Defensive Mechanisms and Managerial Discretion





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    • University of British Columbia. Giammarino and Hollifield thank the Social Sciences and Humanities Research Council of Canada for financial support. We thank participants at the 1995 Pacific Northwest Finance Conference, the 1996 Northern Finance Association Meetings, and seminar participants at UC Berkeley, Stanford, the Stockholm School of Economics, and the University of Vienna for helpful comments. We are especially grateful to the referee and to the editor, René Stulz, for their helpful comments. The usual disclaimer applies.


We study a model where firms may possess free cash flow and takeovers may be disruptive. We show that the possibility of a takeover, combined with defensive mechanisms and the ability to pay greenmail, can solve the free cash flow problem in an efficient way. The payment of greenmail reveals information that generates a stock price decline that exceeds the value of the greenmail payment, even though the payment of greenmail is value maximizing. Optimal defensive measures limit takeover attempts if the target stock price is too low. We also provide cross-sectional implications of the analysis.