(11) TAKEOVER DEFENCES

Core Reading:
• Straska, M. and Waller, H.G. (2014). Antitakeover Provisions and Shareholder Wealth: A Survey of
the Literature. Journal of Financial and Quantitative Analysis, 49(4), 933-956.

Role of The Board of Directors

Friendly & Hostile takeovers
• Takeover Code provides rules for UK PLC takeovers
o Ensures arget firm shareholders treated fairly & allowed to decide on the offer
o All shareholders given same information
o No favourable deals for any shareholders
o Board must obtain independent advice on a bid & make advice available to shareholders
o Enforced by Panel on Takeovers & Mergers
• Board also has a duty to act in a firms’ interests
• Friendly takeover
o Target’s Board recommends a bid to its shareholders
• Hostile takeover
o Target’s Board recommends shareholders reject a bid & the bidder then makes an offer
directly to shareholders

Non-Frustration Principle (UK)

Efficient market for corporate control assumes shareholders are happy for the target’s management
to sell their shares
• Limits defensive action by the target Board
o The board shouldn’t prevent shareholders from selling if they want to
§ Persuading shareholders, lobbying, finding a white knight (someone else to take
over the company), litigation (legal action for the transaction not following the
code)
• But the ‘non-frustration principle’ assumes:
o Market for corporate control doesn’t make errors selecting targets
o Hostile bid is a fair price & is beneficial to target & acquirer
• Market for corporate control be ineffective if boards interfere in transactions

Rationale for ‘Non-Frustration Principle’

(Kershaw, 2007)
• Shareholder should be free to buy & sell whenever they want
• Ensures market for corporate control is active and so disciplines under-performing managers
• Takeover defence could be an agency cost
o Underperforming managers use defences to protect their jobs as they might not get same
job elsewhere
o Such defence prevents exploitation of potential synergies & scale/scope economies
• Post-bid takeover defences allowed in the US & if:
o They are in target shareholders’ interests
o Used to achieve a better offer
 (11) TAKEOVER DEFENCES

Reasons for Takeover Defences (Ruback, 1987)

Shareholder interests
• Use defences to force bidder to increase bid & cause a delay to attract competitive bidders
• If managers have private information of hidden extra firm value (that the stock market can’t
value)
• Allows management to defend takeovers without harming the firm in attempts to deter bidders
(e.g. cutting back R&D expenditures to spend more on share repurchases to increase firm share
price, as lower R&D is a long-term disadvantage)

Managerial Entrenchment
• If target management is going to be removed, they use defences to protect their jobs likely they
won’t find another due to the takeover signalling their failure as manager
• Existing managers believe they are the best managers for the target firm

USA vs UK Defences
USA UK
• Pre-bid • Pre-bid
o Dual class recapitalisation o Pure defences illegal but business
o Staggered board elections decisions are allowed if the primary
o Poison pill motivation is not defensive (e.g.
• Post-bid recapitalisation)
o Greenmail • Post-bid
o Litigation o Litigation
o Defensive restructuring o Defensive restructuring
o Golden parachutes o Golden parachutes
o Lobbying o Lobbying

Pre-Bid Defences
Dual Class Recapitalisation
• Restructuring equity of the firm into two classes with different voting rights (preferred stock &
common stock)
o Class A
§ Voting Rights + Dividends
o Class B (e.g. preferred shares)
§ No voting rights + Higher Dividends
• Inside managers can increase their voting power without raising stake by not exchanging from A
to B
• Evidence of negative ARs after announcement of dual-class recapitalisation (Jarrell & Poulsen,
1989)
• Firm value positively associated with management’s cash-flow rights and negatively associated
with voting rights (Gompers, 2010)
o i.e. better if managers hold shares with income instead of voting rights as more
financial incentive for managers to increase firm value
 (11) TAKEOVER DEFENCES

Staggered Board Elections

• Instead of all directors standing for election each year, directors are classed into groups with a
different group standing for election each year
o Change from ‘Unitary Board’ to ‘Staggered Board’
• Makes it difficult for a hostile bidder to quickly gain full board control even with majority
ownership
• Staggered boards associated with a lower in firm value (Cohen & Wang, 2013, 2017)

Poison Pill (Shareholder Rights Plan)

Makes it difficult to ‘swallow’ the target
• Target’s shareholders have shares with special rights that are triggered by a takeover
o Increases costs of takeovers
(1) Flip-in
o Allows target shareholders to purchase additional shares in the target firm at a
discount
o Occurs before merger
(2) Flip-over
o Allows target shareholders to purchase shares in the merged firm at a discount
o Occurs after merger

• Evidence they don’t deter takeovers but associated with higher bid premiums (Comment &
Schwert, 1995)
• Reduce firm value by 5% after takeover (Cremers & Ferrell, 2014)

Post-Bid Defences
Targeted repurchases/Greenmail
• Target firm buys back shares from the bidder at a premium, with an agreement that acquirer
won’t return with another attempt
o No benefit for target’s shareholders
• Protects under-performing managers
• Evidence is generally negative (Ruback, 1987)

Litigation
Lawsuits against bidders on grounds of:
o Anti-competitiveness, Fraud…
• Delays bid, allowing time for a competing bid
• Bidder may raise the price in return for dropped litigation
• Can discourage bids, but the delay caused could increase shareholder wealth if another auction is
created (Franks & Harris, 1986)

Defensive Restructuring
• Financial restructuring
o Issue more shares to investors that support the current management
o Raise debt and use the cash to buy back shares or pay out dividends
§ Keeps shareholders happy with the current management
§ Higher leverage can deter takeovers
• Asset restructuring
o Divest assets that the bidder wants
o Buy assets the bidder doesn’t want
 (11) TAKEOVER DEFENCES

o Restructure firm assets in the way the bidder intends

• Evidence they reduce shareholder wealth (Ruback, 1987)

Golden Parachutes (GPs)

Compensation to senior executives as a form of damage control
• Argued they encourage managers to accept change of control
o Can be in shareholders’ interests if agency costs are present

• Opposing arguments they:

(1) Increase costs of the takeover
(2) Reward managers for failure
(3) Weaken disciplinary effect of market for corporate control
(4) Motivate managers to sell-out
a. Even if their private information shows the firm has hidden value

• Bebchuk (2014) Firms with golden parachutes:

o Have negative ARs
o Experience higher bid premiums
o Have a negative effect on shareholder wealth

• Evidence consistent with:

(1) Golden Parachutes reduce disciplinary effects of market for corporate control
(2) Provide incentive to allow takeover even if it is not in shareholders’ interests