Defensive Strategies

Management can resist hostile takeover and proxy contest attempts through many actions, collectively sometimes called shark repellants, such as the following:

Greenmail: Management uses shareholders' money to "buy off" the shares of a potential acquirer at a premium. Golden Parachutes: Management lets itself be bought off by the acquirer. Acquisitions: A bigger company is more difficult to take over—the "blowfish" strategy. Poison Pills: Other shareholders become entitled to purchase more shares at a discount. The potential raider would then have to repurchase those shares at a higher price. Fair Value Provisions: An acquirer is forced to pay every shareholder the same price, i.e., the highest price at which shares are acquired. Supermajority Rules: An acquirer needs to obtain more than just a majority of votes to replace the board.

Litigation: Management can delay a potential takeover in the courts, especially if the potential acquirer is in the same industry, in which anti-trust issues can come into play. Scorched Earth: Management can threaten to sell off corporate assets that are of particular interest to the acquirer. New Share Issuance: Management can issue more shares to employees and themselves.

Staggered Boards: Each year, only a fraction (typically a third) of the directors are up for reelection. Therefore, no outsider can take control of a company during one annual meeting— even if you own 100% of the shares before the annual meetings, you can only replace one-third of the board. The remaining two-thirds will remain in office, which means that the company will remain under the control of the existing board for at least one more year, during which the existing management can do a lot of harm.

In 2003, a paper by Gompers, Ishii, and Metrick constructed an overall measure of how well a firm is governed, based on 24 governance mechanisms, prominently including the above mechanisms to prevent a takeover. A followup paper by Bebchuk and Cohen drilled deeper and found that staggered boards are the most effective defense. There have been no successful hostile takeovers of firms with effectively staggered boards.

Not all takeover activity is driven by poor managerial performance. Other reasons for takeovers are industry consolidation and acquisition of monopoly power, desire by acquirers to increase their own empires, and a desire to take advantage of corporate tax shelters. That is, takeovers can also occur independently of the target's managerial performance, and they may increase or decrease total value and the value of the acquirer. Nevertheless, a takeover almost inevitably raises the shareholder value of the target. Still, not all managerial resistance by the target is value-reducing. For example, resistance can and often has forced acquirers to pay more for the firm. Even when it prevents the takeover, the incumbent management often shapes up, e.g., by making a competing tender repurchase offer for its own shares, or by forcing management to pay out much of its free cash to shareholders.

A particular form of a takeover is the leveraged buyout (LBO). Especially in the 1980s, there was a window when small private holding companies were able to borrow significant amounts to take over much larger publicly-traded companies in leveraged buyouts (LBOs). The most prominent LBO was the takeover of RJR Nabisco by Kohlberg, Kravis, Roberts (KKR). Because the majority of financing was debt, KKR owned only a small slice of very high-powered equity and even modest post-LBO underperformance could result in a total investment loss for KKR. This gave them enormous incentives to get everything right. In the typical LBO, they would either fire existing management or completely restructure the existing management compensation contracts in order to dramatically improve managerial incentives. Most LBOs created a lot of value, through better control of agency problems plus tax benefits, and much of it went to the existing shareholders in the price they received for tendering their shares. However, by the 1990s, public market valuations had generally increased, management generally began to pay more attention to shareholders, and it became harder and harder to find companies that could

Management can resist. Staggered boards virtually eliminate all hostile takeovers.

Resistance can be good—especially if it is futile.

Some history: Leveraged Buyouts.

be purchased cheaply and then improved. But perhaps most importantly, companies learned how to institute takeover defenses that would be too expensive for a successful acquirer to overcome. Thus, at least for the time being, corporate governance through external takeovers, and especially through leveraged buyouts, has faded into the background.

0 0

Post a comment