An analysis of the reincorporation decision: The evidence since 1980

Randall Allen Heron, Purdue University

Abstract

This thesis examines the decision made by managers of publicly traded corporations to change the firm's state of incorporation. Due to significant differences in state corporation laws, this action, referred to as 'reincorporation,' can materially alter the contractual relationships governing the firm. The apparent state competition in the market for corporate charters has led to competing viewpoints regarding why managers decide to reincorporate and how the resulting recontracting affects shareholders. On one hand, financial researchers contend that reincorporations are the product of managers acting to maximize contractual efficiency by relocating in jurisdictions with corporate laws that are better suited to firm characteristics. Alternatively, many argue that reincorporations are used as a vehicle to relax corporate governance mechanisms and insulate incumbent managers from the market for corporate control. In this analysis of reincorporations that occurred between 1980 and 1992, the evidence reveals that corporate managers offer a variety reincorporation motives. The shareholder wealth effects of the studied reincorporations are found to be dependent upon these motives. The findings lend situational support to both managerial entrenchment arguments and to contractual efficiency theories. In contrast to past research, the tests conducted here reveal that many reincorporations are harmful to securityholders. Over 3/5 of the sampled reincorporation proposals contained at least one antitakeover charter amendment, many of which were either bundled as a part of the reincorporation plan or come in the form of hidden amendments. When such reincorporations are passed for solely defensive purposes, shareholder wealth decreases by over 1.1%. Further, when these plans are passed in the presence of takeover threats, security prices decline by nearly 3%. The evidence also suggests that reincorporations can result in increased shareholder wealth. This is the case for those reincorporations conducted to take advantage of corporate laws that allow for limitations on director and officer liability. When such proposals are passed, shareholder wealth increases by nearly 1%. Further tests reveal that these reincorporations relaxed some of the constraints imposed by the crisis in the market for D&O liability insurance and assisted these firms in achieving increased levels of outside board representation.

Degree

Ph.D.

Advisors

Lewellen, Purdue University.

Subject Area

Finance|Management

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