Lecture On Takeover Defense

TYPES OF TAKEOVER
FRIENDLY TAKEOVER HOSTILE TAKEOVER THROUGH TENDER OFFER HOSTILE TAKEOVER THROUGH PROXY FIGHT HOSTILE TAKEOVER ATTEMPT TO FORCE THE ISSUE OF MISMANAGEMNT FOR POTENTIAL PUBLIC & LEGAL SCRUTINY REVERSE TAKEOVER REVERSE TAKEOVER UNDER AIM RULES BACK FLIP TAKEOVER N L STRATEGY FOR TAKEOVER
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
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
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"
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
POISON PUTS
DEFINITION: POISON PUTS OR EVENT RISK COVENANTS 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
EFFECTS OF POISON PUTS

ENTRENCHMENT HYPOTHESIS : PUTS MADE FIRMS LESS ATTRACTIVE AS 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 DEBTFINANCED 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
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%
COMMENT AND SCHWERT (1995) 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
TAKEOVER DEFENSE
BANKMAIL CROWN JEWEL DEFENSE PAC-MAN DEFENSE SCORCHED-EARTH DEFENSE GOLDEN PARACHUTE
TAKEOVER DEFENSE(CONTD)
WHITE KNIGHT WHITE SQUIRE GREEN MAIL JONESTOWN DEFENSE OR SUICIDE PILL KILLER BEES LEVERAGED RECAPITALIZAION LOBSTER TRAP
NANCY REGAN DEFENSE ISSUANCE OF NONVOTING STOCK PENSION PARACHUTE PEOPLE PILL SAFE HARBOR
CLASSIFIED BOARDS WITH STAGGERED ELECTIONS STANDSTILL AGREEMENT TARGETED REPURCHASE TOP UP OTHER ANTI TAKEOVER MEASURES
LOCK UP PROVISION : A TAKEOVER DEFENSE

BREAK-UP/TERMINATION FEES, OPTIONS GIVEN TO TARGET SHAREHOLDERS TO BUY TARGET STOCK, RIGHTS GIVEN TO TARGET SHAREHOLDERS TO PURCHASE TARGET ASSETS, FORCE THE VOTE PROVISIONS IN MERGER AGREEMENTS, AND AGREEMENTS WITH MAJOR SHAREHOLDERS (VOTING AGREEMENTS, AGREEMENTS TO SELL SHARES OR AGREEMENTS TO TENDER).
ANTITAKEOVER AMENDMENTS
ANTITAKEOVER AMENDMENTS TO FIRM'S CORPORATE CHARTER GENERALLY IMPOSE NEW CONDITIONS ON TRANSFER OF MANAGERIAL CONTROL OF FIRM CALLED "SHARK REPELLENTS" 95% OF PROPOSED ANTITAKEOVER AMENDMENTS ARE RATIFIED
MANAGEMENT INTRODUCES AMENDMENTS THAT IT FEELS ARE SURE OF SUCCESS FAILURE TO PASS MIGHT BE TAKEN AS VOTE OF NO CONFIDENCE
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.
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 INVOLVING CHANGE IN CONTROL INVOLVE "BOARD-OUT" CLAUSE THAT GIVES BOARD POWER TO DETERMINE WHEN AND IF SUPERMAJORITY PROVISIONS WILL BE IN EFFECT
FAIR-PRICE AMENDMENTS
SUPERMAJORITY PROVISIONS WITH BOARD-OUT CLAUSE AND ADDITIONAL CLAUSE WAIVING SUPERMAJORITY REQUIREMENT IF FAIR PRICE IS PAID BY BIDDER FOR ALL PURCHASED SHARES FAIR PRICE HIGHEST MARKET PRICE OF TARGET DURING A PAST SPECIFIED PERIOD DEFEND AGAINST TWO-TIER TENDER OFFERS LEAST RESTRICTIVE AMONG CLASS OF SUPERMAJORITY AMENDMENTS
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
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 ANTITAKEOVER AMENDMENTS AS THEY 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 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

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

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
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
EMPIRICAL RESULTS DIFFICULT TO INTERPRET BECAUSE OF NUMBER OF INFLUENCES OPERATING CONCURRENTLY

ANTITAKEOVER AMENDMENT MAY HAVE BEEN ADOPTED TO HELP MANAGEMENT OBTAIN 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 IN SHAREHOLDER WEALTH SHOULD BE NETTED AGAINST PRIOR POSITIVE RUNUP 1% DECLINE WOULD BE VIEWED AS REFLECTION OF REDUCED PROBABILITY OF TAKEOVER BEING COMPLETED IF 20% IS TYPICAL RUNUP, SMALL NEGATIVE EVENT RETURNS FROM ANNOUNCEMENT OF ANTITAKEOVER MEASURES WOULD HAVE LITTLE POWER TO DETER TAKEOVERS
SHAREHOLDER ACTIVISM
Shareholders may seek to rescind antitakeover devices
Shareholders become active when they are concerned about managerial actions that may impede market for corporate control
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Chapter 19
Takeover Defenses
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2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 24
Introduction
Not all mergers are welcome Arsenals of devices were developed to defend against unwelcome proposals during the 1980s
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
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
Opportunities for rolling-up fragmented industries into stronger firms Likelihood of firm to be rolled-up Improving or deteriorating sales to capacity relationships in industry Impact of consolidating mergers on capacity and cost structure Enhanced capabilities of competitors as a result of their merger activity Preemptive moves Responses to takeover bids
Financial Defensive Measures

Efficiency
One view: Highly efficient firms with favorable sales growth and high profitability margins provide 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
Financial characteristics that make a firm vulnerable to takeover

Low stock price in relation to replacement cost of assets or potential earning power (low qratio) Highly liquid balance sheet with large amounts of excess cash, valuable securities portfolio, and significant unused debt capacity Good cash flows relative to current stock prices; low P/EPS ratios
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 attractive investment 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
Financial defenses
Increase debt use borrowed funds to
Repurchase equity Concentrate management's percentage holdings
Increase dividends Loan covenants structured to force acceleration of repayment 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
Excess liquidity could be used to acquire other firms 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
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 equity in acquisitions Create antitrust problems for bidder
"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 of debt, using proceeds to pay large cash dividends and increase ownership position of insiders "scorched earth" policy
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
Target firm may look for international partner Share repurchase can be used to defend against takeovers
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
Event studies
Restructuring improves firm's efficiency: favorable stock price reaction Restructuring represents scorched-earth policy: negative stock price reaction
Duty of Directors
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
Greenmail
Definition: Represents targeted repurchase of large block of stock from specified shareholders at premium to end hostile takeover threat
Two divergent views of greenmails

Greenmailers damage shareholders
Large block investors are corporate "raiders" who expropriate corporate assets Raiders' voting power used to give themselves excessive compensation and perquisites Raiders receive substantial premium, "looting" corporate treasury
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
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
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
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
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
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
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
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
Extremely costly
Could involve devastating financial effects for both firms Large amount of debt used to purchase shares could cripple firms Under state law, should both firms buy substantial stakes 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
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
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 shares with target management Often accompanied by standstill agreement
Limits amount of additional target stock white squire can purchase for specified period of time Restricts sale of its target stock, usually giving right of first refusal to target
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
Antitakeover Amendments
Antitakeover amendments to firm's corporate charter generally impose new conditions on transfer of managerial control of firm "shark repellents" 95% of proposed antitakeover amendments are ratified
Management introduces amendments that it feels are sure of success Failure to pass might be taken as vote of no confidence
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
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
Supermajority amendments
Require shareholder approval by at least twothirds vote (sometimes as much as 90%) for all transactions involving change in control Involve "board-out" clause that gives board power to determine when and if supermajority provisions will be in effect
Fair-price amendments
Supermajority provisions with board-out clause and additional clause waiving supermajority requirement if fair price is paid by bidder for all purchased shares Fair price highest market price of target during a past specified period Defend against two-tier tender offers Least restrictive among class of supermajority amendments
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-year term each year Reduce effectiveness of cumulative voting because greater shareholder vote is required to elect single director Directors removable only for cause Limit number of directors to prevent "packing"
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
Other antitakeover actions

Abolition of cumulative voting where it is not required 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 restrict company's freedom to buy back raider's shares at premium
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
Boyle, Carter, and Stover (1998)

Studied antitakeover provisions adopted by mutual savings and loan companies converting to stock ownership (SLAs) Strength of insider ownership position after conversion substitutes for strong antitakeover provisions
Low ownership firms associated with strong antitakeover protections High ownership firms adopted less extraordinary antitakeover protections
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
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
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
Empirical results difficult to interpret because of number of influences operating concurrently

Antitakeover amendment may have been adopted to help management obtain 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 in shareholder wealth should be netted against prior positive runup 1% decline would be viewed as reflection of reduced probability of takeover being completed If 20% is typical runup, small negative event returns from announcement of antitakeover measures would have little power to deter takeovers
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 enforceable as long as they did not prevent compliance with Williams Act Many states passed new antitakeover statutes between 1987-1990
Janjigian and Trahan (1996)

Studied factors that influenced firms to opt out of protection under Pennsylvania Senate Bill 1310 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 groups deteriorated substantially from 1989 to 1992 Firms that opted out had significantly better net profit margin, net return on assets, and operating return on assets in 1992
Swartz (1996)
Event date was passage of Pennsylvania Antitakeover Law (Act 36 based on Senate Bill 1310) 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 did not

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 significant positive returns
Poison Pills
Background
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 control of target firm more costly
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"
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
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)
Dead-hand provisions
Definition: Provision that grants board the ability to redeem or amend poison pill only by continuing directors directors on the board prior to bidder's takeover attempt Provision strengthens board's position
Board's ability to redeem poison pill gives it flexibility in negotiating with bidders Hostile bidder can put considerable pressure on the board by making premium cash bid conditional on redemption of pill Provision prevents bidder from achieving control of target's board which then removes pill
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
Some shareholders groups are critical of poison pills 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
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
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
Results
Taking into account whether rumors of bid or actual bid made it likely that control premium was built into issuer's stock 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
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
Shareholder Activism
Shareholders may seek to rescind antitakeover devices Bizjak and Marquette (1998)
Sample 190 shareholder initiated proposals during 1987-1993
Sample of firms that received shareholder proposals to rescind poison pills Matched sample of firms that adopted poison pills but did not receive shareholder proposals to rescind them
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 may impede market for corporate control
Poison Puts
Definition: Poison puts or event risk covenants 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
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
Predicted effects of poison puts

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 interest cost 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
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 studies and 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 debt experienced significant losses
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
Predicted effects of poison puts

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
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)

Background
Definition: Separation provisions of employment contract that compensate managers for loss of their 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
Extreme cases of GPs viewed as "rewards for failure" Cost of GPs estimated to be less than 1% of total cost of takeover not considered to be an effective takeover defense
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
GPs are triggered either when manager is terminated by acquiring firm or when manager resigns voluntarily after change of control Court can invalidate or grant preliminary injunctions against exercise of GPs especially when payment could be triggered by recipient
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
Firm-specific investments by managers

Managers not willing to invest in firm-specific skills and 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
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 of control Increased stock ownership by management
Silver and tin parachutes

Silver parachutes provide less generous severance payments to executives Tin parachutes
Extend relatively modest severance payments to wider coverage of managers including middle management, and in some cases, cover all salaried employees Number of employees to be covered
Jensen (1988) contract should cover only those members of 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
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
GPs reduce incentives for executives to manage firms efficiently 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
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
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
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)
Mogavero and Toyne (MT) (1995)

Sample of 41 large firms with adoption dates from 1982-1990 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
Finding consistent with wealth transfer hypothesis Stock returns associated with GPs changed from positive 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

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Lecture On Takeover Defense

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TYPES OF TAKEOVER

PROLIFERATION OF TECHNIQUES IN TAKEOVER DEFENSE

POISON PILL : A MEASURE OF TAKEOVER DEFENSE

POISON PILL : A MEASURE OF TAKEOVER DEFENSE

EFFECTS OF POISON PUTS

COMMENT AND SCHWERT (1995) EFFECTS OF POISON PILLS ON SHAREHOLDER RETURNS

COMMENT AND SCHWERT (1995) EFFECTS OF POISON PILLS ON SHAREHOLDER RETURNS

LOCK UP PROVISION : A TAKEOVER DEFENSE

SHARK REPELLANTS STRATEGY AGAINST HOSTILE TAKE OVER BIDS

SHARK REPELLANTS STRATEGY AGAINST HOSTILE TAKE OVER BIDS(CONTD)

DUTY OF BOARD OF DIRECTORS IN THE EVENT OF TAKEOVER BIDS

STUDIES ON ADOPTION OF ANTI TAKEOVER AMMENDMENTS IN COMPANY CHARTER

STUDIES ON ADOPTION OF ANTI TAKEOVER AMMENDMENTS IN COMPANY CHARTER

STUDIES ON ADOPTION OF ANTI TAKEOVER AMMENDMENTS IN COMPANY CHARTER

ANTITAKEOVER AMENDMENTS AND SHAREHOLDER RETURNS

EMPIRICAL RESULTS DIFFICULT TO INTERPRET BECAUSE OF NUMBER OF INFLUENCES OPERATING CONCURRENTLY

Possible motivations for takeover defenses

Financial Defensive Measures

Financial characteristics that make a firm vulnerable to takeover

Corporate Restructuring and Reorganization

Fairness opinion from an investment banking firm not sufficient

Two divergent views of greenmails

Greenmail brings about improvements

Greenmail sometimes accompanied by standstill agreement

Wealth effects of greenmail

Greenmail and standstill agreement

Bhagat and Jefferis (1991)

White squire often receives in return

Brickley, Lease, and Smith (1988)

Jarrell and Poulsen (1987)

Staggered or classified boards

Authorization of preferred stock

Other antitakeover actions

Boyle, Carter, and Stover (1998)

Antitakeover amendments and corporate policy

Johnson and Rao (1997)

Antitakeover amendments and shareholder returns

Empirical results difficult to interpret because of number of influences operating concurrently

Janjigian and Trahan (1996)

Firms that did not opt out:

Firms that opted out outperformed firms that did not

Heron and Lewellen (1998)

Effects of poison pills on shareholder returns

Wealth effects of poison pill adoption are diverse:

Different announcement dates and event return windows

Economic role and empirical studies

Bondholder protection hypothesis

Predicted effects of poison puts

Wealth transfers from bondholders in leveraged buyouts

Mutual interests hypothesis

Predicted effects of poison puts

Cook and Easterwood (1994)

Golden Parachutes (GPs)

Firm-specific investments by managers

Berkovitch and Khanna (1991) model

Other possible alternatives to GPs

Silver and tin parachutes

Returns to shareholders and GPs

Wealth transfer hypothesis

Lambert and Larcker (LL) (1985)

Born, Trahan, and Faria (1993)

Hall and Anderson (1997)