMBA, PCPA, PFTEAM, and CORE. TSF is the team structure factor score obtained using common factor analysis on TENURE, TENHET, and FCEO. TSIZE is the size of a firm’s management team, defined as executive officers with the rank of vice president or higher. PMBA is the percentage of a firm’s management team with MBA degrees. PCPA is the percentage of a firm’s management team who are CPAs. PFTEAM is the percentage of the management team having served as executive officers and/or vice presidents prior to joining the SEO firm. CORE is the percentage of the management team having core functional expertise, namely, holding positions in operations, sales and marketing, R&D, and finance. TENURE is the average number of years that management team members have been with the team. TENHET is the coefficient of variation of the team members’ tenure. FCEO is the ratio of CEO salary and bonus in the fiscal year preceding the SEO to the average salary and bonus of other management team members. BOARDS is the number of other companies’ boards on which management team members sit. LNBVA is the natural logarithm of the book value of the firm’s assets at the end of the fiscal year prior to the SEO. LFAGE is the firm age, defined as the natural logarithm of one plus the number of years the firm has return data available from CRSP. ODIR is the number of outside directors. TOBINQ is the market value of assets divided by the book value of assets, where the market value of assets equals the book value of assets plus the market value of common equity less the sum of the book value of common equity and balance sheet deferred taxes. ROA is the ratio of earnings before extraordinary items to the book value of total assets. RETSD is the standard deviation of the total stock return calculated over 255 trading days for the fiscal year of the issue. LEVER, DIVID, INVEST, and RD are winsorized at the 99th percentile. Only observations with positive LEVER and DIVID are included in the regressions. All regressions include two-digit SIC code industry dummies. z-statistics are in parentheses. *, **, and *** indicate statistical significance at the 10%, 5%, and 1% levels, respectively. 5. MANAGEMENT QUALITY AND THE PRODUCTIVITY OF CORPORATE INNOVATION Several recent studies have analyzed the direct impact of management quality on corporate innovation. A study by Chemmanur, Kong, Krishnan, and Yu (2015) empirically analyzes how the quality of a seasoned firm’s top management team affects its innovation activity and shows that firms with higher top management team quality innovate more as measured by the higher levels of R&D expenses, as well as greater numbers of patents and citations per patent. These findings are confirmed even after controlling for the endogeneity of top management team quality using the instrumental variable regression technique. In particular, the instrument used is a function of the number of management team members facing the military draft during the Viet Nam War and with an incentive to go to a graduate school to defer conscription. 12 ADBI Working Paper 780 Chemmanur and Simonyan One of the channels through which seasoned firms with higher top management team quality boost their innovation activity is by hiring a greater number of innovators and by hiring higher quality innovators, as evidenced by the number of citations per their patents. Further, seasoned firms with higher top management team quality engage in both exploratory and exploitative innovation strategies. Specifically, firms with higher top management team quality have a greater number of very successful innovations (patents that receive the highest number of citations), a greater number of unsuccessful innovations (patents that receive no citations at all), as well as a greater number of moderately successful innovations (patents that receive a number of citations somewhere in between) compared with firms with lower top management team quality. The first two findings are indicative of exploratory innovation strategies since such strategies are very risky and result in either highly successful or failed innovations. The latter finding is indicative of exploitative innovation strategies since such strategies employ more conventional technologies in areas that are more familiar to the firm. Another recent study analyzing the effect of management quality on innovation in private firms is that of Chemmanur, Gupta, and Simonyan (2016), who show that entrepreneurial firms with higher top management team quality exhibit significantly greater pre-IPO innovation productivity as measured by the greater amount of R&D expenses, the greater number of patents, and the greater number of citations per patent compared with lower top management team quality firms. These relationships hold even after controlling for the endogeneity of management quality using the instrumental variable regression technique. The instrument used for top management quality is the number of acquisitions in the IPO firm’s industry in the last four years before the firm goes public. Private firms that have higher top management team quality and are also more innovative (have a greater number of patents) pre-IPO receive significantly higher valuations both in the IPO market and in the immediate secondary market, are able to go public at a younger age, and realize significant growth in post-IPO operating performance compared with other firms. Private firms with higher top management team quality and greater pre-IPO innovativeness also have a significantly greater number of anti-takeover provisions in their corporate charters at the time of going public. This last finding is consistent with the idea that higher quality managers use anti-takeover provisions to implement valuable long-term investment projects (which are likely to be more innovative). One more recent study by Custodio, Ferreira, and Matos (2017) shows that CEOs with general managerial skills obtained over their professional career (skills that are transferable across firms and industries and are not firm-specific) produce more patents. A manager who has more general skills will be more likely to undertake risky innovative projects as he/she will be less sensitive to the risk of termination if the project is a failure. The more diverse work experience of “generalist” managers (compared to “specialist” managers) allows them to move easily from one job to another, even if they fail at a particular job, since their general skill sets and abilities are likely to be sought after in other industries and firms. Thus, the broad set of managerial skills possessed by “generalist” managers makes them more failure tolerant and as a result leads to greater innovation productivity. Further, given their diverse work experience in multiple fields, “generalist” managers can support innovation activities with a greater degree of originality. Indeed, the patents of “generalist” managers cite other patents belonging to a wider set of technological classes (as a measure of originality of patents) and receive more citations by subsequent patents across a wide range of technological fields (as a measure of generality of patents). “Generalist” 13 ADBI Working Paper 780 Chemmanur and Simonyan managers also engage in more explorative than exploitative innovation activities, indicating that their innovation activities are more likely to result in technological breakthroughs. 6. MANAGEMENT QUALITY, ANTI-TAKEOVER PROVISIONS, AND CORPORATE INNOVATION As discussed previously, one of the ways in which the higher management quality of a firm can affect its innovation productivity is through better anti-takeover protection. Chemmanur, Paeglis, and Simonyan (2011) empirically investigate the relationship between the top management team quality of a firm going public and the prevalence of anti-takeover provisions in its corporate charter, and test the implications of two competing hypotheses: “management entrenchment” and “long-term value creation.” According to the first hypothesis, anti-takeover provisions serve to entrench firm management by reducing the likelihood of being acquired by rival firms and insulating firm managers from the discipline imposed by the market for corporate control. Such entrenchment allows firm managers to exert less effort in running their firm and to extract a greater amount of control benefits. Thus, firms with lower management quality will be more likely to have stronger anti-takeover defenses (or a larger number of anti-takeover provisions in their corporate charters). This hypothesis also implies that regardless of management quality, better anti-takeover protection will result in lower firm valuation and worse operating performance because of the reduced disciplining effect of the market for corporate control on firm management. According to the second hypothesis, which is derived based on the theoretical model of Chemmanur and Jiao (2012), stronger anti-takeover defenses allow firm managers to invest in valuable but risky long-term investment projects without worrying about losing control of their firms to rival companies in control contests if such projects do not show any signs of success in the short term. Therefore, firms with higher quality managers (who have a greater ability to create long-term value) will be more likely to have stronger anti-takeover defenses since higher quality managers are more likely to use such defenses to implement long-term value-enhancing projects. Further, this hypothesis also predicts that those firms that have both higher quality managers and stronger anti-takeover defenses will have higher market valuations and better operating performance. The above hypotheses are empirically tested using hand-collected data on the top management team quality of 719 IPO firms in 1993−2000, as well as hand-collected data on 19 firm-level anti-takeover provisions (to measure the degree of a firm’s antitakeover protection). Among these IPO firms, those with higher top management team quality have a greater number of anti-takeover provisions in their corporate charters at the time of going public than those with lower top management team quality. Table 4, taken from Chemmanur, Paeglis, and Simonyan (2011), reports the means (frequencies) and medians of individual firm-level anti-takeover provisions, as well as the total number of anti-takeover provisions in the corporate charters of firms with higher top management team quality (firms with above median values for the top management team quality common factor) and firms with lower top management team quality (firms with below median values for the top management team quality common factor).4 Firms with higher top management team quality have significantly greater frequencies of provisions requiring staggered boards, meetings called only by directors 4 The descriptions of these firm-level anti-takeover provisions are provided in Appendix A, taken from Chemmanur, Paeglis, and Simonyan (2011). 14 ADBI Working Paper 780 Chemmanur and Simonyan or executive officers, advance notice requirements, restrictions on actions with written consent, and a supermajority necessary to replace directors. Overall, firms with higher top management team quality have a significantly greater number of anti-takeover provisions (4.5 on average) compared with firms with lower top management team quality (4.1 on average). Table 4: Summary Statistics of Firm-level Anti-takeover Provisions for the Sample of IPO Firms in 1993–2000 Overall Sample Firms with Above Median Management Quality Factor Score Mean Median St. Dev. Mean Median St. Dev. Individual firm-level anti-takeover provisions 1. Anti-greenmail provision 0.0153 0 0.1228 0.0056 0 0.0750 2. Blank check preferred stock 0.9360 1 0.2449 0.9493 1 0.2197 3. Staggered boards 0.4353 0 0.4961 0.4761 0 0.5001 4. Fair price provision 0.0348 0 0.1833 0.0282 0 0.1657 5. Poison pills 0.0139 0 0.1172 0.0169 0 0.1291 6. Stakeholder clause 0.0695 0 0.2545 0.0676 0 0.2514 Shareholder meeting restrictions 7. Meetings called only by directors or executives 0.3727 0 0.4839 0.4338 0 0.4963 8. Supermajority required to call special meetings 0.0181 0 0.1333 0.0169 0 0.1291 9. Advanced notice requirement 0.4117 0 0.4925 0.4620 0 0.4993 10. Restrictions on action by written consent 0.2601 0 0.4390 0.3070 0 0.4619 Supermajority vote requirements 11. Supermajority required to approve mergers 0.1377 0 0.3448 0.1324 0 0.3394 12. Supermajority required to replace directors 0.1433 0 0.3506 0.1690 0 0.3753 13. Supermajority required to amend charter and bylaws 0.2976 0 0.4575 0.3042 0 0.4607 14. Unequal voting rights 0.1029 0 0.3041 0.0958 0 0.2947 Miscellaneous anti-takeover provisions 15. Directors can be removed only for cause 0.2448 0 0.4303 0.2704 0 0.4448 16. Merger must be approved by inside directors 0.0028 0 0.0527 0.0056 0 0.0750 17. Restrictions on transfer of common stock 0.0362 0 0.1868 0.0310 0 0.1735 18. Restrictions on votes each shareholder may cast 0.0097 0 0.0983 0.0085 0 0.0917 19. Prohibition of cumulative voting for election of director 0.7413 1 0.4382 0.7239 1 0.4477 Total number of a firm’s anti-takeover provisions 4.2837 4 2.5905 4.5042 4 2.5505 continued on next page 15 ADBI Working Paper 780 Chemmanur and Simonyan Table 4 continued Firms with Below Median Management Quality Factor Score Difference in Means t-statistic Difference in Medians z-statistic Mean Median St. Dev. Individual firm-level anti-takeover provisions 1. Anti-greenmail provision 0.0253 0 0.1572 –2.126** –2.121** 2. Blank check preferred stock 0.9298 1 0.2559 1.091 1.091 3. Staggered boards 0.4017 0 0.4909 2.001** 1.997** 4. Fair price provision 0.0421 0 0.2012 –1.010 –1.010 5. Poison pills 0.0112 0 0.1056 0.641 0.641 6. Stakeholder clause 0.0730 0 0.2606 –0.283 –0.283 Shareholder meeting restrictions 7. Meetings called only by directors or executives 0.3174 0 0.4661 3.223*** 3.202*** 8. Supermajority required to call special meetings 0.0197 0 0.1390 –0.274 –0.275 9. Advanced notice requirement 0.3652 0 0.4822 2.630*** 2.619*** 10. Restrictions on action by written consent 0.2163 0 0.4123 2.764*** 2.751*** Supermajority vote requirements 11. Supermajority required to approve mergers 0.1461 0 0.3537 –0.526 –0.526 12. Supermajority required to replace directors 0.1180 0 0.3230 1.944* 1.940* 13. Supermajority required to amend charter and bylaws 0.2949 0 0.4567 0.270 0.270 14. Unequal voting rights 0.1124 0 0.3163 –0.723 –0.724 Miscellaneous anti–takeover provisions 15. Directors can be removed only for cause 0.2219 0 0.4161 1.502 1.500 16. Merger must be approved by inside directors 0.0000 0 0.0000 1.418 1.417 17. Restrictions on transfer of common stock 0.0421 0 0.2012 –0.791 –0.791 18. Restrictions on votes each shareholder may cast 0.0112 0 0.1056 –0.376 –0.376 19. Prohibition of cumulative voting for election of director 0.7612 1 0.4269 –1.137 –1.136 Total number of a firm’s anti-takeover provisions 4.1096 3 2.6145 2.037** 2.318** This table reports the means (frequencies) and medians of individual firm-level anti-takeover provisions and the total number of a firm’s anti-takeover provisions for the overall sample of IPO firms and two sub-samples of IPO firms with above and below median management quality factor score. The management quality factor score is obtained using common factor analysis on firm-size-adjusted TSIZE, MBA, CPA, FTEAM, LAWACC, and FCEO. TSIZE is the size of a firm’s management team, defined as the number of executive officers and vice presidents on a firm’s management team. MBA is the number of management team members with MBA degrees. CPA is the number of management team members who are CPAs. FTEAM is the number of management team members who have served as executive officers and/or vice presidents prior to joining the IPO firm. LAWACC is the number of management team members who have previously been partners in a law or accounting firm. FCEO is the ratio of CEO salary and bonus to the average salary and bonus of other management team members in the fiscal year preceding the IPO. Significance levels are based on the parametric t-test for the difference in means between the two sub-samples and the Wilcoxon rank-sum test for the difference in medians between the two sub-samples. *, **, and *** indicate statistical significance at the 10%, 5%, and 1% levels, respectively. 16 ADBI Working Paper 780 Chemmanur and Simonyan Table 5, also taken from Chemmanur, Paeglis, and Simonyan (2011), shows the results of Poisson and logit regressions of the total number of anti-takeover provisions in an IPO firm’s corporate charter at the time of going public on the top management team quality factor, as well as individual management quality proxies and other control variables. The top management team quality factor has a significantly positive effect on the number of anti-takeover provisions in all specifications. Among the individual top management team quality proxies, team size, the percentage of MBAs in the top management team, the percentage of team members who are CPAs, and CEO dominance have a significantly positive effect on the number of anti-takeover provisions. Thus, even after controlling for firm characteristics (such as firm size, growth options, leverage), firm internal governance (such as insider ownership, percentage of outside directors on the board of directors, CEO/Chairman of the board duality), IPO underwriter reputation, and IPO firm’s state of incorporation, management quality is still important in increasing the number of anti-takeover provisions in an IPO firm’s corporate charter. Table 5: Relationship between Management Quality and the Prevalence of Anti-takeover Provisions for the Sample of IPO Firms in 1993−2000 Poisson Maximum-likelihood Regressions with Total Number of Anti-takeover Provisions (1 through 19 in Appendix A) as Dependent Variable Logit Regressions with Dependent Variable Equal to One if a Firm has Four or More Anti-takeover Provisions (as in Appendix A), and Zero Otherwise 1 2 3 4 5 6 7 8 Constant –1.278 –1.207 –9.642 –9.682 (–2.35)** (–2.24)** (–7.04)*** (–7.28)*** MQFACT 0.067 0.052 0.400 0.357 (2.29)** (1.71)* (2.89)*** (2.47)** TSIZE 0.023 0.020 0.108 0.106 (2.36)** (1.98)** (2.31)** (2.17)** PMBA 0.351 0.246 1.901 1.602 (2.79)*** (1.91)* (2.97)*** (2.40)** PCPA 0.309 0.176 1.800 1.647 (2.08)** (1.15) (2.76)*** (2.42)** PFTEAM –0.067 –0.108 –0.036 –0.195 (–0.82) (–1.27) (–0.10) (–0.52) PLAWACC 0.287 0.405 0.943 1.545 (1.22) (1.68)* (0.91) (1.40) FCEO 0.058 0.041 0.368 0.250 (1.74)* (1.21) (2.25)** (1.53) TENURE 0.004 0.005 0.002 0.004 0.004 0.011 –0.000 0.009 (0.81) (1.13) (0.46) (0.90) (0.19) (0.56) (–0.01) (0.43) TENHET 0.000 0.004 0.004 0.007 0.033 0.043 0.042 0.055 (0.07) (0.59) (0.57) (1.01) (0.94) (1.25) (1.15) (1.57) CERDA 0.048 0.050 0.030 0.034 0.192 0.166 0.083 0.064 (0.89) (0.94) (0.51) (0.58) (0.93) (0.80) (0.37) (0.28) INSIDERB –0.081 –0.073 –0.102 –0.096 –0.749 –0.710 –0.707 –0.694 (–0.88) (–0.80) (–1.07) (–1.01) (–1.75)* (–1.70)* (–1.58) (–1.57) ODIR 0.021 0.018 0.071 0.068 –0.182 –0.151 –0.020 –0.010 (0.28) (0.24) (0.91) (0.87) (–0.53) (–0.45) (–0.05) (–0.03) BOSS –0.003 0.002 0.003 0.005 –0.095 –0.097 –0.101 –0.110 (–0.07) (0.05) (0.06) (0.11) (–0.47) (–0.49) (–0.47) (–0.52) continued on next page 17 ADBI Working Paper 780 Chemmanur and Simonyan Table 5 continued Poisson Maximum-likelihood Regressions with Total Number of Anti-takeover Provisions (1 through 19 in Appendix A) as Dependent Variable Logit Regressions with Dependent Variable Equal to One if a Firm has Four or More Anti-takeover Provisions (as in Appendix A), and Zero Otherwise 1 2 3 4 5 6 7 8 LNBVA 0.105 0.126 0.092 0.110 0.389 0.482 0.369 0.445 (5.95)*** (7.81)*** (5.00)*** (6.52)*** (5.02)*** (6.56)*** (4.58)*** (5.79)*** LEVERAGE –0.064 –0.075 –0.111 –0.120 0.079 0.010 –0.046 –0.090 (–1.11) (–1.34) (–1.81)* (–2.00)** (0.35) (0.05) (–0.19) (–0.40) REP 0.282 0.328 0.532 0.612 5.094 4.636 5.192 4.855 (0.54) (0.62) (0.99) (1.15) (1.63) (1.54) (1.65)* (1.59) STATELAW 0.563 0.566 2.015 1.961 (5.93)*** (6.00)*** (4.92)*** (4.93)*** DELAWARE 0.040 0.032 0.112 0.044 (0.99) (0.81) (0.61) (0.25) State fixed effects No No Yes Yes No No Yes Yes Year dummies Yes Yes Yes Yes Yes Yes Yes Yes Industry dummies Yes Yes Yes Yes No No No No N 711 711 707 707 711 711 678 678 Pseudo R2 0.0925 0.0871 0.1855 0.1644 0.1545 0.1346 TSIZE is the number of executive officers and vice presidents on a firm’s management team. PMBA is the percentage of a firm’s management team with MBA degrees. PCPA is the percentage of a firm’s management team who are CPAs. PFTEAM is the percentage of a firm’s management team having served as executive officers and/or vice presidents prior to joining the IPO firm. PLAWACC is the percentage of a firm’s management team having previously been partners in a law or accounting firm. FCEO is the ratio of CEO salary and bonus to the average salary and bonus of other management team members in the fiscal year preceding the IPO. TENURE is the median number of years that management team members have been with a firm. TENHET is the coefficient of variation of the team members’ tenures. CERDA is the ratio of the sum of capital expenditures and R&D expenses to the book value of assets at the end of the fiscal year prior to IPO. INSIDERB is the proportion of voting power owned by firm officers and directors immediately prior to IPO. ODIR is the proportion of outside directors on the board of directors. BOSS is equal to one if a CEO is also Chairman of the board of directors, and zero otherwise. LNBVA is the natural logarithm of the book value of assets immediately prior to IPO. LEVERAGE is the ratio of long-term debt to the book value of assets prior to IPO. REP is the underwriter reputation measured as the lead underwriter’s share of the total proceeds raised by all IPOs in 1993−2000. STATELAW is equal to one if the state in which a firm is incorporated has at least one state anti-takeover provision, and zero otherwise. DELAWARE is equal to one if a firm is incorporated in the state of Delaware, and zero otherwise. MQFACT is the management quality factor score obtained using common factor analysis on firm-size- adjusted TSIZE, MBA, CPA, FTEAM, LAWACC, and FCEO. t-statistics are in parentheses. *, **, and *** indicate statistical significance at the 10%, 5%, and 1% levels, respectively. Other empirical findings indicate that IPO firms with higher top management team quality and greater growth options have a significantly larger number of anti-takeover provisions in their corporate charters compared with other firms. IPO firms with higher management quality that also have a greater number of anti-takeover provisions in their corporate charters realize better post-IPO operating and stock return performance, as well as receive higher IPO valuations. All these findings are consistent with the long-term value creation hypothesis and contradict the management entrenchment hypothesis, indicating that anti-takeover provisions may be valuable if used by higher quality managers as they are more likely to use anti-takeover protection to implement long-term value-enhancing projects (which are likely to be highly innovative). 18 ADBI Working Paper 780 Chemmanur and Simonyan The empirical evidence above suggests that the higher management quality of a firm leads to stronger anti-takeover defenses in its corporate charter. But how do the stronger anti-takeover defenses of a firm affect its innovation productivity? A study by Chemmanur and Tian (2016) shows that established firms with a greater number of anti-takeover provisions (as measured by the G-index developed by Gompers, Ishii, and Metrick [2003]) exhibit greater innovation productivity. In particular, firms with a greater number of anti-takeover provisions have a greater number of patents (quantity of innovation) as well as a greater number of citations per patent (quality of innovation). It is important to recognize that the number of anti-takeover provisions in a firm’s corporate charter is endogenous given that some unobservable firm characteristics may jointly determine both the innovation productivity of the firm and the number of anti-takeover provisions in its corporate charter. To establish causality, Chemmanur and Tian (2016) use regression discontinuity methodology, which relies on “locally” exogenous variation in the number of anti-takeover provisions generated by the governance proposal votes that either pass or fail to pass by a small margin of votes during annual shareholder meetings. For these close-call votes, passing a proposal is a random, independent event that is unlikely to be correlated with firm characteristics. This randomized variation in the number of anti-takeover provisions is a result of voters’ inability to control precisely the number of votes near the cutoff that determines the vote outcome. After controlling for the endogeneity of the number of anti-takeover provisions using regression discontinuity methodology, the number of anti-takeover provisions still has a positive effect on a firm’s innovation. Specifically, the proposals that intend to reduce the number of anti-takeover provisions lead to a decrease in the number of patents and a decrease in the number of citations per patent over the next three years after the vote. Further, the positive effect of anti-takeover provisions on innovation is stronger for firms facing a greater extent of information asymmetry in the financial market and more competition in the product market (these are the characteristics of firms that are more likely to be subject to short-term pressure from public market investors). This last finding provides further support for the “long-term value creation” hypothesis discussed above.5 Anti-takeover provisions also increase firm value, but only if a firm is highly productive in its innovation activities. On the other hand, the valuations of those firms with lower innovation productivity (or no innovation activities at all) decrease with the number of anti-takeover provisions in their corporate charters. This suggests that anti-takeover provisions are value-enhancing for those firms that are innovative, but are valuedestroying for those firms that are not engaged in significant innovation activities. 5 While Chemmanur and Tian (2016) demonstrate that a greater number of firm-level anti-takeover provisions are associated with more corporate innovation, Atanassov (2013) shows that state-level anti-takeover provisions stifle innovation. In fact, firms incorporated in states that pass anti-takeover laws experience a significant decline in their innovation productivity within two years after such laws are passed compared to firms incorporated in states that do not pass anti-takeover laws. Sapra, Subramanian, and Subramanian (2014) predict a U-shaped relationship between corporate innovation and external takeover pressure, and show that corporate innovation is fostered if state antitakeover laws are either practically non-existent or severe enough to be effective in warding off unwanted takeover attempts. 19 ADBI Working Paper 780 Chemmanur and Simonyan 7. VENTURE CAPITAL BACKING, MANAGEMENT QUALITY, AND CORPORATE INNOVATION Venture capital backing is shown in the literature to be one of the important factors contributing to the innovation productivity of a firm. A study by Kortum and Lerner (2000) demonstrates that the increases in venture capital activity in manufacturing industries (while controlling for R&D spending) are associated with greater innovation productivity as measured by higher patenting rates. Given that both venture capital funding and patenting can be positively related to an unobservable factor, such as the arrival of new technologies, the causality between venture capital funding and innovation is established by means of instrumental variable analysis. The 1979 US Labor Department’s clarification of the Employee Retirement Income Security Act is used as an instrument in this analysis. This clarification allowed pension funds to invest in venture capital firms, sharply increasing the inflow of funds to the venture capital industry. Since this exogenous policy change is unlikely to be correlated with the arrival of new technologies, the instrument satisfies the exclusion restriction. The causality concern can be addressed by also using the number of patents over R&D expenses ratios as dependent variables in the regression analysis rather than the number of patents, thus using R&D expenses as a control for the arrival of new technologies. Regardless of the way the causality concern is addressed, the empirical evidence suggests that venture capital backing has a strong positive effect on innovation. Finally, in a small sample of Massachusetts firms (with and without venture capital backing), the patents of venture capital-backed firms are more frequently cited by other patents and are more aggressively litigated, indicating that the patents of venture capitalbacked firms are not of lower quality. One of the channels through which venture capital backing can affect innovation is through management quality. A study by Chemmanur, Simonyan, and Tehranian (2016) analyzes the relationship between venture capital backing and top management team quality, and shows that IPO firms backed by venture capital have higher top management team quality at the time of going public compared to firms not backed by venture capital. In particular, IPO firms backed by venture capital have significantly higher percentages of top management team members with MBA degrees, with prior managerial experience at other firms, and with core functional expertise compared to IPO firms not backed by venture capital. At the same time, IPO firms backed by venture capital have significantly lower percentages of CPAs, shorter tenures, and less heterogeneity in tenures. However, the overall effect of venture capital backing on top management team quality (as measured by the top management team quality common factor) is positive, implying that top management team quality is an important channel through which venture capital affects innovation. Another study on how venture capital backing affects a firm’s management is that of Hellmann and Puri (2002), who investigate 170 Silicon Valley start-up firms and show that venture capital backing leads to the professionalization of such firms, including the formulation of human resource policies, adoption of stock option plans, and hiring of marketing vice presidents. Firms backed by venture capital are more likely to replace the founder of a firm with an outside chief executive officer and do so faster, and venture capitalists take both supportive and controlling roles in such replacement decisions. The effect of venture capital backing is more pronounced for firms in early stages of their development. These findings suggest that venture capitalists act not only as financial intermediaries but also have a broader value-added impact on the development of firms backed by them, in particular in terms of putting together resources for the firm. 20 ADBI Working Paper 780 Chemmanur and Simonyan Chemmanur, T.J., Tian, X., 2016. Do Anti-Takeover Provisions Spur Corporate Innovation? Journal of Financial and Quantitative Analysis, forthcoming. Custodio, C., Ferreira, M.A., Matos, P., 2017. Do General Managerial Skills Spur Innovation? Management Science, forthcoming. Dambra, M., Field, L.C., Gustafson, M.T., 2015. The JOBS Act and IPO Volume: Evidence that Disclosure Costs Affect the IPO Decision. Journal of Financial Economics 116 (1), 121–143. Doidge, C., Karolyi, G.A., Stulz, R.M., 2013. The U.S. Left Behind? Financial Globalization and the Rise of IPOs Outside of the U.S. Journal of Financial Economics 110 (3), 546–573. Ferreira, D., Manso, G., Silva, A.C., 2014. Incentives to Innovate and the Decision to Go Public or Private. Review of Financial Studies 27 (1), 256–300. Gompers, P., Ishii, J., Metrick, A., 2003. Corporate Governance and Equity Prices. Quarterly Journal of Economics 118 (1), 107–155. Harman, H., 1976. Modern Factor Analysis, 3rd ed. (University of Chicago Press, Chicago, IL). He, S., Li, C.W., 2016. Human Capital, Management Quality, and the Exit Decisions of Entrepreneurial Firms. Journal of Financial and Quantitative Analysis 51 (4), 1269–1295. Hellmann, T., Puri, M., 2002. Venture Capital and the Professionalization of Start-Up Firms: Empirical Evidence. Journal of Finance 57 (1), 169–197. Holmstrom, B., 1989. Agency Costs and Innovation. Journal of Economic Behavior and Organization 12 (3), 305–327. Kim, C., Shim, H., Yoo, C.-Y., 2016. Value Creation of Independent Directors with STEM PhD: Evidence from Target Shareholder Gains. Ulsan National Institute of Science and Technology and Korea Advanced Institute of Science and Technology Working Paper. Kortum, S., Lerner, J., 2000. Assessing the Contribution of Venture Capital to Innovation. RAND Journal of Economics 31 (4), 674–692. Maksimovic, V., Pichler, P., 2001. Technological Innovation and Initial Public Offerings. Review of Financial Studies 14 (2), 459–494. Manso, G., 2011. Motivating Innovation. Journal of Finance 66 (5), 1823–1860. Porter, M.E., 1992. Capital Disadvantage: America’s Failing Capital Investment System. Harvard Business Review 70 (5), 65–82. Sapra, H., Subramanian, A., Subramanian, K.V., 2014. Corporate Governance and Innovation: Theory and Evidence. Journal of Financial and Quantitative Analysis 49 (4), 957–1003. Schumpeter, J.A., 1942 (1994). Capitalism, Socialism and Democracy, 5th ed. (Routledge, London, UK). Spiegel, M., Tookes, H., 2013. Dynamic Competition, Valuation, and Merger Activity. Journal of Finance 68 (1), 125–172. Stein, J., 1988. Takeover Threats and Managerial Myopia. Journal of Political Economy 96 (1), 61–80. Tian, X., Wang, T.Y., 2014. Tolerance for Failure and Corporate Innovation. Review of Financial Studies 27 (1), 211–255. 27 ADBI Working Paper 780 Chemmanur and Simonyan APPENDIX A: DESCRIPTIONS OF THE FIRM-LEVEL ANTI-TAKEOVER PROVISIONS IN CORPORATE CHARTERS ANALYZED IN TABLE 4 Provision Description 1. Anti-greenmail provision Greenmail refers to targeted stock repurchases of company shares by management, usually at a substantial premium over the market value, from groups or individuals seeking control of the company. Antigreenmail provisions prohibit managers from entering into such arrangements with bidders, unless they are approved by shareholders or the same repurchase offer is made to all shareholders. 2. Blank check preferred stock This is preferred stock that is authorized but not issued. It gives a company’s board of directors the power to issue shares of preferred stock at its discretion and determine its voting, distribution, conversion, and other rights at the time of the issue. Blank check preferred stock can be placed with friendly parties to deter potential takeover bids by diluting bidders’ equity and voting positions. It can be also used to establish poison pills. 3. Staggered (classified) board A staggered board is a board of directors that is usually divided into three classes, with each class serving a three-year term, and each class being elected in different years. Classifying the board makes it more difficult to change the control of the company through proxy contests since only a minority of directors is elected each year. A bidder who has voting control of the company will be unable to gain control of the board in a single election and will need up to two years to do so. 4. Fair price provision This provision is usually adopted to defend against two-tiered frontend-loaded tender offers when the bidder first buys a controlling block of shares and then offers a lower price to remaining shareholders. This usually forces the target shareholders to tender their shares in the first stage, regardless of the price offered, since the second-stage price is going to be lower. Fair price provisions usually require the bidders to pay the remaining shareholders the same price as that paid to acquire the controlling block in the first stage. The bidder may avoid such pricing requirements if the offer is approved, typically by the supermajority of disinterested shareholders or the board of directors. 5. Poison pills Also known as shareholder rights plans, poison pills are financial instruments in the form of rights or warrants issued to shareholders trading with common shares. When triggered by a hostile takeover attempt, poison pills detach, trade separately, and become valuable. Poison pills can dilute a bidder’s equity holdings and voting interests in a target company by giving a right to common shareholders to buy additional shares of the target company at a steep discount, or they can dilute a bidder’s equity holdings in a merged company by giving the right to target firm shareholders to buy discounted shares of the post-merger company. 6. Stakeholder clause This provision permits directors, when evaluating takeover bids, to consider the interests of constituencies other than shareholders, such as employees, creditors, suppliers, customers, surrounding communities, and others. The stakeholder clause provides target firm directors with a legal basis to take actions that could be valuedecreasing for shareholders, for example, turning down attractive takeover bids. continued on next page 28 ADBI Working Paper 780 Chemmanur and Simonyan Appendix A table continued Provision Description Shareholder meeting restrictions 7. Meetings called only by directors or executives This provision authorizes only directors or executives and not common shareholders to call special shareholder meetings to act on matters that arise between regularly scheduled meetings. It can deter potential takeovers by delaying the removal of directors by a controlling bidder or by hindering the ability of common shareholders to vote on attractive bids. 8. Supermajority required to call special meetings This provision allows common shareholders to call special shareholder meetings if they can get the consent of a shareholder or groups of shareholders holding a supermajority of outstanding shares. 9. Advanced notice requirement This provision requires shareholders to give advanced notice regarding the matters they intend to present at the shareholders’ meeting. It usually specifies a “window” for the earliest and the latest dates for such submissions, e.g., no later than 60 days prior to the meeting, with a submittal window of at least 60 days. Advance notice requirements can deter takeovers by prohibiting shareholders from voting on matters regarding takeover bids if proper advance notice was not submitted. 10. Restrictions on action by written consent An action by written consent is an action taken without a meeting if shareholders individually or collectively consent in writing to such action. A provision that limits the ability of shareholders to act by written consent, by prohibiting it or requiring unanimous/majority written consent, can delay takeovers by forcing a bidder to take action at the next scheduled meeting. Supermajority vote requirements 11. Supermajority required to approve mergers This provision requires the vote of a supermajority (usually, at least two-thirds and up to 90%) of shareholders to approve mergers, business combinations, or asset sales. Supermajority requirements are often unattainable, either because they exceed the level of shareholder participation at a meeting or because of a large size of insider or employee stock ownership plan (ESOP) shareholdings. 12. Supermajority required to replace directors This provision requires the vote of a supermajority of shareholders to replace directors and can deter takeovers by limiting the ability of a bidder to remove directors opposing the takeover. 13. Supermajority required to amend charter and bylaws This provision requires the vote of a supermajority of shareholders to amend a charter or bylaws and restricts the ability of shareholders to repeal other anti-takeover provisions that are usually proposed as amendments to charters and bylaws. 14. Unequal voting rights Unequal voting rights refer to a share structure with more than one class of common shares that have different voting rights. Usually, insiders of a firm, such as managers and inside directors, hold a class of shares that gives them more than one vote per share compared to the class held by other shareholders with only one vote per share. continued on next page 29 ADBI Working Paper 780 Chemmanur and Simonyan Appendix A table continued Provision Description Miscellaneous antitakeover provisions 15. Directors can be removed only for cause According to this provision, members of a board of directors can be removed only for cause, which limits the ability of potential acquirers to remove directors opposing a takeover. 16. Merger must be approved by inside directors This provision requires the approval of inside directors or directors not related to a potential bidder for a merger to take effect. 17. Restrictions on transfer of common stock This type of provision puts various restrictions on the transfer of common stock. For example, a provision like this may require principal shareholders to offer their shares first to other principal shareholders before selling them. 18. Restrictions on votes each shareholder may cast This type of provision puts various restrictions on the votes each shareholder may cast. For example, shareholders who own more shares than a pre-specified threshold may cast only half of their votes. 19. Prohibition of cumulative voting for election of directors Cumulative voting permits shareholders to put together (cumulate) all their votes for directors and distribute these votes among one, a few, or all directors when more than one director is nominated for election. Cumulative voting makes it easy for minority shareholders to elect their own representatives and can be particularly important in proxy contests. The prohibition of cumulative voting limits the ability of bidders to elect their own representatives to the board of directors. 30