Takeover Defenses, Firm-Specific Skills and Managerial Entrenchment

We examine the shareholder wealth effects of takeover defenses by developing a model in which takeovers facilitate the implementation of technological innovations. In the rational expectations equilibrium of the model with explicit contracts, we show that takeover defenses are deployed to insure employees' firm-specific skills and that defenses dominate severance payments as an insurance mechanism because the latter distort the incentives of employees to exert effort. However, takeover defenses also result in managerial entrenchment. Managers of firms with weak boards choose takeover defenses which maximize their benefits of control, rather than shareholder wealth: golden parachutes serve to align managerial and shareholder preferences.