Corporate takeovers:

a governance mechanism?

Corporate Governance

Brief overview of M&A

A merger is often viewed as a combination of
2 firms and an acquisition is viewed as one
firm buying another. However, all mergers are
essentially acquisitions
Purchase method of accounting (vs. pooling)

Takeovers can be synergistic, disciplinary or

both
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The acquirers goals

To takeover the target firm
To make the target firm profitable by
Cutting the target firms fixed or variable costs

Improving its operational efficiency

Getting rid of its bad managers

The target firm

Target firm is the firm to be acquired
An acquiring firm may want to acquire a target
firm because it believes the target firm:
is not performing up to its full potential

the target firm could become a better performer

under someone elses control

Therefore, target firms usually enjoy a share

price increase when its acquisition is announced
to the public
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Synergistic M&A / Takeovers

To improve operational or financial synergies
e.g., Exxon and Mobil
To diversify by expanding into new businesses
e.g., the AOL and Time Warner
Many of the recent mergers have occurred for
growth and for increased market power
e.g., Oracle and PeopleSoft, HP and Compaq
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Disciplinary takeovers
Some firms that get taken over are poorly
performing firms

The fear of a potential takeover might represent

a powerful disciplinary mechanism to make sure
that:
Managers perform to the best of their abilities
Managerial discretion is controlled

Other

Finland

Czech Republic

China

South Korea

Australia

Switzerland

Bulgaria

Belgium

Sweden

Spain

Japan

Ireland

Italy

Bermuda

Canada

Netherlands

Germany

France

United Kingdom

United States

Percent of Total Deal Value

International merger activity

50%

45%

40%

35%

30%

25%

20%

15%

10%

5%

0%

U.S. and U.S. Cross-Border M&A Activity

Transactions
$1,600

12,000

$1,400
Deal Value

10,000

Number of Deals

8,000

$1,200

$800

6,000

$600
4,000
$400
2,000
$200
$0

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

1985

1984

1983

1982

1981

1980

Billions

$1,000

Takeover waves: triggers, performance and

motives - Martynova and Renneboog
There have been 5 obvious waves of takeover
activity (the last one in the 90s)
Takeovers usually occur in periods of economic
recovery
The takeover market is also fuelled by regulatory changes
and its frequently driven by industrial shocks
At their announcement, they trigger substantial increases in
value, but most of these gains are captured by the targets
shareholders
Over the first 5 years after the takeover, there is a decline in
the share prices of the acquiring firm
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Who gains ? (Cai and Vijh 07)

Targets shareholders gain 23.8% (on average)
from announcement to completion
Acquirers shareholders lose 3.8%
Combined shareholders gain 1.9%

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Are takeovers an effective governance

mechanism?
It is not clear whether takeovers are an
effective governance mechanism because:
An acquirer may have to pay too much for a target
Takeovers could occur for the wrong reasons (e.g.,
empire building).

Even if the acquirer is able to pay a fair price for a

target, the amount usually is still significant

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Takeover defenses
There are two categories of takeover defenses
Firm-level defenses

Pre-emptive defenses
Reactionary defenses

Governmental or state-level defenses: laws that

regulate and limit takeovers

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Firm-level pre-emptive takeover defenses

Poison pill: any strategy that makes a target firm less
attractive immediately after it is taken over
A golden parachute: an automatic payment made to
managers if their firms gets taken over
Supermajority rules: two-thirds, or even 90 percent, of
the shareholders have to approve a hand-over in
control
Staggered boards: only a fraction of the board can get
elected each year to multiple-year terms.

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Example of a poison pill: Pernod

Pernod Ricard asked its shareholders to
approve the a poison pill
Investors will vote on a resolution authorizing the
board to issue warrants convertible to shares at a
discounted price in the event of an unsolicited
takeover approach
This would drastically inflate the purchase price for any
suitor making an offer for the company without first
winning over the firms directors

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The return of the poison pill

CFO.com 2008
Triggered by the current economic decline
(value is less of a defense), smaller companies
are displaying a renewed taste for deploying
poison pills as a defense against takeovers
Until Sep, in 2008, 40 US companies had adopted
new poison pills for the first time
In all of 2007, 42 companies adopted poison pills

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Firm-level reactionary takeover defenses

Reactionary defenses include:
The firms management trying to convince its
shareholders that the offer price is too low
Raise antitrust issues
Find another acquirer who might not fire
management after the takeover
Find an investor to buy enough shares so that
he/she can have sufficient power to block the
acquisition.
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Governmental Acts
US - The Bureau of Competition and the
Antitrust Division of the DoJ uphold antitrust
policy

Europe European Commissions antitrust

regulations and national laws
Merger approved by the EC (7/Mar/2011): Steinhoff
(South Africa) acquired Conforama (France)

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Integrating CG systems from

different countries
In a cross-border M&A the nationality of the
target firm may change
This affects the CG system of the new entity
E.g.: 2002 merger between Hoescht (Germany) and RhnePoulec (France) resulted in Aventis (now part of SanofiAventis)
Both firms required a deposit of shares within 5 and 7 days prior to
merger
After the merger, Aventis required such a deposit for only 3 days

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A classic
Corporate governance and equity
prices
By Paul A. Gompers, Joy L. Ishii, Andrew Matrick (2003)

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 Works Methodology:

Governance Index
Long horizon approach
About 1500 firms during the 90s

Works aim:

Try to find the empirycal relationship between corporate

governance and corporate performance, analyzing firms
anti-takeover measures

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 Corporations as republics

Democracy

Little power for management

Strong shareholder rights

Dictatorship

Big power for management

Weak shareholder rights

CG measured by corporate takeover defenses

and anti-takeover laws

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 24 Corporate Governance Provisions

5 subindex:

Delay (4): tactics for delaying hostile bidders

Voting (6): voting rights
Protection (6): director/officer protection
Other (6): other takeover defenses
State (6): anti-takeover state laws

Index construction (G-score):

Add one point for every provision that
restricts shareholder rights (or increases
managerial power)
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23

Governance and Returns

If information about corporate governance is quickly incorporated by the

market, stock price should quickly adjust to any relevant change;
If the information is not immediately incorporated into the stock price: the
realized returns on the stock would differ systematically.

Consider the period from September 1, 1990 to December 31, 1999:

1$ invested in the Dictatorship portfolio would have grown to $3,39
1$ invested in the Democracy Portfolio would have grown to $7,07

The democracy portfolio outperformed the dictatorship portfolio by a

statistically significant 8.5%/year

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 Governance and the value of the firm

Analyze whether there was a change in the governance/value relationship during

1990s.
Statistical results:

1999:
1990:

+ 1 point G
+ 1 point G

-11,4 % value for Q

-2,2 % value for Q

Firms with the weakest shareholder rights significantly

underperformed firms with strongest shareholder rights
These differences have been partially reflected in prices

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What matters in Corporate Governance? Bebchuk et al. (09)

Investigates the relative importance of the 24
provisions in Gompers et al. (03)
Creates an entrenchment index with 6 provisions:
staggered boards, limits to shareholder bylaw
ammendments, poison pills, golden parachutes,
and supermajority requirements for mergers and
charter amendments
Find that the other 18 measures are uncorrelated with either
reduced firm valuation or negative abnormal returns

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Corporate takeovers:
a governance mechanism?

Corporate Governance

27