The effects of takeover threats of shareholders and firm value

We study the role of takeover threats as a corporate control mechanism using Aghion and Tirole's (1997) model of formal and real authority. Shareholders do not monitor the manager's actions, since ownership is widely dispersed. A corporate raider may monitor, and steps in if a profit opportunity exists. In our model, a takeover threat decreases the manager's effort and does not benefit shareholders. The effect of a takeover threat on the expected value of the firm is ambiguous. It is in the interest of the corporate raider if severance payments the manager receives upon being fired are high. Shareholders, however, prefer them to be low.