Takeover defenses

Shark repellent:
Slang term for any one of a number of measures taken by a company to fend off an unwanted or hostile
takeover attempt. In many cases, a company will make special amendments to its charter or bylaws that
become active only when a takeover attempt is announced or presented to shareholders with the goal of
making the takeover less attractive or profitable to the acquisitive firm.
Also known as a "porcupine provision"
Most companies want to decide their own fates in the marketplace, so when the sharks attack, shark
repellent can send the predator off to look for a less feisty target.
hile the concept is a noble one, many shark repellent measures are not in the best interests of
shareholders, as the actions may damage the company!s financial position and interfere with management!s
ability to focus on critical business ob"ectives. Some e#amples of shark repellents are poison pills, scorched
earth policies, golden parachutes and safe harbor strategies
Macaroni Defense
An approach taken by a company that does not want to be taken over. $he company issues a large number
of bonds with the condition they must be redeemed at a high price if the company is taken over.
hy is it called Macaroni %efense& 'ecause if a company is in danger, the redemption price of the bonds
e#pands like Macaroni in a pot(
Bankmail
An agreement made between a company planning a takeover and a bank, which prevents the bank from
financing any other potential acquirer!s bid.
'ankmail agreements are meant to stop other potential acquirers from receiving similar financing
arrangements.
Whitemail
A strategy that a takeover target uses to try and thwart an undesired takeover attempt. $he target firm
issues a large amount of shares at below)market prices, which the acquiring company will then have to
purchase if it wishes to complete the takeover.
If the whitemail strategy is successful in discouraging the takeover, then the company can either buy back
the issued shares or leave them outstanding.
Lobster Trap
A strategy used by a target firm to prevent a hostile takeover. In a lobster trap, the company passes a
provision preventing anyone with more than *+, ownership from converting convertible securities into
voting stock.
-#amples of convertible securities include convertible bonds, convertible preferred stock, and warrants.
Pac Man
A form of defense used in a hostile takeover situation. $he target firm turns around and tries to take over the
company that has made the hostile bid.
Suicide Pill
A defensive strategy by which a target company engages in an activity that might actually ruin the company
rather than prevent the hostile takeover. Also known as the ".onestown %efense."
Shark Watcher
A firm speciali/ing in the early detection of takeovers. $he firm!s primary business is usually the solicitation
of pro#ies for client corporations. A shark watcher monitors trading patterns in a client!s stock and attempts
to determine who is accumulating shares.
Takeover code by justice Bagwati panel
The takeover code review panel of the Securities and Exchange Board of India (SEBI
has decided to exclude the ter! "ac#uirer$ for a co!pany !aking a offer for buyback in
ter!s of Sebi regulations%
The five decisions& taken by the takeover panel on 'riday& focus on the way defense
!echanis! of buyback of shares can be used by !anage!ents in the case of a takeover
bid% (ith the panel clearing the gray areas in the takeover)buyback regulations&
co!panies can effectively use the buyback !ethod to counter takeover%
The panel& which !et under the chair!anship of for!er chief justice * + Bhagwati& has
said that pursuant to buyback& if a shareholder were to involuntary cross the threshold
li!its specified under the takeover regulations& the takeover code will not be triggered
provided there has been no change in !anage!ent%
,ddressing an infor!al press !eeting here today& Bhagwati said: -Thus& post)buyback
even if the threshold li!it under the takeover code is breached& if there is no change
in!anage!ent control the takeover code will not be triggered-%
.e said that when a buyback is open& takeover offer can be !ade% .owever& the buyback
offer cannot be withdrawn% It can& however& be !odified subject to the co!pany
obtaining fresh special resolution fro! its shareholders%
The panel was of the view that buyback offer and takeover offer are !utually exclusive
and independent of each other and would be governed by the respective guidelines%
,ccordingly& any buyback offer !ade when a takeover is in process the sa!e will not be
considered as a co!petitive bid& he said%
The five decisions focus on the way defense !echanis! of buy)back of shares can be
used by !anage!ents in case of a takeover bid& he said% ,ll the reco!!endations !ade
by the Bhagwati panel would be incorporated in the buyback regulations which would be
notified by early next week%
The co!!ittee was also called upon to give its reco!!endations on i!plications for the
takeover code arising fro! buy back% The co!!ittee hasalready finalised its decisions
with respect to a!end!ents to the code& Bhagwati said adding that the final draft would
take another !onth%
Takeover code -- SEBI panel favours 3-level disclosures
THE Securities and Exchange Board of India's (SEBI) takeover panel has decided to
make it mandatory for an ac!uirer' to disclose his holdings at three levels "" at five
per cent# $% per cent and $& per cent "" instead of the existing stipulation of only
five per cent'
The ac!uirer is also re!uired to inform the target company# the (ational Stock
Exchange ((SE) and other exchanges )here the shares are largely traded'
Stock exchanges are expected to put the information on the *e+ site for immediate
pu+lic information# according to ,r -ustice .'(' Bhag)ati# /hairman# SEBI's takeover
panel'
SEBI )ill prepare a legal format for the ac!uirer to disclose his holdings to the
company and the exchanges'
,aking an indirect reference to the recent takeover +ids# ,r -ustice Bhag)ati# said
that it )as found in many cases that the ac!uirers )ere not keeping the target
company informed' The proposed three"level disclosure )ill make the process
more transparent#'' he said'
The Bhag)ati panel had convened a t)o"day meeting from ,onday to deli+erate on
various issues under the takeover code'
0escri+ing today's meeting as more of a +rainstorming' session# ,r -ustice
Bhag)ati said an important issue deli+erated +ut on )hich no decisui+ )as taken
related to increasing the ceiling of the minimum open offer si1e'
2s per the existing regulations# any person )ho ac!uires a $3 per cent stake in a
company has to make an open offer for another 4% per cent'
The vie)s expressed )as )hether the offer si1e could +e increased to 3$ per cent or
$%% per cent or should the current regulations remain unchanged in this regard' The
issue of creeping ac!uisitions )as not discussed# he said'
The evolution of the takeover code
1990
$he 0overnment amends clause 1+ of the listing agreement according to which, threshold
acquisition level reduced from 23, to *+,4 change in management control to trigger public offer4
minimum mandatory public offer of 2+,4 disclosure requirement through mandatory public
announcement.
ovember 199!
Substantial Acquisition of Shares and $akeover, *551, notified by Sebi. 6ew provisions
introduced to enable both negotiated and open market acquisitions and competitive bids allowed.
ovember 199"
Sebi sets up committee under former 7hief .ustice of India 8 6 'hagwati to review the *551
$akeover 9egulations in order to frame comprehensive regulations.
#anuar$ 199%
$he 'hagwati 7ommittee submits its report on the takeover code to Sebi.
&ebruar$ 199%
Sebi accepts 'hagwati committee report and the Substantial Acquisition of Shares and
$akeovers 9egulations, *55:, notified.
&ebruar$ 199'
Sebi proposes to revise the takeover code and make it mandatory for acquirers to make a
minimum open offer for 2+, ;and not *+, as earlier< of the target company!s equity, even if the
holding goes beyond 3*, as a result of the offer.
#une 199'
Sebi asks .ustice 'hagwati to conduct a complete review of the takeover code. Issues likely to be
taken up are the e#tent of disclosures in an open offer and if any change in in the ob"ective of the
offer needs to be spelt out in the revised offer.
#une 199'
Sebi=s proposes to raise the creeping acquisition limit under the $akeover 7ode from 2, to 3,. It
also proposes to increase the share acquisition limit for triggering the takeover code from *+, to
*3,.
ovember 199'
$akeover panel amends the takeover code to incorporate buy)back offers by companies. $he
committee decides to allow takeover offers to be made when a buy)back offer is open and vice
versa.
December 199'
.ustice 8 6 'hagwati criticises Sebi for unilaterally increasing the trigger limit for making a public
offer from *+, to*3,. $he 'hagwati 7ommittee also recommends that once an acquirer
acquires :3, of shares or voting rights in a company, he should be outside the purview of the
$akeover 9egulations.
#anuar$ (000
Sebi again proposes that all open offers made by promoters for consolidating their holding in a
company will have to be for a minimum of 2+, of equity. -#emption to the minimum 2+,
requirement should be given only in the case of such companies in which promoters hold over
:3,.
$he Sebi takeover committee also recommends that a special resolution approved by :3, of the
shareholders should be made mandatory for effecting a change in the management of
professionally managed companies. $he step aims to avoid misuse of the earlier provision, under
which certain groups with 3*, stake could effect the changes through a simple resolution.
Another recommendation that follows was that venture capital funds should be treated on par with
state financial institutions. And like financial institutions, they should be e#empted from making a
public offer, in the event of acquiring a *3, stake in a company.
&ebruar$ (000
Sebi finalises the recommendations of takeover panel and review the takeover norms. 'ut the
crucial decision on issue relating to >change in management control of professionally managed
companies! left unresolved.
#une (000
Sebi plans to bring public financial institutions under the ambit of its takeover code, both as
acquirers and as pledgees.
)ctober (000
7onfederation of Indian Industry, ?icci and Assocham seek amendments in the takeover code,
especially in the case of creeping acquisitions, to provide the promoters a level)playing field
against corporate raiders who may disrupt e#isting managements. @nder the current takeover
code, corporate raiders can pick up *3, of the paid)up equity of the target company over a *2)
month period without triggering off the takeover code.
ovember (000
Sebi takeover panel decides to make it mandatory for an >acquirer! to disclose his holdings in the
target company, to the company as well e#changes, at three levels A 3,, *+, and *1, ))
instead of the e#isting stipulation of only 3,.
December (000
Sebi promises a new draft on the takeover code in place by the end of March 2++*, with >investor
protection! as its pivot. $he main ob"ective of the new code would be to ensure that acquiring
companies are prompt in informing the stock e#changes when they cross the prescribed limits of
holding a company!s stake, make public announcements and allow companies to make counter
offers.
*u+ust (001
Sebi rela#es the creeping acquisition limit for shareholders ;holding between *3):3,< to *+, till
March 2++2 without the compulsion to obtain shareholder approval.
Ma$ (00(
$he $akeover 7ommittee, headed by former chief "ustice of India 8 6 'hagwati, comes out with
recommendations to amend the 7ode. Sebi puts up the recommendations on its site and invites
suggestions on the recommendations proposed.
September (00(
Sebi approves the recommendations of the $akeover 7ommittee with minor modifications and
notifies the new $akeover 7ode. $he new regulations are a finer version of the earlier 7ode and
largely aim at benefiting the investing community.
)ctober (00(
$he new $akeover 7ode comes into effect. Sebi passes orders on : pending open offer cases,
directing the acquirers to declare 2+, open offers to the shareholders of the target company.
March (00,
8rakash .aiswal, Member of 8arliament and the president of Banpur)based Midas $ouch
Investor!s Association, demand the plugging of loopholes in Sebi regulations pertaining to
substantial acquisition and takeovers. $his follows the clean chit to 0rasim Industries and 0u"arat
Ambu"a 7ement in cases related to control of CD$ and A77. .aiswal seeks the intervention in
amending the regulations to protect the interest of small investors.
#anuar$ (00!
Sebi plans to amend the $akeover 7ode to reduce the upper limit of creeping acquisition from
:3, ofa company!s equity capital to 3*,. It plans to make it mandatory for acquirers to come out
with a public offer for any acquisition beyond 3*, of a company!s shares.
&ebruar$ (00!
A Sebi committee recommends that off)market transactions beyond 3, of the equity of the target
company will attract the $akeover 7ode. $his allows an acquirer to take up to 3, equity of the
target company through off)market deals. It further says that an acquirer who holds more than 3,
but less than *3, shares or voting rights shall acquirer additional shares or voting rights only
through the stock market mechanism.

ACC-Gujarat Ambuja deal -- Takeover issues in perspective
(' 5enkites)aran
THE de facto takeover of the cement giant 2// +y 6u7arat 2m+u7a /ement 8imited
(62/8) is a case study of ho) every single agency involved sa) to it that the
investors )ere kept out of the party'
Even more important# this case underscores the serious shortcomings of the
Takeover 9egulations in ensuring that retail investors get a fair deal' 9ather than
!uickly stepping in to amend the regulations to make them more shareholder"
friendly# the Securities and Exchange Board of India (SEBI) is reportedly toying )ith
the idea of doing 7ust the opposite +y incorporating in the regulations its
controversial decision in the 2// case'
The dust may have settled do)n# at least for no)# on the 62/8 ac!uiring a holding in
2//' (onetheless# the episode leaves an uneasy feeling a+out the raison d'etre of
the Takeover 9egulations# the role of SEBI and the domestic financial institutions#
and the responsi+ility of the target company's +oard (2//'s# in this case) in
protecting the interests of investors (see story on :uestiona+le role of key
players')'
;acile decision
SEBI has taken a narro) vie) of )hether there )as a change in control'# and
decided that an open offer )as not needed' *ith the exception of government
companies# ,(/ multinational su+sidiaries and the ne)ly"spa)ned kno)ledge"+ased
companies# most Indian firms are de facto controlled +y persons or groups that do
not have any)here near a ma7ority holding in them'
0irectors are to +e elected individually' Thus# the 3%"plus percentage stake re!uired
for the right to appoint ma7ority of the directors'' )ould have limited relevance in
Indian companies' In most cases# the concept of control' is highly circumscri+ed +y
the covenants and conditions imposed +y financial institutions in their loan
agreements'
The ground reality is different' <ne can effectively control' a company# )hether +y
influencing the constitution of the +oard or +y formulating key policies# even )ith as
lo) a shareholding as $%"$3 per cent' This is despite the fact that the legal test of
control' )ould not +e met' (ot long ago# even those )ith less than $% per cent
holding# the Tatas# )ere certainly in control' of Tata Steel' This +eing the case#
SEBI's conclusion that 62/8 has not ac!uired control of 2// appears some)hat
facile'
9eality ignored=
9ather# SEBI ought to have taken due cognisance of the follo)ing facts>
62/8# the top cement producer in India# has +een locked in intense 7ockeying )ith
other players for leadership position in the industry'
The speed )ith )hich t)o senior 62/8 directors )ere inducted on to the 2// +oard'
*hile one is a promoter and ,anaging 0irector of 62/8# the other is a )holetime
director (of 62/8) and )as# it is pertinent to note# 0irector (;inance) and later a
)holetime director in 2// a fe) years ago'
The alacrity )ith )hich the 62/8 ,anaging 0irector )as appointed 0eputy /hairman
of 2//'
The initial claims +y 62/8 that including 2//'s# it )ould no) control some 4% million
tonnes of cement capacity'
To !uote from a 62/8 press release# '''The proven track record of 2m+u7a
/ement# together )ith the manufacturing and distri+ution strengths of 2//# )ill
create a formida+le strength and )ill make them 7ointly the largest cement
producers in India totalling to over 4% million tonnes per annum''' 62/8 had also
factored 2//'s capacity into its o)n gro)th pro7ections in recent presentations to the
financial institutions'
Even if it is accepted that there )as no outright change in control# there can +e little
dou+t a+out sharing of control# given the facts of this case'
0o)nplaying the motives
<nce it )as kno)n that SEBI )ould examine the case# it appears that the o+vious
motives for 62/8's ac!uisition )ere do)nplayed' The 2// ac!uisition has +een
couched as a strategic alliance'' The fact that +oth the companies )ould operate
independently (at least# in the foreseea+le future) )as also emphasised'
It )as even suggested that the role of the 62/8 nominees )ould +e confined to
attending 2// +oard meetings' It is difficult to +elieve that a strategic investor )ith a
9s' ?%%"crore investment )ould settle for such a hands"off policy' ,ercifully# no+ody
has yet come up )ith a facile clarification that 62/8's 9s' ?%%"crore investment )as
in the nature of a portfolio investment@
Even had SEBI concluded that 62/8 had not ac!uired control' of 2// at the time it
did# ho) could it ensure that 62/8 )ould have no role )hatsoever in influencing in
any manner 2//'s future policy decisions and strategic direction=
/ould it +e that )e )ould have soon an exemption clause in the 9egulations for
creeping control#' similar to creeping ac!uisition= It )ould +e a +ig +lo) to the
fledgling corporate governance movement in the country if a leading company such
as 2// is managed +y +ackseat driving# rather than in a coherent and transparent
manner'
2// shareholders' +ind
It is evident that the 2// takeover is an eminently forgetta+le episode for the
investor' It has confirmed the fears expressed in these columns (Business 8ine#
<cto+er A%# $??B) that the $??B amendments to the Takeover 9egulations raising
the trigger"limit of pu+lic offer to $3 per cent )ere patently investor"unfriendly'
If the underlying rationale for the $3 per cent threshold is that any such shareholder
could effectively control the affairs of a company# there is no reason to +elieve that a
$&'& per cent shareholder could do any less "" particularly in the a+sence of any
other large non"institutional shareholder as in the instant case' There is no) the ne)
danger of the 2// model'' +eing further fine"tuned and replicated ad nauseam +y
investment +ankers and their corporate clients for gainful exits +y promoters' This
could typically happen through classic t)o"stage offers'
2fter +uying out under $3 per cent from existing promoters +y front"loading the
price and possi+ly picking up a couple of seats on the +oard of the target companies#
the ac!uirers' could s!uee1e out the pu+lic shareholders )ith a delayed pu+lic offer
at a lo)er price'
Tighten the norms
The Takeover 9egulations and its administration seem to have had the effect of
making a pu+lic offer a rarest of rare events "" an exception rather than the rule' The
increased threshold limit of $3 per cent and the minimum pu+lic offer limit of 4% per
cent deny the investors a satisfactory exit route# though promoters can do so
conveniently'
Similarly# the $??B amendments also increased the annual exemption limit through
the so"called creeping ac!uisition route to 3 per cent per annum from the earlier 4
per cent' This# if any# gives company managements the incentive to keep the share
prices depressed@ (eedless to say# all these provisions )ould only perpetuate the
status !uo of helping promoters control large corporate resources )ith minimal
resources of their o)n "" that is# our version of capitalism )ithout capital@
Instead of compounding these fla)s in the Takeover 9egulations +y incorporating its
!uestiona+le decision in the 2// case# SEBI should !uickly amend the same#
tightening the norms' It should# for example# revert the pu+lic offer trigger limit to
$% per cent and mandate full"scale ($%% per cent) +id instead of the existing 4% per
cent'
Su+stantive vie) of control
The entire concept of promoter"perpetuation is anachronistic and the host of pu+lic"
offer exemptions linked to promoters should +e scrapped# particularly +ecause
promoters seem to have +een conferred )ith plenty of rights +ut no responsi+ilities
vis"a"vis shareholders' 9ather than taking an unrealistically technical vie) of
control'# it should +e provided that any (largest) holder )ith at least $% per cent
voting rights is deemed to +e in control' SEBI should remind itself that its primary
responsi+ility is to)ards the pu+lic and non"institutional investors# and that its role in
takeover situations is to ensure transparency and e!ual and fair treatment to all
shareholders'
The development of a free# fair and active market for corporate control is an integral
aspect of a healthy capital market and the cornerstone of a sound corporate
governance system to +uild investor confidence'
(The author teaches /orporate Strategy and ;inance at the Indian Institute of
,anagement# 2hmeda+ad')
.indalco Industries
In Septe!ber /00/& Sebi had directed .indalco Industries& the flagship co!pany of
the , 1 Birla group& against going ahead with its proposed /02 open offer for 3s /45
crore in Indian ,lu!iniu! (Indal in the beginning of 6ctober /00/% The offer was
earlier scheduled to begin on 7 Septe!ber to 8 6ctober& but it was later revised to 48
6ctober to 4/ +ove!ber /00/% .owever& by the end of 6ctober& Sebi granted per!ission
to .indalco to resu!e the open offer in Indal%
.indalco9s open offer in Indal at 3s 4/0 per share can be attributed to two reasons% 6ne&
the offer was a part of Birla group9s restructuring plans to consolidate its non)ferrous
!etals business under one co!pany% ,nd two& it intended to up its stake in Indal& over
and above the existing :8%;2 stake% (hile financial institutions hold 48%/2 in Indal& the
re!aining <%82 is held by the public%
In =uly /00/& .indalco& and its wholly)owned subsidiary& 3enukeshwar Invest!ent >
'inance (owning 0%042& as *ersons ,cting in ?oncert (*,?& announced an offer at 3s
4/0 per share payable in cash to pick up the balance /7%82% The open offer price of 3s
4/0 is at a pre!iu! of 7%:2 to its current !arket price of 3s 44@%
Though Sebi has not specified the reason behind its directive to stall the offer& it see!s
pretty obvious% If the /02 open offer goes through& then adding the existing :8%;2 stake&
.indalco9s total stake in Indal will go beyond <02& triggering Sebi9s Takeover ?ode%
,ssu!ing that pursuant to the open offer& public shareholding in Indal falls below 402%
Then as per regulation /4 (@ of Sebi9s Takeover ?ode& within three !onths& .indalco
will be !ade to pick up the outstanding shares at the sa!e offer price& which will re!ain
open for ; !onths% 6nce this happens& Indal will beco!e a wholly)owned subsidiary of
.indalco and get delisted fro! stock exchanges% +aturally& Sebi is frowning upon the
open offer%
The Birla group had initially planned to !erge Indal with .indalco% Indal9s !ines& plants
and other assets are spread all over the country& and if a !erger did take place& it would
have attracted heavy sta!p duty charges% .ence& the group later decided against the
!erger& and instead& thought it prudent to co!e out with a /02 unconditional open offer&
following which Indal will re!ain .indalco9s wholly)owned subsidiary and get delisted
fro! the bourses%
.indalco had ac#uired a controlling stake of 78%;2 in Indal in =une /000 at 3s 4<0 per
share fro! A :%:: billion ?anadian !ajor ,lcan ,lu!iniu!% The resultant /02 open
offer further upped its stake to :8%;2% Interestingly& it was a long)drawn and fierce
takeover battle with Sterlite Industries that !ade ,lcan ac#uire the Indal stake%
,ccording to reports& Sebi insists that the issue of Sterlite Industries open offer be
resolved before the .indalco offer% In 4<<5& Sterlite had !ade a hostile takeover bid on
Indal when it announced a 3s 4/5)crore open offer to ac#uire /02 in Indal at 3s <0 per
share B a pre!iu! of @;2 over the then prevailing !arket price% The battle for control of
Indal intensified further when ,lcan& with its @8%;2 stake& considered !aking an open
offer to counter Sterlite9s bid%
It announced an unconditional open offer to ac#uire /02 in Indal at 3s 407 per share%
Sterlite had no choice but to revise its price to 3s //4 per share& of which 3s 4@4 in cash
and 3s <0 as optionally convertible preferential shares% Subse#uent to which ,lcan& too&
upped its price to 3s 4:7 in cash& which finally !anaged to get !anage!ent control of
Indal%
The /02 open offer raised ,lcan9s stake in Indal to 78%;2% Soon& Sterlite announced that
it was withdrawing the open offer and infor!ed shareholders who had tendered shares
that their shares will be returned% 6n / ,ugust 4<<5& Sebi issued a showcause notice to
Sterlite& seeking forfeiture of the escrow account and directed it to pay shareholders at 3s
//4 per share with interest%
'ollowing this& Sterlite appealed to the Securities and ,ppellate Tribunal (S,T which
upheld the Sebi order% It later approached the .igh ?ourt and the Supre!e ?ourt to
withdraw the open offer& but both the ti!es the plea was rejected% The .igh ?ourt
had ordered Sterlite to pay 3s //4 per share with 472 interest fro! / =uly 4<<5&
a!ounting to 3s ;%/ crore% The co!pany is now obliged to pay shareholders who
tendered shares in the open offer !ade in Cay /00/%
The Sarbanes-!le" Act of #$$#
The Sarbanes)6xley ,ct of /00/ (often shortened to SOX is legislation enacted in
response to the high)profile Enron and (orld?o! financial scandals to protect
shareholders and the general public fro! accounting errors and fraudulent practices in the
enterprise% The act is ad!inistered by the Securities and Exchange ?o!!ission (SE?&
which sets deadlines for co!pliance and publishes rules on re#uire!ents% Sarbanes)
6xley is not a set of business practices and does not specify how a business should store
recordsD rather& it defines which records are to be stored and for how long% The legislation
not only affects the financial side of corporations& but also affects the IT depart!ents
whose job it is to store a corporation$s electronic records% The Sarbanes)6xley ,ct states
that all business records& including electronic records and electronic !essages& !ust be
saved for -not less than five years%- The conse#uences for non)co!pliance are fines&
i!prison!ent& or both% IT depart!ents are increasingly faced with the challenge of
creating and !aintaining a corporate records archive in a cost)effective fashion that
satisfies the re#uire!ents put forth by the legislation%
The following sections of Sarbanes)6xley contain the three rules that affect the
!anage!ent of electronic records% The first rule deals with destruction& alteration& or
falsification of records%
Sec. 802(a) "Whoever knowingly alters, destroys, mtilates, conceals, covers !, "alsi"ies,
or makes a "alse entry in any record, docment, or tangi#le o#$ect with the intent to
im!ede, o#strct, or in"lence the investigation or !ro!er administration o" any matter
within the $risdiction o" any de!artment or agency o" the %nited States or any case "iled
nder title &&, or in relation to or contem!lation o" any sch matter or case, shall #e
"ined nder this title, im!risoned not more than 20 years, or #oth."
The second rule defines the retention period for records storage% Best practices indicate
that corporations securely store all business records using the sa!e guidelines set for
public accountants%
Sec. 802(a)(&) "'ny accontant who condcts an adit o" an isser o" secrities to which
section &0'(a) o" the Secrities ()change 'ct o" &*+, (&- %.S.. /8$0&(a)) a!!lies, shall
maintain all adit or review work!a!ers "or a !eriod o" - years "rom the end o" the "iscal
!eriod in which the adit or review was conclded."
This third rule refers to the type of business records that need to be stored& including all
business records and co!!unications& including electronic co!!unications%
Sec. 802(a)(2) "1he Secrities and ()change .ommission shall !romlgate, within &80
days, sch rles and reglations, as are reasona#ly necessary, relating to the retention o"
relevant records sch as work!a!ers, docments that "orm the #asis o" an adit or
review, memoranda, corres!ondence, commnications, other docments, and records
(inclding electronic records) which are created, sent, or received in connection with an
adit or review and contain conclsions, o!inions, analyses, or "inancial data relating to
sch an adit or review."
4
The Sarbanes)6xley ,ct of /00/ is perhaps the !ost controversial refor! of the
,!erican business law since the 4<@0s% It established new rules affecting every public
co!pany and every profession& industry organiEation& and govern!ent agency dealing
with public co!panies: lawyers& accountants& auditors& invest!ent bankers& securities
analysts& stock exchanges& the ,!erican Institute of ?ertified *ublic ,ccountants& the
'inancial ,ccounting Standards Board& the Securities and Exchange ?o!!ission& the
'ederal Sentencing ?o!!ission& and so forth% It also substantially federaliEed areas of
law that were previously in the jurisdiction of states%
,cade!ics diverged sharply in their evaluation of the ,ct% The critics called it
F#uack corporate governanceG (3o!ano /008D doubted its effectiveness& and
e!phasiEed the costs of co!pliance and avoidance (3ibstein /00/% The supporters
suggested that it !ight i!prove corporate governance and strengthen financial !arkets
(Citchell /00@D *rentice and Spence& /00;% So!e argued that the ,ct9s i!portance has
been overstated and predicted its effect to be !odest (?unningha! /00@D *erino /00/%
Several e!pirical papers study the effects of the ,ct& looking at stock returns&
changes in accounting and audit costs& and registration dyna!ics% The findings are !ixed%
So!e papers (Berger et al% /007D Hai /00@D Hi& *incus& and 3ego /008D 3eEaee and =ain
/007 found a variety of positive effectsD others (,sthana et al% /008D Block /008D
Eldridge and Iealey /007D Ia!ar et al% /007D HeuE et al% /00;D Jhang /007 found
negative effects%
*rior studies had difficulty separating the effects of the Sarbanes)6xley ,ct fro!
the effects of other conte!poraneous events% Cost prior studies exa!ined the i!pact of
the ,ct on KS co!panies% Since the ,ct applies to all KS public co!panies& this
approach does not create a FcontrolG group unaffected by the ,ct but affected by other
econo!ic and political trends% Hack of a control group co!plicates the efforts to isolate
the effects of the ,ct%
This paper adopts a novel approach to overco!ing this proble!% The ,ct applies
not only to KS fir!s& but also to non)KS fir!s listed on levels / and @ ,L3s% It does not
/
apply to foreign co!panies listed on levels 4 or 8 ,L3s% Thus& cross)listing creates a
natural experi!ent: in three doEen countries& we have three distinct groups of co!panies:
(4 a Ftreat!entG group of co!panies subject to the ,ct (listed on levels / or @D (/ a
FcontrolG group of co!panies not subject to the ,ct& but perhaps indirectly subject to the
general tightening of KS business regulation (listed on levels 4 or 8D and (@ a FcontrolG
group of co!panies that are neither subject to the ,ct nor otherwise exposed to KS
regulation (non)cross)listed co!panies% By co!paring stock price reactions of foreign
co!panies subject to the ,ct to reactions of the two control groups& we can control for
broader econo!ic and political trends that affect all fir!s in a given country& and
hopefully isolate the effects of the ,ct%
(e e!ploy two principal !ethodological approaches% In the first approach& for
each foreign co!pany listed in the KS on any level& we select a !atch B a co!pany fro!
the sa!e country and industry& and si!ilar in siEe and in the #uality of its pre),ct
governance% This creates 404; !atched pairs% (e divide these !atched pairs into Fthe
S6M setG (where the cross)listed co!pany is listed on level / or @ and Fthe non)S6M
setG (where the cross)listed co!pany is listed on level 4 or 8%
(e identify 48 distinct event windows corresponding to the dates when i!portant
infor!ation about the chances of the ,ct9s passage& contents& and applicability to
crosslisted
co!panies was released% 6ur dataset contains the entire population of foreign
co!panies cross)listed in the K%S% for which relevant trading data and !atches are
available on Latastrea!% (e proceed as follows%
(e first co!pare the changes in stock prices of cross)listed co!panies to the
changes in stock prices of their non)cross)listed !atches (second difference% This allows
us control for conte!poraneous events affecting all fir!s in the ho!e country of each
cross)listed fir!% (e then co!pare the differences between the reactions of !atched
pairs in the S6M set to the reactions of !atched pairs in the non)S6M set% This
-tripledifference-
approach lets us control for conte!poraneous events that affect all co!panies
in ho!e countries& and also all co!panies cross)listed in the KS& including those not
subject to the ,ct%
6ur second !ethodology is to study returns of individual level /)@ cross)listed
co!panies& rather than !atched pairs% .ere& we control for conte!poraneous events
@
through the use of two hand)collected indices: F+on)?ross)Histed IndexG
(e#uallyweighted
index of non)cross)listed co!panies fro! the sa!e country& and si!ilar in
industry co!position& siEe& and governance to the level /)@ cross)listed co!panies and
F?ross)Histed 48 IndexG (e#ually)weighted index of all level 4 or 8 cross)listed
co!panies fro! the sa!e country& and si!ilar in industry co!position& siEe& and
governance to the level /)@ cross)listed co!panies%
6ur !ain result is that level)/@ !atched pairs& and level)/@ co!panies& exhibited
significant negative (positive returns around the events indicating the increased
(decreased chance of the ,ct9s adoption and applicability to foreign issuers% Hevel)48
!atched pairs and level)48 co!panies also reacted negatively& but !uch !ore weakly%
The difference between the reactions of the two sets is statistically significant% These
results are consistent across principal events& and are robust to a variety of regression
specifications%
(e next investigate the factors that predict& in cross section& the strength of
investor reaction to the adoption of S6M% ,t the fir! level& better co!pany)level
disclosure prior to the ,ct9s adoption predicts !ore negative reaction& as does belonging
to an already highly regulated industry% .igher sales growth predicts less negative
reaction% ,t the country level& a country)level !easure of disclosure predicts !ore
negative reaction% 6ther country)level characteristics are less i!portant& and beco!e
insignificant when co!bined with the disclosure !easure in a single regression%
These findings are consistent with the view that investors expected the ,ct to
have a net negative effect on cross)listed co!panies& with biggest losers being
highdisclosing
co!panies and co!panies fro! high)disclosing countries% .igh)growth fir!s
suffered less negative reactions& and high)growth fir!s fro! low)disclosing countries
!ay have gained& on average& fro! S6M adoption%
This paper also contributes to the literature analyEing cross)listing as the fir!s9
atte!pt to piggyback on other countries9 corporate and securities laws (?offee /00/&
Loidge et al% /008% 6ur findings support the view that the ,ct !ade it !ore expensive
for !any foreign co!panies to borrow the KS securities regi!e% Benefits !ay have
increased as well& but by less than costs& or so investors judged%
8
/% 3elated 3esearch
, nu!ber of recent working papers exa!ine the conse#uences of the Sarbanes)
6xley ,ct& !easured by a variety of indicators%
, series of studies asked whether the passage of the ,ct affected accounting and
audit costs% ,sthana et al% (/008 found that both average audit fees and pre!iu! charged
by the Big 'our audit fir!s increased significantly in /00/% They also found that bigger
and riskier clients faced larger increases in their audit fees% Eldridge and Iealey (/007
found a significant average increase in the cost of the new internal control audit re#uired
by the ,ct% ?ohen& Ley > Hys (/007 docu!ented that the passage of the ,ct was not
associated with changes in the infor!ativeness of accounting earnings%
,n i!portant #uestion is whether the ,ct influenced fir!s9 strategic and
!anage!ent decisions% Hinck& +etter& and Nang (/00; docu!ent large increases in the
cost of the board& especially for s!all co!panies% ?ohen& Ley > Hys (/008 found that
the passage of the ,ct was associated with a significant decline in the ratio of incentive
co!pensation to salary& and with a decline in research and develop!ent expenses and
capital expenditures%
,nother interesting #uestion is the effect of the ,ct on !arket li#uidity% =ain at al%
(/008 found that li#uidity !easures& such as spreads and depths& have deteriorated
during pre),ct financial scandals and i!proved following the ,ct9s passage% The ,ct9s
positive effects are found to affect all types of fir!s& particularly large fir!s%
Several papers investigated whether the ,ct affected the fir!9s going)private
decisions% Ia!ar et al% (/007 asked whether the ,ct has driven fir!s out of the public
capital !arket% They exa!ined the post),ct change in the propensity of public KS targets
to favor private ac#uirers over public ones& as co!pared to the choices by foreign targets%
Their findings are consistent with the view that the ,ct induced s!all fir!s& but not large
fir!s& to exit the public !arket% Block (/008 surveyed 440 fir!s that went private
between /004 and /00@ and found that the cost of being public was the nu!ber one cited
reason for going private by s!aller fir!s& relating this directly to the passage of the ,ct%
Carosi and Cassoud (/008 found that the cost of co!plying with the ,ct has been a
driving force behind the Fgoing darkG choices% Engel& .ayes and (ang% (/008 found that
the passage of the ,ct was associated with a !odest increase in the #uarterly fre#uency
7
of going private% They also found that s!aller fir!s and fir!s with greater inside
ownership have experienced higher going)private announce!ent returns in the post),ct
period co!pared to the pre),ct period%
HeuE et al% (/008 found a large increase in the incidence of co!panies Fgoing
darkG after the passage of the ,ct% They also found that the announce!ent and filing of
deregistration was associated with large negative abnor!al returns& especially for s!all
fir!s and fir!s that went dark after the passage of the ,ct% Their evidence is consistent
with the view that investors infer negative infor!ation about the fir!9s prospects fro!
the going)dark decision& or with the view that deregistration serves principally insiders9
interests%
'inally& several working papers are event studies% Hi& *incus& and 3ego (/008
found significantly positive stock returns around the events resolving uncertainty about
the ,ct9s contents% 3eEaee and =ain (/007 likewise found a positive abnor!al return
associated with legislative events that increased the likelihood of the ,ct9s passage% They
also found that the !arket reaction is !ore positive for !ore co!pliant fir!s with
effective corporate governance& reliable financial reporting& and credible audit functions
prior to the ,ct9s enact!ent%
In contrast& Jhang (/007 found that the cu!ulative abnor!al return around
legislative events leading to the passage of the ,ct is significantly negative& and
esti!ated that the loss in total !arket value around the !ost significant of those events
a!ounts to A4%8 trillion%
Berger et al% (/007 co!pared the value)weighted portfolio of foreign private
issuers listed on KS !arkets to the value)weighted portfolio of KS co!panies and found
that the for!er had a significantly !ore negative stock price reaction to the ,ct than the
for!er% They interpreted this result as indicating that incre!ental legal bonding benefit
provided by the ,ct for cross)listed fir!s was exceeded by the ,ct9s incre!ental costs%
*rior papers had difficulty separating the effects of the ,ct fro! the effects of
other econo!ic and political trends that !ight have occurred si!ultaneously% Cost prior
papers studied only KS public co!paniesD since the ,ct applies to all of those co!panies&
this approach does not allow control for other factors that affected the entire KS !arket at
the sa!e ti!e%
;
Three papers conte!poraneous to ours (Berger et al% /007D Ia!ar et al% /007D
S!ith /00; look beyond KS public co!panies to cross)listed foreign co!panies% Berger
et al% (/007 conduct an event study in which they co!pare returns to cross)listed foreign
co!panies to returns to KS issuers% This approach lets the! evaluate cross)sectional
variation in reaction based on ho!e)country characteristics& but does not let the! assess
overall investor reaction to S6M& because they lack a control group of co!panies to
which S6M does not apply% Hikewise& the difference)in)differences approach used in
Ia!ar et al% (/007 co!pares changes in behavior of foreign issuers to changes in
behavior of KS issuers& but does not co!pare changes in behavior of issuers subject to
the ,ct to changes in behavior of otherwise si!ilar issuers that are not subject to the ,ct%
The paper !ost si!ilar to ours is S!ith (/00;% S!ith$s initial focus was on
testing the bonding hypothesis for why fir!s cross list by studying listing and delisting
decisions& but he also adopted an event study approach si!ilar& but si!pler& than ours%
6ur paper is different in several key respects% 6ur !ain !ethodology is to control for
conte!poraneous events through a co!bination of (i co!paring level)/@ cross)listed to
non)cross)listed fir!s& and (ii co!paring level)/@ !atched pairs (fir!s& to level)48
pairs (fir!s% S!ith initially used only publicly available sa!e)country indices& which are
often do!inated by cross)listed co!panies% Core recently& he also co!pares returns to
level)/@ co!panies to level)4 co!panies% .owever& S!ith uses event dates copied fro!
Engel& .ayes and (ang (/008& who study only K%S%)relevant events% ,s a result& he
!isses so!e of the !ost i!portant events B pre)adoption events that affect only
crosslisted
co!panies and post)adoption events that bear on whether S6M will apply to non)
KS fir!s% +onetheless& his results are generally consistent with those reported here&
though weaker and less detailed (he reports only cu!ulative return across !ultiple
events& rather than the event)by)event analysis provided here%4
4 Because S!ith does not effectively acknowledge this paper& so!e chronology is necessary% This paper
was first sub!itted in Cay /007 to the ?anadian Haw and Econo!ics ,ssociation annual !eeting&
presented there in Septe!ber /007& included in the Kniversity of Texas Haw and Econo!ics 3esearch
*aper Series in fall /007& sub!itted in revised for! to the Boundaries of SE? 3egulation conference in
Lece!ber /007 and to ,!erican Haw and Econo!ics ,ssociation conference in =anuary /00;& posted on
SS3+ in =anuary /00;& presented at the Boundaries conference in 'ebruary /00; and at ,!erican Haw and
Econo!ics ,ssociation in Cay /00;& resub!itted to this journal in =uly /00;& and reposted to SS3+ in
6ctober /00;& prior to this (=an% /00: revision% ,ll versions co!pare level)/@ pairs (fir!s to level)48
pairs (fir!s% S!ith$s early -bonding hypothesis- draft was presented at (estern 'inance ,ssociation in
su!!er /00;% That version co!pared level)/@ co!panies to a public ho!e)country index& and excluded
:
This paper differs fro! the prior literature in that it co!pares stock price reactions
of foreign issuers cross)listed in the KS to stock price reactions of otherwise si!ilar
foreign issuers that are not cross)listed in the KS% Each cross)listed co!pany in our
dataset is assigned a !atch B another co!pany fro! the sa!e country& sa!e industry&
si!ilar in siEe& but not cross)listed in the KS% ,s a result& this study is first to have an
experi!ental group (co!panies subject to the ,ct and a control group (otherwise si!ilar
co!panies not subject to the ,ct%
Because this approach allows to control for alternative econo!ic and political
trends affecting all co!panies in their respective !arkets& we are also able to ask whether
the effect of the ,ct depends on countries9 other laws& on the strength of a country9s legal
syste! in general& on a country9s OL*& and other legal and econo!ic characteristics%
@% The ?osts and Benefits of the Sarbanes)6xley ,ct for ?ross)
Histed ?o!panies
a% 6verall 3eaction to the Sarbanes)6xley ,ct
Hegal scholars analyEed the contents of the ,ct in detail and generally concluded
that the ,ct9s costs are substantial while the benefits are s!all (3o!ano /007D 3ibstein
/00/% ,!ong the ,ct9s !ost significant burdens are the costs of direct co!pliance
created by the FInternal ?ontrolsG Section 808 (Orundfest /00:% 6ther often)discussed
costs include the ,ct9s strong pressures on the !anage!ent to !aintain paper trails and
organiEe !anage!ent activities around the paper)trail re#uire!entsD the i!position of
!onitoring !echanis!s that have not been shown to i!prove fir! perfor!ance (such as
an independent audit co!!itteeD restrictions on the relatively har!less for!s of
executive co!pensation (such as executive loansD and pressures to reduce
perfor!ancebased
part of executive co!pensation created by the re#uire!ent that executives return
their perfor!ance)based co!pensation in case of accounting restate!ents (Butler and
level)4 co!panies fro! the sa!ple% S!ith thereafter adopted an approach si!ilar to ours and co!pared
level)/@ to level)4 co!panies& but found insignificant results% .e posted that version on SS3+ in Sept%
/00;% In a revised posting to SS3+ (Lec% /00;& he reports a significant difference between the two groups
in countries with -high)#uality accounting syste!s%- .e barely !entions this paper& does not discuss our
!ethodology& and clai!s incorrectly that his paper is the first to co!pare level)/@ fir!s to other crosslisted
fir!s%