The Consequences of Stockholder Powerlessness

If the two institutions of corporate governance -- annual meetings and the board of directors -- fail to keep management responsive to stockholders, as argued in the previous section, we cannot expect managers to maximize stockholder wealth, especially when their interests conflict with those of stockholders. Consider the following examples.

1. Fighting Hostile Acquisitions

When a firm is the target of a hostile takeover, managers are sometimes faced with an uncomfortable choice. Allowing the hostile acquisition to go

Golden Parachute: A golden parachute refers to a contractual clause in a management contract that allows the manager to be paid a specified sum of money in the event control of the firm changes, usually in the context of a hostile takeover.

through will allow stockholders to reap substantial financial gains but may result in the managers losing their jobs. Not surprisingly, managers often act to protect their interests, at the expense of stockholders:

• The managers of some firms that were targeted by acquirers (raiders) for hostile takeovers in the 1980s were able to avoid being acquired by buying out the raider's existing stake, generally at a price much greater than the price paid by the raider and by using stockholder cash. This process, called greenmail, usually causes stock prices to drop but it does protect the jobs of incumbent managers. The irony of using money that belongs to stockholders to protect them against receiving a higher price on the stock they own seems to be lost on the perpetrators of greenmail.

• Another widely used anti-takeover device is a golden parachute, a provision in an employment contract that allow for the payment of a lump-sum or cash flows over a period, if the manager covered by the contract loses his or her job in a takeover. While there are economists who have justified the payment of golden parachutes as a way of reducing the conflict between stockholders and managers, it is still unseemly that managers should need large side-payments to do that which they are hired to do-- maximize stockholder wealth. Firms sometimes create poison pills, which are triggered by hostile takeovers. The objective is to make it difficult and costly to acquire control. A flip over rights offer a simple example. In a flip over right,

Poison Pill: A poison pill is a security or a provision that is triggered by the hostile acquisition of the firm, resulting in a large cost to the acquirer.

existing stockholders get the right to buy shares in the firm at a price well above the current stock price as long as the existing management runs the firm; this right is not worth very much. If a hostile acquirer takes over the firm, though, stockholders are given the right to buy additional shares at a price much lower than the current stock price. The acquirer, having weighed in this additional cost, may very well decide against the acquisition. Greenmail, golden parachutes and poison pills generally do not require stockholder approval and are usually adopted by compliant boards of directors. In all three cases, it can be argued, managerial interests are being served at the expenses of stockholder interests.

2. Anti-takeover Amendments:

Anti-takeover amendments have the same objective as greenmail and poison pills, i.e., dissuading hostile takeovers, but differ on one very important count. They require the assent of stockholders to be instituted. There are several types of anti-takeover amendments, all designed with the objective of reducing the likelihood of a hostile takeover. Consider, for instance, a super-majority amendment; to take over a firm that adopts this amendment, an acquirer has to acquire more than the 51% that would normally be required to gain control. Anti-takeover amendments do increase the bargaining power of managers when negotiating with acquirers and could work to the benefit of stockholders6, but only if managers act in the best interests of stockholders.

6 As an example, when AT&T tried to acquire NCR in 1991, NCR had a super-majority anti-takeover amendment. NCR's managers used this requirement to force AT&T to pay a much higher price for NCR

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