Chapter 8

Corporate Takeovers: A Governance Mechanism?

Chapter Overview
Brief overview of M&A The target firm Takeover defenses Assessments of takeover defenses International perspective

U.S. and U.S. Cross-Border M&A Activity Transactions

$1,600 $1,400 Deal Value $1,200 Number of Deals $1,000 8,000 10,000 12,000

Billions

$800 $600

6,000

4,000 $400 2,000 $200 $0 0

1980

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Brief Overview of M&A

A merger is often viewed as a combination of two firms. An acquisition is viewed as one firm buying another. However, almost all mergers are essentially acquisitions. M&A can be synergistic or disciplinary or both.
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Synergistic M&A
To improve operational or financial synergies. e.g., Exxon and Mobil To diversify by expanding into new businesses. e.g., the AOL and Time Warner
Both synergistic and diversifying. e.g., the Morgan Stanley and Dean Witter Extremely diversifying e.g., General Electrics acquisition of NBC

Most of the recent mergers have occurred for growth and for increased market power. e.g., Oracle and PeopleSoft, HP and Compaq.

The Target Firm

Target firm is the firm to be acquired. An acquiring firm may want to acquire a target firm because it believes the target firm:
is not performing up to its full potential. the target firm could become a better performer under someone elses control.

Therefore, target firms usually enjoy a share price increase when its acquisition is announced to the public.

The Acquirers Goals

To takeover the target firm To make the target firm profitable by
Cutting the target firms fixed or variable costs
Improving its operational efficiency Getting rid of its bad managers

To Acquire a Successful Firm or an Unsuccessful Firm?

A successful firm An unsuccessful firm

Takeover cost Subsequent net gains

Pay a large sum May be limited

Pay a relatively small sum May be significantly positive

Paying a Significant Premium for Target Firms

Acquirers almost always end up paying a significant premium for target firms. Whether or not the premium paid for target firms is ever fully recovered is still under debate. The target firms shareholders might like their firms are taken over, while the target firms management team may oppose being acquired because they might get fired afterwards.

Hostile Takeover
Hostile takeover happens
First, when the target firms management balks at a takeover bid, acquirer may take their takeover bid directly to the target firms large shareholders. Second, an interested acquirer circumvents the target firms management and effectively takes control of the target firm.

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The Notion of the Disciplinary Takeover

Takeovers are viewed as an important governance mechanism because some firms that get taken over are poorly performing firms. The fear of a potential takeover might represent a powerful disciplinary mechanism to make sure that:
Managers perform to the best of their abilities. Managerial discretion is controlled.

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Are Takeovers an Effective Governance Mechanism?

It is not clear whether takeovers are an effective governance mechanism because:
An acquirer may have to pay too much for a target.
Takeovers could occur for the wrong reasons (e.g., empire building). Even if the acquirer is able to pay a fair price for a target, the amount usually is still significant.

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Why Did Many Disciplinary Takeovers Not Take Place Recently?

Share prices might have been inflated due to poor governance. Disciplinary takeovers get rid of managers whose questionable actions lead to low, not high, stock prices. It costs a lot of money to buy a firm. There are too many defenses against takeovers.
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Takeover Defenses
There are two categories of takeover defenses: Pre-emptive defenses (1) Firm-level defenses
Reactionary defenses

(2) U.S. state-level defensesstate laws that regulate and limit takeovers

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Firm-level Pre-emptive Takeover Defenses

Poison pillany strategy that makes a target firm less attractive immediately after it is taken over. A golden parachutean automatic payment made to managers if their firms gets taken over. Supermajority rulestwo-thirds, or even 90 percent, of the shareholders have to approve a hand-over in control. Staggered boardsonly a fraction of the board can get elected each year to multiple-year terms.

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Firm-level Reactionary Takeover Defenses

Greenmaillike a bribe that prevents someone from pursuing a takeover Other reactionary defenses include:
The firms management trying to convince its shareholders that the offer price is too low. Raise antitrust issues. Find another acquirer who might not fire management after the takeover. Find an investor to buy enough shares so that he/she can have sufficient power to block the acquisition.

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State-level Anti-takeover Laws

There are five common state-leave antitakeover laws:
Freeze-out laws
Fair price laws Poison pill endorsement laws

A control share acquisition law

A constituency statute

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Federal Acts
There are also federal acts that prevent mergers that would significantly reduce competition. The Bureau of Competition of the FTC and the Antitrust Division of the DOJ uphold antitrust policy. These two government agencies focus on anti-competitive business practices and ensure a competitive industry environment.
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Assessments of Takeover Defenses

Takeover defenses at least contributed to the end of disciplinary takeovers. Takeover defenses are bad for the governance system. Many firms with takeover defenses do eventually agree to be acquired.

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International Perspective
The U.K. experiences its own merger wave since the early 1990s. In bank-centered financial systems, banks seem to play a significant role in which firms merge. Many Asian governments relaxed the foreign ownership restrictions of their firms. Many countries have their own unique set of circumstances that make M&As difficult.
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United Kingdom

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Percent of Total Deal Value
10% 15% 20% 25% 30% 35% 40% 45% 50% 0%
United States France Germany Netherlands Canada Bermuda Italy Ireland Japan Spain Sweden Belgium Bulgaria Switzerland Australia South Korea China Czech Republic Finland Other

International Merger Activity

5%

Summary
M&As have been viewed as a corporate governance device. Firm-level and state-level takeover defenses weaken disciplinary takeovers. Besides the U.S., takeover activity is only common in the U.K. However, we may see a world-wide increase in M&A activity in the near future.
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