There are two classes of restrictions on takeovers - (1) those imposed by the firm through the use of anti-takeover clauses and amendments in the corporate charter, and (2) those imposed by the state to make takeovers more difficult or even impossible.
Anti-takeover Amendments
In response to a wave of hostile takeovers in the 1980s, many firms changed their corporate charters to make takeovers more difficult. The managers of these firms offered many reasons for these changes. First, they would release managers from the timeconsuming tasks of having to deal with hostile takeovers and enable them to spend their time making productive decisions. Second, they would give managers additional tools to extract a higher price from hostile bidders in a takeover by increasing their bargaining power. Third, they would enable managers to focus on maximizing 'long-term' value as opposed to the 'short-term' value maximization supposedly implicit in most takeovers.
The managers of firms offered a range of anti-takeover amendments to this end. Among them were staggered board elections, whereby only a portion of the board could be replaced each year, making it more difficult for a shareholder to gain control, supermajority clauses requiring more than majority approval for a merger (typically 70 to 80%), and the barring of two-tier offers[20]. In theory, these anti-takeover amendments should affect value negatively, because they make takeovers less likely and entrench incumbent management.
One way to value these anti-takeover amendments is to rewrite the market price of a firm as follows: Market Value of firm = Market value of firm as is + Probability of a takeover * (Market Value of restructured firm-Market Value of firm as is)
By passing anti-takeover amendments, firms reduce the probability of a takeover and, hence, their market price. The net effect on value varies across firms, however; firms with the most inefficient management are most likely to experience a drop in value on the passage of these amendments, while firms with more efficient management are not likely to show any noticeable change in value. There is a surprising lack of consensus on the effects of anti-takeover amendments on stock prices. Linn and McConnell (1983) studied the effects of anti-takeover amendments on the stock price and found positive but insignificant reactions to antitakeover amendments.
DeAngelo and Rice (1983) investigated the same phenomenon and found a negative, albeit insignificant, effect. Dann and DeAngelo (1983) examined standstill agreements[21] and negotiated premium buybacks[22] and reported negative stock price reactions around their announcements, a finding consistent with the loss of shareholder wealth. Dann and DeAngelo (1988) extended their study to anti-takeover measures passed not in response to a takeover attempt, but in advance of a takeover as a defensive measure. They reported a stock price decline of 2.33% around the announcement of these measures.
Restrictions on Acquisitions
Many financial markets outside the United States impose significant legal and institutional restrictions on takeover activity. While few markets forbid takeovers altogether, the cumulative effect of the restrictions is to make hostile takeovers just about impossible. Even in the United States, many states imposed restrictions on takeovers in the 1980s, in response to the public and political outcry against hostile takeovers. One example of stateimposed restrictions is the Pennsylvania law passed in 1990, which contained three provisions to make takeovers more difficult.
First, bidders who cross ownership thresholds of 20, 33, or 50% without management approval must gain the approval of other shareholders to use their voting rights. This approval is made even more difficult to obtain because voting is restricted to only those shareholders who have held stock for more than 12 months. Second, the board of directors is allowed to weigh the effect of the takeover on all stakeholders, including customers, employees, and local community groups, in accepting or rejecting a takeover, thus providing members of the board with considerable leeway in rejecting hostile bids.
Third, bidders are forced to return any profits made from any sale of stock in the target corporation within 18 months of the takeover attempt, thus increasing the cost of an unsuccessful bid. Karpoff and Malatesta (1990) examined the consequences of this law, and found that the stock prices of Pennsylvania-based firms dropped (after adjusting for market movements), on average, 1.58% on October 13, 1989, the first day a news story on the law appeared. Over the entire period, from the first news story to the introduction of the bill into the Pennsylvania legislature, these firms saw their stock prices decline 6.90%.[23]
--> CT 26.4: Consider only anti-takeover amendments that require shareholder approval. What types of firms are most likely to be successful in getting such amendments approved? In particular, do you see such amendments having a greater chance of success in well managed or badly managed firms?
20 In two tier tender offers, acquirers offer a higher price for the first 51% of the shares tendered, and a lower price for the remaining 49% that are not. By doing so, they hope to increase the number of stockholders who do tender.
21 In a standstill agreement, a firm enters into an agreement with a potential hostile acquirer whereby the acquirer agrees not to acquire any more shares. In return, the acquirer receives cash or other compensation.
22 This is a fancy name for greenmail, whereby the stake acquired by a raider is bought back by the company at a substantial premium over the price paid. In return, the raider signs a 'standstill' agreement not to acquire shares in the company for a specific time period.
23 The controversy provoked by the Pennsylvania anti-takeover law created a strong counter-movement among institutional investors, who threatened to sell their holdings in Pennsylvania companies that opted to be covered by the law. Faced with this ultimatum, many Pennsylvania firms chose to opt out of the antitakeover law.
Prof. Aswath Damodaran
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Summary: Index