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Introduction
The unique and defining feature of a hostile takeover is that the management and board of directors of the target company resist the proposed transaction. In order to overcome their opposition, the bidder wishing to gain control over the target company directly approaches and appeals to the targets shareholders1.
Hostile takeovers were predominantly present in the middle of the 1980s both in the U.S.A and in the U.K, particularly when acquirers found there to be a large discrepancy between a particular companys assets and its relative stock market value2. Nobody seemed safe during this period of 1980-1990 when around 30% of the Fortune 500 companies faced one or more takeover attempts, over 50% of them explicitly hostile3. Although studies indicate that this takeover wave has benefited the target companies shareholders4, companies management who feared losing their positions and associated private benefits have raised objections to this phenomenon.
In light of the enhanced pressure by the companys management and as hostile bidders became more aggressive and creative, companies and their lawyers searched for new techniques to either prevent the hostile takeover or to increase the targets leverage in negotiating a favorable deal5. One of those newly developed techniques was the poison pill (the Pill ) which is still considered one of the most remarkable but also controversial innovations in corporate law practice in the U.S.
Conscious of the extensive experience in the U.S., and as the hostile takeover attempts have begun to spread to other countries, foreigner companies have also started to consider enlarging their takeover defense arsenal and to adopt Pills and other antitakeover measures. However, although hostile takeovers are always colorful affairs all around the world, one of the most striking differences between U.S. and foreign corporate law over the last thirty years is the further flexibility of U.S. companies and in particular their board of directors to implement defensive measures aimed at discouraging hostile bidders6.
In recent years, as globalization marches forward, one might argue that a cohesive and unified international approach towards takeover defenses is essential. This may bridge information asymmetry and reduce transaction costs associated with foreign investments, disincentives countries from adopting takeover policies oriented to defend their local interests and prompt overall cross-border transaction activity7.
The first section of this essay describes the various common antitakeover measures, the pros and cons of these measures and empirical studies regarding their impact on companies values. The second section reviews and analyzes major differences in takeover regulations among several countries, focusing on the recent attempt to harmonize national takeover rules in Europe under the EU Thirteenth Directive on takeover regulation (the Directive ). The following section addresses the question of whether a cohesive international approach towards takeover defenses is recommended. This section will give a normative analysis of the effectiveness of the different legal frameworks in Europe and the U.S. in light of the different types of ownership structures common in those regions. The last section of this paper suggests hidden virtue of adopting takeover defenses in certain foreign markets.
Hostile Antitakeover Measures
Shark Repellents
Shark repellents are provisions in the incorporation documents of a company which are adopted by the shareholders to discourage unwanted takeovers. They can be generally divided into the following main categories:
Controlling Changes in the Board of Directors
The most common technique is to classify the boards members into three separate groups of which only one may be elected each year ( Staggered Board )8. It basically provides antitakeover protection by both
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forcing any hostile bidder to wait at least one year before gaining control over the board; and
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requiring the hostile bidder to win two elections far apart in time9.
A study examining the impact of Staggered Board provision on hostile bids in the U.S. during the five-year period 1996-2000 concluded that these provisions reduced the returns of shareholders of the target company by 8-10%10. In addition, a research study conducted in 2005 indicated that Staggered Board is systematically associated with lower company value since it insulates the directors from the vital market for corporate control11.
Therefore, it is not surprising that during the years 2000-2004 board declassification proposals have experienced a dramatic rise in support at the shareholder voting stage12. These findings can explain the fact that the percentage of S&P 500 firms employing a Staggered Board has shrunk from 56% in 2004 to 34% in March 200913. However, a study conducted in 2007 indicates that Staggered Board may actually benefit shareholders as it found that shareholders of companies with Staggered Board received a larger proportional share of the total value gains from a merger14.
Additional common techniques to restrict a change in the board are removal for cause only or by supermajority vote of the shareholders and prohibiting cumulative voting15.
Shareholders Actions Provisions and Majority requirement
Those types of provisions designated to limit the flexibility of a bidder to call for and obtain a shareholder vote regarding either director removal or approval of the transaction. A provision requiring a supermajority vote will usually stipulate certain events like a bid to takeover, which require higher level of approval than the default rule of the applicable corporate law. This can be accompanied by a fair price provision which exempts transactions from the supermajority requirement if the price to be paid by the bidder exceeds a specified amount16.
Additional provisions in this respect may include a requirement to provide adequate notice and supply information before a proposal is brought to the shareholders meeting and a prohibition to bypass procedural requirements by using shareholders written consent17.
Stakeholder Clause
This type of provision usually stipulates that the board is authorized to consider the impact of its decisions on various stakeholders (employees, suppliers, host communities etc.). This may offer an overt legal footing to decline any takeover attempts.18
Poison pills
The Pills which were described by John C. Coat as the most common, controversial, and distinctive type of defense 19 were developed as a reaction to the panic created by the 1980s hostile takeover wave in the U.S. The Pills are usually special purpose shareholders right plans which in the U.S. as well as in Japan may be initiated and approved by the board without the need to acquire the shareholders consent unless otherwise specified in the companys incorporation documents. In other jurisdictions, like France and Canada, in which Pills are legal and in practical use, shareholders approval for adopting Pills is required.
The essence of the common Pill is to encourage a potential bidder to deal with a target companys board in order to avoid substantial dilution. The Pill usually specifies certain triggering events, such as commencement of a tender offer or purchase of a specified percentage of the issuers stock without the boards approval, upon which the shareholders have the right to buy either the stock of the target company ( Flip-In ) or the acquirers stock ( Flip-Over ) at a significantly discounted price20.
A Flip-In provision is generally much more powerful defense than Flip-Over, partly since Flip Over provision will not deter a bidder who is not planning a merger with the target company. However, modern pills usually include both features21. It should be noted that the Flip-Over device is not allowed under some jurisdictions, such as France, that recognize only the legality of the Flip-In provision22.
The Pill may include a back-end provision, according to which the targets shareholders are allowed to exchange their rights for a package of the target securities valued at the present minimum fair value of the target set by the board. This Pill is usually redeemable if the bidders offer exceeds such price and therefore it basically establishes a minimum fair price at which the bidder can cash out the securities holders. In addition, debt securities issued under the Pill may prevent bidders from selling targets assets or increasing its debt, precluding his option to finance the acquisition from the targets own resources.
Another type of Pill which was invalidated by many jurisdictions, including several states in the U.S. stipulates a voting provision which involves with the issuance of preferred stocks with special voting powers to the target companys common shareholders (excluding the acquirer). Therefore, the result might be a severe dilution in voting power of the hostile acquirer.23
The last types of Pills which should be mentioned confront the possibility that the perspective acquirer will conduct a proxy or equivalent procedure (if applicable) in other jurisdictions to ask shareholders to vote for his proposal onto the board and thereafter to redeem the Pill24. Those types of Pills include the dead end provision which stipulates that the Pill may be redeemed only by those directors, who had been in office when it was adopted, or their successors25, and the no hand provision which specifies that the Pill is nonredeemable for six months after a change of control in the board26.
However, Delaware Supreme Court invalidated the dead hand Pill for violating Delaware statute and constituting disproportional defensive tactic27 and the no hand Pill for conflicting with the statuary right of directors to manage the business of the company28.
Since the hostile bidder can usually ask shareholders to vote for his propose onto the board and thereafter redeem the Pill, the Pills do not exclude the possibility of a hostile takeover but rather create a delay. This delay makes takeover more expensive in light of costs associated with soliciting shareholders votes.
However, in most takeover battles those costs are relatively minor29. Therefore it seems that the main costs derived from the fact that since the market values may fluctuate rapidly, deals that cannot be concluded rapidly are frequently of lesser values30. From the target companys perspective, although these costs may be reflected in the proposed price, the Pill, especially when combined with Staggered Board provision, may provide the board with substantially more time than would be provided by the law to consider the offer and search for competing bids31.
For example, in 2007, AirTran launched a tender offer for Midwest Air and won a proxy fight for one third of Midwests Staggered Board. Midwests Pill prevented AirTran from purchasing the tendered shares and its Staggered Board prevented AirTran from quickly gaining control of a majority of the board to redeem the Pill. Midwest then put itself up for sale on the market and received from TPG Capital an offer of 13% above the price offered in the original takeover bid32.
Self Tender and Greenmail
Boards power to deal selectively in companies own stock has emerged as a powerful defensive measure. The company may offer to purchase its own stocks from current shareholders at a higher price than that offered by the hostile bidder. Greenmail is a practice in which the target company enters into a contract to repurchase companys stock owned by a shareholder threatening to gain control over the company, typically in exchange of shareholders consent not to initiate a contest for control over the company for a particular phase of the period. Since the premium payments are unavailable to the other shareholders, this practice, resulting from apparent takeover threats, has caused much debate33 and is illegal in several jurisdictions, including for example Australia34. Other jurisdictions, such as Japan, impose severe procedural and financial restrictions on this practice and therefore its effectiveness there is limited35.
Golden Parachute and Pension Parachutes
Golden parachutes are severance contracts between the company and its top executives providing benefits in the event of a change of control or termination of the executives employment in other specified circumstances36. The pension parachute provides usually for the vesting of increased pension benefits to be paid out of the pension funds surplus assets in the event of an unfriendly change of control37. The main defensive feature is that raiders may want to use these surplus assets to finance the acquisition38.
Although golden and pension parachutes may certainly deter potential bidders, they are usually not explained by antitakeover concerns but rather on the ground of protecting employees reasonable expectations and provide them with security39.
Loans
The target may borrow loans which will be immediately due in the event of a hostile takeover. Therefore the bidder may find himself taking over company which owes a large amount of money immediately due.
Cross shareholdings
Cross shareholdings is a mechanism in which controlling block of shares are held by stable shareholders in order to prevent other companies from targeting them for acquisition. Stable shareholders include, for example, members of the same enterprise group, banks, directors, employees and customers40.
This tactic is traditionally common in Japan as Japanese companies and their financial banks constitute business groups by holding each others shares. It should be noted that since the early 1990s the use of cross-shareholdings decreased significantly in Japan41 as well as in other countries in which it was widely used such as France and Germany42.
Litigation
In order to delay the consummation of the hostile bid, the targets management may try to initiate
legal proceedings against the bidder. The proceedings will usually be based on alleged violation of an applicable corporate law or antitrust regulations. A study conducted by Jarrell to examine the effectiveness of this tactic, concluded that if the management is not blocking other competitive offers, this tactic can extract a higher takeover premium for the shareholders. It was reported that in 62% of the cases when the target company uses this method, there were other competing offers proposed to the stockholders in comparison to only 11% of the cases where such offers were not made. This frequently resulted in takeover premiums43.
White Knight
Under this strategy, the companys management pursues a White Knight, meaning a friendly probable acquirer which will offer the company a better deal44. It is commonly agreed that this tactic usually enhances shareholders wealth. Nevertheless, opposing views argue that it may cause losing the original bid and that since shareholders typically face collective action problems, competing bids could actually lead to a pressure to tender, forcing shareholders to accept the later offer even if the prior bid is more convenient for them45.
Crown Jewel and Lockup Option
Defensive restructure may take a form of spin-offs46, defensive acquisition or sale of crown jewel (one of the targets key assets) in order to make the target less attractive to the bidder47.
In order to demonstrate the lockup option technique an example will be used. Assume that a hostile bidder A offers to purchase at 40$ per share a target company which owns a valuable asset (e.g., oil field). The board approaches a favorable white knight B , who also offers 40$. In order to ensure that favorable bidder B will win the contest, the board provides him with the prevailing advantage of an option to purchase the oil field for a fixed sum. If A increases his offer, B can still purchase the oil field for a fixed sum and A may find himself paying a high price for a valuable asset which will be taken out of the company.
The downside of those tactics is that the board may find it hard to justify that they were in good faith and in companys best interests if they were not under consideration before the takeover attempt48.
Pac-Man Defense
Under this strategy, the target Company would react to the hostile takeover attempt by conducting an attempt of its own to take over the original raider49.
Defensive Acquisitions
Acquisition of another company might have a defensive value since the target may become less attractive for the bidder following such an acquisition either in light of the resulting scale of the company, its increased leverage or due to the creation of potential regulatory or antitrust issues50. Particularly, acquiring companies in certain highly regulated industries (i.e. banks), or companies engaged in the business area of the bidder, may expand the grounds for antitrust challenges to the takeover attempts and discourages a bidder who might not be willing to endure the risk and time associated with obtaining the necessary regulatory approvals51. The main risk under this tactic is that the company will use its resources for unbeneficial purchases at excessive prices.
Recapitalization
The common forms are merger recapitalization in which the common shares are converted into a combination of cash and/or debt as well as to new common stock of the surviving company or a reclassification recapitalization, in which common shares are reclassified as preferred stock which are in turn redeemed for cash and/or debt as well as to common stock52. The purpose of recapitalization as a defensive tactic is to make the deal less attractive for the bidder by threatening him with dilution or increased company debt. The threat of dilution may be also achieved through a newly created or enlarged employee stock option plan53.
Restructured Voting
The purpose of this tactic is to concentrate voting power in friendly hands in order to frustrate the ability to gain effective control over the company. The common technique is to issue dual class Common Stock when usually the lower voting shares carry more rights regarding dividends, liquidations and transferability54. This practice was traditionally common in Europe in the pre-Directive era, while in the U.S., it was and still is primarily used by start-up or closely held companies. In Japan, companies may issue shares without voting rights but it is unlawful to grant one common stock with multiple voting rights55. It should be noted that in most jurisdictions publicly held companies are prohibited from issuing dual class stocks under the applicable corporate law or as in the U.S. under the domestic securities exchanges regulations.
The Advantages of Antitakeover Measures
One of the most common and frequently discussed problems in the field of corporate governance is the cost associated with the separation between ownership and control and the fact that the interests of corporate management and corporate shareholders do not always align (the Management Agency Problem ). The assumption that directors are acting as shareholders direct agents seems problematic when considering scattered shareholders inability to properly supervise directors. The attempt of companys management to entrench themselves through the employment of takeover defenses is a fundamental aspect of the Management Agency Problem. It is argued that the mere threat of a hostile takeover incentivizes managers to maintain efficient levels of performance and more completely align their interests with those of the shareholders. Therefore, employment of takeover defenses increases the Management Agency Problem and particularly the risk of managers misconduct56.
Another argument against the usage of antitakeover measures emphasizes the potential harmful consequences both at the macro-economic level and for the shareholders themselves. It is widely agreed that takeovers are usually a wealth-maximizing, positive phenomenon, since they enable replacing inefficient management with a more efficient one and promoting the allocation of resources to a higher use value57. This argument is also backed by empirical studies concluding that hostile takeovers tend to increase the value of the target company58.
The significant impact of antitakeover measures on the actual frequency of hostile bids is illustrated in the table attached as Exhibit A, which specifies the significant higher percentage of hostile takeovers initiated and consummated in the U.K. in which Pills and other defense measures are less frequently used, in comparison to the U.S. It should be noted that several commentators claim that hostile takeovers lead to redistribution of wealth, rather than the generation of additional wealth59.
The Disadvantages of Antitakeover Measures
The following arguments are typically used to justify adoption of antitakeover measures:
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Antitakeover measures can increase the bargaining power of the company. Scholars claim that targets with strong takeover defenses will extract more in a negotiated acquisition than an unshielded target company since the acquirers no-deal alternative in the event of a hostile bid is less attractive compared with a strong-shielded target60. The Pill or other measures may provide the board with more time to consider an offer and to simultaneously solicit a competing bid. Therefore, if the bidder is eager to consummate the transaction or if other competing offers are at stake, it can encourage him to increase their offers. In addition, the shareholder may have a collective action problem which will lead them to accept irrational decisions61. The board may negotiate with potential buyer much better than the scattered body of shareholders and therefore by binding themselves ex ante, the shareholders may be able to improve their collective position ex post62.
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The management usually holds private and inside information concerning the companys real value and has superior skills to evaluate the contemplated transaction. Therefore, antitakeover measures may protect shareholders interests by enabling the board to prevent a transaction that undervalues the company.
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Defensive measures may mitigate distorted managerial incentives 63. The threat of hostile takeover may increase the managers incentive to adopt a strategy focused on maximizing short-term profits at the expenses of long-term strategy. An increase in company value and shareholder satisfaction may prevent hostile takeovers but may prove detrimental for the long term interest of the company. For example, according to Stout (2002), takeover strategies may offer a new company enough time to wholly implement its business plan and to upgrade employees skills64.
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Supporters of the corporate social responsibility approach claim that the central role of companies in the modern society constitutes a responsibility towards third parties such as employees, consumers, and suppliers as well as towards the community in which it operates in general65. Since shareholders tend to focus solely on their economic benefit, it is argued that Stakeholders Clause66 is required to consider the impact of takeovers on such third parties67.
Empirical Review
Studies of companies stock prices when they adopt new antitakeover measures provide a clear indication that companies stock prices decrease in the wake of news that the company has adopted antitakeover measures68. However, the evidence regarding the impact of antitakeover measures on takeover premium and shareholder return are more inconsistent.
According to Jarrell and Poulsen (1987), takeover defenses have ended on average in negative changes in target company share price. Similarly, the Comment and Schwert study conducted in 1995 revealed that the majority of takeover defenses like supermajority provisions, staggered board, reincorporation, fair price provisions and dual capitalization have ended in a slight decline in shareholder returns, of about 0.5%. Similar research results were also found in previous empirical studies including Jarrell and Poulsen (1987), Malatesta and Walking (1988), Ryngaert (1988), Karpoff and Malatesta (1989) and Romano (1993)69.
Bebchuk and others (2005) built a management entrenchment index that is negatively correlated to a companys value. The index includes restrictions to amendments to a shareholder bylaw, staggered board, supermajority requirement, golden parachutes and Pills. The above studys chief finding is that the companies with low entrenchment index where the interest of management is more in line with those of shareholders have higher unusual returns than companies with a high entrenchment index70.
However, as was already briefly demonstrated in Section 2.1.1 above regarding Staggered Board, there are some opposing findings with respect to the impact of takeover defenses on shareholders have a good effect on returns to shareholders if the company management would employ such a guard to enhance the purchase price during takeover negotiation. Other studies (e.g., Field and Karpoff (2002)), found no significant impact of takeover defenses on returns of shareholders71.
An interesting explanation given to the inconclusive evidence regarding the impact of takeover defenses is that the opportunity to significantly benefit or lose from them is foreclosed due to the delicacies of market forces. They provide the target company with bargaining power but simultaneity divert takeover activity to unshielded companies so eventually the market may reach a unique equilibrium that strikes a balance between shielded and unshielded companies72.
In conclusion, in spite of some inconsistency, the empirical evidence appears to highlight that takeover defenses normally tend to have a negative effect on shareholder return. Nevertheless, when they are not used just to entrench the management but rather as a delaying tactic without blocking other competing bids, antitakeover measures, including Pills and Staggered Board, may have a welcome effect.
Recent Trends in the U.S.
Until 2007, U.S. Companies were largely and gradually dismantling their takeover defenses. At the end of 2007, about 1,400 U.S. companies had Pills in force in compared to 2,200 companies at the end of 2002. In 2007, the percentage of S& P companies with Pills had come down to 30% from 60% in 200273. This derived mainly from pressure and actions of institutional shareholders as part of their attempts to gain further control over companies74.
2008 seemed to indicate a turnaround point as it was the first year since 2005 in which there was a year-on-year increase in the number of companies adopting Pills75. However, it seems to be only a reaction to the market meltdown and the surge in the hostile takeover activity rather than a turning point as in March 30, 2010 it was reported that the number of U.S. incorporated companies with Pills in effect was in the lowest level since 1990.76
Takeover Defenses Around the World
Takeover regulation and in particular the extent to which a company is entitled to adopt takeover defenses differs significantly from one jurisdiction to another. Even among countries in which companies are allowed to and do indeed adopt Pills, the related procedures differ significantly, particularly with respect to the need for shareholders approval and whether the Pill can be automatically triggered upon a hostile attempt, or an active decision by the board is required.
A table comparing the use of Pill, Staggered Board, unequal voting rights, cross share-holdings, as well as specifying the compulsory bid requirements and fundamental market characteristics in France, Canada, Japan and the U.S. is attached as Exhibit B.
Japan
In light of the increased hostile takeover activity in Japan in the last decade, many Japanese directors and managers looked for an authority to adopt more effective defensive measures. Amendments in the Commercial Code of Japan in 2005 have legalized new antitakeover measures, including the Pill, to defend Japanese companies from hostile takeovers77. The U.S. takeover legal framework was the guideline for the Japanese policymakers designing the current takeover regulations which clearly follow the American model rather than the European one78. Under the code, Japanese directors have wide discretion in implementing antitakeover measures and shareholder approval is not required for the adoption of a Pill79.
Nevertheless, Japanese courts have promoted the principle that companies will receive shareholders approval to assure that the Pills are a reasonable measure and proportional to the actual threat80. Therefore, not surprisingly, out of the 382 listed Japanese companies that adopted Pills as of July 2007, 218 of them had received prior shareholder approval81.
The Pills in Japan are usually a pre-warning defensive scheme , according to which the companies disclose in advance the managements possible countermeasures to be employed upon hostile takeover as well as the type of information and waiting period that they would demand that the bidder observe82. In contrast to the U.S. where the Pill is automatically triggered, in Japan the board must actively exercise the Pill83.
Therefore, although Japan generally followed the American takeover legal framework, Japanese companies have more restriction on the use of antitakeover measures than their American counterparts. Japans first Pill was exercised on July 12, 2007 by Bull-Dog Sauce Co. in order to dilute the stake of Steel Partners, which launched hostile bid over Sauce84.
Some scholars have raised their concerns that the Pill has the potential to be greatly more pernicious in Japan than it has been in the United States 85. Firstly, it was argued that the institutional infrastructure that plays a major role in mediating the market for corporate control and limiting the use of the Pills in the U.S. (i.e. Delaware Courts, institutional shareholders) do not exist in Japan to the same extent86. Secondly, the potential advantage of increasing bargaining power is doubtful since managers in Japan do not like to negotiate with unsolicited bidders and therefore have tried to design Pills as devices to definitively defeat hostile bids87.
E.U.
After fifteen years of debate, the E.U adopted in 2004 (effective as of May, 2006), the Thirteenth Directive on takeover regulation in an attempt to harmonize national rules of takeover in Europe. Some of the most fundamental rules of the Directive are as follow88:
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The compulsory bid rule, according to which a bidder must make a bid for all the outstanding shares of the target company after acquiring a certain percentage of its shares.
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