Takeover Defenses

Prof Ashutosh Kumar Sinha

IIM Lucknow
 Meaning
• All actions by managers to resist having their firm acquired
– Pre-offer as well as post offer actions

• Shareholder Concern: Firm’s market value

Market Value of the Probability Change in
Value of = firm with + of a control x value from a
the firm current change control
managers change

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 Rationale behind Resistance
• Belief that the firm may have hidden values
– Comparison of the offered price with managers own estimate of
value of the firm
• Value of the private information
– Problem of general optimism of the managers

• Belief that resistance will increase the offer price

– “It pays to haggle about the price”
– Resistance can give time to potential competing bidders
• Soliciting an offer from a ‘white knight’ after hostile bid
– Board as a ‘centralized bargaining agent’?

• Managers want to retain their positions

– Natural belief that they are best for the firm
– Takeover as a sign of failure of target management
– Sense of loyalty toProfthe
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employees
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 Pre Offer Takeover Defenses
• Shark repellants
– Amendments to corporate charter approved by shareholders
through voting

• Examples
– Staggered Board
• Board may be classified into three equal groups- only one group gets
elected every year
• Bidder cannot obtain control of the target immediately after obtaining
a majority of shares
• Shareholder approval is required
• Moderately severe

– Super Majority
• A high % of shares is required to approve a merger, usually 80%
• The number of shares needed to obtain control in hostile deal increase
• Shareholder approval is required
• Mildly severe- bidder may go for a tender offer for whole firm
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 Pre Offer Takeover Defenses
• Fair Price Amendments
– Designed to prevent two tier takeover offers
– Supermajority provisions waived if all shareholders are paid same
price

• Dual Class Recapitalization

– Distributes a new class of equity to shareholders with superior
voting rights but inferior dividends or marketability
– Shareholders can exchange the new shares for ordinary common
stock
– Allows incumbent managers to obtain majority of votes without
owning a majority of common stock
– Shareholder approval is required
– Highly effective
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 Pre Offer Takeover Defenses
• Poison pill
– Intended to economically ‘poison’ the would be acquirer, if
swallowed
– Right to purchase preferred stock is issued to shareholders
– Can be exercised only after a “trigger”- tender offer, or
accumulation of large block of shares by an outside party
– Flip over plans
• Rights to purchase preferred stock, that may be converted into equity at high
price
• A rights plan- call on target firm stock far out of the money, flips over in the
event of a merger to permit call on acquirer at price deep in the money
• Raises the minimum price that shareholder would accept in a tender offer
– Flip in plans
• Repurchase of rights from shareholder by issuing firm at a substantial
premium
• The bidding firm is excluded from the repurchase
– Makes the hostile bid prohibitively expensive
– Shareholder approval is NOT required
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 Post Offer Takeover Defenses
• Targeted repurchase/ Greenmail
– Target firm repurchases large block of stock from an individual or a
sub-set of shareholders at a premium (corporate raiders)
– Both payers and givers receive negative publicity
• Expropriation of corporate assets to the detriment of other
shareholders
– Eliminates a potential bidder, but sig. –ve returns on announcement

• Standstill agreements
– Voluntary contract made by the bought out shareholder not to make
further investments in the target firm for a certain period of time
– Agreement may include board seats, and the shareholder agreeing
to vote with the management
– Eliminates a potential bidder, but sig. –ve returns on announcement

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 Post Offer Takeover Defenses
• Litigation
– Most common, suit filed against bidder for violations
– Delays the bidder, encouraging entry of competing bidders
– Encourages the bidder to raise prices to induce the target to
drop the charges made and avoid legal expenses

• Acquisitions & Divestitures

– ‘Sale of crown jewels’
– Buying assets that the bidder does not want
• E. g. That may create antitrust or other regulatory problems

• Liability restructuring
– Issuing voting securities- in friendly hands
– Repurchases to reduce the number of public shares
– Finance such repurchase through debt to make it even more
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unattractive Prof Ashutosh Kumar Sinha, IIM Lucknow 8
 Further Defensive Measures
• Leveraged recapitalization
– One time cash dividend to shareholders financed through debt
– Recapitalization to raise the equity ownership of the
management- buybacks

• Golden Parachutes
– NOT a defense mechanism in the true sense
– Compensation for managers for loss of job under change of
control clause
– Helps reduce agency issues in the organization
– Small compared to total acquisition prices, therefore not
considered effective defense mechanism
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 Wealth effects of Target Firm Response
Reduction of shareholder wealth Increase of shareholder wealth
• Greenmail (target buys shares from acquirer • White knights (a bidder invited by the target)
at premium)

• Standstill agreements (usually • Creation of bidding auction

negotiated with Greenmail- acquirer agrees not to take
over for some period)
• Poison pills (actions that make target
prohibitively expensive, e.g. special cash dividend)
• Golden parachutes (compensation for
top management in lieu of loss of job due to
acquisition- reduces agency cost)

No Effect on Wealth
 Shark Repellents (relatively small corporate governance changes, e.g. supermajority voting rules)
 Pac Man Defense (Target firm tries to take over bidder itself)
 Crown Jewel sale (target sells off only assets/ business lines of acquirer’s interest)
 Lawsuits (usually ineffective, but a first response of target)
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 Thank You

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