Takeover Defenses: The Thorn in the Side of US Corporation Shareholders

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John-TaylorNo decent soap opera is complete without a few episodes dominated by the drama and shenanigans surrounding a hostile takeover bid for a corporation.  U.S. listed companies have long adopted “takeover defenses” to assist them in resisting hostile takeovers.  Aside from making stimulating TV viewing, hostile takeover bids are uniquely placed at the intersection of law, politics and business.  Their permissibility and adoption is policy driven.  Once that door is open, lawyers and businessmen have been hugely creative in the construction and implementation of takeover defenses.

U.S. takeover defenses come in all shapes and sizes and are generally permissible in law.  Some are extraordinarily complex.   Many have evocative and dramatic names like “Poison Pill”, “The Crown Jewel Defense”, “Greenmail”, “The Nancy Reagan Defense” and “The Scorched Earth Defense”.  All seek to assist the target in resisting takeover activity.  They block a potential bidder, as an automatic consequence of the launch of a takeover bid, by transferring value from a corporation to its shareholders, by disposing of a key asset (a crown jewel) to a third party or by diluting a bidder’s anticipated position by an issue of additional shares to existing shareholders at a discount.

Shareholders would be better off if takeover defenses were prohibited.  The stifling of merger activity that results from the adoption of takeover defenses by corporations is bad for shareholders.

By adopting takeover defenses, boards of corporations highjack shareholders’ decision making power in relation to takeover bids.  They do this by placing themselves in the “king maker” position as their agreement to the dismantling of a takeover defense becomes necessary for a takeover bid to succeed (regardless of the view of the shareholders). The effect is to permit boards to substitute their interests over those of shareholders.

Takeover defenses entrench underperforming management (who would be encouraged to perform better by the risk of losing their jobs following a takeover from an unwelcome suitor).  Merger activity creates and returns shareholder value and efficiently reallocates capital and labor resources in the economy.  All shareholders benefit from the reduced agency costs that result from activist shareholders’ monitoring of management – takeover defenses deter activists from taking significant positions in corporations (even where no takeover is intended).

Takeover defenses permit boards only to dismantle takeover defenses for transactions that benefit them.  Boards use the dismantling of takeover defenses (which are necessary for an acquisition to proceed) as leverage to negotiate bonuses for their members and/or to entrench themselves post-closing.  This redirects merger consideration from shareholders into the pockets of board members.

Takeover defenses cause bidders to pay more for targets.  Value created by takeovers predominantly accrues to target shareholders.  A more equal allocation between bidders and targets of merger-created value is in the interests of institutional investors, as they are exposed to both sides of merger transactions.  It may also increase merger activity and thus the frequency of value-creating events.

John Taylor

John has a BA LLB (UCT) and LLM (commercial law) (NYU). He was admitted as an attorney in early 2000 after having completed articles at Bowman Gilfillan. He spent a year at Richards Butler in London before returning to take up an associate position at ENS in 2001. He rose to the level of senior associate at ENS before leaving to focus on his corporate and commercial practice in 2006. John has been admitted at the New York Bar and will shortly be admitted as a solicitor in England and Wales. He joined Caveat Legal in 2012.