Proposed Takeover Directive and
Reforms ofEuropean Corporate Law
Professor Joseph A. McCahery
Tilburg University, TILEC &
Research Fellow, ECGI
Outline
• Winter I: Level Playing Field for Takeovers
• Draft Directive on Takeover Bids
• Fair Compensation Approach for Holders of
Dual Class Shares
• Winter II
• Conclusion
Winter Committee Proposal on
Takeover Bids
• Aim: to create a level playing field for takeover
bids
• In absence of efficient capital markets, two
general rules are required—
– Shareholder decision-making (Art 9)
– Proportionality between risk bearing and control;
holder of majority of risk decides (new rule proposed)
• Pre-bid measures--differentiated voting rights,
voting caps, golden shares, voting trusts, etc.
inconsistent with two legal principles
Article 9: Problem of Frustrating
Actions
• HLG endorsed EC position that boards should be
neutral after bid is announced
• Prior shareholder approval necessary for
frustrating actions
• Scope of board action—board sets out option on
bid; may seek other bids
• Art 9 alone insufficient to ensure that principle of
proportionality (between risk-bearing and control)
is adhered to once bid is made public
Break-through Rule
• All holders of risk-bearing capital attend AGM to
vote in proportion to holdings
• Aim: allows bidder, upon acquisition of 75% of
cash flow rights, to remove any barriers to
takeover
• Two sub-rules—designed to eliminate:
• 1) Provisions preventing exercise of proportional
voting rights
• 2) Provisions that limit exercise of internal affairs
Critique of Breakthrough Rule
• 1. Winter Report assumes BTR only applies if
target board rejects bid—in fact, bidder can decide
not to ask incumbent to tender in first place
• 2. Change in control structure—migration from
dual class to pyramids (Hart/Bebchuk)
• 3. Increase in de-listings (Bolton)
• 4. Will impact a number of the largest EC firms
• 5. Inconsistent w/ mandatory bid rule—private
benefits of control eliminated
• 6. May lead to free-rider problems
Winter View of Dual Class
Shares—Evidence is ambiguous
• Evidence—Winter correct that dual class restricts
flow of bids but studies show that they have:
–
–
–
–
Limited impact on bid outcome;
Harmful only at the margin;
Company value implications of dual class unclear;
Few European studies—Danish evidence (Rose 2002)
shows that unprotected firms do not outperform
protected firms
– Aggregate studies show market is able to distinguish
between corporate governance arrangement (Gompers
et al 2003);
– Capital cost considerations prompting firms to change
design of their share class structure (eg, Ericsson)
Barriers not covered by
Breakthrough Rule
• 1. Provisions in articles of association and
related constitutional documents related to
transferability of shares;
• 2.Contractual arrangements, viz. golden
parachutes (to be dealt w/ under company
law)
• 3. Pyramid structures—complicated and
expensive to deal with properly
Conflict w/in EU
Breakthrough Rule—conflicts with prior shareholder
preferences
Choice of which shareholders to redistribute to—one
group v. another group
Compensation does not deal with real problem of
regulatory taking, in effect
Mandatory Bid Rule
• Two components—(1)full bid must be made; (2)
consideration offered in bid
• Restricting bids—no longer possible to have two
prices (front and back end of bid) & thus bidder
will not propose a bid below the market price
• Blockholders—demand compensation for loss of
enjoyment of private benefits of control;
• Tradeoff—rule promises small shareholders will
obtain same price offered to blockholders, yet as
consequence number of deals could be reduced
Squeeze and sell out rights
• Squeeze out threshold (right to by minority
shares to be exercised): 90% or 95% of
capital (also where there are several classes
of securities)
• Sell-out rights: 90% threshold triggers
undertaking that would allow minority
shareholders to request their shares to be
acquired
Critique of Winter I
• Art 9—severe restrictions on defensive measures
will limit auctioning of firms; also leave certain
firms exposed (US-EU level playing field
considerations);
• Breakthrough rule—question of compensation
(Sweden—European Court of Human rights issue)
• Volkswagen statute—special statute should not be
set aside
Proposed Directive on Takeover
Bids (Oct. 2, 2002)
• Provides for:
• Strict board neutrality on part of target board
• Mini-breakthrough rules that stipulate that during
period of acceptance any restrictions on transfer of
securities in Articles or contractual arrangements
are not enforceable
• Set of disclosure rules
• Squeeze out and sell out rules
Reaction
• European Parliament—Rapporteur stated
that multiple voting rights should be within
breakthrough rule (necessary to protect
unprotected German companies)
• Report draft for Parliament to devise
systems of compensation for dual and
multiple shares
Proponents of BTR
• EP Study (2003): multiple voting rights
should be within scope of BTR
• Justifications:
• 1) dual class shares are designed primarily
to block takeovers;
• 2) Aim of EC legislation is to enhance legal
certainty and takeovers which dual and
multiple class shares deny
Fair Compensation Proposal—EP
Study (Jan. 2003)
• Concept of fair Compensation for holders of dual
class shares (rule out by Winter Report)
• Compensation Approaches:
• 1) based on difference between ordinary and
voting shares—use average premium paid on dual
class shares
• 2) But fair price does not have to be market price
• 3) Adopt average of premiums—between 10%20%: 15% (EU average 14% Dyck & Zingales
2002)
Critique
• Premiums range from 80% to 5% across EU
• Compensation rule reverses causality—premiums
would move toward 15%
• Case by case approach (default rule of EP)
• -creates legal uncertainty;
• -higher legal costs
• -a flexible approach—delegated to MS--would
better meet the needs of diverse firms and member
states
Alternative approaches to
valuation
Appraisal (Gr)—discount value of future returns
(problem—appropriate discount rate; arbitrary
outcomes)
Herinig & Olbich (2001) discount value of future
cash flow; compensation denied to non-controlling
blockholders (self-defeating if blockholder can
sell to biding blockholder);
Stock class conversions—market value (impounded
in difference between A and B shares)
Board Neutrality—Commission’s
proposal requires affirmative vote
• Commission correctly favors shareholder voting
as a means to allow shareholders the opportunity
to accept bid or not;
• Shareholders are better informed after bid and
have incentives to analyze its effects;
• Limits the potential coercive effect of a bid;
• Allows for more than passivity in face of bid
• Simple coordination approach is better than
complex rules which provide conficting signals
about limits of ex post board intervention
Conflict with Germany
• Art 33 German Takeover Code—permits post bid
intervention
• Exceptions—actions that would have been taken
in interests of company & actions to which
supervisory board has agreed
• Scope of Art 33—actions taken by supervisory
board
• Pre-bid actions—reserve authorizations, share
repurchases
• Conflict w/ Art 9—Commission wants simple rule
Proposal—UK/Germany
compromise
Open issues
• Level playing field—US v. Europe (rescind
Art 9—proposal)
• Volkswagen statute—second thoughts by
Commission
• Golden Shares—Left out of directive (Gr.
Wants back in)
Winter II
• Corporate Governance
• 3.1 Annual report publishes corporate governance
rules and practices of firm
• 3.2 Listed firms publish on website information
relevant to shareholders
• 3.3 Companies should disclose how investors can
ask questions & how they will be answered
• 3.4 Voting in absentia—direct vote or proxy
(electronic means)
• 3.5 Attendance via electronic means
Recommendations
• 3.7 Institutional investors—disclose
investment policy and policy w/r/t/ voting
rights
– --assumes that institutional investor voting
matters ( for dissenting view Cf. Romano 2002)
– If investors have 5-10 % can apply to court for
special investigation (3.8)
Board Structure & non-Execs.
• Firms should have option to select single or dual
board structure (consistent with Euro Company
Statute)
• 3.10 Listed firms ensure that nomination and
payment of directors & audit decided by nonexecs or supervisors who are indep.
• Principles of independence—list of relationships;
publish in annual account directors that are
independent; publish statement of board
composition (qualifications, etc.)
Remuneration/Responsibilities
• 3.11 Disclosure of executive pay in detailed financial
statements
• Executive pay linked to index should obtain prior
shareholder approval
• Executive compensation should appear on balance sheet
(no exemption for high tech)
• 3.12 Financial Statements—management responsible for
financial and governance statements
• 3.13 Wrongful trading—liability
• 3.14 Director sanctions—liability for filing misleading
statements, fines
Groups & Pyramids
• Law of Groups unnecessary
• Reform suggestions
– Transparency of group structures
– Tension between groups
– Pyramid structures
Transparency
• Transparency not main issue
• Information: group structure, managing
system, governance structure, rights &
responsibilities
• Mandatory disclosure
– Consolidated financial statements (7th Dir.
Accompanied by key information—intra-group
services, etc; non-financial information