By Alla Gul (MBA) – Our Contributor
“Hostile takeover usually involves a public offer of a specific price, usually at a substantial premium over the prevailing market price, for a substantial percentage of the target firm’s stock” (Jarrell, n.d.). This type of takeover is called hostile because it goes against the wishes of the target company’s management and board of directors. Hostile takeovers are often seen as inefficient and undesirable. On the other hand, as Lee and McKenzie (2006) stated, there is plenty of evidence that the shareholders of the target company in a hostile takeover realize large gain.
Critics of takeovers state that these gains ignore the economic loses that takeovers impose on other groups connected with the target firms (Jarrell, n.d.). However it has been shown in a variety of studies that hostile takeovers actually are efficient. At the same time, even if it is accepted that hostile takeovers are generally efficient, there still should be corporate defenses against such takeovers (Lee & McKenzie, 2006). Among the most common reasons for defense are the desire to retain autonomy or management control, the preference for an alternative partner, and the desire to negotiate a more favorable financial takeover (Pearce & Robinson, 2004). Opposing hostile takeovers, managers of target companies have access to a variety of anti-takeover defensive strategies. The efficiency of hostile takeovers and several anti-takeover defensive strategies are discussed in the sections below.
Takeover bids increase the wealth of the corporation’s stockholders significantly (Lee & McKenzie, 2006). But what about other parties involved?
First, critics of hostile takeovers argue that the acquiring corporation often bids too much and loses in the deal. However, Lee and McKenzie (2006) have shown that for the acquiring corporation’s stockholders, their wealth is not greatly affected since “the winning bid for the stock of a corporation targeted for a takeover will fairly accurately reflect the value of that corporation to the winner” (p.510).
Second, also unsupported is the charge that losses to bondholders finance the shareholder gains from takeovers (Jarrell, n.d.). According to several studies mentioned by Lee and McKenzie, takeovers do not impose losses on bondholders, and “…any losses to bondholders do not come anywhere close to offsetting the gains to stockholders” (2006, p. 511). Considering shareholders of bidding firms, “…the studies that find net losses from bidders also show that these losses – at 1 to 3 percent of the stock price – are minuscule compared with the enormous gains to target shareholders” (Jarrell, n.d.).
Next, there is also an opinion that the constant threat of hostile takeover forces corporate managers to stress short-term policies at the expense of more valuable long-term plans, “thereby impairing the economic health and competitive vigor of their companies and the nation” (Jarrell, n.d.). However, the research has shown that the threat of a hostile takeover is not a reason for managers to become short-sighted. Moreover, making decisions that increase the long-term profitability of the firm even if those decisions temporarily reduce profits is the best protection against a takeover (Lee & McKenzie, 2006).
Also, after a corporation is taken over, often it is broken up as the acquiring firm sells off divisions, often ones that have been profitable. And, therefore, as critics of takeovers state, takeover is disruptive and inefficient. However, multiple examples have proven that by spinning off some of the acquired firm divisions, its total value often increases (Lee & McKenzie, 2006).
To continue, there is a claim made that although stockholders gain from takeovers, they do it at the expense of workers being laid off. But the fact that workers are laid off after hostile takeovers is consistent with the view that these takeovers promote efficiency (Lee & McKenzie, 2006). Lee and McKenzie (2006) further argued that one of the advantages of the market for corporate control is the increased pressure on managers to keep the size of their workforce under control. In addition, most of the harmed workers are not necessarily made worse off by the system that encourages takeovers. “Workers harmed in the case of their firm’s takeover can receive offsetting benefits from the efficiency improvements they, the workers, realize through the lower price of the goods they buy” (Lee & McKenzie, 2006, p.515).
They can be classified into two categories: preventive and reactive. Preventive strategies are taken by executives to make the firm less attractive as an acquisition target. Reactive strategies are used when a hostile takeover has begun because the particular suitor is not wanted (Pearce & Robinson, 2004). Poison pills and golden parachutes are examples of preventive defenses’ forms, and greenmail and litigation are the forms of reactive anti-takeover defenses.
A poison pill is a very effective way for managers of a corporation to defend against a takeover. It is a defensive strategy that allows shareholders of the target firm to acquire additional shares at attractive prices to dilute the stockholdings of the acquiring corporation causing attacking firms to lose money on its investment (Lee & McKenzie, 2006). Based on results of several studies, the poison pill is a highly popular and effective defensive strategy and may be beneficial to the target firms (Pearce & Robinson, 2004). However, as Lee and McKenzie (2006) have stated, studies indicate that they are in general harmful to the wealth of the target corporation’s shareholders.
Golden parachutes are another form of defensive strategy. Golden parachutes are special, valuable compensation packages that are distributed to a selected group of executives ‘if a pre-specified threshold of outside stock ownership is acquired in a takeover bid” (Pearse & Robinson, 2004, p. 19). Lee and McKenzie (2006) have pointed out that golden parachutes reduce management opposition to takeover bids that benefit shareholders. They can also encourage executives to take greater risks, “given that they know that they will receive a significant severance-pay package if the risks they take result in losses and they lose their jobs” (Lee & McKenzie, 2006, p.517). However, as Lee and McKenzie (2006) continued, ” There is at least tentative support for the proposition that that golden parachutes, across a range of companies, tend to promote the interest of shareholders… by bringing the interests of top managers more in line with those of their shareholders ” (p. 517). Moreover, according to Pearce and Robinson (2004), many studies have indicated that golden parachutes have low effectiveness as a defense strategy and have negligible effects on stockholder wealth.
The next strategy, greenmail, involves repurchasing the shares of stock that have been acquired by the aggressor at a premium in exchange for an agreement that the aggressor will no longer target the company for a takeover (Pearse & Robinson, 2004). Some studies suggest that greenmail can result in small gains for the repurchasing firm’s shareholders. However, any gain to shareholders may encourage others to attempt a takeover (Lee & McKenzie, 2006). Other studies indicate that greenmail has medium effectiveness as a defense strategy and that the effect of greenmail payments on shareholder wealth is generally negative (Pearce & Robinson, 2004, p.21). In addition, Lee and McKenzie (2006) concluded that paying greenmail consistently does not promote the long-run profitability of a firm.
Finally, litigation is a defensive strategy that involves pursuing a legal sanction and restraining order against a pursuer to block that company from acquiring additional stock until the pursuer can prove that that justification for the injunction is unfounded. Litigation is often undertaken to extend the negotiation period so that more attractive offers can be solicited and/or to insure a higher probability of a successful takeover (Pearce & Robinson, 2004). In general, according to a number of studies, the strategy has low effectiveness as a defense mechanism against takeover but has a positive wealth effect for stockholders (Pearce & Robinson, 2004)
To summarize, some individuals and groups do lose in any takeover. However, “The empirical studies offer little or no support for the notion that the huge gains to shareholders reflect similarly large loses to related parties…On average, takeovers reflect wealth-enhancing and socially valuable redeployment of corporate recourses… Huge gains to target shareholders created large net economic gains”( Jarrell, n.d.).
At the same time, even if it is accepted that hostile takeovers are generally efficient, there still should be corporate defenses against such takeovers (Lee & McKenzie, 2006). It is difficult to define what the best means to protect a corporation against hostile takeover are. Strategies vary in their efficiency and effectiveness. However, “The best defense is efficient management that provides shareholders with a competitive return on their investment” (Lee & McKenzie, 2006, p.516).
The main consequence of a bid being considered hostile is practical rather than legal. If the board of the target cooperates, the bidder can conduct extensive due diligence into the affairs of the target company. It can find out exactly what it is taking on before it makes a commitment. But a hostile bidder knows only publicly-available information about the target, and so takes a greater risk. Also, banks are less willing to back hostile bids with the loans that are usually needed to finance the takeover. However, some investors may proceed with hostile takeovers because they are aware of mismanagement by the board and are trying to force the issue into public and potentially legal scrutiny
Jarrell G. Takeovers and leveraged buyouts. The Concise Encyclopedia of Economics. Retrieved on November 5, 2007 from http://www.econlib.org/Library/Enc/TakeoversandLeveragedBuyouts.html
Lee, D.R. & McKenzie, R. B. (2006). Microeconomics for MBAs. New York.
Cambridge University Press
Pearce. J & Robinson. R. (2004). Hostile takeover defenses that maximize shareholder wealth. Business Horizons. 47/5, pp.15-24