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- - - - - - - - Chapter 19 - - - - - - - -

- - - - - - - - Chapter 19 - - - - - - - -. Takeover Defenses. Introduction. Not all mergers are welcome Arsenals of devices were developed to defend against unwelcome proposals during the 1980s. Possible motivations for takeover defenses Target is resisting to get a better price

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  1. - - - - - - - - Chapter 19- - - - - - - - Takeover Defenses ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1

  2. Introduction • Not all mergers are welcome • Arsenals of devices were developed to defend against unwelcome proposals during the 1980s ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 2

  3. Possible motivations for takeover defenses • Target is resisting to get a better price • Management of target judges that company will perform better on its own • Management is seeking to entrench itself ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 3

  4. Strategic Perspectives • Management and board of company must continuously reassess competitive environment • All forms of M&A activities may impact firm both as threats and opportunities • Main developments in industry • Opportunities for adding critical capabilities to participate in attractive growth areas ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 4

  5. Opportunities for rolling-up fragmented industries into stronger firms • Likelihood of firm to be rolled-up • Improving or deteriorating sales to capacity relationships in industry • Impact of consolidating mergers on capacity and cost structure • Enhanced capabilities of competitors as a result of their merger activity • Preemptive moves • Responses to takeover bids ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 5

  6. Financial Defensive Measures • Efficiency • One view: Highly efficient firms with favorable sales growth and high profitability margins provide defense against takeovers • Alternative view: Highly efficient firms become good takeover targets • Bidder firm seeks to learn from efficiencies of target • Target firm may be viewed as undervalued ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 6

  7. Financial characteristics that make a firm vulnerable to takeover • Low stock price in relation to replacement cost of assets or potential earning power (low q-ratio) • Highly liquid balance sheet with large amounts of excess cash, valuable securities portfolio, and significant unused debt capacity • Good cash flows relative to current stock prices; low P/EPS ratios ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 7

  8. Subsidiaries or properties that could be sold off without significantly impairing cash flows • Relatively small stockholdings under control of incumbent management • Combinations of these factors can simultaneously make firm an attractive investment and facilitate its financing • Firm's assets can be used as collateral for acquirer's borrowing • Target's cash flows from operations and divestitures can be used to repay loans ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 8

  9. Financial defenses • Increase debt — use borrowed funds to • Repurchase equity • Concentrate management's percentage holdings • Increase dividends • Loan covenants structured to force acceleration of repayment in event of takeover • Liquidate securities portfolio • Decrease excess cash • Invest in positive net present value projects • Return to shareholders in dividends or share repurchases ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 9

  10. Excess liquidity could be used to acquire other firms • Divest subsidiaries that can be eliminated without impairing cash flows; or spin-offs to avoid large cash inflows • Divest low-profit operations • Undervalued assets should be sold • Value increased by restructuring ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 10

  11. Corporate Restructuring and Reorganization • Restructuring and reorganization policies can be used positively or defensively • Reorganization of assets • Asset acquisitions can be used to block takeovers • Dilute ownership position of bidder by using equity in acquisitions • Create antitrust problems for bidder ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 11

  12. "Selling off crown jewels" — firm may dispose of business segment in which bidder is most interested • Reorganizing financial claims • Debt-for-equity exchanges — increase leverage to levels unacceptable to bidder • Dual-class recapitalizations — increase voting powers of insider groups to levels that would enable them to block tender offers • Leveraged recapitalizations — incur huge amounts of debt, using proceeds to pay large cash dividends and increase ownership position of insiders — "scorched earth" policy ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 12

  13. Other strategies • Joint ventures could represent liaisons that potential bidders might prefer to avoid • ESOPs can be used to decrease voting shares available for tender • MBOs and LBOs • Widely used as defense against outside tender offer • Management can take firm private • Managers may turn to LBO specialist because their stock ownership position may increase more than in an outside tender offer ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 13

  14. Target firm may look for international partner • Share repurchase can be used to defend against takeovers • Increase ownership of insiders • Low reservation price shareholders can be bought out — higher tender offer price needed for bid to succeed • Proxy contest — aim is to change control group and make performance improvements ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 14

  15. Event studies • Restructuring improves firm's efficiency: favorable stock price reaction • Restructuring represents scorched-earth policy: negative stock price reaction ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 15

  16. Duty of Directors • Business judgment rule: Directors must demonstrate to the courts that the best interests of shareholders have been served ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 16

  17. Duty of directors to demonstrate sound business reasons to reject offer • Duty of directors to approve only a transaction that is fair to shareholders and is best transaction available • Duty of directors to fully explore independent competitive bids and obtain best offer • Fairness opinion from an investment banking firm not sufficient ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 17

  18. Greenmail • Definition: Represents targeted repurchase of large block of stock from specified shareholders at premium to end hostile takeover threat ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 18

  19. Two divergent views of greenmails • Greenmailers damage shareholders • Large block investors are corporate "raiders" who expropriate corporate assets • Raiders' voting power used to give themselves excessive compensation and perquisites • Raiders receive substantial premium, "looting" corporate treasury ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 19

  20. Greenmail brings about improvements • Large block investors involved in greenmail force improvements in corporate personnel or in corporate strategies and policies • Large block investors have stronger incentives and superior skills for evaluating potential takeover targets • Managers make greenmail payments to buy time to turn around the firm ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 20

  21. Greenmail sometimes accompanied by standstill agreement • Voluntary contract in which blockholder agrees not to make further investments in target company during specified period of time • If no targeted repurchase is made, large blockholder agrees not to further increase ownership percentage of the firm ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 21

  22. Wealth effects of greenmail • Announcement associated with negative return to shareholders of 2-3% (significant) • Other studies find positive abnormal returns, both in initial "foothold" period and in full "purchase-to-repurchase" period ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 22

  23. Greenmail and standstill agreement • Negative returns — standstill agreement viewed as reducing probability of subsequent takeover • 40% of firms experience subsequent control change within three years of greenmail even with standstill agreement • Positive market reaction if greenmail viewed as giving directors more time to work out better solution ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 23

  24. Antigreenmail developments • Internal Revenue Code Section 5881 of 1986 — imposes 50% excise tax on recipient of greenmail payments • Antigreenmail charter amendments • Require management to obtain approval of majority or supermajority of nonparticipating shareholders prior to targeted repurchase ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 24

  25. Bhagat and Jefferis (1991) • Proxy statements proposing antitakeover amendments include one or more of (other) antitakeover amendment proposals • Sample of 52 NYSE-listed firms proposing antigreenmail amendments in 1984-1985 • 40 firms offered one or more antitakeover amendments • 29 cases, shareholders had to approve or reject antitakeover provisions and antigreenmail amendments jointly ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 25

  26. Eckbo (1990) • Average market reaction to charter amendments prohibiting greenmail payments weakly negative • Subsample of firms with abnormal stock price runup over three months prior to mailing of proxy: Market reaction strongly positive • Particularly true if runup associated with evidence or rumors of takeover activity • Prohibition against greenmail removes barrier to takeovers with positive gains to shareholders ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 26

  27. Strategic Actions • Pac Man defense • Definition: Target firm counteroffers for bidder firm • Rarely used; usually designed not to be used • Effective if target much larger than bidder • Implies target finds combination desirable but seeks control of surviving entity • Target gives up using antitrust issues as defense ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 27

  28. Extremely costly • Could involve devastating financial effects for both firms • Large amount of debt used to purchase shares could cripple firms • Under state law, should both firms buy substantial stakes in each other, each could be ruled as subsidiaries of each other • Severity of defense may lead bidder to disbelieve target will employ such defense ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 28

  29. White knight • Definition: Target company chooses another company with which it prefers to be combined • Alternative company preferred by target because: • Greater compatibility • New bidder may promise not to break up target or engage in massive restructuring ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 29

  30. White squire • Definition: Modified form of white knight; white squire does not acquire control of target • Target sells block of its stock to third party it considers to be friendly • White squire may be required to vote its shares with target management • Often accompanied by standstill agreement • Limits amount of additional target stock white squire can purchase for specified period of time • Restricts sale of its target stock, usually giving right of first refusal to target ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 30

  31. White squire often receives in return • Seat on target board • Generous dividend and/or • Discount on target shares • Preferred stock usually used in white squire transactions because it enables board to tailor characteristics of stock as described ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 31

  32. Antitakeover Amendments • Antitakeover amendments to firm's corporate charter generally impose new conditions on transfer of managerial control of firm — "shark repellents" • 95% of proposed antitakeover amendments are ratified • Management introduces amendments that it feels are sure of success • Failure to pass might be taken as vote of no confidence ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 32

  33. Brickley, Lease, and Smith (1988) • Institutional shareholders (banks, insurance companies) more likely to vote with management on antitakeover amendments • Have continuing business relationships with management • Pension funds, mutual funds, and college endowments more likely to be independent • Blockholders participate more actively in voting than non-blockholders and may oppose proposals that appear to harm shareholders ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 33

  34. Jarrell and Poulsen (1987) • Amendments having most negative effect on stock price are adopted by firms with lowest percentage of institutional shareholders and highest percentage of insider holdings • Blockholders play monitoring role — institutional holders are well informed and vote in accordance with their economic interests ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 34

  35. Supermajority amendments • Require shareholder approval by at least two-thirds vote (sometimes as much as 90%) for all transactions involving change in control • Involve "board-out" clause that gives board power to determine when and if supermajority provisions will be in effect ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 35

  36. Fair-price amendments • Supermajority provisions with board-out clause and additional clause waiving supermajority requirement if fair price is paid by bidder for all purchased shares • Fair price — highest market price of target during a past specified period • Defend against two-tier tender offers • Least restrictive among class of supermajority amendments ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 36

  37. Staggered or classified boards • Delay effective transfer of control following takeover • Management's rationale is to assure continuity of policy and experience • Examples: • One-third of board stands for election to three-year term each year • Reduce effectiveness of cumulative voting because greater shareholder vote is required to elect single director • Directors removable only for cause • Limit number of directors to prevent "packing" ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 37

  38. Authorization of preferred stock • Board authorized to create new class of securities with special voting rights • Typically preferred stock issued to friendly parties in control contest (white squire) • Historically, used to provide board with financing flexibility • Could also include poison pill security to buy shares at a discount ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 38

  39. Other antitakeover actions • Abolition of cumulative voting where it is not required by state law • Reincorporation in state with more protective antitakeover laws • Provisions with respect to scheduling of shareholder meetings and introduction of agenda items • Antigreenmail amendments that restrict company's freedom to buy back raider's shares at premium ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 39

  40. Lock-in amendments to make it difficult to void previously passed antitakeover amendments • Termination of overfunded pension plans — (Iqbal, Shetty, Haley, and Jayakumar, 1999) • Firms can remove a significant source of cash flows to bidder firms by liquidating excess assets • Stockholders favor termination only when firm faced takeover and managerial ownership was high — view takeover as threat to their claim on excess pension assets ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 40

  41. Boyle, Carter, and Stover (1998) • Studied antitakeover provisions adopted by mutual savings and loan companies converting to stock ownership (SLAs) • Strength of insider ownership position after conversion substitutes for strong antitakeover provisions • Low ownership firms associated with strong antitakeover protections • High ownership firms adopted less extraordinary antitakeover protections ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 41

  42. Antitakeover amendments and corporate policy • Garvey and Hanka (1999) • Effects of antitakeover statutes on firm leverage • Firms protected by state antitakeover statutes substantially reduced debt ratios • Results not influenced by size, industry, or profitability • Weak evidence that protected managers undertook fewer major restructuring programs • Firms eventually covered by antitakeover legislation used greater leverage in years preceding adoption of statutes ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 42

  43. Johnson and Rao (1997) • Compared financial attributes (based on income, expenses, investment, and debt) before and after antitakeover amendment adoptions • For full sample, firms exhibited no significant differences from industry means except for decline in net income to total assets ratio • Fair price amendments • For non-fair price subsample, no significant differences from industry mean for any of financial attributes • For fair price subsample, results similar to those of full sample ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 43

  44. Antitakeover amendments and shareholder returns • General predictions • Positive returns • Announcement of antitakeover measure signals increased likelihood of takeover • DeAngelo and Rice (1983) — shark repellents may help shareholders respond in unison to takeover bids • Negative returns • Antitakeover amendments reflect management entrenchment • Comment and Schwert (1995) — decline of less than 1% for most types of antitakeover measures ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 44

  45. Empirical results difficult to interpret because of number of influences operating concurrently • Antitakeover amendment may have been adopted to help management obtain better deal • Announcement of takeover may have contagion effects on industry • Positive runup in abnormal returns because of possibility of other takeovers • Announcement of antitakeover amendments with typical 1% decline in shareholder wealth should be netted against prior positive runup • 1% decline would be viewed as reflection of reduced probability of takeover being completed • If 20% is typical runup, small negative event returns from announcement of antitakeover measures would have little power to deter takeovers ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 45

  46. State Laws • Background • By 1982, 37 states passed first generation antitakeover laws • First generation laws ruled to be preempted by 1968 Williams Act in Edgar v. MITE (1982) • In 1987, Supreme Court reversed in Dynamic v. CTS; ruled that state antitakeover laws were enforceable as long as they did not prevent compliance with Williams Act • Many states passed new antitakeover statutes between 1987-1990 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 46

  47. Janjigian and Trahan (1996) • Studied factors that influenced firms to opt out of protection under Pennsylvania Senate Bill 1310 introduced on 10/20/89 • 20 opt out firms: significant -9.50% return • 13 no-opt out firms: insignificant 9.15% • Accounting performance of both groups deteriorated substantially from 1989 to 1992 • Firms that opted out had significantly better net profit margin, net return on assets, and operating return on assets in 1992 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 47

  48. Swartz (1996) • Event date was passage of Pennsylvania Antitakeover Law (Act 36 based on Senate Bill 1310) on 4/27/90 • Event returns (CARs) • Firms that opted out: • For window [-130,+60] = -5.24% (not significant) • For window [-60,+20] = 0.70% (not significant) • Firms that did not opt out: • For window [-130,+60] = -23.35% (significant) • For window [-60,+20] = -4.71% (significant) • Firms that opted out outperformed firms that did not ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 48

  49. Heron and Lewellen (1998) • Reincorporations to establish stronger takeover defenses had significant negative returns • Reincorporations to limit director liability to attract better qualified directors had significant positive returns ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 49

  50. Poison Pills • Background • Definition: Creation of securities carrying special rights exercisable by triggering event such as accumulation of specified percentage of target shares or announcement of tender offer • Make acquisition of control of target firm more costly ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 50

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