Corporate control
Ownership and control
• one share – one vote?
Hart, ch. 8
The market for corporate control
• takeover bidding
Hirshleifer; Stein
Bankruptcy
• How to make sure that viable firms are not declared
bankrupt?
White
Tore Nilssen – Economics of the Firm – Lecture 3 – slide 1
The structure of voting rights
In most firms at the Oslo Stock Exchange:
• all shares receive the same fraction of dividends
• all shares have the same voting rights at the general
assembly
But in a few firms:
• one class of shares without voting rights
• all shares still receive the same fraction of dividends
• class A and class B shares
Tore Nilssen – Economics of the Firm – Lecture 3 – slide 2
Why does the structure of voting rights matter?
What do you get from controlling a firm? Let us distinguish
between:
• public value – money gained from owning shares in a
firm
ƒ dividends
and
• private value – benefits gained from managing the
firm
- widespread?
- newspapers, sports teams
- but: fiduciary duty / minority interests
A management team may want to take over a firm because
their private value are high, despite their public value being
low.
If control is gained from a low fraction of the firm, then it
is less costly in terms of public value to obtain the high
private benefits from managing.
Tore Nilssen – Economics of the Firm – Lecture 3 – slide 3
A model
Incumbent management team vs. rival management team:
I vs. R.
Everybody risk neutral. No discounting.
Public value:
Private value:
yI and yR.
bI and bR.
Is the rival team better in terms of public benefits?
- If Yes, then yR ≥ yI. If No, then yR < yI.
Date 0:
The firm goes public.
A large number of very small shareholders.
None of the two management teams own shares.
Voting structure chosen.
Two classes of shares, A and B.
Dividend entitlements: sA, sB,
sA + sB = 1
Vote entitlements:
vA, vB,
vA + vB = 1
Assume: vB > ½.
[Special case, one share - one vote:
sA/vA = sB/vB = 1]
Incumbent management team starts up.
Uncertainty about the ys and bs.
Tore Nilssen – Economics of the Firm – Lecture 3 – slide 4
Date 1:
Uncertainty about the ys and bs is resolved.
Rival team appears, decides on a take-over.
If take-over, then incumbent team must decide on
resistance.
The control contest.
If take-over is successful, management is replaced.
Date 2:
The company is closed down.
Dividend is paid to shareholders.
Tore Nilssen – Economics of the Firm – Lecture 3 – slide 5
The control contest
Suppose the rival team decides to take over.
The rival team makes a public tender offer.
The incumbent team may choose to make a counteroffer.
Shareholders are faced with one or two offers. They may
choose to tender to the rival, to the incumbent, or to hold on
to their shares.
The offers are unrestricted: In order to buy any shares in a
particular class of shares, the bidders must offer to buy all
shares in that class.
[One share – one vote: vB > ½ ⇒ sB = 1.]
The offers are unconditional: The bidders buy shares also
when the bid for control fails.
The control contest centers on the class B shares.
(Remember: vB > ½.)
No use in bidding for the class A shares in addition.
(Current shareholders will hold on to those shares as long
as there are any capital gains.)
Special case: Suppose the private value of the incumbent
management is insignificant – bI = 0.
If the incumbent team bids, they offer the whole public
value of class B shares, given that they continue: sByI
- They cannot afford to buy more
- Shareholders are not willing to accept less
Tore Nilssen – Economics of the Firm – Lecture 3 – slide 6
The rival team makes an offer if
- it is going to beat the incumbent offer
- it is profitable
(i) Suppose the rival management team is better: yR ≥ yI.
The rival team offers the whole public value of class-B
shares, given that they take over: sByR
- This beats the incumbent offer and is profitable.
ƒ profitable, because of the private value bR
- Shareholders are not willing to accept less.
(ii) Suppose the incumbent team is better: yR < yI.
In order to win, the rival must offer sByI.
This is profitable if and only if: bR > sB(yI – yR).
→ If yR < yI and bR > sB(yI – yR), then the less efficient
management wins the contest, and public value gets low.
At the outset (date 0), owners don’t want this to happen.
What should they do? – Make sB(yI – yR) as large as
possible.
→ Put sB = 1. → One class of shares.
– One share – one vote.
As long as one or both of bI and bR are close to zero, one
share – one vote is (weakly) best. But what if they both are
significant?
Tore Nilssen – Economics of the Firm – Lecture 3 – slide 7
Example with both bI and bR significant.
Suppose rival team has higher public value but smaller
private value.
yI = 200 < yR = 300.
bI = 55 > bR = 10.
Suppose we have two classes of shares of equal size, with
all voting power in class B:
sA = sB = ½; vA = 0, vB = 1.
How much is rival team willing to pay for control over
class-B shares? – sByR + bR = ½300 + 10 = 160.
How much is incumbent team willing to pay to keep their
control? – sByI + bI = ½200 + 55 = 155.
→ The rival team will succeed with an offer 155 + ε ≈ 155.
The total value of the firm is:
sAyR + (sByI + bI) = ½300 + 155 = 305.
With one share – one vote:
The incumbent team cannot win the contest.
Shareholders will accept all offers better than 300.
The rival team will succeed with an offer 300 + ε ≈ 300.
The total value of the firm is: 300.
Owners prefer two classes!
Tore Nilssen – Economics of the Firm – Lecture 3 – slide 8
Social value versus owners’ value
Social value is y + b; always maximized with one share –
one vote, even when both bs are significant.
- The contest always won by the team with the higher
y + b.
Restricted offers
An offer can be made to buy only a fraction, say λ, of the
controlling class-B shares.
This makes it cheaper to take over, and chances that an
inefficient management team will succeed increase.
The problem is reduced with a voting structure such that:
sA/vA = sB/vB = 1. → One share – one vote.
Tore Nilssen – Economics of the Firm – Lecture 3 – slide 9