A critical analysis of whether allowing directors to implement anti-takeover defences is beneficial for all corporate constituencies

Table of Contents

1. Introduction

2. The Market for Corporate Control

3. Hostile Takeovers

4. Anti-Takeover Defences
4.1Common Types of Anti-Takeover Defences
a)Poison Pill (Shareholder Rights Plan)
b)Staggered Board
c)Supermajority Voting Requirement
d)Director Removal for Cause
e)Change of Control Clauses / Golden Parachutes
f)White Knight and White Squire
g)Restructuring
h)Just Say No
4.2Defensive Capabilities of UK and US Companies
a)Shareholder Primacy (UK)
b)Director Primacy (US, Delaware)

5. Corporate Constituencies in the Takeover Context 1
5.1Affected Corporate Constituencies
5.2Legal Consideration of Stakeholder Interests

6.Are Anti-Takeover Defences Beneficial for All Corporate
Constituencies?
6.1Directors’ Perspective
6.2Shareholders’ Perspective
a) The Market for Corporate Control’s Disciplinary Capability and
Agency Costs
b) Coercion to Tender and Directors’ Superior Information:
Protecting Shareholders from Themselves
c)Bargaining Power and Increased Premia
d)Long-Term Shareholder Value
6.3Remaining Stakeholders’ Perspective

7. Conclusion

Bibliography

1. Introduction

There was an outcry throughout the United Kingdom after the takeover of the historic and reputable confectionary firm Cadbury by the US multinational food conglomerate Kraft Foods. In order to restructure its own business, Kraft launched a hostile takeover bid initially amounting to 745 pence per share in 2009, as Cadbury was not for sale.¹ Cadbury resisted for several months finding the offer “unattractive” and undervaluing the company. However, the management finally had to give in and concluded the deal at 840 pence per share which the majority of Cadbury’s shareholders approved. The real controversy arose when Kraft announced short after the takeover that it would close Cadbury’s Somerdale factory. This was contrary to its previous statement at the beginning of the bid to keep the factory open.² Furthermore, in 2016 Kraft resigned from its promise³ to maintain Cadbury’s corporate social responsibility commitment with Fairtrade.⁴

The Kraft-Cadbury-takeover has again ignited the debate about reforming the UK takeover rules, not only among corporate law and economics scholars but the UK Takeover Panel and the UK Government.⁵ The House of Commons’ BIS Committee examined the takeover and identified “short-termism” as the core problem. It found that the destiny of Cadbury was decided by institutional investors, such as hedge funds and arbitrageurs, focussing on short-term profits rather than by shareholders interested in the long-term future of the company.⁶

In the meantime, many M&A professionals have criticised that ‘it had become too easy for US firms to buy UK rivals’.⁷ Even Roger Carr, the then Chairman of Cadbury, found ‘that it is very difficult for target boards to resist a premium bid’ suggesting that Cadbury was ultimately not able to defend the hostile takeover bid by Kraft.⁸

This Essay examines the question whether allowing directors to implement anti-takeover defences is beneficial for all corporate constituencies. Beginning with the classification of the topic in the law and economics context of the market for corporate control in Chapter 2, I will briefly outline in Chapter 3 the scenarios in which anti-takeover defences usually come into operation, namely hostile takeovers. Chapter 4 presents the most common anti-takeover defences and sets out the legal framework to what extent directors are permitted to adopt such defences in accordance with the applicable law. A distinction is made between UK and US law, with the latter focussing on Delaware law, where more than a half of all US publicly traded corporations are established. The Delaware Court of Chancery and Supreme Court have developed an extraordinary body of jurisprudence concerning corporate takeovers and anti-takeover defences. Chapter 5 points out potential impacts on the various constituencies of a company and deals with the fact why their interests have to be regarded in the takeover context. Finally, Chapter 6 critically evaluates anti-takeover defences from different stakeholder perspectives and concludes that these are not beneficial for all corporate constituencies, but for directors only.

2. The Market for Corporate Control

The market for corporate control is the market place where companies are acquired and sold through takeovers or mergers and acquisitions.⁹ A change of control in a company can be pursued either by purchasing the assets or shares of the target company or by merging the companies of the bidder and the target.¹⁰

Takeovers can create value for the companies’ shareholders and the economy as a whole by efficiently combining corporate assets and generating synergies, such as economies of scale or cost savings.¹¹ It can also destroy value where companies’ cultures do not fit together or where transactions are driven by managerial hubris, overoptimism, empire-building and self-enrichment.¹²

The downside of creating efficiency and synergy effects by combining corporate entities sometimes are redundancies of employees and plant closings. The market for corporate control has therefore distributional and behavioural effects on stakeholders. The empirical evidence suggests that a growing combined corporation creates more jobs in the long-term and that the reallocation of employment in a functioning market contributes to the competitiveness of the overall economy.¹³ However, takeovers discourage employees to invest themselves in the company’s business when they have to worry about their job incentives and safeguards.¹⁴

More important, the market for corporate control has an external disciplining capability on directors in order to reduce agency costs which occur due to the separation of ownership and control. In the absence of control, directors may have an incentive to shirk or use their delegated powers to benefit themselves in a way of self-dealing instead of maximising their efforts to enhance shareholder value.¹⁵ According to Manne’s theory of the market for corporate control, the managerial (in)efficiency is reflected in the share price of the company.¹⁶ Thus, when a company is poorly managed and agency costs occur, its share price will decline. A low share price attracts a takeover by a competing management team, who think they are able to run the company more efficiently.¹⁷ Consequently, the market for corporate control not only generates value for shareholders by reallocating corporate assets to a more capable management team, it induces ex ante a disciplinary force on directors.¹⁸ The continuous threat of being replaced encourages slack incumbents to maximise their efforts and discourages them from self-dealing resulting in a reduction of agency costs.

However, the disciplining capability of the market for corporate control depends on the existence and effectiveness of other regulatory devices and internal disciplining tools, such as corporate governance rules.¹⁹ Moreover, Manne’s theory is based on the assumption that the capital markets are efficient. This means that the share price embodies all publicly available information about the company’s value, a discount for agency costs²⁰ and the value that a management team is likely to generate in the future.²¹

There is indeed evidence showing that the capital markets are not always efficient, and the opinions as regards to the disciplinary capability of the market for corporate control diverge.²² For the purpose of this Essay, it is assumed that the market for corporate control has a certain disciplining effect on directors.

3. Hostile Takeovers

A hostile takeover is the proposed acquisition of a target company where the board of directors does not recommend the takeover offer to its shareholders.²³ However, if a bidder wants to acquire the target company despite board’s refusal, the bidder can apply hostile takeover methods – tender offer or proxy contest.²⁴ A tender offer is a bidder’s offer directly to the shareholders of the target company, by bypassing the board’s approval, to purchase their shares at a premium above the market price in order to acquire a controlling stake in the target company.²⁵ Whereas in a proxy contest, the bidder persuades the target companies’ shareholders to replace the incumbent directors with those who facilitate a change of control.²⁶ In particular, a proxy contest is initiated when the target company has implemented anti-takeover defences which frustrate a takeover. The renewed board is then able to dismantle the defences.²⁷

The reasons for a (hostile) takeover of another company are different and depend on the strategic objectives of the acquirer. These include, for example, the enhancement of business abilities, increase of efficiency, obtaining a larger market share by reducing competition, diversification of products and services, reduction of production and management costs while making the target company more profitable.²⁸

There are several preconditions which provides an incentive for a hostile takeover. For instance, a dispersed share ownership, rational apathetic shareholders, the quality of publicly available information about the target company and the level of disclosure.²⁹ Furthermore, cheap share prices as well as the invention of new finance instruments, such as junk bonds, enable even smaller companies to acquire other entities.³⁰

However, hostile takeovers represent only a small part of all acquisitions as they are time-consuming and expensive, especially when anti-takeover defences are in place.³¹

4. Anti-Takeover Defences

There are many motives for the board of directors to object a change of control facing a hostile takeover.³² One the one hand, it may believe that the bid price for the shares does not reflect the true value of the target company and the acceptance of the offer would be not in the best interest of the shareholders or other corporate constituencies. On the other hand, directors may also pursue selfish interests, such as keeping their current job. It is therefore understandable that a board would like to implement anti-takeover defences in order to be able to resist unwelcome hostile takeover bids.

However, the adoption of anti-takeover defences does not generally preclude hostile takeovers, but it will be more difficult and costlier for a hostile bidder to acquire the target company without the board’s approval.³³

4.1 Common Types of Anti-Takeover Defences

Directors theoretically have a wide range of possible anti-takeover defences at their disposal. The implementation, however, depends on the applicable law and, as we will see, shareholder approval, if necessary. A board may implement anti-takeover defences in the light of a current hostile takeover attempt or as a precaution since the IPO.³⁴ The most common are briefly described below.

a) Poison Pill (Shareholder Rights Plan)

A poison pill gives all shareholders of the target company, except an unwelcome investor, the right to purchase additional shares at a substantial discount.³⁵ This right is triggered, when an investor, not approved by the board, crosses a certain ownership threshold in the target company, as stipulated in the shareholder rights plan. All rights of the investor crossing the threshold are voided, including the right to buy shares at a discount. As a result, the value and proportion of the investors stake in the target company will dilute. The existence of a poison pill makes an acquisition costly and may therefore frustrate a hostile bidder.

b) Staggered Board

The company’s articles of association may provide a staggered board structure which is comprised of directors with different perennial terms and expiry dates. Thus, a hostile bidder is precluded from replacing the entire board of the target company in a single year.³⁶

c) Supermajority Voting Requirement

A board of directors may also consider requiring a shareholder supermajority vote in order to amend the articles of association or certain provisions of it, in particular those regarding anti-takeover defences.³⁷ Such a requirement makes it more difficult for a hostile bidder to dismantle the defences before or after a takeover.

d) Director Removal for Cause

UK and US law both allow shareholders to dismiss board members at any time without cause. Thus, limiting shareholders’ right to remove directors only for cause would permit the replacement of the board after a hostile takeover only at the annual shareholder meeting.³⁸

e) Change of Control Clauses / Golden Parachutes

Employment, commercial and loan agreements often contain change of control clauses which give a contracting party certain rights when a change of control in the target company occurs.³⁹ These may comprise consent requirements, termination rights, payments of large compensation sums to dismissed directors (golden parachutes) or the immediate repayment of loan sums. Such contract clauses impose additional burdens and costs on the hostile bidder.

f) White Knight and White Squire

Facing a hostile takeover bid, the board of directors may solicit a competing bid from a friendly individual or company (white knight) to gain a controlling interest in the target company.⁴⁰ Thereby, the board is of the view that the target company is better managed by the white knight than the hostile bidder. By contrast, a white squire only acquires (temporarily) a non-controlling stake in the target company in order to block a hostile takeover.

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¹ Scott Moeller, ‘Case Study: Kraft’s Takeover of Cadbury‘ The Financial Times (London, 9 January 2012) <www.ft.com/content/1cb06d30-332f-11e1-a51e-00144feabdc0> accessed 20 December 2018.

² Business, Innovation and Skills Committee, Mergers, Acquisitions and Takeovers: The Takeover of Cadbury by Kraft (HC 2009-10, 234) paras 7-20.

³ ibid paras 40-45.

⁴ Hannah Fearn, ‘In a Final Betrayal of the Cadbury Brand, Kraft has Quietly Abandoned its Promise to Stick with Fairtrade‘ The Independent (London, 29 November 2016) <https://www.independent.co.uk/voices/cadburys-chocolate-fairtrade-fair-trade-mark-farmers-kraft-american-brand-abandoned-promise-a7445826.html> accessed 20 December 2018.

⁵ Business, Innovation and Skills Committee (n 2); UK Government, Government Response to the Business, Innovation and Skills Committee’s Report on ‘Mergers, Acquisitions and Takeovers: The Takeover of Cadbury by Kraft ‘ (Cm 7915, 2010); House of Commons Library, Contested Mergers and Takeovers (Briefing Paper 5374, 2018).

⁶ Business, Innovation and Skills Committee (n 2) paras 56-63.

⁷ Ben Morris, ‘The Cadbury Deal: How It Changed Takeovers‘ BBC News (London, 2 May 2014) <www.bbc.co.uk/news/business-27258143> accessed 20 December 2018.

⁸ David Kershaw, Principles of Takeover Regulation (OUP 2016) para 11.13.

⁹ Kershaw (n 8) para 1.01.

¹⁰ ibid para 2.02.

¹¹ ibid paras 1.05-1.09.

¹² ibid paras 1.11-1.12.

¹³ ibid paras 1.25-1.27.

¹⁴ ibid paras 1.28-1.29.

¹⁵ ibid para 1.30.

¹⁶ Henry G Manne, ‘Mergers and the Market for Corporate Control‘ (1965) 73[2] Journal of Political Economy 110, 112.

¹⁷ ibid 113.

¹⁸ Frank H Easterbrook and Daniel R Fischel, ‘The Proper Role of a Target’s Management in Responding to a Tender Offer‘ (1981) 94[6] Harvard Law Review 1161, 1169-1174, 1182-1184; Frank H Easterbrook and Daniel R Fischel, ‘Takeover Bids, Defensive Tactics, and Shareholders’ Welfare‘ (1981) 36 The Business Lawyer 1733, 1735, 1736, 1744; Michael C Jensen, ‘Takeovers: Their Causes and Consequences‘ (1988) 12[1] Journal of Economic Perspectives 21, 27, 28; Ernst-Ludwig von Thadden, ‘On the Efficiency of the Market for Corporate Control‘ (1990) 43[4] Kyklos 635, 640, 641; Kershaw (n 8) paras 1.31, 1.32.

¹⁹ Kershaw (n 8) para 1.33.

²⁰ Easterbrook and Fischel, ‘The Proper Role of a Target’s Management in Responding to a Tender Offer‘ (n 18) 1165-1168; Kershaw (n 8) para 1.34.

²¹ William T Allen and Leo E Jr Strine, ‘When the Existing Economic Order Deserves a Champion: The Enduring Relevance of Martin Lipton’s Vision of the Corporate Law‘ (2005) 60 The Business Lawyer 1383, 1386.

²² Lucian A Bebchuk, ‘The Case Against Board Veto in Corporate Takeovers‘ (2002) 69 The University of Chicago Law Review 973, 997-999; Kershaw (n 8) paras 1.34-1.47.

²³ Corporate Finance Institute, ‘What is a Hostile Takeover?‘ <https://corporatefinanceinstitute.com/resources/knowledge/deals/hostile-takeover> accessed 21 December 2018.

²⁴ Thomson Reuters Practical Law US Corporate & Securities, ‘Defending Against Hostile Takeovers‘ <https://uk.practicallaw.thomsonreuters.com/Document/I03f4d95feee311e28578f7ccc38dcbee/View/FullText.html> accessed 21 December 2018.

²⁵ Corporate Finance Institute, ‘What is a Hostile Takeover?‘ (n 24).

²⁶ ibid.

²⁷ Thomson Reuters Practical Law US Corporate & Securities, ‘Defending Against Hostile Takeovers‘ (n 24).

²⁸ Corporate Finance Institute, ‘What is a Black Knight?‘ <https://corporatefinanceinstitute.com/resources/knowledge/deals/black-knight> accessed 21 December 2018.

²⁹ Allen and Strine (n 21) 1387; John Armour and Brian Cheffins, ‘The Origins of the Market for Corporate Control‘ (2014) 2014 University of Illinois Law Review 1835, 1842, 1844, 1846.

³⁰ Jensen (n 18) 36-39; Allen and Strine (n 21) 1387.

³¹ Thomson Reuters Practical Law US Corporate & Securites, ‘Defending Against Hostile Takeovers‘ (n 24).

³² ibid.

³³ ibid.

³⁴ ibid.

³⁵ Kershaw (n 8) para 11.28; Thomson Reuters Practical Law US Corporate & Securites, ‘Defending Against Hostile Takeovers‘ (n 24).

³⁶ Thomson Reuters Practical Law US Corporate & Securites, ‘Defending Against Hostile Takeovers‘ (n 24).

³⁷ ibid.

³⁸ ibid.

³⁹ ibid.

⁴⁰ ibid.