When a company faces the prospect of a hostile takeover, its board may reach for traditional anti-takeover defences. “Poison pills,” for instance, allow existing shareholders to buy additional shares at a discount, diluting a would-be acquirer’s stake and making the target more expensive to absorb.
Hostile takeovers occur when one company attempts to acquire another against the wishes of the target’s board of directors, typically by purchasing a majority of its shares on the open market. They are, by design, adversarial, and the defences against them have historically been financial and legal.
But a growing body of research points to a more preventive kind of protection: a company’s performance on environmental, social and governance (ESG) measures. Businesses are legally required to invest in ESG initiatives to offset any harm they cause and to contribute to a net positive for our world at large.
While companies rarely frame ESG investment in these terms, a recent study by me and my colleagues suggests that’s part of what’s happening, and that the effects extend well beyond the firms under direct threat.
What the research found
To examine the relationship between ESG investment and hostile takeover risk, we analyzed a large sample of publicly traded American firms using methods designed to isolate the effect of takeover pressure from other factors.
We tracked what happened to ESG investment when companies faced acquisition threats, looking for changes in behaviour that could be tied to that pressure specifically.
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When companies face meaningful hostile takeover threats, our research found they invest significantly more in ESG than comparable firms facing lower levels of risk. When at least one company in a given industry receives a hostile bid, others in that industry increase their ESG investment by between 3.6 and 6.1 per cent.
That reaction is strongest among firms with fewer existing anti-takeover protections. It is also more pronounced in American states with constituency statutes, which give companies broader legal grounds to weigh the interests of employees, customers and communities — not just shareholders — when responding to a takeover threat. More than 30 U.S. states have adopted such statutes since the 1980s.
We also found that firms in states with newly adopted poison pill provisions subsequently reduced their ESG investment as they became less vulnerable to hostile takeovers. That pattern is consistent with ESG investment serving, at least in part, as a substitute protection mechanism.
Why ESG deters acquirers
ESG investment works as a takeover defence for three main reasons. First, target firms — the ones being threatened with a takeover — with strong ESG records tend to command higher valuation premiums, which raises the cost of any acquisition attempt.
Second, a would-be acquirer with a weaker ESG record than its target firm can face legal, regulatory and reputational hurdles in the takeover process, given the imbalance in priorities.
Third, even if the takeover succeeds, the acquirer has to maintain or improve the target’s ESG record, which consumes great resources. If an acquiring firm wants to take over a target with a stronger ESG record, it will need to invest more in its own ESG efforts first.
Each of these deterrents make high-ESG targets more costly, more complicated and slower to absorb.
(AP Photo/Richard Drew)
A ripple effect across industries
Perhaps the most significant finding is what happens beyond the firm directly being targeted. When one company got targeted, its peers in the same industry would boost their ESG performance in response to a perceived threat, because takeovers come in waves. Whether intentional or not, this benefits many others outside of that one vulnerable firm.
This means the hostile takeover threat — one of the more adversarial forces in corporate finance — can end up inadvertently setting new benchmarks for how corporations should function in relation to the rest of the world.
ESG investment that begins as corporate self-protection can produce real-world benefits: stronger sustainability initiatives, better relationships with communities and employees, and more robust oversight. The motivations behind those investments may be strategic, but the outcomes are not confined to the balance sheet.
By integrating ESG investment and commitment into corporate strategies, companies are able to more easily navigate challenges to their corporate control and better manage risk, and they also enhance sustainability and stakeholder value.
Responsible business practices benefit everyone, from the people who create the goods we consume all the way through to the environmental effects we all experience from the means of their production.
Mary Margaret Licharson, Senior Lead for Research Facilitation and Mobilization at the Asper School of Business, University of Manitoba, co-authored this article.
