INTRA-INDUSTRY EFFECTS OF TAKEOVERS: A STUDY OF THE OPERATING PERFORMANCE OF RIVAL FIRMS

This paper investigates whether the managers of industry rivals act to mitigate their agency exposure and improve operating performance when one of the firms in the industry is subject to a takeover attempt. The results indicate that rival firms in general decrease free cash flows, improve operating performance, reduce capital expenditures and increase leverage in response to a control threat within the industry. In particular, rival firms with potentially higher agency costs i.e. fewer investment opportunities and high cash or high free cash flows exhibit a higher reduction in cash levels and free cash flows subsequent to a control threat in their industry. These results are consistent with the inefficient management hypothesis, which suggests poorly performing firms are more likely to be the target of a takeover attempt and the acquisition probability hypothesis proposed by Song and Walkling (2000), which states that rivals of initial targets earn abnormal returns because of an increased probability that they themselves will be targets. These results lend support to the argument that takeovers act as an effective external contro