Hostile Takeovers

Friendly Takeovers

• 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 collaborates with the acquiring company to implement the takeover proposal.

Hostile Takeovers

• A hostile takeover occurs when an acquiring corporation attempts to take over a target corporation without the agreement of the target corporation's board of directors.
• Directors can implement defensive measures to defeat an attempted hostile takeover.

Types of Hostile Takeovers

• Tender Offer (Stock Acquisition)
• Proxy Contest

Tender Offers

• A tender offer is a public offer by an acquiring company to all stockholders of a publicly-traded target corporation to tender their stock for sale at a specified price during a specified time.
• This is 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.
• Example: If a target corporation’s stock is trading at $50$ per share, the acquiring company might offer $55$ per share to shareholders of the target company, conditional on $51\%$ of shareholders agreeing.

Two-Tier Tender Offer

• Involves a two-step acquisition process.
  • Step 1: The acquirer makes a 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

• The 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 (second step) to squeeze out minority shareholders and convert their shares for consideration offered by the merger subsidiary.
• The target company becomes 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 a shareholder who tenders still receives $105$. * If more than $50\%$ of shareholders tender (tender succeeds), then a shareholder who tenders receives: $105 \times (50/X) + 90 \times [(X - 50)/X] = 90 + 15 \times (50/X)$, 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 a shareholder who does not tender receives the pre-tender price of $100$.
• If more than $50\%$ of shareholders tender (tender succeeds), then a 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.
• Nonetheless, tendering to a front-loaded, two-tiered tender offer is the dominant strategy.

Dominant Strategy

• The matrix illustrates the payouts based on whether a shareholder tenders or does not tender, depending on whether less than or more than 50% of shareholders tender.
• Tendering is the 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 by using 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.

Williams Act

• Background: Cash tender offers were not regulated (tender offers involving the exchange of securities were subject to 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 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 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 an 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 the target company for false and misleading statements.
• This holding blunts the remedial effect of the anti-fraud provision.

State Regulation: Constitutionality

• States have enacted tender offer legislation often designed to protect local companies from outside take-over.

Edgar v. Mite Corp. (1982)

• The U.S. Supreme Court 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 three statutory thresholds ($20\%$, $30\%$, or $50\%$.)

Restoration of 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 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 the voting rights are affirmatively approved by other shareholders of the company.
• Purports to give shareholders a greater say in a takeover.

Control Shares Defined

• Control shares are shares that would give a person voting power crossing one of the following three statutory thresholds:
  • $\frac{1}{5}$ or more (but less than $\frac{1}{3}$) of all voting power
  • $\frac{1}{3}$ 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, a 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 so-called 2-tier, front-end loaded tender offers, Florida adopted the affiliated transaction statute.
• The statute does not apply to any corporation with fewer than 300 shareholders.

2-Tier Front-End Loaded Tender Example

• A 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, an 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
  • $\frac{2}{3}$ of the remaining disinterested shareholders.

Approval Example

• A merger with an interested shareholder following a hostile tender offer must be approved by a $\frac{2}{3}$ vote of the minority shareholders, in addition to the 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 $\frac{2}{3}$ 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.

Statutes Compared

• 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 shareholders of the target corporation to use their 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.

Proxy Solicitation

• 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 costly and uncertain undertakings.

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 the company.

Shareholder Protection

• 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

• 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 the 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.
• The acquirer 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 a takeover.
• To prevent the loss of their 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.
• Question: 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 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