Legal Investor Protection and Takeovers

Does legal investor protection improve efficiency in the market for corporate control? To address this question, we incorporate financing constraints and legal investor protection into a standard takeover model. In the model, stronger legal investor protection increases a bidder's outside funding capacity. However, absent effective bidding competition, this does not improve efficiency, as the bid price – and thus the bidder's need for funds – increases in lockstep with his pledgeable income. In contrast, under effective bidding competition, the increased outside funding capacity improves efficiency by making it less likely that more efficient but less wealthy bidders are outbid by less efficient but wealthier rivals. Our model provides a novel rationale for the optimality of “one hare-one vote,” shows that margin requirements impair takeover efficiency while shadow costs of internal funds improve it, and makes empirical predictions relating the takeover outcome to, e.g., asset tangibility, financing frictions, firm-level governance, block ownership, cross-border M&A, and the security-voting structure