About the philosophy of the Israeli Companies Law, 1999

Uriel ProcacciaThe Interdisciplinary Center, Herzlia

and The Center for the Study of Rationality, The Hebrew

University

Rule Number One

• If it ain’t broke, don’t fix it

Rule Number Two

• If anything looks fishy…

Then…

• First, identify the relevant “market failure”: This is the “disease”.

• Only then, introduce some form of regulation; This is the “remedy” for the “disease”. and remember:

• Not every remedy is suitable for any given ailment.

This sounds simple, but…

• In following this simple recipe the Israeli Companies Law became the first of its kind to have been consciously and deliberately informed by the economic approach to corporate law.

The rest of today’s presentation…

• Will be devoted to a detailed example of this simple principle.

• Consider a simple situation, where (B)uyer wants to acquire a (T)arget corporation. Roughly speaking, we can think of a situation where T is owned, prior to the acquisition attempt, by a single (P)erson, or a group of persons acting in concert. B's acquisition from P is termed "a private acquisition of control". B is likely to pay P a premium reflecting the value of control in T. Or else T can be owned by the public at large. In this case B must make a public offer to the T shareholders, and pay the premium for control to the them. B's acquisition from the public is termed "a public acquisition of control". Prior to the new Companies Law private acquisitions of control were regulated in Israel, but public acquisitions of control were not. The Law reversed this regulatory policy by deregulating private acquisitions of control and regulating the unregulated sphere of public acquisitions. Let us see why we took that regulatory approach.

Private acquisitions of control

• Forms of regulation of private acquisitions– The Perlman v. Feldmann approach– The approach taken by the City Code of Takeovers and

Mergers

• Why does B agree to pay a premiums for the T shares?

• Assuming that B is justified in his plans for the company, how is this going to affect the minority shareholders in T?

• Assuming that private acquisitions are regulated how is this going to affect the number of acquisitions in equilibrium?

This seems a good reason to deregulate…but

• Is this the only story that is consistent with the motivation of the buyer in acquiring control of the target?

Why prefer the “optimistic” narrative?

• Most businessmen are honest

• Corporate looting is unlawful and corporate looters are punished (if apprehended)

• Those who sell out to corporate looters may be accountable as well (if they were not diligent enough to select honest buyers).

Public acquisitions of control

– Acquisitions in a regulatory void: The possibility of street-sweeps

– The Companies Law's approach: All acquisitions must be made through the channels of regulated mergers or takeovers.

– We shall focus attention on takeovers.

Why regulate takeovers?

• Coercive choice. Assume a public shareholder subjectively evaluates the value of a share in his company as 120, but believes that if other shareholders will sell their shares and she will remain a minority shareholder in T, the value of her shares will drop to 80. The tender offer is for 100 a share. This shareholder faces the following matrix of payoffs.

• majority of other stockholdersmajority of other stockholders

• sell don’t sell

• sell -20 0

• MeMe don’t -40 0

• sell

How to regulate?

– Design inspired by Lucian Bebchuk's article, Uudistorted Choice and Equal Treatment in Corporate Takeovers, 98 Harvard L. Rev. 1695 (1985).

– Offer must be universal– Offer effective only if majority of T's shareholders,

exclusive of shareholders controlled by B, tender their shares. Otherwise no shares can be purchased by B, not even those of the tendering shareholders.

– All shareholders failing to tender their shares have a second chance, exercisable within 4 days after the results of the "first round" are announced, to tender their shares, at the same per share price as in the original tender offer. This feature modifies the payoff structure as follows.

• majority of other stockholdersmajority of other stockholders

• sell don’t sell

• sell -20 0

• MeMe don’t -20 0

• sell

Conclusion

• Whom do we trust more- free markets or the regulatory gang?

• We trust the market better when it works.

• We resort to regulation if markets are expected to malfunction.

• Thank you!