"Companies in the sample that took on above-average debt loads to fight off a takeover significantly outperformed both less-leveraged target companies and the stock market as a whole in the five years after the takeover bid."
When a corporate takeover bid fails, Wall Street is usually disappointed. The target company's stock price drops; if the company has gone to great lengths to fight off the takeover, there are also grumblings that shareholders' interests are being ignored.
In Debt and Corporate Performance: Evidence From Unsuccessful Corporate Takeovers (NBER Working Paper No. 6068) , Assem Safieddine and NBER Research Associate Sheridan Titman examine whether this reaction is justified. They find that, at least in the case of companies that run up a lot of debt in the course of fighting off a takeover, it is not.
Safieddine and Titman examined the targets of 573 unsuccessful takeover bids between 1982 and 1991. The share prices of target companies in the sample that took on above-average debt loads to fight off a takeover significantly outperformed both less-leveraged target companies and the stock market as a whole in the five years after the takeover bid. In searching for an explanation for this outperformance, Safieddine and Titman found that companies with the largest debt increases after a failed takeover reduced capital expenditures, sold off assets, reduced employment, and increased cash flows. Target companies that didn't increase their debt loads were much less likely to take such actions, and their subsequent stock performance was simply average. Taking on debt, the authors conclude, "commits the target's manager to make the improvements that would have been made by a potential raider."
Investors aren't entirely blind to this: They reacted less negatively to failed takeovers when the target company took on lots of debt than when it didn't. But they still reacted negatively, while the highly-leveraged failed-takeover targets went on to outperform the market over the following five years. This outperformance was not offset by higher volatility, which indicates that investors underestimated how much a target company's value would be improved even if the takeover didn't go through.