lecture on takeover defense

7/31/2019 Lecture on Takeover Defense

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TYPES OF TAKEOVER

FRIENDLY TAKEOVER

HOSTILE TAKEOVER THROUGH TENDER OFFER

HOSTILE TAKEOVER THROUGH PROXY FIGHT

HOSTILE TAKEOVER ATTEMPT TO FORCE THEISSUE OF MISMANAGEMNT FOR POTENTIALPUBLIC & LEGAL SCRUTINY

REVERSE TAKEOVER

REVERSE TAKEOVER UNDER AIM RULES BACK FLIP TAKEOVER

N L STRATEGY FOR TAKEOVER


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PROLIFERATION OF TECHNIQUES

IN TAKEOVER DEFENSE

POST 1980S SHOWED INCREASING ROLE OF

INVESTMENT BANKERS & SOLICITER FIRMS AS

ADVISORY ROLE IN M&A DEALS

FOR DOMESTIC AS WELL AS CROSS BORDER

DEALS INNOVATIVE FINANCIAL CLOSURE

PACKAGES WERE EVOLVED

WITH A SPATE OF M&A BIDS THERE WERE

ALSO PROLIFERATION OF TAKEOVER DEFENSES


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TAKEOVER DEFENSE

BACK-END

BANKMAIL

CROWN JEWEL DEFENSE

FLIP-IN

FLIP-OVER

GOLDEN PARACHUTE GRAY KNIGHT

GREENMAIL

JONESTOWN DEFENSE

KILLER BEES

LEVERAGED RECAPITALIZATION

LOBSTER TRAP LOCK-UP PROVISION

NANCY REAGAN DEFENSE

NON-VOTING STOCK

PAC-MAN DEFENSE

Pension parachute

People Pill

Poison pill

Safe Harbor

Scorched-earth defense

Shark Repellent Staggered board of directors

Standstill agreement

Targeted repurchase

Top-ups

Treasury stock

Trigger Voting plans

White knight

White squire

Whitemail

SOURCE: WIKIPAEDIA
http://en.wikipedia.org/wiki/Back-endhttp://en.wikipedia.org/wiki/Bankmailhttp://en.wikipedia.org/wiki/Crown_Jewel_Defensehttp://en.wikipedia.org/wiki/Flip-inhttp://en.wikipedia.org/wiki/Flip-overhttp://en.wikipedia.org/wiki/Golden_Parachutehttp://en.wikipedia.org/wiki/White_knight_(business)http://en.wikipedia.org/wiki/Greenmailhttp://en.wikipedia.org/wiki/Jonestown_Defensehttp://en.wikipedia.org/wiki/Killer_bees_(business)http://en.wikipedia.org/wiki/Leveraged_recapitalizationhttp://en.wikipedia.org/wiki/Lobster_trap_(finance)http://en.wikipedia.org/wiki/Lock-up_provisionhttp://en.wikipedia.org/wiki/Nancy_Reagan_Defensehttp://en.wikipedia.org/wiki/Non-voting_stockhttp://en.wikipedia.org/wiki/Pac-Man_Defensehttp://en.wikipedia.org/wiki/Pension_parachutehttp://en.wikipedia.org/wiki/People_Pillhttp://en.wikipedia.org/wiki/Poison_pillhttp://en.wikipedia.org/wiki/Safe_Harborhttp://en.wikipedia.org/wiki/Scorched-earth_defensehttp://en.wikipedia.org/wiki/Shark_Repellenthttp://en.wikipedia.org/wiki/Staggered_board_of_directorshttp://en.wikipedia.org/wiki/Standstill_agreementhttp://en.wikipedia.org/wiki/Targeted_repurchasehttp://en.wikipedia.org/wiki/Top-upshttp://en.wikipedia.org/wiki/Treasury_stockhttp://en.wikipedia.org/wiki/Voting_planhttp://en.wikipedia.org/wiki/White_knight_(business)http://en.wikipedia.org/wiki/White_Squirehttp://en.wikipedia.org/wiki/Whitemailhttp://en.wikipedia.org/wiki/Whitemailhttp://en.wikipedia.org/wiki/White_Squirehttp://en.wikipedia.org/wiki/White_knight_(business)http://en.wikipedia.org/wiki/Voting_planhttp://en.wikipedia.org/wiki/Treasury_stockhttp://en.wikipedia.org/wiki/Top-upshttp://en.wikipedia.org/wiki/Top-upshttp://en.wikipedia.org/wiki/Top-upshttp://en.wikipedia.org/wiki/Targeted_repurchasehttp://en.wikipedia.org/wiki/Standstill_agreementhttp://en.wikipedia.org/wiki/Staggered_board_of_directorshttp://en.wikipedia.org/wiki/Shark_Repellenthttp://en.wikipedia.org/wiki/Scorched-earth_defensehttp://en.wikipedia.org/wiki/Scorched-earth_defensehttp://en.wikipedia.org/wiki/Scorched-earth_defensehttp://en.wikipedia.org/wiki/Safe_Harborhttp://en.wikipedia.org/wiki/Poison_pillhttp://en.wikipedia.org/wiki/People_Pillhttp://en.wikipedia.org/wiki/Pension_parachutehttp://en.wikipedia.org/wiki/Pac-Man_Defensehttp://en.wikipedia.org/wiki/Pac-Man_Defensehttp://en.wikipedia.org/wiki/Pac-Man_Defensehttp://en.wikipedia.org/wiki/Non-voting_stockhttp://en.wikipedia.org/wiki/Non-voting_stockhttp://en.wikipedia.org/wiki/Non-voting_stockhttp://en.wikipedia.org/wiki/Nancy_Reagan_Defensehttp://en.wikipedia.org/wiki/Lock-up_provisionhttp://en.wikipedia.org/wiki/Lock-up_provisionhttp://en.wikipedia.org/wiki/Lock-up_provisionhttp://en.wikipedia.org/wiki/Lobster_trap_(finance)http://en.wikipedia.org/wiki/Leveraged_recapitalizationhttp://en.wikipedia.org/wiki/Killer_bees_(business)http://en.wikipedia.org/wiki/Jonestown_Defensehttp://en.wikipedia.org/wiki/Greenmailhttp://en.wikipedia.org/wiki/White_knight_(business)http://en.wikipedia.org/wiki/Golden_Parachutehttp://en.wikipedia.org/wiki/Flip-overhttp://en.wikipedia.org/wiki/Flip-overhttp://en.wikipedia.org/wiki/Flip-overhttp://en.wikipedia.org/wiki/Flip-inhttp://en.wikipedia.org/wiki/Flip-inhttp://en.wikipedia.org/wiki/Flip-inhttp://en.wikipedia.org/wiki/Crown_Jewel_Defensehttp://en.wikipedia.org/wiki/Bankmailhttp://en.wikipedia.org/wiki/Back-endhttp://en.wikipedia.org/wiki/Back-endhttp://en.wikipedia.org/wiki/Back-end


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POISON PILL : A MEASURE OF

TAKEOVER DEFENSE

DEFINITION: CREATION OF SECURITIES CARRYING SPECIAL

RIGHTS EXERCISABLE BY TRIGGERING EVENT SUCH AS

ACCUMULATION OF SPECIFIED PERCENTAGE OF TARGET

SHARES OR ANNOUNCEMENT OF TENDER OFFER

MAKE ACQUISITION OF TARGET FIRM MORE COSTLY

ADOPTED BY BOARD WITHOUT SHAREHOLDERS' APPROVAL

POISON PILL ADOPTIONS OFTEN SUBMITTED FOR

SHAREHOLDERS RATIFICATION THOUGH NOT REQUIRED

USE OF POISON PILLS ARE OFTEN CHALLENGED IN COURTS

ADOPTION OF POISON PILLS IN THE BEST INTEREST OF

SHAREHOLDERS :"BUSINESS JUDGMENT RULE"


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POISON PILL : A MEASURE OF

TAKEOVER DEFENSE

BACK-END RIGHTS PLAN

OWNERSHIP FLIP-IN PLAN

FLIPOVER RIGHTS PLAN PREFERRED STOCK PLAN

VOTING PLAN

A DEAD HAND PROVISION
http://en.wikipedia.org/wiki/Front-end_and_back-endhttp://en.wikipedia.org/wiki/Flip-inhttp://en.wikipedia.org/wiki/Flipoverhttp://en.wikipedia.org/wiki/Preferred_stockhttp://en.wikipedia.org/wiki/Voting_planhttp://en.wikipedia.org/wiki/Voting_planhttp://en.wikipedia.org/wiki/Preferred_stockhttp://en.wikipedia.org/wiki/Flipoverhttp://en.wikipedia.org/wiki/Flip-inhttp://en.wikipedia.org/wiki/Flip-inhttp://en.wikipedia.org/wiki/Flip-inhttp://en.wikipedia.org/wiki/Front-end_and_back-endhttp://en.wikipedia.org/wiki/Front-end_and_back-endhttp://en.wikipedia.org/wiki/Front-end_and_back-endhttp://en.wikipedia.org/wiki/Front-end_and_back-end


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POISON PUTS

DEFINITION: POISON PUTS OR EVENT RISKCOVENANTS GIVE BONDHOLDERS RIGHT TO PUT,AT PAR OR BETTER, TARGET BONDS IN EVENT OFCHANGE IN CONTROL PROTECT AGAINST RISK OF TAKEOVER-RELATED

DETERIORATION OF TARGET BONDS

ESPECIALLY WHEN LEVERAGE INCREASES ARESUBSTANTIAL

BEGAN TO BE INCLUDED IN BOND COVENANTSIN 1986

PLACE POTENTIALLY LARGE CASH DEMANDS ON NEWOWNER, RAISING COSTS OF ACQUISITION


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EFFECTS OF POISON PUTS

ENTRENCHMENT HYPOTHESIS : PUTS MADE FIRMS LESS ATTRACTIVEAS TAKEOVER TARGETS WITH NEGATIVE EFFECT ON SHAREHOLDER

RETURNS NO EFFECT ON DEBT-HOLDER RETURNS

BONDHOLDER PROTECTION HYPOTHESIS : PUTS PROTECT

BONDHOLDERS FROM WEALTH TRANSFERS ASSOCIATED WITH DEBT-

FINANCED TAKEOVERS AND LEVERAGED RECAPITALIZATIONS MUTUAL INTERESTS HYPOTHESIS : BOTH MANAGERS AND

BONDHOLDERS SEEK TO PREVENT HOSTILE DEBT-FINANCED

TAKEOVERS MANAGERS SEEK TO PROTECT THEIR CONTROL POSITIONS

BONDHOLDERS SEEK TO AVOID LOSSES FROM DETERIORATION IN

CREDIT RATINGS EFFECTS ON DEBT & EQUITY : STOCK PRICE REACTIONS WOULD BE

NEGATIVE EFFECTS ON PRICE OF EXISTING DEBT WOULD BE POSITIVE

WEALTH EFFECTS FOR DEBT AND EQUITY WOULD BE NEGATIVELY

CORRELATED


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COMMENT AND SCHWERT (1995)

EFFECTS OF POISON PILLS ON

SHAREHOLDER RETURNS

SAMPLE OF ENTIRE POPULATION OF 1,577 POISON PILLS ADOPTED

1983 TO 1991

WEALTH EFFECTS OF POISON PILL ADOPTION ARE DIVERSE:

MAY BE VIEWED AS SIGNAL FOR INCREASED PROBABILITY OF

TAKEOVER :POSITIVE INFLUENCE ON RETURNS MAY ENABLE MANAGERS TO OBTAIN BETTER NEGOTIATED

PRICE : POSITIVE INFLUENCE ON RETURNS

MAY DETER TAKEOVERS : NEGATIVE INFLUENCE ON RETURNS

WHETHER RUMORS OF BID /ACTUAL BID MADE IT LIKELY THAT

CONTROL PREMIUM WAS BUILT INTO ISSUER'S STOCK PRICE

DURING POISON PILL ANNOUNCEMENT: WEALTH EFFECT

NEGATIVE 2% .M&A NEWS ANNOUNCED SAME TIME AS PILL:

WEALTH EFFECT POSITIVE 3 4%


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EFFECTS OF POISON PILLS ON SHAREHOLDER

RETURNS

SYSTEMATIC EVIDENCE INDICATES SMALL DETERRENCE

EFFECTS FROM POISON PILLS

ONLY EARLIEST PILLS (BEFORE 1985) ASSOCIATED WITH LARGE

DECLINES IN SHAREHOLDERS' WEALTH

TAKEOVER PREMIUMS HIGHER WHEN TARGET FIRMS ARE

PROTECTED BY STATE ANTITAKEOVER LAWS OR BY POISON

PILLS

TARGET SHAREHOLDERS GAINED EVEN AFTER TAKING INTO

ACCOUNT DEALS THAT WERE NOT COMPLETED BECAUSE OF

POISON PILLS

DECLINE IN TAKEOVER ACTIVITY IN 1991 AND 1992 RESULTED

FROM GENERAL ECONOMIC FACTORS, NOT WIDESPREAD USE

OF ANTITAKEOVER MEASURES


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TAKEOVER DEFENSE

BANKMAIL

CROWN JEWEL DEFENSE

PAC-MAN DEFENSE

SCORCHED-EARTH DEFENSE

GOLDEN PARACHUTE


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TAKEOVER DEFENSE(CONTD)

WHITE KNIGHT

WHITE SQUIRE

GREEN MAIL JONESTOWN DEFENSE OR SUICIDE PILL

KILLER BEES

LEVERAGED RECAPITALIZAION LOBSTER TRAP


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NANCY REGAN DEFENSE

ISSUANCE OF NONVOTING STOCK

PENSION PARACHUTE

PEOPLE PILL

SAFE HARBOR


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CLASSIFIED BOARDS WITH STAGGERED

ELECTIONS

STANDSTILL AGREEMENT

TARGETED REPURCHASE

TOP UP OTHER ANTI TAKEOVER MEASURES


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LOCK UP PROVISION : A TAKEOVER

DEFENSE

BREAK-UP/TERMINATION FEES,

OPTIONS GIVEN TO TARGET SHAREHOLDERS TO BUYTARGET STOCK,

RIGHTS GIVEN TO TARGET SHAREHOLDERS TOPURCHASE TARGET ASSETS,

FORCE THE VOTE PROVISIONS IN MERGERAGREEMENTS, AND

AGREEMENTS WITH MAJOR SHAREHOLDERS (VOTINGAGREEMENTS, AGREEMENTS TO SELL SHARES ORAGREEMENTS TO TENDER).


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ANTITAKEOVER AMENDMENTS

ANTITAKEOVER AMENDMENTS TO FIRM'SCORPORATE CHARTER GENERALLY IMPOSE NEWCONDITIONS ON TRANSFER OF MANAGERIALCONTROL OF FIRM CALLED "SHARK

REPELLENTS"

95% OF PROPOSED ANTITAKEOVERAMENDMENTS ARE RATIFIED

MANAGEMENT INTRODUCES AMENDMENTS THAT ITFEELS ARE SURE OF SUCCESS

FAILURE TO PASS MIGHT BE TAKEN AS VOTE OF NOCONFIDENCE


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SHARK REPELLANTS STRATEGY

AGAINST HOSTILE TAKE OVER BIDS GRANT CURRENT SHAREHOLDERS THE RIGHT TO

SELL THEIR SHARES TO THE ACQUIRER AT AN

INCREASED PRICE (USUALLY 100%) IF ACQUIRER'S

SHARE REACHES ONE THIRD

SPECIAL CLAUSE IN CONTRACT WITH CUSTOMERS

ABNORMALLY INCREASE THE DEBT LOAD

THE TARGET COMPANY BUYS SMALLER COMPANIES

USING STOCK SWAP, DILUTING ITS STOCK VALUE

GRANT EMPLOYEES STOCK OPTIONS WHICH VESTS

IMMEDIATELY UPON TAKEOVER.
http://en.wikipedia.org/wiki/Stock_swaphttp://en.wikipedia.org/wiki/Stock_optionshttp://en.wikipedia.org/wiki/Stock_optionshttp://en.wikipedia.org/wiki/Stock_swap


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SHARK REPELLANTS STRATEGY AGAINST

HOSTILE TAKE OVER BIDS(CONTD)

SUPERMAJORITY AMENDMENTS REQUIRE SHAREHOLDER APPROVAL BY AT LEAST TWO-THIRDS VOTE

(SOMETIMES AS MUCH AS 90%) FOR ALL TRANSACTIONS INVOLVINGCHANGE IN CONTROL

INVOLVE "BOARD-OUT" CLAUSE THAT GIVES BOARD POWER TODETERMINE WHEN AND IF SUPERMAJORITY PROVISIONS WILL BE INEFFECT

FAIR-PRICE AMENDMENTS

SUPERMAJORITY PROVISIONS WITH BOARD-OUT CLAUSE ANDADDITIONAL CLAUSE WAIVING SUPERMAJORITY REQUIREMENT IFFAIR PRICE IS PAID BY BIDDER FOR ALL PURCHASED SHARES

FAIR PRICE HIGHEST MARKET PRICE OF TARGET DURING A PASTSPECIFIED PERIOD

DEFEND AGAINST TWO-TIER TENDER OFFERS

LEAST RESTRICTIVE AMONG CLASS OF SUPERMAJORITYAMENDMENTS


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DUTY OF BOARD OF DIRECTORS IN THE

EVENT OF TAKEOVER BIDS

BUSINESS JUDGMENT RULE: DIRECTORS MUST

DEMONSTRATE TO THE COURTS THAT THE BEST INTERESTS OF

SHAREHOLDERS HAVE BEEN SERVED

DUTY OF DIRECTORS TO DEMONSTRATE SOUND BUSINESS

REASONS TO REJECT OFFER

DUTY OF DIRECTORS TO APPROVE ONLY A TRANSACTION

THAT IS FAIR TO SHAREHOLDERS AND IS BEST TRANSACTION

AVAILABLE

DUTY OF DIRECTORS TO FULLY EXPLORE INDEPENDENT

COMPETITIVE BIDS AND OBTAIN BEST OFFER

FAIRNESS OPINION FROM AN INVESTMENT BANKING FIRM

NOT SUFFICIENT


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STUDIES ON ADOPTION OF ANTI TAKEOVER

AMMENDMENTS IN COMPANY CHARTER

BRICKLEY, LEASE, AND SMITH (1988)

INSTITUTIONAL SHAREHOLDERS (BANKS, INSURANCE COMPANIES)MORE LIKELY TO VOTE WITH MANAGEMENT ON ANTITAKEOVERAMENDMENTS AS THEY HAVE CONTINUING BUSINESSRELATIONSHIPS WITH MANAGEMENT

PENSION FUNDS, MUTUAL FUNDS, AND COLLEGE ENDOWMENTSMORE LIKELY TO BE INDEPENDENT

BLOCKHOLDERS PARTICIPATE MORE ACTIVELY IN VOTING THANNON-BLOCKHOLDERS AND MAY OPPOSE PROPOSALS THATAPPEAR TO HARM SHAREHOLDERS

JARRELL AND POULSEN (1987)

AMENDMENTS HAVING MOST NEGATIVE EFFECT ON STOCK PRICEARE ADOPTED BY FIRMS WITH LOWEST PERCENTAGE OFINSTITUTIONAL SHAREHOLDERS AND HIGHEST PERCENTAGE OFINSIDER HOLDINGS

BLOCKHOLDERS PLAY MONITORING ROLE INSTITUTIONALHOLDERS ARE WELL INFORMED AND VOTE IN ACCORDANCE WITHTHEIR ECONOMIC INTERESTS


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GARVEY AND HANKA (1999)

EFFECTS OF ANTITAKEOVER STATUTES ON FIRM LEVERAGE

FIRMS PROTECTED BY STATE ANTITAKEOVER STATUTES

SUBSTANTIALLY REDUCED DEBT RATIOS

RESULTS NOT INFLUENCED BY SIZE, INDUSTRY, OR

PROFITABILITY

WEAK EVIDENCE THAT PROTECTED MANAGERS UNDERTOOK

FEWER MAJOR RESTRUCTURING PROGRAMS

FIRMS EVENTUALLY COVERED BY ANTITAKEOVERLEGISLATION USED GREATER LEVERAGE IN YEARS

PRECEDING ADOPTION OF STATUTES


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JOHNSON AND RAO (1997)

COMPARED FINANCIAL ATTRIBUTES (BASED ONINCOME, EXPENSES, INVESTMENT, AND DEBT) BEFOREAND AFTER ANTITAKEOVER AMENDMENT ADOPTIONS

FOR FULL SAMPLE, FIRMS EXHIBITED NO SIGNIFICANTDIFFERENCES FROM INDUSTRY MEANS EXCEPT FORDECLINE IN NET INCOME TO TOTAL ASSETS RATIO

FAIR PRICE AMENDMENTS

FOR NON-FAIR PRICE SUBSAMPLE, NO SIGNIFICANTDIFFERENCES FROM INDUSTRY MEAN FOR ANY OF FINANCIALATTRIBUTES

FOR FAIR PRICE SUBSAMPLE, RESULTS SIMILAR TO THOSE OFFULL SAMPLE


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ANTITAKEOVER AMENDMENTS AND

SHAREHOLDER RETURNS

GENERAL PREDICTIONS POSITIVE RETURNS

ANNOUNCEMENT OF ANTITAKEOVER MEASURE SIGNALS INCREASED LIKELIHOOD OF TAKEOVER

DEANGELO AND RICE (1983) SHARK REPELLENTS MAY HELP SHAREHOLDERS RESPOND INUNISON TO TAKEOVER BIDS

NEGATIVE RETURNS ANTITAKEOVER AMENDMENTS REFLECT MANAGEMENT ENTRENCHMENT


DECLINE OF LESS THAN 1% FOR MOST TYPES OFANTITAKEOVER MEASURES

EMPIRICAL RESULTS DIFFICULT TO INTERPRET BECAUSE OF NUMBER OFINFLUENCES OPERATING CONCURRENTLY

ANTITAKEOVER AMENDMENT MAY HAVE BEEN ADOPTED TO HELP MANAGEMENTOBTAIN BETTER DEAL

ANNOUNCEMENT OF TAKEOVER MAY HAVE CONTAGION EFFECTS ON INDUSTRY POSITIVE RUNUP IN ABNORMAL RETURNS BECAUSE OF POSSIBILITY OF OTHER TAKEOVERS

ANNOUNCEMENT OF ANTITAKEOVER AMENDMENTS WITH TYPICAL 1% DECLINE INSHAREHOLDER WEALTH SHOULD BE NETTED AGAINST PRIOR POSITIVE RUNUP

1% DECLINE WOULD BE VIEWED AS REFLECTION OF REDUCED PROBABILITY OF TAKEOVERBEING COMPLETED

IF 20% IS TYPICAL RUNUP, SMALL NEGATIVE EVENT RETURNS FROM ANNOUNCEMENT OFANTITAKEOVER MEASURES WOULD HAVE LITTLE POWER TO DETER TAKEOVERS


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SHAREHOLDER ACTIVISM

Shareholders may seek to rescind antitakeover

devices

Shareholders become active when they are

concerned about managerial actions that mayimpede market for corporate control


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2001 Prentice Hall Takeovers,

Restructuring, and Corporate Governance,

3/e Weston - 24

- - - - - - - - Chapter 19 - - - - - - - -

Takeover Defenses


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3/e Weston - 25

Introduction

Not all mergers are welcome

Arsenals of devices were developed todefend against unwelcome proposals

during the 1980s


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3/e Weston - 26

Possible motivations for takeover defenses

Target is resisting to get a better price

Management of target judges that company

will perform better on its own

Management is seeking to entrench itself


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3/e Weston - 27

Strategic Perspectives

Management and board of company must

continuously reassess competitive

environment

All forms of M&A activities may impact firm

both as threats and opportunities

Main developments in industry

Opportunities for adding critical capabilities to

participate in attractive growth areas


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3/e Weston - 28

Opportunities for rolling-up fragmentedindustries into stronger firms

Likelihood of firm to be rolled-up

Improving or deteriorating sales to capacityrelationships in industry

Impact of consolidating mergers on capacity andcost structure

Enhanced capabilities of competitors as a resultof their merger activity

Preemptive moves Responses to takeover bids


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3/e Weston - 29

Financial Defensive Measures

Efficiency

One view: Highly efficient firms with favorable

sales growth and high profitability marginsprovide defense against takeovers

Alternative view: Highly efficient firms become

good takeover targets

Bidder firm seeks to learn from efficiencies of target

Target firm may be viewed as undervalued


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3/e Weston - 30

Financial characteristics that make a firm

vulnerable to takeover Low stock price in relation to replacement cost

of assets or potential earning power (low q-

ratio)

Highly liquid balance sheet with large amountsof excess cash, valuable securities portfolio, and

significant unused debt capacity

Good cash flows relative to current stock prices;low P/EPS ratios


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3/e Weston - 31

Subsidiaries or properties that could be sold off

without significantly impairing cash flows

Relatively small stockholdings under control of

incumbent management

Combinations of these factors can

simultaneously make firm an attractiveinvestment and facilitate its financing

Firm's assets can be used as collateral for acquirer's

borrowing

Target's cash flows from operations and divestitures

can be used to repay loans


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3/e Weston - 32

Financial defenses

Increase debt use borrowed funds to

Repurchase equity

Concentrate management's percentage holdings

Increase dividends

Loan covenants structured to force acceleration ofrepayment in event of takeover

Liquidate securities portfolio

Decrease excess cash Invest in positive net present value projects

Return to shareholders in dividends or share

repurchases


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3/e Weston - 33

Excess liquidity could be used to acquire otherfirms

Divest subsidiaries that can be eliminated

without impairing cash flows; or spin-offs to

avoid large cash inflows

Divest low-profit operations

Undervalued assets should be sold

Value increased by restructuring


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3/e Weston - 34

Corporate Restructuring and

Reorganization

Restructuring and reorganization policies

can be used positively or defensively

Reorganization of assets

Asset acquisitions can be used to block

takeovers

Dilute ownership position of bidder by using equityin acquisitions

Create antitrust problems for bidder


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3/e Weston - 35

"Selling off crown jewels" firm may dispose of

business segment in which bidder is most

interested

Reorganizing financial claims

Debt-for-equity exchanges increase leverage to

levels unacceptable to bidder Dual-class recapitalizations increase voting powers

of insider groups to levels that would enable them to

block tender offers

Leveraged recapitalizations

incur huge amounts ofdebt, using proceeds to pay large cash dividends and

increase ownership position of insiders "scorched

earth" policy


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3/e Weston - 36

Other strategies

Joint ventures could represent liaisons that

potential bidders might prefer to avoid

ESOPs can be used to decrease voting shares

available for tender

MBOs and LBOs Widely used as defense against outside tender offer

Management can take firm private

Managers may turn to LBO specialist because their

stock ownership position may increase more than in

an outside tender offer


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3/e Weston - 37

Target firm may look for international partner

Share repurchase can be used to defend againsttakeovers

Increase ownership of insiders

Low reservation price shareholders can be bought out

higher tender offer price needed for bid to succeed

Proxy contest aim is to change control group

and make performance improvements


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Restructuring, and Corporate Governance,3/e Weston - 38

Event studies Restructuring improves firm's efficiency:

favorable stock price reaction

Restructuring represents scorched-earthpolicy: negative stock price reaction


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Duty of Directors

Business judgment rule: Directors must

demonstrate to the courts that the best

interests of shareholders have been served


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Duty of directors to demonstrate sound

business reasons to reject offer Duty of directors to approve only a transaction

that is fair to shareholders and is best

transaction available

Duty of directors to fully explore independent

competitive bids and obtain best offer

Fairness opinion from an investment

banking firm not sufficient


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Greenmail

Definition: Represents targeted repurchase

of large block of stock from specified

shareholders at premium to end hostiletakeover threat


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Two divergent views of greenmails

Greenmailers damage shareholders

Large block investors are corporate "raiders" who

expropriate corporate assets

Raiders' voting power used to give themselvesexcessive compensation and perquisites

Raiders receive substantial premium, "looting"

corporate treasury


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Greenmail brings about improvements

Large block investors involved in greenmail force

improvements in corporate personnel or in

corporate strategies and policies

Large block investors have stronger incentives and

superior skills for evaluating potential takeover

targets

Managers make greenmail payments to buy time to

turn around the firm


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Greenmail sometimes accompanied by

standstill agreement Voluntary contract in which blockholder agrees

not to make further investments in target

company during specified period of time If no targeted repurchase is made, large

blockholder agrees not to further increase

ownership percentage of the firm


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Wealth effects of greenmail Announcement associated with negative

return to shareholders of 2-3% (significant)

Other studies find positive abnormal returns,

both in initial "foothold" period and in full

"purchase-to-repurchase" period


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Greenmail and standstill agreement

Negative returns standstill agreement viewed as

reducing probability of subsequent takeover

40% of firms experience subsequent control change

within three years of greenmail even with standstill

agreement

Positive market reaction if greenmail viewed as

giving directors more time to work out better

solution


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Antigreenmail developments Internal Revenue Code Section 5881 of 1986

imposes 50% excise tax on recipient of

greenmail payments

Antigreenmail charter amendments

Require management to obtain approval of majority

or supermajority of nonparticipating shareholders

prior to targeted repurchase


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Bhagat and Jefferis (1991) Proxy statements proposing antitakeover amendments

include one or more of (other) antitakeover amendment

proposals

Sample of 52 NYSE-listed firms proposing antigreenmail

amendments in 1984-1985 40 firms offered one or more antitakeover

amendments

29 cases, shareholders had to approve or reject

antitakeover provisions and antigreenmail

amendments jointly


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Eckbo (1990) Average market reaction to charter amendments

prohibiting greenmail payments weakly negative

Subsample of firms with abnormal stock price runup over

three months prior to mailing of proxy: Market reaction

strongly positive Particularly true if runup associated with evidence or

rumors of takeover activity

Prohibition against greenmail removes barrier to

takeovers with positive gains to shareholders


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Strategic Actions

Pac Man defense

Definition: Target firm counteroffers for bidder

firm

Rarely used; usually designed not to be used

Effective if target much larger than bidder

Implies target finds combination desirable but

seeks control of surviving entity

Target gives up using antitrust issues as defense


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Extremely costly

Could involve devastating financial effects for bothfirms

Large amount of debt used to purchase shares

could cripple firms

Under state law, should both firms buy substantialstakes in each other, each could be ruled as

subsidiaries of each other

Severity of defense may lead bidder to disbelieve

target will employ such defense


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White knight

Definition: Target company chooses another

company with which it prefers to be combined

Alternative company preferred by target

because: Greater compatibility

New bidder may promise not to break up target or

engage in massive restructuring


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White squire

Definition: Modified form of white knight; white

squire does not acquire control of target

Target sells block of its stock to third party it

considers to be friendly

White squire may be required to vote its shareswith target management

Often accompanied by standstill agreement

Limits amount of additional target stock white squirecan purchase for specified period of time

Restricts sale of its target stock, usually giving right of

first refusal to target


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White squire often receives in return Seat on target board

Generous dividend and/or

Discount on target shares

Preferred stock usually used in white squire

transactions because it enables board to tailor

characteristics of stock as described


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Antitakeover Amendments

Antitakeover amendments to firm's corporatecharter generally impose new conditions ontransfer of managerial control of firm "shark repellents"

95% of proposed antitakeover amendmentsare ratified

Management introduces amendments that it

feels are sure of success Failure to pass might be taken as vote of no

confidence


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Brickley, Lease, and Smith (1988) Institutional shareholders (banks, insurance

companies) more likely to vote with management on

antitakeover amendments

Have continuing business relationships with management

Pension funds, mutual funds, and college endowments

more likely to be independent

Blockholders participate more actively in voting than

non-blockholders and may oppose proposals that

appear to harm shareholders


57/106



Jarrell and Poulsen (1987) Amendments having most negative effect on stock

price are adopted by firms with lowest percentage

of institutional shareholders and highest

percentage of insider holdings Blockholders play monitoring role institutional

holders are well informed and vote in accordance

with their economic interests


58/106



Supermajority amendments

Require shareholder approval by at least two-

thirds vote (sometimes as much as 90%) for all

transactions involving change in control

Involve "board-out" clause that gives boardpower to determine when and if

supermajority provisions will be in effect


59/106



Fair-price amendments

Supermajority provisions with board-out clauseand additional clause waiving supermajority

requirement if fair price is paid by bidder for all

purchased shares

Fair price highest market price of targetduring a past specified period

Defend against two-tier tender offers

Least restrictive among class of supermajorityamendments


60/106



Staggered or classified boards

Delay effective transfer of control following

takeover Management's rationale is to assure continuity

of policy and experience

Examples:

One-third of board stands for election to three-yearterm each year

Reduce effectiveness of cumulative voting becausegreater shareholder vote is required to elect single

director Directors removable only for cause

Limit number of directors to prevent "packing"


61/106



Authorization of preferred stock Board authorized to create new class of

securities with special voting rights

Typically preferred stock issued to friendly

parties in control contest (white squire) Historically, used to provide board with

financing flexibility

Could also include poison pill security to buy

shares at a discount


62/106



Other antitakeover actions

Abolition of cumulative voting where it is notrequired by state law

Reincorporation in state with more protective

antitakeover laws

Provisions with respect to scheduling of

shareholder meetings and introduction of

agenda items

Antigreenmail amendments that restrictcompany's freedom to buy back raider's shares

at premium


63/106



Lock-in amendments to make it difficult to void

previously passed antitakeover amendments Termination of overfunded pension plans

(Iqbal, Shetty, Haley, and Jayakumar, 1999)

Firms can remove a significant source of cash flows

to bidder firms by liquidating excess assets

Stockholders favor termination only when firm faced

takeover and managerial ownership was high view

takeover as threat to their claim on excess pension

assets


64/106



Boyle, Carter, and Stover (1998)

Studied antitakeover provisions adopted by mutualsavings and loan companies converting to stock

ownership (SLAs)

Strength of insider ownership position after

conversion substitutes for strong antitakeoverprovisions

Low ownership firms associated with strong antitakeover

protections

High ownership firms adopted less extraordinary

antitakeover protections


65/106



Antitakeover amendments and corporate

policy

Garvey and Hanka (1999)

Effects of antitakeover statutes on firm leverage

Firms protected by state antitakeover statutes

substantially reduced debt ratios Results not influenced by size, industry, or

profitability

Weak evidence that protected managers undertook

fewer major restructuring programs Firms eventually covered by antitakeover legislation

used greater leverage in years preceding adoption of

statutes


66/106



Johnson and Rao (1997)

Compared financial attributes (based on income,expenses, investment, and debt) before and after

antitakeover amendment adoptions

For full sample, firms exhibited no significant

differences from industry means except for decline in

net income to total assets ratio

Fair price amendments

For non-fair price subsample, no significant differences

from industry mean for any of financial attributes

For fair price subsample, results similar to those of full

sample


67/106



Antitakeover amendments and shareholder

returns General predictions

Positive returns

Announcement of antitakeover measure signals increased

likelihood of takeover DeAngelo and Rice (1983) shark repellents may help

shareholders respond in unison to takeover bids

Negative returns

Antitakeover amendments reflect management

entrenchment

Comment and Schwert (1995) decline of less than 1% for

most types of antitakeover measures

i i l l diffi l i b f


68/106



Empirical results difficult to interpret because ofnumber of influences operating concurrently

Antitakeover amendment may have been adopted to

help management obtain better deal

Announcement of takeover may have contagion effectson industry

Positive runup in abnormal returns because of possibility ofother takeovers

Announcement of antitakeover amendments with typical 1%decline in shareholder wealth should be netted against priorpositive runup

1% decline would be viewed as reflection of reducedprobability of takeover being completed

If 20% is typical runup, small negative event returns fromannouncement of antitakeover measures would have littlepower to deter takeovers


69/106



State Laws

Background By 1982, 37 states passed first generation

antitakeover laws

First generation laws ruled to be preempted by 1968

Williams Act in Edgar v. MITE (1982) In 1987, Supreme Court reversed in Dynamic v. CTS;

ruled that state antitakeover laws were enforceableas long as they did not prevent compliance with

Williams Act Many states passed new antitakeover statutes

between 1987-1990


70/106



Janjigian and Trahan (1996)

Studied factors that influenced firms to opt out

of protection under Pennsylvania Senate Bill1310 introduced on 10/20/89

20 opt out firms: significant -9.50% return

13 no-opt out firms: insignificant 9.15%

Accounting performance of both groupsdeteriorated substantially from 1989 to 1992

Firms that opted out had significantly better net

profit margin, net return on assets, andoperating return on assets in 1992


71/106



Swartz (1996)

Event date was passage of Pennsylvania

Antitakeover Law (Act 36 based on Senate Bill1310) on 4/27/90

Event returns (CARs)

Firms that opted out:

For window [-130,+60] = -5.24% (not significant)

For window [-60,+20] = 0.70% (not significant)

Firms that did not opt out:

For window [-130,+60] = -23.35% (significant)

For window [-60,+20] = -4.71% (significant)

Firms that opted out outperformed firms that didnot


72/106



Heron and Lewellen (1998)

Reincorporations to establish stronger takeover

defenses had significant negative returns

Reincorporations to limit director liability to

attract better qualified directors had significantpositive returns


73/106



Poison Pills

Background

Definition: Creation of securities carrying special

rights exercisable by triggering event such as

accumulation of specified percentage of targetshares or announcement of tender offer

Make acquisition of control of target firm more

costly


74/106



Can be adopted by board without

shareholders' approval

Poison pill adoptions often submitted to

shareholders for ratification even though not

required to do so Use of poison pills requires justification to be

upheld by courts adoption of poison pills in

the best interest of shareholders "business

judgment rule"


75/106



Types of plans

Flip-over plans

Bargain purchase of bidder's shares at some trigger

point

Weakness: If rights are exercisable only when

bidder obtains 100% of company stock, bidder may

buy just over 50% to obtain control


76/106



Flip-in plans

Bargain purchase of target's shares at some trigger

point

More widely used than flip-over plans

Ownership flip-in provision allows rights holder to

purchase shares of target at a discount if acquirer

exceeds a shareholding limit rights of bidder who

triggered pill become void

Some plans waive flip-in provision if acquisition is

cash tender offer for all outstanding shares (defend

against two-tier offers)


77/106



Dead-hand provisions

Definition: Provision that grants board the ability

to redeem or amend poison pill only bycontinuing directors directors on the boardprior to bidder's takeover attempt

Provision strengthens board's position

Board's ability to redeem poison pill gives it flexibilityin negotiating with bidders

Hostile bidder can put considerable pressure on theboard by making premium cash bid conditional onredemption of pill

Provision prevents bidder from achieving control oftarget's board which then removes pill


78/106



In some 3,000 poison pills nationwide, 200

contained dead-hand features

State laws

New York court invalidated dead-hand provisions

in Bank of New York v. Irving Bank 1988 case

Other state courts upheld dead-hand provisions

Georgia approved dead-hand pill in Invacare v.

Healthdyne Technologies 1997 case


79/106



Some shareholders groups are critical of poisonpills because they can be used to prevent

takeovers

Pension fund TIAA-CREF lobbied 35 companies to

remove dead-hand pills Pressure from Counsel for Institutional Investors

and International Brotherhood of Teamsters forced

Phillip Morris to remove entire poison pill

provisions


80/106



Effects of poison pills on shareholder

returns

Malatesta and Walkling (1988) and Ryngaert

(1988) Early event studies found about -2%

impact on wealth

Comment and Schwert (1995) Early studies covered only earlier one-fourth of

adopted pills

Sample of entire population of 1,577 poison pills

adopted 1983 to 1991


81/106



Wealth effects of poison pill adoption are diverse: May be viewed as signal for increased probability of

takeover positive influence on returns

May enable managers to obtain better price in

negotiations with bidder positive influence on returns

May deter takeovers negative influence on returns

representing expected present value of future takeover

premiums lost


82/106



Results

Taking into account whether rumors of bid or actual bid

made it likely that control premium was built into issuer'sstock price at time of poison pill announcement:

Wealth effect = negative 2%

Taking into account whether M&A news was announced at

same time as pill:

Wealth effect = positive 3 - 4%

Taking into account year of adoption

In year-by-year results, only 1984 had negative wealth

effects of 2.3% and 2.9%

For later seven years, wealth effects positive by about 1%or less, significant only in 1988


83/106



Systematic evidence indicates small deterrence effects

from poison pills

Only earliest pills (before 1985) associated with large

declines in shareholders' wealth

Takeover premiums higher when target firms are

protected by state antitakeover laws or by poison pills

Target shareholders gained even after taking into account

deals that were not completed because of poison pills

Decline in takeover activity in 1991 and 1992 resulted

from general economic factors, not widespread use of

antitakeover measures

Sh h ld A i i


84/106



Shareholder Activism

Shareholders may seek to rescindantitakeover devices

Bizjak and Marquette (1998)

Sample 190 shareholder initiated proposalsduring 1987-1993

Sample of firms that received shareholder proposalsto rescind poison pills

Matched sample of firms that adopted poison pillsbut did not receive shareholder proposals to rescindthem


85/106



Wealth effects

Cumulative abnormal returns for three-day event

window Proposal sample = -0.43%

Matched sample = 1.35%

Different announcement dates and event return

windows Negative market reaction to initial shareholder proposal

Positive market reaction to pill restructuring

Shareholders become active when they are

concerned about managerial actions that mayimpede market for corporate control

P i P t


86/106



Poison Puts

Definition: Poison puts or event riskcovenants give bondholders right to put, at

par or better, target bonds in event of change

in control Protect against risk of takeover-related

deterioration of target bonds

Especially when leverage increases are substantial

Began to be included in bond covenants in 1986

Place potentially large cash demands on new

owner, raising costs of acquisition


87/106



Economic role and empirical studies

Entrenchment hypothesis Puts made firms less attractive as takeover targets

Predicted effects of poison puts

Negative effect on shareholder returns

No effect on debt-holder returns

Bondholder protection hypothesis

Puts protect bondholders from wealth transfers

associated with debt-financed takeovers and

leveraged recapitalizations


88/106




Impact on stock returns would be net of two opposite

effects

If takeovers motivated primarily by wealth transfer

from bondholders to shareholders were deterred

negative influence on shareholder returns

Debt with event risk covenants could be issued at

interest cost lower than unprotected debt; if interestcost savings outweighed forgone wealth transfer

nonnegative stock price reaction to sale of protected

debt

If puts and related covenants did not increase protection

to existing debt, hypothesis predicts no effect on price of

firm's outstanding debt


89/106



Empirical test:

Test for difference in yield spreads at offering date for

samples of protected and unprotected bonds Inclusion of event risk protection reduced required yields

on protected bonds by 25-50 basis points in two studiesand no effect in a third

Wealth transfers from bondholders in leveraged

buyouts No evidence of bondholder losses (Marais, Schipper, and

Smith, 1989)

Small losses (Warga and Welch, 1993)

Losses depend on covenant protections protected

bonds did not experience losses while unprotected debtexperienced significant losses


90/106



Mutual interests hypothesis

Both managers and bondholders seek to preventhostile debt-financed takeovers

Managers seek to protect their control positions

Bondholders seek to avoid losses from deterioration in credit

ratings


Stock price reactions would be negative

Effects on price of existing debt would be positive

Wealth effects for debt and equity would be negatively

correlated


91/106



Cook and Easterwood (1994)

Issuance of bonds with poison puts caused negative

returns to shareholders and positive returns to

outstanding bondholders

Control sample of straight bond issues without poison

puts had no effect on stock prices may be related to

economic environment of study period (1988 and 1989)

Cross-sectional regression: Strong negative relation

between returns for stocks versus returns for outstanding

bonds for put sample but not for nonput sample

Results consistent with mutual interests hypothesis

Golden Parachutes (GPs)


92/106



Golden Parachutes (GPs)

Background

Definition: Separation provisions of employment

contract that compensate managers for loss oftheir jobs under change-of-control clause

Provision usually calls for lump-sum payment or

payment over specified period at full or partial

rates of normal compensation


93/106



Extreme cases of GPs viewed as "rewards forfailure"

Cost of GPs estimated to be less than 1% of total

cost of takeover

not considered to be aneffective takeover defense


94/106



Regulation

Deficit Reduction Act of 1984

Denies corporate tax deductions for "excess

parachute payments"

Executive has to pay additional 20% income tax on"excess parachute payments"

GPs have to be entered into at least one year

prior to date of control change to be legally

binding


95/106



GPs are triggered either when manager isterminated by acquiring firm or when manager

resigns voluntarily after change of control

Court can invalidate or grant preliminaryinjunctions against exercise of GPs especially

when payment could be triggered by recipient


96/106



Rationale

Implicit contracts Managers' real contribution to firm cannot be

evaluated exactly in current period

Optimal contract between managers and

shareholders will include deferred compensation Since detailing all future possibilities and contingent

payments in written contract is costly, long-term

deferred contract largely implicit


97/106



Firm-specific investments by managers

Managers not willing to invest in firm-specific skillsand knowledge when likelihood of loss of job is high

Managers may focus unduly on short term or even

take unduly high risks if there is increased risk of

losing job through takeover

Encourage managers to accept changes of

control that bring shareholders gains reduce

agency problem and transaction costs from

managerial resistance


98/106



Berkovitch and Khanna (1991) model

Tender offer

More desirable for target shareholders as more

information is released in tender offers leading to

competitive bidding for target

Excessive GP payment will tend to motivate managers to

sell firm at too low a gain Mergers by tying payment to synergy gains in case

of mergers, firm avoids misuse of GPs

Other possible alternatives to GPs

Stock options exercisable in event of change ofcontrol

Increased stock ownership by management

Silver and tin parachutes


99/106



Silver and tin parachutes

Silver parachutes provide less generous

severance payments to executives Tin parachutes

Extend relatively modest severance payments towider coverage of managers including middle

management, and in some cases, cover all salariedemployees

Number of employees to be covered

Jensen (1988) contract should cover only those membersof top-level management team involved in negotiating and

implementing any transfer of control Coffee (1988) control-related severance contracts should

be extended to middle management


100/106



3/e Weston - 100

Returns to shareholders and GPs

Hypotheses (Mogavero and Toyne, 1995) Alignment hypothesis

Prearranged severance agreements reduced conflicts of

interest between managers and shareholders

GPs make executives more willing to support takeover

offers beneficial to shareholders

Positive gains to shareholders

Wealth transfer hypothesis

GPs reduce stock values by shifting gains from

shareholders to managers GPs reduce probability of takeover bids by increasing costs

to bidders


101/106



3/e Weston - 101

GPs reduce incentives for executives to manage firmsefficiently

GPs may indicate level of influence of management over

boards

Negative gains to shareholders

Signaling hypothesis Signal of likelihood of future takeover, which would be

associated with positive gains to shareholders

Signal of increased management influence over boards,

which would have negative implications


102/106



3/e Weston - 102

Lambert and Larcker (LL) (1985)

Period 1975-1982

Adoption of GPs resulted in abnormal positive

returns to shareholders = positive 3%

Finding consistent with alignment hypothesis cost

of reducing conflicts of interest between

management and shareholders low relative to

potential gains from takeover premium

Findings consistent with signaling hypothesis from

1975 to 1982 relatively few firms adopted GPs, so

that GPs could be taken as signals of likely takeover


103/106



3/e Weston - 103

Born, Trahan, and Faria (1993)

Period 1979-1989

Sample firms that announced GPs while in process of

being acquired

There should be no takeover signal effect

No significant abnormal stock returns

Sample firms from 1979 through 1984 not in process

of takeover when GPs adopted positive stock

returns

Combined evidence consistent with takeover

signaling hypothesis, but not with alignment

hypothesis

H ll d A d (1997)


104/106



3/e Weston - 104

Hall and Anderson (1997)

Sample of 52 firms that announced adoption of GPs

during 1982-1990 Adoptions were for new contracts and not

amendments

Firms did not experience pre-existing takeover bids

for three years prior to GP Mean CAR

Window [-20,+20] = -1.21% (not significant)

Announcement day = 0.46% (not significant)

Window [-5,-2] = -1.19% (significant) Other event windows were not significant

When three firms were excluded as possible outliers, for

window [-5,0] = -1.29% (significant)


105/106



3/e Weston - 105

Mogavero and Toyne (MT) (1995)

Sample of 41 large firms with adoption dates from1982-1990

Full sample, CAR = -0.5% not significant

Subsample of 18 firms from 1982-1985,

CAR = +2.3% not significant

Subsample of 23 firms from 1986-1990,

CAR = -2.7% significant


106/106

Finding consistent with wealth transfer hypothesis

Stock returns associated with GPs changed frompositive for 1975-1982 period of LL study to

negative for 1986-1990 in MT

Associated with initiation of legislative restraints on GPs

that may have encouraged boards to adopt them to avoid

further restrictions

Shareholders in later years may have perceived adoption

of GPs as unfavorable signals of management's ability to

control directors in their interest at expense of

shareholders

lecture on takeover defense

Documents