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Do Takeover Defenses Impair Equity Investors’ Perception of ‘Higher Quality’ Earnings?

Lee-Seok Hwang, Seoul National University
Woo-Jong Lee, The Hong Kong Polytechnic University

ABSTRACT: Prior studies show that managerial entrenchment deteriorates the credibility of earnings, hence reducing the value relevance of earnings. However, recent works of Zhao and Chen [2008a, 2008b, 2009] document that the likelihood of earnings management is lower in firms with more antitakeover provisions since entrenched managers pursue a ‘quiet life’ instead of striving to maximize wealth of shareholders. Despite ‘higher quality’ earnings of such firms, we find that takeover protection impairs the perception of equity investors on earnings quality. We attribute this contradictory result to the failure of management to take risky but value-enhancing projects owing to pursuits of a quiet life. We also expect and find that investments of more defensive firms are valued at a discount, suggesting that equity investors expect such firms to take less advantage of their growth potentials. We corroborate this result by showing lower variability in firm value of more defensive firms.

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