By 1 Kenneth A Kim John R Nofsinger

By: 1. Kenneth A. Kim John R. Nofsinger And 2. A. C. Fernando

Lesson 20

Corporate Takeovers: A Governance Mechanism Last Lecture Review ◦ Brief overview of M & A. Strategic reason (to reduce cost, to get new business) Synergistic reason (combined effort) Diversification (reduce the risk by making investment in different locations) ◦ Are corporate takeover good for shareholders Acquirer firm’s shareholders perspective Acquiree firm’s shareholders perspective

Corporate Takeovers: A Governance Mechanism The Target Firm ◦ Increase in share price Is it appropriate to acquire ◦ Successful firm ◦ Unsuccessful firm What if the management (acquiree firm) didn’t accept the takeover bid

Corporate Takeovers: A Governance Mechanism “Hostile” takeover is in the eye of the beholder ◦ Acquisition/merger being approved by the target firm. ◦ Target firm may go for “friendly” deal Perks for the management Premium for the shareholders

Corporate Takeovers: A Governance Mechanism Lecture Outlines ◦ Takeover Defences 1. Firm Level Pre-emptive defences Poison Pills Acquirer firm stocks at a deep discount rate Target firm’s debt immediately due Golden Parachute (payment to managers) Super majority rule (2/3 shareholders approval) Staggered Board

Corporate Takeovers: A Governance Mechanism 1. 1 Firm Level Reactionary Takeover Defences Greenmail (purchasing shares from the major shareholders at a premium to prevent takeover) Convincing (by management to convince the shareholders) 2. State Level Anti-Takeover Laws Freeze-out Laws Fair price law (later shareholders get the same price) Poison pill endorsement laws A control share acquisition law ( shareholders approval) A constituency statute (include non-shareholders)

Corporate Takeovers: A Governance Mechanism Assessment of takeover Defences ◦ Are takeover defences bad for governance system Takeover defences are bad for governance system But the pros and cons of takeover defences should be evaluated. But normally these defences are just to increase the company price

Corporate Takeovers: A Governance Mechanism Takeover Defences ◦ Takeover defences include all actions by managers to resist having their firms acquired. ◦ We can place takeover defences into two categories: Firm Level Pre-emptive Defences Reactionary Defences State Level

Corporate Takeovers: A Governance Mechanism Firm-Level Pre-Emptive Takeover Defences ◦ 1. Poison Pill The term poison pill represent any strategy that makes a target firm less attractive immediately after it is taken over. Most poison pills are simply favourable rights given to its shareholders. a. i. e. target firm shareholders the right to buy the acquirer’s stocks at a deep discount if its firm is acquired. Of course these rights make those firms much less attractive to takeover from the acquirer’s standpoint.

Corporate Takeovers: A Governance Mechanism b. Other type of poison pills could involve a firm’s debt becoming immediately due once it is taken over or an immediate deep-discount selling of fixed assets once it is taken over. So these are some of the strategies through which a target firm can prevent its firm to be acquired.

Corporate Takeovers: A Governance Mechanism ◦ 2. Golden Parachute A golden parachute is an automatic payment made to managers if their firms gets taken over. Because the acquirer ultimately bears the costs of these parachutes, their existence make those firms less attractive. Golden parachute can also be viewed as one type of poison pill.

Corporate Takeovers: A Governance Mechanism ◦ 3. Super Majority Rules Where 2/3 or even 90 percent of the shareholders have to approve a hand-over in control. ◦ 4. Staggered Boards A staggered board consists of a board of directors whose members are grouped into classes; for example, Class 1, Class 2, Class 3, etc. Each class represents a certain percentage of the total number of board positions. For example, a class is commonly comprised on one-third of the total board members. During each election term only one class is open to elections, thereby staggering the board directorship.

Corporate Takeovers: A Governance Mechanism Firm-Level Reactionary Takeover Defences ◦ 1. Greenmail To prevent hostile takeover, the target firm force the shareholders to purchase stocks from the major shareholders at premium. ◦ 2. Convincing It’s a sort of defence by the management to convince the shareholders that the bid price is very low.

Corporate Takeovers: A Governance Mechanism State-Level Anti-takeover Laws ◦ 1. Freeze-out Laws It stipulate a length of time that a bidder that gains control has to wait to merge the target with its own assets. ◦ 2. Fair Price laws Fair price laws make sure that shareholders who sell their shares during a later stage of an acquisition get the same price as any other shareholder that sold their shares to the acquirer earlier.

Corporate Takeovers: A Governance Mechanism ◦ 3. Poison Pill Endorsement Laws This law protect the firm’s right to adopt poison pills. ◦ 4. A Control Share Acquisition Law A control share acquisition law requires shareholders approval before a bidder can vote his shares. ◦ 5. A Constituency Statute A constitute statute allows managers to include nonshareholders’ (such as employees and creditors) interests in defending against takeovers

Corporate Takeovers: A Governance Mechanism Assessment of Takeover Defences ◦ Are takeover defences bad for the governance system? Takeover defences at least contributed to the end of disciplinary takeovers. If takeover defences prevent disciplinary takeovers then their existence cause us to be left with one less governance mechanism. In this sense, takeover defences are bad for the governance system. Adopting takeover defences can badly affect the target firm share price.

Corporate Takeovers: A Governance Mechanism ◦ But this is not to say that we staunchly advocate eliminating anti-takeover mechanisms. ◦ We should continue to evaluate the pros and cons of anti-takeover defences in the light of re-evaluation of corporate governance that is taking place today. ◦ Some anti-takeover devices appear only to benefit managers.

Corporate Takeovers: A Governance Mechanism ◦ On the other hand, many firms with takeover defences do eventually agree to be acquired. When they do the acquisition price tend to be much higher than the original offer. ◦ Therefore, fighting against the merger for a while may cause the bid price to increase, thereby increasing wealth to the target firm’s shareholders.

Corporate Takeovers: A Governance Mechanism Summary ◦ Definition ◦ What are mergers and acquisitions? ◦ Importance of discussing M & A in corporate governance. ◦ General process: Acquisition ◦ General process: Merger

Corporate Takeovers: A Governance Mechanism ◦ Characteristics of M & A Type (vertical/horizontal) The valuation of firm involved The payment (Cash, Newly created stocks) The new corporate structure The legal issue

Corporate Takeovers: A Governance Mechanism ◦ Brief overview of M & A. Strategic reason (to reduce cost, to get new business) Synergistic reason (combined effort) Diversification (reduce the risk by making investment in different locations) ◦ Are corporate takeover good for shareholders Acquirer firm’s shareholders perspective Acquiree firm’s shareholders perspective

Corporate Takeovers: A Governance Mechanism The Target Firm ◦ Increase in share price Is it appropriate to acquire ◦ Successful firm ◦ Unsuccessful firm What if the management (acquiree firm) didn’t accept the takeover bid

Corporate Takeovers: A Governance Mechanism “Hostile” takeover is in the eye of the beholder ◦ Acquisition/merger being approved by the target firm. ◦ Target firm may go for “friendly” deal Perks for the management Premium for the shareholders

Corporate Takeovers: A Governance Mechanism ◦ Takeover Defences 1. Firm Level Pre-emptive defences Poison Pills Acquirer firm stocks at a deep discount rate Target firm’s debt immediately due Golden Parachute (payment to managers) Super majority rule (2/3 shareholders approval) Staggered Board

Corporate Takeovers: A Governance Mechanism 1. 1 Firm Level Reactionary Takeover Defences Greenmail (purchasing shares from the major shareholders at a premium to prevent takeover) Convincing (by management to convince the shareholders) 2. State Level Anti-Takeover Laws Freeze-out Laws Fair price law (later shareholders get the same price) Poison pill endorsement laws A control share acquisition law ( shareholders approval) A constituency statute (include non-shareholders)

Corporate Takeovers: A Governance Mechanism Assessment of takeover Defences ◦ Are takeover defences bad for governance system Takeover defences are bad for governance system But the pros and cons of takeover defences should be evaluated. But normally these defences are just to increase the company price. The End