Hostile Takeovers
Friendly Takeover
In a friendly takeover, the board of directors of the target company approves the takeover.
They advise the company’s shareholders to vote in favor of the proposed deal.
The board of directors of the target company works with the acquiring company to implement the takeover proposal.
Hostile Takeover
A hostile takeover occurs when an acquiring corporation attempts to take over a target corporation without the agreement of the board of directors of the target corporation.
Directors can implement defensive measures to defeat an attempted hostile takeover.
Types of Hostile Takeovers
Tender Offer (Stock Acquisition)
Proxy Contest
Tender Offer
A tender offer is a public offer by an acquiring company to all stockholders of a publicly-traded target corporation to tender stock for sale at a specified price during a specified time, conditional upon the tendering of a minimum and maximum number of shares.
The bidder contacts shareholders directly, and the board of directors of the target company has no control over whether shareholders decide to tender.
Market Premium
To induce shareholders of the target company to sell, the acquirer’s offer price is usually at a premium over the current market price of the target company’s shares.
For example, if a target corporation’s stock were trading at $50 per share, then an acquiring company might offer $55 per share to shareholders of the target company on condition that 51% of shareholders agree.
Two-Tier Tender Offer
Involves a two-step acquisition process.
Step 1: The acquirer makes a “first step” tender offer directly to the target’s public shareholders.
Step 2: A “second step” merger is required to acquire the remaining untendered shares.
After the consummation of the back-end merger, the target becomes a wholly-owned subsidiary of the acquirer.
Tender Offer (Step 1)
A hostile buyer creates a merger subsidiary.
The merger subsidiary makes a conditional offer to purchase at least 50% of the shares at a certain price per share to gain effective control of the firm.
Back-End Merger (Step 2)
The acquiring company proceeds with a back-end merger which squeezes out minority shareholders to convert shares for consideration offered by the merger subsidiary.
The target company is now a wholly-owned subsidiary of the acquiring company.
Two-Tiered Structure
Potential Advantage: Avoids potential holdup problems.
Potential Disadvantage: Potentially coercive.
Coercive Tender Offer: Front-Loaded Two-Tier Tender Offer
Pre-Takeover Price: $100 per share.
First-Tier: $105 to the first shareholders until 50% of the total shares are tendered.
Second-Tier: $90 to the remaining 50% of shareholders.
Coercive Tender Offer: Payouts if Shareholders Tender (Unconditional Tender)
If less than 50% of shareholders tender (tender fails), then the shareholder who tenders still receives $105.
If more than 50% of shareholders tender (tender succeeds), then the shareholder who tenders receives:
, where X = % who tender (between 50 and 100).
Coercive Tender Offer: Payouts if Shareholder Does NOT Tender
If less than 50% of shareholders tender (tender fails), then the shareholder who does not tender receives the pre-tender price of $100.
If more than 50% of shareholders tender (tender succeeds), then the shareholder who does not tender receives $90.
Coercive Tender Offer: Key Point
If all shareholders tender, then all shareholders receive: 90 + 15 \times (50/100) = 97.5 < 100 (= pre-tender price).
All shareholders are worse-off after the tender offer.
Dominant Strategy: Nonetheless, tendering to a front-loaded, two-tiered tender offer is a dominant strategy.
Dominant Strategy
Other Shareholders Less Than 50% Tender | More Than 50% Tender | |
|---|---|---|
Shareholder Tender | $105 | |
No Tender | $100 | $90 |
Tender is a dominant strategy.
Dominant Strategy (Coercive)
A front-loaded two-tier tender allows the acquiring company to acquire the target company for less than its true value because the acquiring company uses the low price of the second-tier to gain an unfair advantage.
Fix: Target shareholders can vote for corporate charter amendments that prevent the company from entertaining two-tiered tender offers.
Regulation of Tender Offers
Federal Regulation: Williams Act Amendments
State Regulation:
Control Share Acquisition Statute (regulates the acquisition of corporate control).
Affiliated Transaction Statute (regulates the exercise of corporate control).
Federal Regulation: Williams Act
Background: Cash tender offers were not regulated (tender offers involving the exchange of securities were subject to the normal registration and prospectus requirements of the Securities Act).
Shareholders were often faced with making hasty decisions or missing out on the opportunity to sell at a premium.
The Williams Act amended the 1934 Act to provide for the regulation of all tender offers of more than 5% of the target’s stock.
Williams Act: Disclosure Requirements
The Williams Act amendments require full disclosure concerning the identity of the tender offeror and any material change planned if the offeror gains control of the target.
Similar disclosure is required whenever any person or group acquires more than 5% of the stock of a registered company (whether by tender offer or otherwise).
Antifraud Provisions
The Williams Act also imposes a broad prohibition against the use of false, misleading, or incomplete statements in connection with a tender offer by either the offeror, the target (incumbent management in attempting to oppose the tender offer), or any other person.
Antifraud Provisions: Connection to Insider Trading
The prohibition includes trading on material nonpublic information (MNPI) about the upcoming tender offer.
The purpose of the prohibition is to establish a level playing field so that financial institutions with material inside information about upcoming corporate transactions do not take unfair advantage of investors who do not have access to that inside information.
Piper v. Chris-Craft Industries
Holding: An unsuccessful tender offeror does not have standing to assert a claim for damages against a successful competing tender offeror or target company for false and misleading statements.
This holding blunts the remedial effect of the anti-fraud provision.
State Regulation: Constitutionality of State Regulation
States have also enacted tender offer legislation often designed to protect local companies from outside take-over.
Edgar v. Mite Corp. (1982)
The U.S. Supreme Court has struck down legislation designed to protect local companies from outside take-over when the statute purported to regulate all tender offers:
Made to target shareholders who were residents of the state, or
Involving target companies incorporated or doing business in the state.
Indiana Control Share Statute
Applies only to target corporations that are incorporated in and have significant business or shareholder contacts with Indiana.
Control Share Acquisition: Disenfranchisement
Does not regulate tender offers directly but rather indirectly by disenfranchising shares acquired by any control share acquisition.
Control Share Acquisition: Any acquisition of shares that would give the purchaser voting power crossing one of 3 statutory thresholds (20%, 30%, or 50%).
Restoration of Purchaser’s Voting Rights
The purchaser’s voting rights with respect to such control shares can be restored only with the approval of the target corporation’s disinterested shareholders.
Example: If P acquires 60% of the target’s stock in a tender offer, then P cannot exercise control unless P’s voting rights are restored by a majority vote of the remaining 40% minority shareholders.
CTS Corp v. Dynamics Corp
Holding: The U.S. Supreme Court found that Indiana’s Control Share Acquisitions Act was neither an undue burden on interstate commerce nor preempted by the Williams Act.
Florida’s Control Share Acquisition Statute
Florida has adopted a control share acquisition statute nearly identical to the Indiana statute.
The statute applies to any issuing public corporation.
Issuing Public Corporation Defined
A target corporation having:
100 or more shareholders
Its principal place of business or office, or substantial assets in Florida, AND
Either 1,000 shareholders or more or more than 10% of its shareholders resident in Florida.
Control Share Acquisition Statute: Comment
The control share statute provides that a shareholder who acquires beneficial ownership of a company’s shares more than a specified percentage of the company’s total outstanding shares has no voting rights with respect to such excess shares.
The shareholder cannot vote those shares unless voting rights are affirmatively approved by other shareholders of the company.
Purports to give shareholders a greater say in the takeover.
Control Shares Defined
Control shares are shares that would give a person voting power crossing one of the following 3 statutory thresholds:
1/5 or more (but less than 1/3) of all voting power
1/3 or more (but less than a majority) of all voting power, OR
A majority or more of all voting power.
Once a threshold is reached, the shareholder has no voting rights with respect to shares acquired in excess of that threshold (control shares) until approved by other shareholders.
That process would apply again at each enumerated threshold level.
Reinstatement of Voting Rights
Voting rights are restored only to the extent approved by disinterested shareholders (which excludes the bidder).
Alternatively, the bidder’s shares will have voting rights if the acquisition is approved by the target company’s board of directors.
Opting Out
A corporation may elect to opt out of the control share acquisition statute by charter or bylaw amendment adopted before the control share acquisition.
The acquirer cannot avoid the statute by adopting such an amendment after acquiring control shares.
Florida’s Affiliated Transactions Statute
To protect shareholders from the dilemma posed by the so-called 2-tier, front-end-loaded tender offer, Florida adopted an affiliated transaction statute.
The statute does not apply to any corporation with fewer than 300 shareholders.
2-Tier Front-End Loaded Tender Example
Front-end cash tender offer for 51% of the stock at a price of $65 per share.
Followed by a take-out merger for the remaining 49% at a price of $45 per share.
Affiliated Transaction Defined
A significant transaction (e.g., merger, sale of more than 10% of assets, issuance of an additional 10% of stock, or dissolution) with an interested shareholder who beneficially owns more than 15% of the corporation’s outstanding shares.
Approval
In addition to the approval generally required by law or corporate charter, the affiliated transaction must be approved by:
A majority of the corporation’s disinterested directors (defined as incumbent directors, excluding any elected subsequently by interested shareholders), OR
2/3 of the remaining disinterested shareholders.
Approval Example
A merger with an interested shareholder following a hostile tender offer must be approved by a 2/3 vote of the minority shareholders, in addition to a majority vote of all shareholders (including the interested shareholder).
Approval Exceptions
The special approval required for affiliated transactions can be avoided if:
Fair Price
3-Year Holding Period, or
90% Stake
Fair Price
The consideration paid to the remaining minority shareholders in the affiliated transaction meets fairness standards set forth in the statute.
At a minimum, the price paid to the remaining shareholders must be at least as high as the highest price the interested shareholder paid for any shares acquired within the previous 2 years.
Fair Price Comment
The fair price exception is the essence of the affiliated transaction statute because it provides a strong incentive for hostile bidders to pay a fair price at the back end of any acquisition (as this is the only practical way to avoid the special 2/3 vote of disinterested shareholders).
The affiliated transactions statute is designed to assure that squeezed-out shareholders receive a fair price for their shares.
3-Year Holding Period
The interested shareholder has owned 80% of the corporation’s outstanding shares for at least 3 years before the public announcement of the affiliated transaction.
90% Stake
The interested shareholder owns more than 90% of all outstanding shares before the affiliated transaction occurs.
Opting Out
A corporation may elect to opt out of the affiliated transaction provision by charter or bylaw approved by a majority vote of disinterested shareholders.
The amendment is not effective, however, for 18 months and does not apply thereafter to any shareholder who becomes interested prior to the effective date of the amendment.
Relationship Between Statutes
The control share statute addresses the initial accumulation of voting power at the moment of acquisition.
The affiliated transaction statute regulates subsequent business dealings (e.g., mergers, asset sales, share issuances) after someone becomes an interested shareholder.
2-Stage Defense System
The control share statute makes it harder for someone to acquire voting control quickly.
Then, if they do acquire a significant stake, the affiliated transaction statute makes it harder for them to exploit that position through unfair deals.
The outer wall (control share) makes it difficult to enter.
The inner wall (affiliated transaction) limits what you can do even if you get past the first defense.
Proxy Contest
An acquiring corporation attempts to persuade the shareholders of the target corporation to use proxy votes to install new management or take other types of corporate action.
The acquiring corporation seeks to have its own candidates installed on the board of directors.
By installing friendly candidates on the board of directors, the acquiring corporation can now make desired changes at the target corporation.
Solicitation of Shareholder Proxies
The acquiring firm can appeal to shareholders by soliciting their proxies to oust the incumbent board and install the acquirer’s proposed slate of directors.
The acquirer firm must convince the target firm’s shareholders that the company would be better off with a new set of directors.
Proxy contests are a costly and uncertain undertaking.
Federal Regulation of Proxy Solicitation
The solicitation of proxies from shareholders is highly regulated by federal proxy rules promulgated by the SEC pursuant to its authority under Section 14 of the Securities Exchange Act of 1934.
Solicitation Procedure
Notice of Shareholder Meeting
Proxy Statement Preparation
Solicitation
Shareholder Meeting
Notice of Shareholder Meeting
While activist shareholders can solicit proxies for the company’s annual meeting, many contested proxy contests culminate at a special shareholder meeting.
Procedures for calling a special shareholder meeting and establishing matters that can be brought before the meeting are typically governed by the company’s constituent documents and applicable state law.
Proxy Statement Preparation
Once a shareholder meeting has been called and proposals for that meeting established, the shareholder must prepare a proxy statement and obtain SEC approval before the actual solicitation of shareholder votes can begin.
Solicitation of Proxies
In accordance with SEC rules, shareholders engaged in a proxy contest can publicly disclose certain information relating to their solicitation in advance of the final proxy statement.
However, only after the final proxy statement has been approved by the SEC and sent to each shareholder of the company can actual proxies be solicited.
Shareholder Meeting
Following the solicitation of votes, proxies granted by other shareholders of the company are finally cast at the shareholder meeting.
Although the outcome of the solicitation is typically known by the time of the meeting, official results will usually be determined by an independent examiner agreed to by the shareholder and company.
Market for Corporate Control
Shareholders in publicly-traded corporations are provided protection through 4 principal mechanisms:
Contract
Corporate Governance
Market for Corporate Control
Wall Street Walk (Selling)
Market for Corporate Control Defined
The market for the right to control the management of corporate resources.
Corporate control includes the power to hire, fire, and compensate top-level decision managers and to ratify and monitor important decisions.
Competing Views of Market for Corporate Control
Reduces Agency Costs: Solves the agency cost problem between shareholders and management.
Asset-Stripping: Allows corporate raiders to engage in asset stripping.
Potential Gains: Target’s Profit Potential
A lower stock price (relative to more efficient management) makes a takeover more attractive to those acquirers who believe that they can manage the company more efficiently.
The potential return from a successful takeover and revitalization of a poorly run company can be enormous.
Acquirers can be expected to target firms that perform poorly.
Disciplining Mechanism: Threat of Job Loss
Current management will almost certainly be replaced by the acquirer after the takeover.
To prevent the loss of a job, management will exert optimal effort to keep the stock price high.
In this way, the market for corporate control reduces agency costs by facilitating greater accountability of directors to their investors.
The takeover market serves as an important source of protection for investors from opportunistic managerial behavior.
Empirical Facts
The typical target company in a hostile takeover has:
A return on equity almost 5% lower than its peer group.
Stock that has significantly underperformed its peer group over the previous 2 years.
The best defense against a hostile takeover is to run the firm well and earn good returns for shareholders.
Who do you protect when you limit hostile takeovers? A well-run firm? A poorly-run firm?
Antitakeover Provisions: Defensive Tactics
A company that does not want to become the target of an unsolicited hostile takeover can adopt defensive mechanisms to defeat the attempted hostile takeover.
Common antitakeover protections include:
Shareholder rights plans (i.e., poison pills)
Dual-class shares
Staggered boards
Restricted rights to call a special meeting
Terminology of Takeover Defenses
Crown Jewel: When threatened with a takeover, management makes the company less attractive to the raider by selling the company's most valuable asset (the