The Corporate Takeover
Market
Common Takeover Tactics,
Takeover Defenses, and
Corporate Governance
Treat a person as he is, and he will remain as he is.
Treat him as he could be,
and he will become what he should be.
—Jimmy Johnson
Course Layout: M&A & Other
Restructuring Activities
Part I: M&A
Environment
Part II: M&A
Process
Part III: M&A
Valuation &
Modeling
Part IV: Deal
Structuring &
Financing
Part V:
Alternative
Strategies
Motivations for
M&A
Business &
Acquisition
Plans
Public Company
Valuation
Payment &
Legal
Considerations
Business
Alliances
Regulatory
Considerations
Search through
Closing
Activities
Private
Company
Valuation
Accounting &
Tax
Considerations
Divestitures,
Spin-Offs &
Carve-Outs
Takeover Tactics
and Defenses
M&A Integration
Financial
Modeling
Techniques
Financing
Strategies
Bankruptcy &
Liquidation
Cross-Border
Transactions
Current Lecture Learning Objectives
Providing students with an understanding of
• Corporate governance and its role in protecting
stakeholders in the firm;
• Factors external and internal to the firm affecting
corporate governance;
• Common takeover tactics employed in the
market for corporate control and when and why
they are used; and
• Common takeover defenses employed by target
firms and when and why they are used.
Alternative Models of Corporate Control
• Market model applies when:
– Capital markets are liquid
– Equity ownership is widely
dispersed
– Board members are largely
independent
– Ownership & control are
separate
– Financial disclosure is high
– Shareholder focus more on
short-term gains
• Prevalent In U.S. and U.K.
• Control model applies when:
– Capital markets are illiquid
– Ownership is heavily
concentrated
– Board members are largely
“insiders”
– Ownership & control
overlap
– Financial disclosure limited
– Shareholder focus more on
long-term gains
• Prevalent in Europe, Asia, &
Latin America
Factors Affecting Corporate Governance:
Market Model Perspective
External to Firm
Legislation:
1933-34 Securities Acts
Dodd-Frank Act of 2010
Sherman Anti-Trust Act
External to Firm
Regulators:
SEC
Justice Department
FTC
Internal to Firm
•Board of Directors
•Management
•Internal Controls
•Incentive Systems
•Takeover Defenses
External to Firm
Institutional Activism:
Pension Funds (Calpers)
Mutual Funds
Hedge Funds
External to Firm
Market for Corporate
Control:
Proxy Contests
Hostile Takeovers
Internal Factors: Board of Directors
and Management
• Board responsibilities include:
--Review management proposals/advise CEO
--Hire, fire, and set CEO compensation
--Oversee management, corporate strategy, and
financial reports to shareholders
• Good governance practices include:
--Separation of CEO and Chairman of the Board
--Boards dominated by independent members
--Independent members serving on the audit and
compensation committees
Internal Factors: Controls &
Incentive Systems
• Dodd-Frank Act (2010):
-- Gives shareholders of public firms nonbinding right to
vote on executive compensation packages
--Public firms must have mechanism for recovering
compensation 3-yrs prior to earnings restatement
• Alternative ways to align management and shareholder
objectives
– Link stock option exercise prices to firm’s stock price
performance relative to the overall market
– Key managers should own a significant portion of the
firm’s outstanding shares
External Factors: Legislation
• Federal and state securities laws
– Securities Acts of 1933 and 1934
– Williams Act (1968)
• Insider trading laws
• Anti-trust laws
– Sherman Act (1890)
– Clayton Act (1914)
– Hart-Scott-Rodino Act (1976)
• Dodd-Frank Act (2010)
Dodd-Frank Act of 2010: Governance &
Executive Compensation
• Say on Pay: In a nonbinding vote, shareholders may vote
on executive pay every 3 yrs.
• Say on Golden Parachutes (executive severance
packages): Proxy statements seeking shareholder approval
of M&As or sale of most of a firm’s assets must disclose
pay agreements with target or acquirer executives
• Clawbacks: Public firms must disclose mechanisms for
recovering incentive pay paid during 3-yrs prior to earnings
restatements.
• Proxy Access: SEC has authority to require public firms to
include nominees submitted by shareholders in proxy
materials
• Broker Discretionary Voting: Stock exchanges must
prohibit brokers from voting shares without direction from
owners in election of directors and executive compensation
Dodd-Frank Act of 2010: Systemic
Regulation and Emergency Powers
• Financial Stability Oversight Council (FSOC): Monitors U.S. financial
markets to identify banks and nonbank banks exhibiting “systemic” risk.
• New Fed Bank/Nonbank Supervisory Powers: Banks/nonbanks with
total assets ≥ $50 billion must
– Submit plans for their rapid dissolution in event of failure
– Limit their credit exposure in any unaffiliated firm to 25% of its
capital
– Conduct semiannual stress tests to determine capital adequacy
– Provide advance notice of intent to buy voting shares in financial
firms
• Leverage Limitations: Fed may require banks with assets ≥ $50 billion
to maintain debt-to-equity ratio of no more than 15 to 1.
• Size Limitations: No bank or nonbank can hold deposits > 10% of
deposits nationwide; does not apply to mergers involving failing banks.
• FDIC Guaranty Powers: May guaranty liabilities of solvent banks if
FSOC and Fed determine appropriate to do so.
• Orderly Liquidation Authority: FDIC may seize and liquidate banks
threatening U.S. financial stability
• New Bank Capital Requirements: At discretion of regulators.
Dodd-Frank Act of 2010:
Capital Markets
• Office of Credit Ratings: Sets rules for transparency,
conducts audits and makes it easier to sue rating
agencies.
• Securitization: Issuers of asset-backed securities must
retain an interest of at least 5% of any security sold to
third parties.
• Hedge and Private Equity Fund Registration: Must
register with SEC as investment advisors if assets ≥
$100 million; those with < $100 million subject to state
regulation.
• Clearing and Trading of OTC Derivatives: Must be
traded on formal exchanges to provide real time data
reporting to market participants (e.g., CDS-lender
insurance).
Dodd-Frank Act of 2010:
Financial Institutions
• Volcker Rule: Prohibits insured banks from
buying and selling securities with their own
money (i.e., proprietary trading) or sponsoring or
investing in hedge funds or private equity funds;
banks may do so if they have no control over
funds. Does not apply to U.S. banks with foreign
operations.
• Consumer Financial Protection Bureau:
Writes rules governing financial institutions
offering consumer financial products
• Federal Insurance Office: Monitors insurance
industry and recommends which firms should be
considered systemically important.
External Factors: Regulators
•
•
•
•
Securities and Exchange Commission
Justice Department
Federal Trade Commission
Public Company Accounting Oversight
Board
• Financial Accounting Standards Board
• Financial Stability Oversight Council
External Factors:
Institutional Activism
• Pension funds, mutual funds, and insurance
companies
• Ability to discipline management often limited by
amount of stock can legally own in a single firm
• Investors with huge portfolios (e.g., TIAA-CREF,
California Employee Pension Fund) can exert
significant influence
• Recent trend has been for institutional investors
to simply withhold their votes
External Factors: Market for
Corporate Control
• Changes in control can result from hostile takeovers or
proxy contests
• Management may resist takeover bids to
– Increase the purchase price (Shareholders’ Interests
Theory) or
– Ensure their longevity with the firm (Management
Entrenchment Theory)
• Takeovers may
– Minimize “agency costs” and
– Transfer control to those who can more efficiently
manage the acquired assets
Discussion Questions
1.Do you believe corporate governance should be
narrowly defined to encompass shareholders
only or more broadly to incorporate all
stakeholders? Explain your answer.
2.Of the external factors impacting corporate
governance, which do you believe is likely to be
the most important? Be specific.
Market for Corporate Control:
Alternative Takeover1 Tactics
• Friendly (Target board and
management supports bid)
• Hostile (Target board and management
contests bid)
1A
corporate takeover refers to a transfer of control from one investor group to another.
Market for Corporate Control:
“Friendly” Takeover Tactics
• Potential acquirer obtains support from the target’s board and
management early in the takeover process before proceeding to a
negotiated settlement
– The acquirer and target firms often enter into a standstill
agreement in which the bidder agrees not to make any further
investments for a stipulated period in exchange for a break-up
fee from the target firm.
• Such takeovers are desirable as they avoid an auction environment
• If the bidder is rebuffed, the loss of surprise gives the target firm time
to mount additional takeover defenses
• Rapid takeovers are less likely today due to FTC and SEC prenotification and disclosure requirements1
1The
permitted reporting delay between first exceeding the 5% ownership stake threshold and the filing of a 13D
allowed Vornado Realty Trust to accumulate 27% of J. C. Penny’s outstanding shares before making their holdings
public.
Market for Corporate Control:
Hostile Takeover Tactics
• Limiting the target’s actions through a
“bear hug”
• Proxy contests in support of a takeover
• Purchasing target stock in the open
market
• Circumventing the target’s board through
a tender offer
• Litigation
• Using multiple tactics concurrently
Market for Corporate Control:
Pre-Offer Takeover Defenses
• Poison pills to raise the cost of takeover1
• Shark repellants to strengthen the target board’s defenses
– Staggered or classified board elections
– Limiting when can remove directors
• Shark repellants to limit shareholder actions
– Limitations on calling special meetings
– Limiting consent solicitations
– Advance notice and super-majority provisions
• Other shark repellants
– Anti-greenmail and fair price provisions
– Super-voting stock, re-incorporation, and golden parachutes
1Note
that poison pills could also be classified as post-bid defenses as they may be issued by the board as dividends without
shareholder approval.
Poison Pill: Cash for Share Purchase
Target Price Share
D
S1
S2
P3
A
B
Target shareholder Profit/Share on
Poison Pill Conversion
P1
P2
DD reflects relationship between
shares outstanding and price/share for
given level of expected earnings &
interest rates.
D
C
Q1
D
Q2
Target Shares Outstanding
P1 = Pre-offer equilibrium price/target share
P2 = Poison pill conversion price/target share
P3 = Offer price/target share
Q1 = Pre-offer target shares outstanding
Q2 = Target shares outstanding following poison pill conversion
ABCD = Incremental acquirer cash outlay due to poison pill conversion
Poison Pills: Share for Share Exchange
Acquirer Shareholder Ownership Dilution Due to Poison Pill
New Company Shares
Outstanding1
Without Pill
With Pill
Target Firm Shareholders
Shares Outstanding
Total Shares Outstanding
1,000,000
1,000,000
2,000,000
2,000,000
Acquiring Firm Shareholders
Shares Outstanding
New Shares Issued
Total Shares Outstanding4
1,000,000
1,000,000
2,000,000
1,000,000
2,000,0002
3,000,000
1Acquirer
Ownership Distribution in
New Company (%)
Without Pill
With Pill
50
673
50
33
agrees to exchange one share of acquirer for each share of target stock.
2Poison pill provisions enable each target shareholder to buy one share of target stock at a nominal
price for each share they own. Assume all target shareholders exercise their rights to do so.
32,000,000/3,000,000
4Target shares are cancelled upon completion of transaction.
Market for Corporate Control:
Post-Offer Takeover Defenses
•
•
•
•
•
•
•
•
•
•
Greenmail
Standstill agreement
Pac-man defense
White knights
Employee stock ownership plans
Recapitalization
Share buy-back plans
Corporate restructuring
Litigation
“Just say no”
Discussion Questions
1. Discuss the advantages and disadvantages of
the friendly versus hostile approaches to
corporate takeovers. Be specific.
2. Do you believe that corporate takeover
defenses are more motivated by the target’s
managers attempting to entrench themselves
or to negotiate a higher price for their
shareholders? Be specific.
Impact on Shareholder Value
• Friendly transactions result in average abnormal returns
to target shareholders of 20%
• Hostile transactions result in average abnormal returns
to target shareholders of 30-35%
• Bidders’ shareholders earn average abnormal returns
that are zero or slightly negative; however, often positive
in certain situations
• Recent studies suggest
– Takeover defenses have small negative impact on
abnormal target shareholder returns
– Defenses put in place prior to an IPO may benefit
target shareholders
– Bondholders in firms with ineffective defenses (i.e.,
vulnerable to takeover) may lose value
Things to remember...
• Hostile takeover attempts and proxy contests affect
governance through the market for corporate control
• Hostile takeover attempts tend to benefit target
shareholders substantially more than the acquirer’s
shareholders by putting the target into “play.”
Consequently, acquirers generally consider friendly
takeovers preferable.
• Anti-takeover measures share two things in common.
They are designed to
– Raise the overall cost of the takeover to the acquirer’s
shareholders and
– Increase the time required for the acquirer to
complete the transaction to give the target additional
time to develop an anti-takeover strategy.