Chapter 03 Common Takeover Tactics and Defenses

7/29/2019 Chapter 03 Common Takeover Tactics and Defenses

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The Corporate TakeoverMarket

Common Takeover Tactics,Takeover Defenses, andCorporate Governance


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Treat a person as he is, and he will remain as he is.

Treat him as he could be,

and he will become what he should be.Jimmy Johnson


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Course Layout: M&A & OtherRestructuring Activities

Part IV: DealStructuring &

Financing

Part II: M&AProcess

Part I: M&AEnvironment

Payment &Legal

Considerations

Public CompanyValuation

FinancialModeling

Techniques

M&A Integration

Business &Acquisition

Plans

Search throughClosing

Activities

Part V:AlternativeStrategies

Accounting &Tax

Considerations

BusinessAlliances

Divestitures,Spin-Offs &Carve-Outs

Bankruptcy &Liquidation

RegulatoryConsiderations

Motivations forM&A

Part III: M&AValuation &Modeling

Takeover Tacticsand Defenses

FinancingStrategies

PrivateCompanyValuation

Cross-BorderTransactions


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Current Lecture Learning Objectives

Providing students with an understanding of

Corporate governance and its role in protectingstakeholders in the firm;

Factors external and internal to the firm affectingcorporate governance;

Common takeover tactics employed in themarket for corporate control and when and why

they are used; and Common takeover defenses employed by target

firms and when and why they are used.


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Alternative Models of Corporate Control

Market model applies when:

Capital markets are liquid

Equity ownership is widelydispersed

Board members are largelyindependent

Ownership & control areseparate

Financial disclosure is high

Shareholder focus more on

short-term gains Prevalent In U.S. and U.K.

Control model applies when:

Capital markets are illiquid

Ownership is heavilyconcentrated

Board members are largelyinsiders

Ownership & controloverlap

Financial disclosure limited

Shareholder focus more on

long-term gains Prevalent in Europe, Asia, &

Latin America


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Factors Affecting Corporate Governance:Market Model Perspective

Internal to FirmBoard of DirectorsManagementInternal ControlsIncentive SystemsTakeover Defenses

External to Firm

External to Firm

External to Firm

External to Firm

Legislation:1933-34 Securities ActsDodd-Frank Act of 2010Sherman Anti-Trust Act

Regulators:SECJustice Department

FTC

Institutional Activism:Pension Funds (Calpers)Mutual FundsHedge Funds

Market for CorporateControl:

Proxy ContestsHostile Takeovers


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Internal Factors: Board of Directorsand Management

Board responsibilities include:--Review management proposals/advise CEO

--Hire, fire, and set CEO compensation

--Oversee management, corporate strategy, and

financial reports to shareholders

Good governance practices include:

--Separation of CEO and Chairman of the Board

--Boards dominated by independent members--Independent members serving on the audit and

compensation committees


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nterna actors: ontro sIncentive Systems

Dodd-Frank Act (2010):

-- Gives shareholders of public firms nonbinding right tovote on executive compensation packages

--Public firms must have mechanism for recoveringcompensation 3-yrs prior to earnings restatement

Alternative ways to align management and shareholderobjectives

Link stock option exercise prices to firms stock price

performance relative to the overall market Key managers should own a significant portion of thefirms outstanding shares


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External Factors: Legislation

Federal and state securities laws Securities Acts of 1933 and 1934

Williams Act (1968)

Insider trading laws Anti-trust laws

Sherman Act (1890)

Clayton Act (1914) Hart-Scott-Rodino Act (1976)

Dodd-Frank Act (2010)


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o - ran c o : overnanceExecutive Compensation

Say on Pay: In a nonbinding vote, shareholders may voteon executive pay every 3 yrs.

Say on Golden Parachutes (executive severancepackages): Proxy statements seeking shareholder approvalof M&As or sale of most of a firms assets must disclosepay agreements with target or acquirer executives

Clawbacks: Public firms must disclose mechanisms forrecovering incentive pay paid during 3-yrs prior to earningsrestatements.

Proxy Access: SEC has authority to require public firms toinclude nominees submitted by shareholders in proxy

materials Broker Discretionary Voting: Stock exchanges must

prohibit brokers from voting shares without direction fromowners in election of directors and executive compensation

D dd F k A t f 2010 S t i


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Dodd-Frank Act of 2010: SystemicRegulation and Emergency Powers

Financial Stability Oversight Council (FSOC): Monitors U.S. financialmarkets to identify banks and nonbank banks exhibiting systemic risk.

New Fed Bank/Nonbank Supervisory Powers: Banks/nonbanks withtotal assets $50 billion must Submit plans for their rapid dissolution in event of failure Limit their credit exposure in any unaffiliated firm to 25% of its

capital

Conduct semiannual stress tests to determine capital adequacy Provide advance notice of intent to buy voting shares in financial

firms Leverage Limitations: Fed may require banks with assets $50 billion

to maintain debt-to-equity ratio of no more than 15 to 1. Size Limitations: No bank or nonbank can hold deposits > 10% of

deposits nationwide; does not apply to mergers involving failing banks. FDIC Guaranty Powers: May guaranty liabilities of solvent banks if

FSOC and Fed determine appropriate to do so. Orderly Liquidation Authority: FDIC may seize and liquidate banks

threatening U.S. financial stability New Bank Capital Requirements: At discretion of regulators.

D dd F k A t f 2010


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Dodd-Frank Act of 2010:Capital Markets

Office of Credit Ratings: Sets rules for transparency,conducts audits and makes it easier to sue ratingagencies.

Securitization: Issuers of asset-backed securities mustretain an interest of at least 5% of any security sold to

third parties. Hedge and Private Equity Fund Registration: Must

register with SEC as investment advisors if assets $100 million; those with < $100 million subject to stateregulation.

Clearing and Trading of OTC Derivatives: Must betraded on formal exchanges to provide real time datareporting to market participants (e.g., CDS-lenderinsurance).

D dd F k A t f 2010


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Dodd-Frank Act of 2010:Financial Institutions

Volcker Rule: Prohibits insured banks frombuying and selling securities with their ownmoney (i.e., proprietary trading) or sponsoring orinvesting in hedge funds or private equity funds;banks may do so if they have no control over

funds. Does not apply to U.S. banks with foreignoperations.

Consumer Financial Protection Bureau:Writes rules governing financial institutions

offering consumer financial products Federal Insurance Office: Monitors insuranceindustry and recommends which firms should beconsidered systemically important.


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External Factors: Regulators

Securities and Exchange Commission

Justice Department

Federal Trade Commission

Public Company Accounting OversightBoard

Financial Accounting Standards Board

Financial Stability Oversight Council


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External Factors:Institutional Activism

Pension funds, mutual funds, and insurancecompanies

Ability to discipline management often limited byamount of stock can legally own in a single firm

Investors with huge portfolios (e.g., TIAA-CREF,California Employee Pension Fund) can exertsignificant influence

Recent trend has been for institutional investorsto simply withhold their votes

E t l F t M k t f


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External Factors: Market forCorporate Control

Changes in control can result from hostile takeovers orproxy contests Management may resist takeover bids to

Increase the purchase price (Shareholders InterestsTheory) or

Ensure their longevity with the firm (ManagementEntrenchment Theory)

Takeovers may Minimize agency costs and

Transfer control to those who can more efficientlymanage the acquired assets


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Discussion Questions

1.Do you believe corporate governance should benarrowly defined to encompass shareholdersonly or more broadly to incorporate all

stakeholders? Explain your answer.2.Of the external factors impacting corporate

governance, which do you believe is likely to be

the most important? Be specific.


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Market for Corporate Control:Alternative Takeover1 Tactics

Friendly (Target board andmanagement supports bid)

Hostile (Target board and managementcontests bid)

1A corporate takeover refers to a transfer of control from one investor group to another.


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Market for Corporate Control:Friendly Takeover Tactics

Potential acquirer obtains support from the targets board andmanagement early in the takeover process before proceeding to anegotiated settlement The acquirer and target firms often enter into a standstill

agreement in which the bidder agrees not to make any furtherinvestments for a stipulated period in exchange for a break-up

fee from the target firm. Such takeovers are desirable as they avoid an auction environment

If the bidder is rebuffed, the loss of surprise gives the target firmtime to mount additional takeover defenses

Rapid takeovers are less likely today due to FTC and SEC pre-notification and disclosure requirements1

1The permitted reporting delay between first exceeding the 5% ownership stake threshold and the filing of a 13Dallowed Vornado Realty Trust to accumulate 27% of J. C. Pennys outstanding shares before making theirholdings public.


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Market for Corporate Control:Hostile Takeover Tactics

Limiting the targets actions through abear hug

Proxy contests in support of a takeover

Purchasing target stock in the openmarket

Circumventing the targets board through

a tender offer Litigation

Using multiple tactics concurrently

M k f C C l


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Market for Corporate Control:Pre-Offer Takeover Defenses

Poison pills to raise the cost of takeover1

Shark repellants to strengthen the target boards defenses Staggered or classified board elections Limiting when can remove directors

Shark repellants to limit shareholder actions Limitations on calling special meetings

Limiting consent solicitations Advance notice and super-majority provisions Other shark repellants

Anti-greenmail and fair price provisions Super-voting stock, re-incorporation, and golden parachutes

1Note that poison pills could also be classified as post-bid defenses as they may be issued by the board as dividends withoutshareholder approval.


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Poison Pill: Cash for Share Purchase

P1 = Pre-offer equilibrium price/target shareP2 = Poison pill conversion price/target shareP3 = Offer price/target shareQ1 = Pre-offer target shares outstandingQ2 = Target shares outstanding following poison pill conversion

ABCD = Incremental acquirer cash outlay due to poison pill conversion

Q1 Q2 Target Shares Outstanding

Target Price Share D S1 S2

D

P3

P1

P2

Target shareholder Profit/Share onPoison Pill Conversion

A B

C D

DD reflects relationship betweenshares outstanding and price/share forgiven level of expected earnings &interest rates.


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Poison Pills: Share for Share Exchange

Acquirer Shareholder Ownership Dilution Due to Poison Pill

New Company SharesOutstanding1

Ownership Distribution inNew Company (%)

Without Pill With Pill Without Pill With Pill

Target Firm Shareholders

Shares Outstanding

Total Shares Outstanding

1,000,000

1,000,000

2,000,000

2,000,000

50 673

Acquiring Firm Shareholders

Shares Outstanding

New Shares Issued

Total Shares Outstanding4

1,000,0001,000,000

2,000,000

1,000,0002,000,0002

3,000,00050 33

1Acquirer agrees to exchange one share of acquirer for each share of target stock.

2Poison pill provisions enable each target shareholder to buy one share of target stock at a nominalprice for each share they own. Assume all target shareholders exercise their rights to do so.32,000,000/3,000,0004Target shares are cancelled upon completion of transaction.

f C C


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Market for Corporate Control:Post-Offer Takeover Defenses

Greenmail Standstill agreement

Pac-man defense

White knights

Employee stock ownership plans

Recapitalization

Share buy-back plans

Corporate restructuring

Litigation

Just say no


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Discussion Questions

1. Discuss the advantages and disadvantages ofthe friendly versus hostile approaches tocorporate takeovers. Be specific.

2. Do you believe that corporate takeoverdefenses are more motivated by the targetsmanagers attempting to entrench themselvesor to negotiate a higher price for their

shareholders? Be specific.

I t Sh h ld V l


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Impact on Shareholder Value

Friendly transactions result in average abnormal returnsto target shareholders of 20%

Hostile transactions result in average abnormal returnsto target shareholders of 30-35%

Bidders shareholders earn average abnormal returnsthat are zero or slightly negative; however, often positivein certain situations

Recent studies suggest

Takeover defenses have small negative impact onabnormal target shareholder returns

Defenses put in place prior to an IPO may benefittarget shareholders

Bondholders in firms with ineffective defenses (i.e.,vulnerable to takeover) may lose value

Thi t b


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Things to remember...

Hostile takeover attempts and proxy contests affectgovernance through the market for corporate control

Hostile takeover attempts tend to benefit targetshareholders substantially more than the acquirersshareholders by putting the target into play.Consequently, acquirers generally consider friendly

takeovers preferable. Anti-takeover measures share two things in common.

They are designed to

Raise the overall cost of the takeover to the acquirersshareholders and

Increase the time required for the acquirer tocomplete the transaction to give the target additionaltime to develop an anti-takeover strategy.

Documents

Chapter 03 Common Takeover Tactics and Defenses