Corporate takeovers: a governance mechanism?

Corporate Governance 1

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Brief overview of M&A

A merger is often viewed as a combination of 2 firms and an acquisition is viewed as one firm buying another. However, all mergers are essentially acquisitions

Purchase method of accounting (vs. pooling)

Takeovers can be synergistic, disciplinary or both

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The acquirers goals

To takeover the target firm

To make the target firm profitable by

Cutting the target firms fixed or variable costs

Improving its operational efficiency

Getting rid of its bad managers

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The target firm

Target firm is the firm to be acquired

An acquiring firm may want to acquire a target firm because it believes the target firm:

Therefore, target firms usually enjoy a share price increase when its acquisition is announced to the public

is not performing up to its full potential

the target firm could become a better performer under someone elses control

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Synergistic M&A / Takeovers

To improve operational or financial synergies

e.g., Exxon and Mobil

To diversify by expanding into new businesses

e.g., the AOL and Time Warner

Many of the recent mergers have occurred for growth and for increased market power

e.g., Oracle and PeopleSoft, HP and Compaq

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Disciplinary takeovers

Some firms that get taken over are poorly performing firms

The fear of a potential takeover might represent a powerful disciplinary mechanism to make sure that:

Managers perform to the best of their abilities

Managerial discretion is controlled

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Takeover waves: triggers, performance and motives - Martynova and Renneboog

There have been 5 obvious waves of takeover activity (the last one in the 90s) Takeovers usually occur in periods of economic

recovery The takeover market is also fuelled by regulatory changes

and its frequently driven by industrial shocks

At their announcement, they trigger substantial increases in value, but most of these gains are captured by the targets shareholders

Over the first 5 years after the takeover, there is a decline in the share prices of the acquiring firm

Who gains ? (Cai and Vijh 07)

Targets shareholders gain 23.8% (on average) from announcement to completion

Acquirers shareholders lose 3.8%

Combined shareholders gain 1.9%

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Are takeovers an effective governance mechanism?

It is not clear whether takeovers are an effective governance mechanism because:

An acquirer may have to pay too much for a target

Takeovers could occur for the wrong reasons (e.g., empire building).

Even if the acquirer is able to pay a fair price for a target, the amount usually is still significant

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Takeover defenses

There are two categories of takeover defenses

Firm-level defenses

Governmental or state-level defenses: laws that regulate and limit takeovers

Pre-emptive defenses

Reactionary defenses

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Firm-level pre-emptive takeover defenses

Poison pill: any strategy that makes a target firm less attractive immediately after it is taken over

A golden parachute: an automatic payment made to managers if their firms gets taken over

Supermajority rules: two-thirds, or even 90 percent, of the shareholders have to approve a hand-over in control

Staggered boards: only a fraction of the board can get elected each year to multiple-year terms.

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Example of a poison pill: Pernod

Pernod Ricard asked its shareholders to approve the a poison pill

Investors will vote on a resolution authorizing the board to issue warrants convertible to shares at a discounted price in the event of an unsolicited takeover approach

This would drastically inflate the purchase price for any suitor making an offer for the company without first winning over the firms directors

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The return of the poison pill CFO.com 2008

Triggered by the current economic decline (value is less of a defense), smaller companies are displaying a renewed taste for deploying poison pills as a defense against takeovers Until Sep, in 2008, 40 US companies had adopted

new poison pills for the first time In all of 2007, 42 companies adopted poison pills

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Firm-level reactionary takeover defenses

Reactionary defenses include:

The firms management trying to convince its shareholders that the offer price is too low

Raise antitrust issues

Find another acquirer who might not fire management after the takeover

Find an investor to buy enough shares so that he/she can have sufficient power to block the

acquisition.

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Governmental Acts

US - The Bureau of Competition and the Antitrust Division of the DoJ uphold antitrust policy

Europe European Commissions antitrust regulations and national laws Merger approved by the EC (7/Mar/2011): Steinhoff

(South Africa) acquired Conforama (France)

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Integrating CG systems from different countries

In a cross-border M&A the nationality of the target firm may change This affects the CG system of the new entity

E.g.: 2002 merger between Hoescht (Germany) and Rhne-Poulec (France) resulted in Aventis (now part of Sanofi-Aventis)

Both firms required a deposit of shares within 5 and 7 days prior to merger

After the merger, Aventis required such a deposit for only 3 days

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Corporate governance and equity

prices

By Paul A. Gompers, Joy L. Ishii, Andrew Matrick (2003)

A classic

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Works Methodology: Governance Index

Long horizon approach

About 1500 firms during the 90s

Works aim: Try to find the empirycal relationship between corporate

governance and corporate performance, analyzing firms anti-takeover measures

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Corporations as republics Democracy

Dictatorship

Little power for management Strong shareholder rights

Big power for management Weak shareholder rights

CG measured by corporate takeover defenses and anti-takeover laws

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24 Corporate Governance Provisions

5 subindex:

Index construction (G-score):

Delay (4): tactics for delaying hostile bidders Voting (6): voting rights Protection (6): director/officer protection Other (6): other takeover defenses State (6): anti-takeover state laws

Add one point for every provision that restricts shareholder rights (or increases managerial power)

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Governance and Returns If information about corporate governance is quickly incorporated by the

market, stock price should quickly adjust to any relevant change; If the information is not immediately incorporated into the stock price: the

realized returns on the stock would differ systematically. Consider the period from September 1, 1990 to December 31, 1999: 1$ invested in the Dictatorship portfolio would have grown to $3,39 1$ invested in the Democracy Portfolio would have grown to $7,07

The democracy portfolio outperformed the dictatorship portfolio by a

statistically significant 8.5%/year

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Governance and the value of the firm Analyze whether there was a change in the governance/value relationship during

1990s.

Statistical results:

1999: + 1 point G -11,4 % value for Q

1990: + 1 point G -2,2 % value for Q

Firms with the weakest shareholder rights significantly

underperformed firms with strongest shareholder rights

These differences have been partially reflected in prices

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Investigates the relative importance of the 24 provisions in Gompers et al. (03)

What matters in Corporate Governance? - Bebchuk et al. (09)

Creates an entrenchment index with 6 provisions: staggered boards, limits to shareholder bylaw ammendments, poison pills, golden parachutes, and supermajority requirements for mergers and charter amendments Find that the other 18 measures are uncorrelated with either

reduced firm valuation or negative abnormal returns

Corporate takeovers: a governance mechanism?

Corporate Governance 27