The Corporate Takeover Market

Common Takeover Tactics, Takeover Defenses, and Corporate Governance

Treat a person as he is, and he will remain as he is. Treat him as he could be, and he will become what he should be.
Jimmy Johnson

Current Lecture Learning Objectives

Providing students with an understanding of Common takeover tactics employed in the market for corporate control and when and why they are used; and Common takeover defenses employed by target firms and when and why they are used.

Factors Affecting Corporate Governance: Market Model Perspective

External to Firm Legislation: 1933-34 Securities Acts Dodd-Frank Act of 2010 Sherman Anti-Trust Act External to Firm Regulators: SEC Justice Department FTC External to Firm Market for Corporate Control: Proxy Contests Hostile Takeovers

Internal to Firm Board of Directors Management Internal Controls Incentive Systems Takeover Defenses External to Firm Institutional Activism: Pension Funds (Calpers) Mutual Funds Hedge Funds

Internal Factors: Board of Directors and Management

Board responsibilities include: --Review management proposals/advise CEO --Hire, fire, and set CEO compensation --Oversee management, corporate strategy, and financial reports to shareholders Good governance practices include: --Separation of CEO and Chairman of the Board --Boards dominated by independent members --Independent members serving on the audit and compensation committees

External Factors: Regulators

Securities and Exchange Commission Justice Department Federal Trade Commission Public Company Accounting Oversight Board Financial Accounting Standards Board Financial Stability Oversight Council

External Factors: Institutional Activism

Pension funds, mutual funds, and insurance companies Ability to discipline management often limited by amount of stock can legally own in a single firm Investors with huge portfolios (e.g., TIAA-CREF, California Employee Pension Fund) can exert significant influence Recent trend has been for institutional investors to simply withhold their votes

External Factors: Market for Corporate Control

Changes in control can result from hostile takeovers or proxy contests Management may resist takeover bids to Increase the purchase price (Shareholders Interests Theory) or Ensure their longevity with the firm (Management Entrenchment Theory) Takeovers may Minimize agency costs and Transfer control to those who can more efficiently manage the acquired assets

Market for Corporate Control: Alternative Takeover1 Tactics

Friendly (Target board and management supports bid) Hostile (Target board and management contests bid)

1A

corporate takeover refers to a transfer of control from one investor group to another.

Market for Corporate Control: Friendly Takeover Tactics

Potential acquirer obtains support from the targets board and management early in the takeover process before proceeding to a negotiated settlement The acquirer and target firms often enter into a standstill agreement in which the bidder agrees not to make any further investments for a stipulated period in exchange for a break-up fee from the target firm. Such takeovers are desirable as they avoid an auction environment If the bidder is rebuffed, the loss of surprise gives the target firm time to mount additional takeover defenses Rapid takeovers are less likely today due to FTC and SEC prenotification and disclosure requirements1
1The

permitted reporting delay between first exceeding the 5% ownership stake threshold and the filing of a 13D allowed Vornado Realty Trust to accumulate 27% of J. C. Pennys outstanding shares before making their holdings public.

Market for Corporate Control: Hostile Takeover Tactics

Limiting the targets actions through a bear hug Proxy contests in support of a takeover Purchasing target stock in the open market Circumventing the targets board through a tender offer Litigation Using multiple tactics concurrently

Market for Corporate Control: Pre-Offer Takeover Defenses

Poison pills to raise the cost of takeover1 Shark repellants to strengthen the target boards defenses Staggered or classified board elections Limiting when can remove directors Shark repellants to limit shareholder actions Limitations on calling special meetings Limiting consent solicitations Advance notice and super-majority provisions Other shark repellants Anti-greenmail and fair price provisions Super-voting stock, re-incorporation, and golden parachutes
1Note

that poison pills could also be classified as post-bid defenses as they may be issued by the board as dividends without shareholder approval.

Poison Pill: Cash for Share Purchase

Target Price Share P3 A P1 P2 B
Target shareholder Profit/Share on Poison Pill Conversion

S1

S2

DD reflects relationship between shares outstanding and price/share for given level of expected earnings & interest rates.

D C Q1 D Q2 Target Shares Outstanding

P1 = Pre-offer equilibrium price/target share P2 = Poison pill conversion price/target share P3 = Offer price/target share Q1 = Pre-offer target shares outstanding Q2 = Target shares outstanding following poison pill conversion ABCD = Incremental acquirer cash outlay due to poison pill conversion

Poison Pills: Share for Share Exchange

Acquirer Shareholder Ownership Dilution Due to Poison Pill New Company Shares Outstanding1 Without Pill Target Firm Shareholders Shares Outstanding Total Shares Outstanding 1,000,000 1,000,000 1,000,000 1,000,000 2,000,000 With Pill 2,000,000 2,000,000 1,000,000 2,000,0002 3,000,000 Ownership Distribution in New Company (%) Without Pill 50 With Pill 673

Acquiring Firm Shareholders Shares Outstanding New Shares Issued Total Shares Outstanding4
1Acquirer

50

33

agrees to exchange one share of acquirer for each share of target stock. 2Poison pill provisions enable each target shareholder to buy one share of target stock at a nominal price for each share they own. Assume all target shareholders exercise their rights to do so. 32,000,000/3,000,000 4Target shares are cancelled upon completion of transaction.

Market for Corporate Control: Post-Offer Takeover Defenses

Greenmail Standstill agreement Pac-man defense White knights Employee stock ownership plans Recapitalization Share buy-back plans Corporate restructuring Litigation Just say no

Discussion Questions
1. Discuss the advantages and disadvantages of the friendly versus hostile approaches to corporate takeovers. Be specific. 2. Do you believe that corporate takeover defenses are more motivated by the targets managers attempting to entrench themselves or to negotiate a higher price for their shareholders? Be specific.

Impact on Shareholder Value

Friendly transactions result in average abnormal returns to target shareholders of 20% Hostile transactions result in average abnormal returns to target shareholders of 30-35% Bidders shareholders earn average abnormal returns that are zero or slightly negative; however, often positive in certain situations Recent studies suggest Takeover defenses have small negative impact on abnormal target shareholder returns Defenses put in place prior to an IPO may benefit target shareholders Bondholders in firms with ineffective defenses (i.e., vulnerable to takeover) may lose value

Things to remember...
Hostile takeover attempts and proxy contests affect governance through the market for corporate control Hostile takeover attempts tend to benefit target shareholders substantially more than the acquirers shareholders by putting the target into play. Consequently, acquirers generally consider friendly takeovers preferable. Anti-takeover measures share two things in common. They are designed to Raise the overall cost of the takeover to the acquirers shareholders and Increase the time required for the acquirer to complete the transaction to give the target additional time to develop an anti-takeover strategy.