Οικονομικό Πανεπιστήμιο Αθηνών
Τμήμα Οικονομικής Επιστήμης
Άνοιξη 2012
Χρηματοοικονομικές αγορές και εταιρική διακυβέρνηση
Lecture 2: Separation of ownership and management (part 2).
The board of Directors.
Board members are directly elected by stock-holders and under corporate law they
represent the stockholder’s interests in the company.
A board of directors is a mix of inside and outside directors.
Inside directors (executive directors) are senior employees of the company. They are
well informed about the company’s activities. However, as employees, their interests
are aligned with those of management.
(It is possible to have employees as non executive members in Greece)
Disadvantages of board of directors.
(a) Lack of independence.
Independent directors (nonexecutive directors) are not linked with the company.
However, they usually have personal connections with the managers.
(b) Insufficient attention.
Outside directors are very busy, and they do not have time to prepare for the
meetings.
(c) Insufficient incentives.
There is a weak link between firm performance and directors’ compensation.
(d) Avoidance of conflicts.
In general, they avoid to confront management.
Boards interfere in some decisions. It is possible to remove underperforming
managers. It is possible to disagree with managers during takeover contests.
The relation between directors and managers breaks down mainly during crises. In
general, decreases in the share price, lead to an increase in board activity as measured
by the annual number of board meetings.
Investor activism.
Active monitors intervene in firm’s strategic decisions like: Investments, asset sales,
managerial compensation, design of takeover defenses and board size and
composition.
Active monitors must have control. Control may be formal or real.
Formal control have: Majority shareholders, venture capitals with explicit control
rights over a start-up company. It allows large owners to directly implement the
changes they find necessary.
Real control have: Minority owners who persuade other owners of the need for
intervention.
In a proxy contest shareholders unhappy with management policies seek either
election to the board of directors with the ultimate goal of removing management or
support by a majority of shareholders for a resolution on a specific corporate policy.
Sometimes, the threat of a proxy contest suffices to achieve the active monitor’s aims,
and the contest need not occur.
Pattern of Ownership.
Investor activism is linked to the structure of ownership. The decomposition of
shareholding among the various types of investors (households, institutional
investors) is important as institutional investors do not have the same incentives to
monitor.
I.e. The president of ΤΣΜΕΔΕ and ATTICA Bank
The limits of active monitoring by money managers.
There are very few mechanisms which make institutional money managers
accountable: They do not face any threat of a hostile takeover or proxy fights. As they
do not have debts, they face less pressure to generate profits than ordinary
corporations. Also, executive compensation is hard to design.
Managers in institutional investors (managers of pension and mutual funds) focus on
short term profits. Also, in many cases have limited managerial competency. The
active monitor does not internalize the welfare of other investors and therefore may
not monitor efficiently.
For example: If a pension funds owns only 1% of a corporation it does not have an
incentive to acquire strategic information and launch a proxy fight as its income from
this corporation may be a small fraction of its income.
Takeovers and leveraged buyouts.
The volume of mergers and acquisitions was very high during the 1980s and the
1990s in US. In Greece: Ioniki and Alpha Bank, MIG, Marfin, Egnatia, Laiki etc.
Benefits: Fresh ideas from a new management team, superior efficiency, the
willingness to abandon past mistaken strategies, the disciplining effect on incumbent
management of the threat of a takeover in case of poor performance.
Takeovers facilitate exit and cash wasteful ejection in slow growth industries where
management refuses to unwind its empire and uses the available cash if any to engage
in wasteful diversifications.
Also, the threat of takeovers may improve corporate governance. However, it may
induce managers to act “myopically” and boost short-term performance at the expense
of the long-run one.
The Tobin's Q ratio: A ratio comparing the market value of a company's stock with
the value of a company's equity book value.
Market value of installed capital/replacement cost of capital
It is the ratio between two valuations of the same physical asset. More specifically:
The numerator, is the market valuation: the going price in the market for exchanging
existing assets. The other, the denominator, is the replacement or reproduction cost:
the price in the market for the newly produced commodities.
High Tobin's Q values encourage companies to invest more in capital because they
are "worth" more than the price they paid for them.
Usually firms with low Q ratios of market value of securities over the accounting
value of assets are targets of takeover bids. A low Q (between 0 and 1) means that the
cost to replace a firm's assets is greater than the value of its stock. This implies that
the stock is undervalued.
A takeover starts as a tender offer, i.e. as an invitation to buy the firm’s shares at an
announced price: Before a bidder makes an offer for another company, it usually first
informs that company's board of directors. If the board feels that accepting the offer
serves shareholders better than rejecting it, it recommends the offer be accepted by the
shareholders.
In a tender offer the management is not opposed to the invitation to buy the firm’s
shares at an announced price. The offer may concern part or all of the stock. It may be
conditional on a certain number of shares effectively tendered (the bidder is often
interested in the shares only if he obtains a controlling stake).
Example: Aegean and Olympic Air
A hostile takeover allows a suitor to bypass a target company's management unwilling
to agree to a merger or takeover. A takeover is considered "hostile" if the target
company's board rejects the offer, but the bidder continues to pursue it, or the bidder
makes the offer without informing the target company's board beforehand.
In a “hostile” takeover the raider invites shareholders to accept the offer whether the
board recommends it or not.
A hostile takeover can be conducted in several ways:
(a) A tender offer can be made where the acquiring company makes a public offer at a
fixed price above the current market price. (b) An acquiring company can also engage
in a proxy fight, whereby it tries to persuade enough shareholders, usually a simple
majority, to replace the management with a new one which will approve the takeover.
(c) Another method involves quietly purchasing enough stock on the open market,
known as a creeping tender offer, to effect a change in management.
In all of these ways, management resists the acquisition but it is carried out anyway.
The management may use takeover defenses (measures against a possible takeover).
Managers sometimes look for a white knight, namely, an alternative acquirer with a
friendlier attitude towards the current management and willing to bid up the price.
OTE vs MIG and Deutsche Telekom
Leveraged Buyouts.
The acquisition of another company using a significant amount of borrowed money
(bonds or loans) to meet the cost of acquisition. Often, the assets of the company
being acquired are used as collateral for the loans in addition to the assets of
the acquiring company. The purpose of leveraged buyouts is to allow companies to
make large acquisitions without having to commit a lot of capital.
An LBO consists in taking a firm private by purchasing its shares and allocating them
to a concentrated ownership composed of management, a general partner (an LBO
specialist who brings equity of his own and finds investors to cofinance the LBO) and
other investors.
In an LBO there is a substantial increase of debt (as equity decreases).
In such case we have:
Stronger monetary incentives for the firm’s managers (relative to those of a publicly
traded corporation)
Active monitoring taking seriously as the general partner has both the incentives and
the means of intervention.
High leverage forces management and the partnership to work out cost reductions and
improvements in efficiency.
LBO targets have to generate large and steady cash flows in order to service the high
debt payments. I.e. must be mature industries with steady cash flows. I.e. oil and gas,
mining and chemicals, tobacco etc.
Takeovers occurred because:
(a) There was decline in corporate governance. The lack of monitoring led managers
to invest in unattractive projects as in that period managers had substantial amounts of
cash to spend. On the other hand, international competition, technological change etc
implied that a number of firms had to exit or downsize. Thus, the capital market
substituted for that deficient corporate governance.
(b) Financial innovation. LBOs created a superior and more efficient form of
corporate governance.
(c) Break up of conglomerates built in the 1960s and 1970s. Conglomerates were
unmanageable and managers did not want to reduce their size.
The outcome of the takeovers.
Takeovers are associated with an increase in total value.
The winners from takeovers: The target shareholders.
Bidders neither gained nor lost. Takeovers create value. However, a raider cannot
offer less than the post-acquisition value of the firm and have the target shareholders
tender their shares; for, it would then be optimal for an individual shareholder to
refuse to tender his shares and to enjoy the higher value of the post-acquisition firm.
They prevented some managers from wasting free cash flow, forced some exit or
curtailments in excess capacity. Did not reduce wages or employment. Did not have a
large negative impact on long-term investments i.e. R&D expenditures.
Reference
Jean Tirole, “The theory of corporate finance,” Princeton University Press 2006,
Chapter 1.