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1 Lecture Notes Corporate Control and Takeovers Prof Armando Gomes
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Lecture NotesCorporate Control and Takeovers
Prof Armando Gomes
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Outline
Recent trends in M&A
Factors spurring M&A transactions
Key questions about M&As
Why companies acquire other companies? Where do the gains come from?
Does M&A create value? For whom?
How are the benefits (if any) associated with M&A divided between the acquirer and target?
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Recent Trends in M&A
Worldwide M&AUS M&A
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Wordwide M&A Activity (1)
Sources: Thomson Financial as of 3 January 2006; Morgan StanleyNote: (1) Includes global announced transactions of $100MM or more; excludes terminated transactions.
2005 3rd Most Active Year EverOnly 1999/2000 Better
M&A Volumes Grew 41%Increase of $732 Billion
2006 Could Be Record Year
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2005 Was Similar to 1998 in Terms of Volumes… But…
2005 1998
Average Premium 27 % 39 %
Global Announced Volume ($Bn) $ 2,497 $ 2,282
10 Yr Treasury Rate 4.4 % 4.7 %
% All Cash Consideration 61 % 28 %
% Involving “Sponsor” Acquiror 16 % 5 %
% Hostile or Unsolicited 12 % 4 %
% Increase Over Year 0 % 15 %
DJIA 10,718 9,181
S&P NTM P/E 17.7x 27.9x
Source: Thomson Financial as of 3 January 2006.Note: (1) Includes global announced deals valued at $100MM or more; excludes terminated transactions.
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156249
850
1,2851,181
355
144194
283
0
500
1,000
1,500
2,000
2,500
1996 1997 1998 1999 2000 2001 2002 2003 2004 YTD
Dollar Volume$Bn
M&A Environment Worldwide M&A Environment
Worldwide Target Transactions of $10Bn or More (1) (2)
Source Thomson Financial as of 6 October 2004
Notes1. Includes announced transactions, each with an aggregate value of $10Bn or more. Includes transactions with estimated values. Excludes terminated transactions. Future terminations of
pending transactions will reduce totals. Seven largest transactions are detailed for each of 2001, 2002, 2003 and 20042. Includes transactions announced as of 30 September 2004
American (North/South) Target European Target Rest of World
No. ofTransactions 9 13 28 45 45 20 7 10 10
F:\ENVIRON\2004\3Q_2004\M&A Environment.ppt\A2XP\08 NOV 2004\6:18 PM\8
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Target/Acquiror $BnAT&T Broadband/Comcast 72Conoco/Phillips Petroleum 25Compaq Computer/Hewlett-Packard 24American General/AIG 23Dresdner Bank/Allianz 20Immunex/Amgen 17Billiton/BHP 16
Target/Acquiror $BnPharmacia/Pfizer 61Lattice Group/National Grid 18Crédit Lyonnais/Crédit Agricole 16Household Int’l/HSBC 15TRW/Northrop Grumman 12Railtrack/Network Rail 11CH Mobile/China Mobile 10
Target/Acquiror $BnAventis/Sanofi-Synthélabo 66Bank One/JP Morgan 59AT&T Wireless/Cingular 47UFJ/Sumitomo Mitsui Financial 29Westfield/Westfield Holdings 20Abbey Nat’l/Santander Central Hispano 15SouthTrust/Wachovia 14
Target/Acquiror $BnTime Warner/America Online 182SmithKline Beecham/Glaxo Welcome 77Nortel Networks/Shareholders 60Liberty Media (AT&T)/Shareholders 46Texaco/Chevron 43Seagram/Vivendi 43SDL/JDS Uniphase 41
Target/Acquiror $BnFleetBoston/Bank of America 49Telecom Italia/Olivetti 28Resona Bank/Dep. Ins Corp of Japan 17Sibneft/Yukos 17Wellpoint Health/Anthem 16Travelers Ppty Casualty/St. Paul 16GM Hughes/General Motors 15
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Recent Trends in M&A
Worldwide M&AUS M&A
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• Divestitures (de-mergers) almost as frequent as mergers– 36% of all transactions in 2004 are divestitures (historically around 35% - 45%) – Divestitures of corporate divisions and management buyouts (MBOs)
• Private seller are orders of magnitude more common than public sellers
Source: Mergerstat Review (2005)
10Source: Mergerstat Review (2005)
Transactions with purchase price information
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COMMON WAYS FIRMS RESTRUCTURE
TYPES OFRESTRUCTURING
• ASSET• FINANCIAL• OWNERSHIP
ACQUISITION(TAKEOVER)
SPLITTING FIRMINTO PARTS
RECAPITALIZATION SHARE REPURCHASE
MERGER ORCONSOLIDATION
ACQUISITION OFASSETS
TENDER OFFER
PROXY FIGHT
SELLOFF(DIVESTITURE)SPINOFFEQUITY CARVEOUT
LEVERAGED CASHOUT
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Common Ways Firms Restructure
ACQUISITIONPurchase of assets or >51% of stock.
MERGER/CONSOLIDATIONTwo entities combine into a single legal entity.
SELL-OFF (DIVESTITURE)Firm Divests A Business Unit such as a Subsidiary or a Division.
SPIN-OFFCommon Stock of Unit is Distributed to Stockholders on a Pro-Rata Basis.Afterwards Unit Is Separate Company.
EQUITY CARVE-OUTFirm Sells Common Stock In Business Unit to Public.Usually Maintains Equity Stake and Does Not Relinquish Control.
LEVERAGED RECAPITALIZATION (RECAP, CASH-OUT)Firm Radically Changes Its Financial Structure by Distributing a Large Amount of Cash to Stockholders Financed by a Debt Issue
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M&A Activity and S&P 500 Index
M&A activity is positively related to the stock market returns Source: Mergerstat Review (2005)
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Interest Rates and M&A Activity
The current low interest environment is also contributing to the increase in the level of M&A activity
Source: Mergerstat Review (2005)
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Why the Increase in Restructuring Activity?
Surge in international M&AsGlobalizationEuropean Union: European deals 38% in 2005
Surge in private equity acquisitions (LBOs) Enormous amount of capital committed to private equity funds
– by some estimates private equity funds have over $300 bil of funds to investLow interest environmentStock market presenting good exit opportunities (IPOs) for private equity investors (reverse LBO)
Increased pressure from institutional investorsHold 65% of U.S. common stockStronger monitoring role
– Increase in shareholder activism in 1990s
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Industry Mergers Waves
Mergers and acquisitions come in waves (well-known)Less well-known, though, is that, at any point in time, M&A activity is clustered in a few industries
Industry mergers waves
External industry shocks often leads to industry restructuring/consolidation through mergers and acquisitions
When many industries are undergoing shocks at the same time we have an aggregate or macro merger wave
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Turbulence Drives M&A Activities and Opportunities
Many industries are now undergoing significant turbulences fueled by
Technological changes– Telecom (1990s), computers and software (1990s)
Deregulation– Such as banking (1990s), airlines (1980s), trucking (1980s), natural gas
(1980s), media (1990s), utilities (1990s), insurance (1990s)Globalization
– Foreign competition (drop in trade barriers and investment restrictions)Some affected industries: steel, apparel, textiles, tire and rubber
Demand or supply shocks– Input price changes (e.g., oil price), changes in the cost structure (drugs
(1990s)), changes in customers’ preferences and lifestyle (food and beverage)
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M&A activity is concentrated in a few industries
Industry M&A deal volume (deals over $1.5 billion during 95-99)
$0$100$200$300$400$500$600$700$800
Tele
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mun
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Com
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Ban
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Dru
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Bill
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of d
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Main questions about M&A
Why companies acquire other companies? Where do the gains come from?
Does M&A create value? For whom?
How are the benefits (if any) associated with M&A divided between the acquirer and target?
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Types of mergers and acquisitions
Three categories of M&A transactionsStrategic acquisitions
– operating synergiesdominant form of acquisition in the 1990s
Financial acquisitions– usually structured as an LBO (became popular in the 1980s)– disciplinary takeovers– tax gains
Conglomerate acquisition– diversification– financial synergies
very common in the 1960s
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Operating Synergies
Cost reductioneconomies of scale/scope in horizontal mergers
– manufacturing– research and development– administration and finance
economies of vertical integration– can achieve more efficient coordination with suppliers
Revenue enhancementmarket or monopoly powerimproved marketing and distribution
– cross-selling
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Financial Acquisitions
Buy-out funds are dedicated to acquire firms taking them private and enhance valueBuy-out fund later on exit the investment by a public offerings, a private sales to a strategic investor or a leveraged recapitalization FT 10/13/03, “European buy-out groups lead US”
European buy-out groups raised €13bn in the first 9 months of 2003, and €16bn in the first 9 months of 2002
– E.g., Permira, Charterhouse, Nordic Capital, Apax PartnersUS buy-out groups raised $9bn in the first 9 months of 2003, and $28bn in the first 9 months of 2002
– E.g., The Carlyle Group, Blackstone, KKR, Texas Pacific, WarburgPincus, Clayton Dubilier and Rice, Muse Tate & Furst, Thomas Lee, Goldman Sachs Capital Partners, J. P. Morgan Partners
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Financial Acquisitions
Case: Permira- a leading European-based private equity firm (approximately € 11 billion invested)
Involved in leveraged buyouts, public-to-private transactions, turnaroundsSeek situations where a path to value creation can be identified through
– Divestiture of non-core assets: refocusing– Operational improvement of underperforming assets– Acquisition-driven sector consolidation
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Disciplinary takeovers
The change of control induced by a takeover is a disciplinary device that deters managers from acting in their own interest rather than shareholders’interests
– mechanism to address agency problems
The threat of a hostile takeover may be enough to make managers perform well
– Why do shareholder activists insist in the elimination of classified boards, voting by written consent and other shark repellents?
Takeovers motivated to distribute free cash flow to investors that would otherwise be wasted in negative NPV projects
– oil industry in mid to late 1970's, industry wound up with too many crude oil reserves but high prices
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Hostile and Friendly Transactions
Most transactions are neither completely hostile nor friendly
They fall in the continuum between these two extremes
Hostile takeovers Hostile takeovers now are much more common around the world than before
Hostile transactionsmore likely to be driven to discipline target manager
Friendly transactionmore likely to be driven by operational synergies
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Conglomerate diversificationConglomerate pools risks of different business
diversification reduces the probability of default and could lower borrowing costscan lower tax payments by using losses of some divisions againstthe gains of othersprovide more job security to employeesdivisions can be financed using access to internal capital market
– manager of conglomerate evaluate proposals of divisions and allocate funds to them
Conglomerates that were formed in the 60s and 70s were “busted-up” in the 80s
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Main questions about M&A
• Why companies acquire other companies? Where do the gains come from?
Does M&A create value? For whom?
How are the benefits (if any) associated with M&A divided between the acquirer and target?
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Does M&A create value? For whom?
There are two ways to answer this questionLook at the acquiror’s and target’s:
Stock market reaction at the announcement of the takeover (event study)
– If markets are efficient this will tell us whether the stock market expects mergers to be profitable
Actual performance post-merger in comparison to peers in the same industry
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• Does M&A create value for the target?– Overwhelming amount of
evidence in favor.• Does M&A create value for
the acquiror?– Mixed views
• E.g., Business Week article 10/2/2002, “The Merger Hangover: How Most Big Acquisitions Have Destroyed Shareholder Value”
• Academic studies find that acquiror’s return are essentially insignificantly different from zero or moderately positive (0.5%)
33Source: Mergerstat Review (2005)
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Acquiror’s Short-term Stock Price Performance around announcements
Acquiror’s shareholders suffered losses of around 0.5%–0.7% on a market-adjusted basis around the initial announcement date. But one-quarter of the transactions led to acquiror market-adjusted gains in excess of 5% and one eighth of the transactions led to gains higher than 10% in the short run.
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Acquiror’s Long-term Stock Price Performance Relative to Peers in the Same Industry
A typical acquiror’s stock outperformed its peers by approximately 0.5% over the two years following the acquisition’s announcementThere is wide variation in outcomes over the long run.
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Which Transactions Create Value to Acquirors?
The market reacted more positively to cash-financed acquisitions than to stock-financed acquisitions in both the short and long run. The market reacted more positively to acquisitions of private companies, or units or assets of public companies, than to acquisitions of whole public companies.Acquisitions of foreign companies and assets created more value than domestic acquisitions
suggests that the synergies and benefits underlying overseas expansion have been a source of significant strategic value.
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Means of payment in M&A
Cash offersconsideration used to pay target shareholders is cash
Stock swap (or stock offers)target shareholders receive newly issued shares of the acquirer
– negotiate the fraction of shares that target shareholders will receive of the combined firm
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Means of payment in M&As
WHY do bidders’ stock prices react more favorably when the bidders make a cash offer rather than a stock offer?
A stock swap acquisition is composed of two corporate finance transactions1. The acquisition per se and2. Issue of common equity by the acquirer
But issuance of equity by the acquirer signals information to the market that the stock of the acquirer is overvalued
Thus it is expected that the stock price should drop at the stock swap announcement– similar effect when the firm issues equity!!!
The Business Week article only considered stock-swap deals– Thus the conclusion that acquirors’ are destroying value with the
acquisition is potentially misleading!!
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Evidence on valuation effects of common equity issuance announcements
The market typically does not react positively when firms announce that they are going to issue equity to the public
stock prices typically decline by about 1 to 3%– market reaction typically measured by the two day
announcement period return
the larger the size of the issue the more negative the reaction
WHY?
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The asymmetric information problem
When managers/insiders have private informationabout the value of the firm’s assets in place or the value of its future opportunities there is asymmetric information
investors know that the managers might have private information
The existence of asymmetric information can lead to a negative announcement when the firm issues equity
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Main questions about M&A
• Why companies acquire other companies? Where do the gains come from?
• Does M&A create value? For whom?
How are the benefits (if any) associated with M&A divided between the acquirer and target?
M&A activity on average creates value but most of the value gain is accrued by the target shareholders
– WHY?
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Why aren’t Returns to Acquirors positive ?
1. Competition By Other Bidders Insures Any Value Created GoesTo Target - "Winner's Curse"
2. Acquiring Firm Pursues Target At Expense Of Shareholders(A) Incorrect Target Valuation(B) Acquisition Motivated By "Managerial Motives" Rather Than
By Wealth Maximizing Motives(C) Management Hubris
3. Positive Returns Are Disguised(A) Market Anticipated Announcement Of Acquisition(B) Other Corporate Information Released(C) Acquisition Small Relative To Total Value Of Acquirer(D) information released by stock offer rationally drives the acquirer price down (discussed before)
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OTHER FACTORS THAT AFFECT GAINS TO ACQUIRERS AND TARGETS
1. RELATED BUSINESSES
2. RESISTANCE BY TARGET'S MANAGEMENT
3. TENDER OFFER V. NEGOTIATED OFFER
4. CASH USED AS METHOD OF PAYMENT
5. PERIOD EXAMINED1960s (BEFORE WILLIAMS ACT) 1970s 1980s
6. PERCENT OF ACQUIRER'S STOCK HELDBY ITS MANAGEMENT
7. MULTIPLE BIDS
ACQUIRER TARGET
+ - +
mixed + + +
5% 19% 2% 35%-2% 35%
+
- +
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Bottom Line
M&A is a very significant source of value creationBut acquirers should be careful
There is a significant amount of variation in how much value acquisition creates to buyersEvidence shows that bad acquiror’s become good targets down the road! (Mitchell and Lehn, 1990)
Buyers beware! avoid overpaying (pricing aspects)design the deal carefully (non-pricing aspects)
– Sharpen your M&A skills
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Sources of information on M&ASecurities Data Corporation (SDC)
comprehensive information about US and non-US acquisitionsSummary info of recently announced deals available at http://money.cnn.com/news/deals/
Analysis of M&A deals: Merger deals in SDC Number of deals: search criteria
– DATABASES: (US-MA, International- MA)– Date Announced: 1/1/1990 to 10/15/2003 (Custom)– 59,040 Form of the Deal : M– 31,839 Deal Value ($ Mil).: Where Information is Available– 23,413 Deal Status : C
Over 23,000 deals since 1990
Lecture Notes
Corporate Control and Takeovers
Prof. Armando Gomes
Market Microestructure Review
Milgrom and Stokey (1982): Information, Trade and CommonKnowledge.
No-trade theorems.
1. Acquiring information is costly.
2. The rents from information are higher, the lower is the number of informedtraders.
• If everyone is informed, the rents are zero.• If only a few are informed, the rents are higher than the costs.
3. Noise means that prices do not reveal private information completely.Prices only convey a noisy signal of private information.
4. Why do we need noise?
Claim: There is no equilibrium without noise.
Proof: Suppose that if someone is informed, then prices convey all the in-formation. Therefore everyone is informed. But then, there is no rent frominformation. But then, no one has an incentive to become informed. So, theonly possibility is that no one is informed. But then, it is optimal for someoneto become informed.
Grossman and Stiglitz (AER 1980): On the impossibility of In-formationally Efficient Markets
• There are two assets: a safe asset yielding a return R, and a risky assetwith return u.
• For a cost c > 0 traders can become informed and get a signal θ cor-related with u: θ = u + ε . There are two types of individuals, thosewho observe θ (informed traders) and those who observe only price (un-informed traders). All individuals are ex-ante identical; whether they areinformed or uninformed depends on whether they have spent c to obtaininformation.
• Informed traders demands will depend on θ and on the price of the riskyasset P . Uninformed traders’ demandwill depend only on P . Uninformedtraders have rational expectations; they extract any information given inthe price and use it in deriving their demand for the risky asset.
• If x denotes the supply of the risky asset, an equilibrium when a givenpercentage, λ, of traders are informed, is thus a price function Pλ(θ, x)
such that, demand equals supply.
• Uninformed traders do not observe the supply x. It follows that unin-formed traders cannot learn θ via observation of Pλ(θ, x) because theycannot distinguish variations in price due to changes in the informedtrader’s information from variations in price due to changes in aggregatesupply. Still Pλ(θ, x) reveals some of the information to the uninformedtraders.
•We can calculate the expected utility of the informed and of the unin-formed. If the former is greater than the latter (taking into account thecost of getting information c), some individuals will switch from beinguninformed to being informed. As more individuals become informed, theexpected utility of the informed relative to the uninformed declines fortwo reasons:
1. The price system becomes more informative because θ is better re-flected in the price. Thus, more of the information of the informed isavailable to the uninformed. For this reason, the profit to informed
from trading with the uninformed declines.2. Since there are more informed, the per capita gains to informed tradersdeclines as there are just more informed traders.
• Implications of the“rational expectations equilibriu”:1. The more individuals who are informed, the more informative is theprice system.
2. The more individuals who are informed, the lower the ratio of expectedutility of the informed to uninformed. In an overall equilibrium thisratio is 1.
3. The higher the cost of information, the smaller will be the equilibriumpercentage of individuals who are informed.
4. If the quality of the informed trader’s information (measured asCorr(u, θ))increases, the price system becomes more informative. The equilibriumproportion of informed to uninformed may either increase or decrease,because even though the value of being informed has increased dueto the increased quality of θ, the value of being uninformed has also
increased because the price system becomes more informative.5. The greater the magnitude of noise (V ar(x)), the less informative theprice system will be, and hence the lower the expected utility of unin-formed traders. Hence, the greater the magnitude of noise, the largerthe proportion of informed traders.
6. In the limit, when there is no noise, prices convey all the information,and there is no incentive to purchase information. Hence, the onlypossible equilibrium is one with no information. But if everyone isuniformed, it clearly pays some individual to become informed. Thus,there does not exist a competitive equilibrium without noise.
Kyle (1985): Continuous Auctions and Insider Trading
Assumptions:
• The underlying value of the security is v ∼ N(p0,σ20)• Three types of traders1. Noise traders
— Trade an exogenously given amount u ∼ N(0,σ2u)— v and u are joint normal and independent
2. Informed traders
— Knows the realization of v— Trades a quantity denoted by x
3. Market maker
— Uninformed— Role is to clear the market
• Everyone is risk neutral
Two steps of trading:
1. v and u are realized. The informed chooses x observing the realization ofv, but not of u.
2. The market maker observes the realization of x+ u, and given this infor-mation he sets a price p, and takes a market clearing position.
We denote the order placement strategy of the insider by X(·), x = X(v).We denote the pricing of the market maker by P (·), where p = P (x + u).The profit of the informed trader is π(p, x) = (v − p)x. Sometimes we writeπ = π(x, P ) and p = P (x) to emphasize the interdependence between theinformed trades and the market makers price.
Definition: An equilibrium is a pair of functions (X,P ) such that:
(1) Given the pricing strategy of the market maker, P (x), the informed trader
maximizes his profits:
X(v) = argmaxx
E(π(x, P (x))|v = v) ∀V ∈ R
(2) Given the order placement strategy of the informed, X(v), the marketmaker breaks even:
P (x + u) = E(v|x + u)Theorem: There exists a unique equilibrium in which X and P are linear.This equilibrium is given by:
X(v) = β(v − p0) and P (x + u) = po + λ(x + u)
whereβ =
σuσ0
and λ =1
2
σ0σu
Discussion
β is a measure of the aggressiveness of informed traders.
• Increase in σu⇒↑ β More aggressive informed trading.• Decrease in σ0⇒↑ β More aggressive informed trading.Reason: The informed trader has less of an information advantage sohe/she is less apprehensive about revealing it.
• λ is a measure of the liquidity of the market (low λ more liquid market)
• 1λ tells how much does the order have to change to move prices one unit.
Remarks: N(po,σ20)
The posterior variance is
σ21 = σ2v|y = σ20(1− ρ2vy)
=1
2σ20
⇒More or less, that the informed trader reveals half of his or her information,which is measured by half the variance of the posterior distribution.
Note: In the limit prices converge, but initially they may move further fromthe true value.
Takeovers
Takeovers are hard (and should be aided): Grossman-Hart (Bell, 1980)
Stylized facts (last class)
• See, e.g., Jarrell, Brickley and Netter (JEP, 1988)• Big premium to shareholders of target firm (on the order of 10-50%)• Small or negligible return to shareholders of acquiring company• Overall value increase
The basic free-rider problem
• It is an old idea that if a manager is performing badly, a rival will takeoverthe company and replce the manager
• However, there is an obvious free-rider problem• That is, suppose the value of the firm under existing management is y...
• ... whereas under a raider it would be y• (and let the private benefits of control be z, z)• Suppose that the raider needs α ∈ (0, 1) of the shares to gain control• Bidding game: Offers to buy up to α shares “tendered” for price p.• Say that the offer is unconditional and unrestricted.• Assume existing shareholders are small• Bid costs c• Result: The raider cannot make an expected capital gain on sharesacquired in a successful bid.
— suppose the raider bids p— if bid succeeds with probability β, each shareholder accepts iff
p ≥ βy + (1− β) y
— so in expectation, raider makes an expected capital gain ofβy + (1− β) y − p ≤ 0
• So if bidding has even ε costs and z = 0, raider never bids – no matterhow large the difference between z and z
• In general, the raider enjoys a utility gain ofβz + αβy + α (1− β) y − αp− c
if the bid is successful
• Assume that y > y• No point in bidding p < y or p > y (in the latter case, we are ruling outequilibria in weakly dominating strategies)
• So if bid is p ∈ [y, y], equilibrium success rate must be β s.t. p = βy +(1− β) y
— for suppose β were lower— then everyone not tendering would tender— so β would be 1— on the other hand, if β were higher,
— then everyone tendering would prefer not to tender— so β would be 0
• So equilibrium utility gain isβz − c
• Increasing in β (i.e. in p) so utility gain is
z − c
Devices to make takeovers easier
Toeholds
• Suppose raider already owns a fraction θ of the shares
• So now expected utility gain isβz + βθ (y − y) + αβy + α (1− β) y − αp− c
• So after setting p = y, expected gain isz + θ (y − y)− c
• Related ideas:• Shleifer and Vishny (JPE 1986): Large (minority) shareholders can alsoallow for a solution to the free-rider problem by facilitating a third-partytakeover splitting the gain with the raider
• Kyle and Villa (RAND 1991)
Dilution
• Suppose that after a successful takeover, the raider is able to capture φfrom any remaining shareholders
— e.g. merge with related company at disadvantegeous terms
• Thus the expected gain isβz + β (1− α)φ + αβy + α (1− β) y − αp− c
(assuming that raider only tries to buy α of the shares)
• Equilibrium condition is nowp = β (y − φ) + (1− β) y
• So raider gets (after setting p = y − φ)
z + φ− c• Grossman-Hart discuss optimal level of φ— high φ reduce tender price— but increases number of takeovers (i.e. lower c raiders raid)
— and so may improve incentives for incumbent management— (note: only of probability of takeover increased by more for bad man-agement)
Freezouts
• Most tender offers (90%) are followed by a second step freezeout merger• This also solves the free-rider problem• The bidder makes an offer conditional on the freezeout fraction— even if shareholder does not tender their shares you know that youwould not be able to free ride because if the offer is successful yourshares are going to be frozen out or compulsorily acquired
• Note that the charter of corporations usually allow a merger if— board approves the transaction— and a fraction (freezeout fraction) of the shareholders vote in favor ofthe merger
— the freezeout fraction depends:— in the US in Delaware 50% , New York 2/3 etc. Later modified byfreezeout laws
— in the UK and many European countries the freezeout fraction is 90%
• Arbitrageurs may be able to hold out a freezeout if they have a largeenough stake (not tendering their shares)
• This could be useful in forcing the bidder to increase the offering price• A variation on the theme are two-tiered offers— Under two-tier tender offer, bidder makes high offer up front for afraction of shares and purchases the remaining shares in a second step(freezeout) merger at a lower price
Takeover defences: Poison pills
• Most common example of a poison pill – the flipover plan
— gives shareholders right to purchase new shares at a discounted price,e.g. q
• So shareholders tender iffp = β (y + y − q) + (1− β) y
(assume for simplicity that shares sold by raider)
• So raider’s gain if buy α shares is
βz + β (1− α) (q − y) + αβy + α (1− β) y − αp− c = βz + (q − y)− c• after setting β = 1, get
z − (y − q)− c• i.e. just the opposite of allowing raider to dilute existing shareholders
Value-reducing raids
• Up to now, have focused on y > y case
• Now consider possibility that y < y (takeover geared for the private ben-efits z > 0 )
• Multiple share classes— A shares have sA of the cash flow rights and vA of the voting rights— B shares ...
• Rule out partial offers – need to offer to buy all shares within class
—Why?— Grossman-Hart suggest that acquirer may want to merge firm withanother firm
— Suppose merger price is p— But if p < y, shareholders will claim “unfair” price— Also, proposals for a “mandatory bid rule” (see Bergstrom, Hogfeldtand Molin, JLEO, 1997)
•What are the optimal (sA, vA, sB, vB)?
• Assume c = 0•Want to maximize amount received by existing shareholders• If y ≥ y, sA = vA = 1 (one-share-one-vote) certainly optimal— raider will pay y— but would never pay more
• And if y < y, sA = vA = 1 again optimal— as before, in a successful bid pay sAy for class A shares, sBy for classB shares∗ (only dividend rights effect price here)
— suppose sA < 1— then raider may be able to get firm for less than y— whereas with sA = vA = 1 raiding firm must pay y— (with class B shares, these shareholders experiences a loss of y − y)— Basically, one-share-one-vote (plus no partial offers) protects existingshareholders
• Note: Now consider case where shareholders may actually be pivotal— then if y > y and c > 0, optimal structure is one-share-all-votes— one-share-all votes minimizes free-rider problem.— raider purchases single voting at small premium
