Referee Report

Referee Report on

(Marco Pagano and Paolo Volpin, 2005)

Part I Summary

This paper studies the labor-management alliance at the firm level, and explains the circumstances under which the incumbent can use the employment policy and the ESOP as two anti-takeover devices and the circumstances under which the employees act as white squires to deter a hostile takeover.

In this model, a manager can collude with employees. To be more concrete, a manager who has high private benefits and owns only a small equity stake has an incentive to sign long-term contracts with workers and give them generous wages, so that he can avoid hostile takeovers and the workers will help him doing so. There are two reasons for such a labor-management alliance. On one hand, the long-term contracts reduce the value of the company to a raider because the raider may not be able to renegotiate the long-term workers’ wages since they are protected by the law. On the other hand, workers are willing to take actions, such as lobbying and voting against the takeover, in order to protect their high wages, given the fact that the raider will cut the wages as much as possible and employ intensive monitoring upon successful takeover.

The origin of these different preferred policies by the incumbent and the raider is the different stakes they have (or will have upon successful bid). As to the incumbent, he has a small stake, β, in the company, and therefore he would only receive a small portion of the gains from the increased efficiencies if he monitors intensively, while he would bear the entire cost of monitoring. As to the raider, he will have acquired a large portion of the common shares, at least β, after taking over, and therefore will have an incentive to cut wages as much as possible and monitor workers intensively. Besides the different stakes in the company, there are other factors that influence the incumbent’s and the raider’s behaviors, including the differences in monitoring...