Defensive Tactics and Optimal Search: a Simulation Approach

Abstract: The appropriate division of authority between a company’s board and its shareholders is the central issue in the corporate governance debate. In the US, a target board can prevent shareholders from responding to a hostile bid. Whether this is efficient cannot be answered empirically because the econometrician can observe bids but cannot observe deterred bids. Whether defensive tactics maximize target shareholder is difficult to answer because of defensive tactics are hard to compare. This paper uses a search equilibrium model of the market for corporate control, which it solves by simulating parameters for the variables of interest, including the number of ex ante efficient acquisitions. We have two results: (i) Strong defensive tactics reduce market efficiency--the ratio of made matches to efficient matches--significantly (ii) The defensive tactics level that maximizes target shareholder welfare is materially higher than the level that maximizes social welfare. Because simulations such as ours are rough approximations, our stronger claim is that equilibrium analyses can illuminate how the corporate control market performs.