Hostile Takeovers Essay

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A hostile takeover is a corporate acquisition that is forcefully resisted by the target firm’s top management and board of directors. Although they constitute less than 3 percent of all merger and acquisition (M&A) activity, hostile takeovers have long garnered a disproportionately large share of attention from the news media, the general public, and business scholars for many reasons. Compared to so-called friendly M&As, which are generally planned and negotiated in relative secrecy, hostile takeovers tend to unfold in a more public arena, where representatives of both the acquirer (popularly called a “raider”) and target firm vie for the favor of shareholders, regulators, and other influential parties. Sociologists note how the intensity and ritualized nature of these contests has contributed to the unusually colorful terminology used to describe hostile takeovers. More than virtually any other corporate activity, hostile takeovers bring about abrupt and dramatic changes to a firm’s strategy, structure, and leadership.

Hostile takeovers have remained a highly controversial practice since their inception in the United States during the early 1950s. While proponents argue that hostile takeovers serve an important corporate governance function that helps maximize shareholder value, critics emphasize their potentially damaging effect to such stakeholders as workers, the local community, and managers of the target firm.

Tender Offers And Proxy Contests

Within the United States, hostile takeovers are most frequently attempted through a financial and legal mechanism known as a tender offer (i.e., a public solicitation to purchase shares of the target company at a fixed price, within a given time period, and usually contingent upon shareholders tendering sufficient shares for the bidder to gain control of the firm). To convince shareholders to sell their shares, the tender offer price is usually set at a significant premium over the current market price (frequently 50 percent or more). Prior to announcing a tender offer, a raider will often purchase shares in the open stock market at prevailing market prices. Such purchases enable the raider to minimize the cost of a successful acquisition, and to sell these shares (often at a significant profit) if the hostile takeover attempt is not completed. Once accumulating more than 5 percent of a voting class of a company’s equity, however, the acquirer is required by United States law to file a Schedule 13D (beneficial ownership report) within 10 days. Since the acquirer must disclose the purpose for the share purchase within Schedule 13D, the filing of this report often marks the beginning of the takeover battle.

With the extensive reporting requirements defined by federal law, particularly the Securities Exchange (1934) and Williams (1968) Acts, it would be very difficult in the United States for a party, or group of parties acting together, to gain control of a company solely by accumulating shares gradually in the open market (a practice known as a “creeping tender offer”). Some international business experts suggest that this approach may become an increasingly frequent and less costly alternative to traditional tender offers in countries with less stringent reporting requirements. At present, however, tender offers continue by far to be the most common hostile takeover mechanism worldwide.

Raiders may also initiate a proxy contest, an attempt to convince target firm shareholders to replace existing board members with a new group that will approve the acquisition. While tender offers and proxy contests can be used in tandem, they are often regarded as alternative mechanisms for accomplishing hostile takeovers. Empirical evidence suggests that proxy contests are more prevalent when there is greater evidence of managerial ineffectiveness, as measured by stock market performance and return on assets. Tender offers are used more frequently when the target is highly leveraged.

Anti-Takeover Measures

Companies can take several precautionary steps to curb the threat of a hostile takeover. The most famous anti-takeover measure is the “poison pill,” which was first conceived by the attorney Martin Lipton in the 1980s. While there are many variations, the basic poison pill grants shareholders the option to purchase additional shares at a significant discount in the event of a hostile takeover bid, thus diluting the raider’s ownership and making the acquisition more costly. Firms can also implement a “staggered board” in which directors serve multiyear terms with only a portion of members coming up for election each year. Another popular anti-takeover practice involves amending the corporate charter so that a “supermajority” of shareholders (often two-thirds or more) is needed to approve major strategic changes, including mergers. All of the anti-takeover practices highlighted above face rigorous opposition by shareholder rights activists.

Somewhat less controversially, a firm may include a provision in its charter that authorizes its directors to consider the well-being of stakeholders other than just shareholders when evaluating major strategic decisions. Once a hostile bid has been announced, the target firm may take on additional debt or sell off a valuable asset (“the crown jewels”) to make itself less attractive. In a practice known as “greenmail,” the target might buy back its shares from the raider at a premium. Thus, a failed hostile takeover could easily leave the target firm weaker, both competitively and financially, than prior to the bid. The target firm might also enlist a third party “white knight” to acquire sufficient shares to block the hostile takeover, or to initiate a friendly acquisition. Many target firms begin to pursue the types of practices most commonly associated with hostile acquirers, such as laying off workers, outsourcing, rationalizing operations through facility closures, and refocusing on core markets. Target firms will also commonly lobby governmental regulators and legislators to oppose the acquisition.

Effects

The use of hostile takeovers as a means for achieving good corporate governance was originally outlined by Henry Manne in 1965. According to his theoretical premise of a market for corporate control, stock prices are not only efficient but they also provide a critical indicator of managerial effectiveness. When a company’s share price falls relative to the overall market, it signals that the firm’s managers are underperforming. This, in turn, provides an incentive for an outside party to gain control of the company and implement changes that will increase shareholder value. Advocates of a market-based corporate governance system find this theoretical framework particularly appealing since monitoring managers directly is considered very costly and frequently ineffective. Regardless of whether managers are underperforming due to incompetence or self-interested behavior, the market for corporate control promises that the fault will become readily apparent via the firm’s share price. Conversely, critics of hostile takeovers argue that the practice forces managers to focus too narrowly on short-term stock performance to the detriment of long-run shareholder value.

Another important debate involves whether the benefits of hostile takeovers are sufficient to offset their harmful effects. Hostile takeovers tend to lead to workforce reductions in both the target and acquiring organization that are even greater in magnitude than those of friendly acquisitions. The negative impact of facility closures on a local economy can be profound and enduring. Hostile takeovers have also been argued to reduce average wage levels by shifting employment away from older, longer-tenured workers.

Empirical findings support the contention that weak stock market and accounting performance increases a firm’s likelihood of becoming a hostile takeover target. Shareholders of target firms generally experience substantial financial gains from hostile takeovers, as they also do from friendly acquisitions. While some studies suggest that the performance of the target generally improves after a hostile takeover, it is not clear that the acquirer benefits financially from these gains after accounting for the purchase premium.

Prevalence

The level of hostile takeover activity differs dramatically across countries. According to a 2004 study by William Schneper and Mauro Guillén, there were 478 hostile takeover attempts in the United States from 1988 to 2003, compared to 273 in the United Kingdom, 19 each in France and Sweden, seven in Germany, three each in Japan and Malaysia, and one in China. Hostile takeovers are relatively less common in countries characterized by high ownership concentration and where state ownership of firms is commonplace. While the corporate cross-ownership of shares has traditionally stifled the hostile takeover market in Japan, the unraveling of these arrangements during recent years has been accompanied by an increase in predatory activity.

From a more sociological perspective, hostile takeovers have been found to be more frequent in countries with strongly individualistic national cultures and where the corporate legal code privileges shareholder rights. Hostile takeovers are less common in countries where workers and commercial banks receive a stronger degree of legal protection. Despite the German system of codetermination, which guarantees workers a significant role in the control of firms, the recent movement toward Unternehmenswertsteigerung (increasing shareholder value) appears to have been accompanied by a nascent, but still growing, hostile takeover market. The hostile bid of €124 billion ($128 billion) for Germany’s Mannesmann by the UK firm Vodafone in 1999 was the world’s largest hostile takeover attempt to date. The deal was later completed as an amicable merger in 2000.

During 1993, China’s first hostile bid resulted in Shanghai Bao gaining a 20 percent share of the Yanzhong Industrial Company. Whether hostile takeover activity will continue to spread in these and other countries remains an open question. Regardless of the answer, hostile takeovers will remain an important topic of discussion and spirited debate for the foreseeable future.

 

Bibliography:

  1. Alan J. Auerbach, ed., Corporate Takeovers: Causes and Consequences (University of Chicago Press, 1991);
  2. Dennis J. Block, Contests for Corporate Control 2008: Current Offensive & Defensive Strategies in M & A Transactions (Practicing Law Institute, 2008);
  3. John Raymond Boatright, Ethics in Finance (Blackwell, 2008);
  4. Enrico Colcera, The Market for Corporate Control in Japan: M&As, Hostile Takeovers and Regulatory Framework (Springer, 2007);
  5. Patrick A. Gaughan, Mergers, Acquisitions and Corporate Restructurings, 4th ed. (Wiley, 2007);
  6. Paul M. Healy, Krishna G. Palepu, and Richard S. Ruback, “Which Takeovers Are Profitable? Strategic or Financial?” Sloan Management Review (v.38/4, 1997);
  7. Paul M. Hirsch, “From Ambushes to Golden Parachutes: Corporate Takeovers as an Instance of Cultural Framing and Institutional Integration,” American Journal of Sociology (v.91/4, 1986);
  8. Henry G. Manne, “Mergers and the Market for Corporate Control,” Journal of Political Economy (v.73/4, 1965);
  9. William D. Schneper and Mauro F. Guillén, “Stakeholder Rights and Corporate Governance: A Cross-National Study of Hostile Takeovers,” Administrative Science Quarterly (v.49, 2004).

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