Although, since 1 994, when the Takeover Regulations were first framed by SIB, no successful hostile takeover has taken place in India, in the past few years it certainly seems to be picking up and it may not be long before inefficient management coupled with low stock prices make them attractive preys for a hostile bidder. A hostile takeover primarily involves changing the control of the company against the wishes of the incumbent management and the Board of Directors. This throws up a lot of social, legal, and economic issues.
The prominent among these are the following which form the subject-matter of this project assignment: Whether hostile takeovers are always beneficial to the target shareholders? Whether hostile takeover has a disciplining effect on an inefficient management or does it just destabilize the incumbent management? Do hostile takeovers always lead to efficient allocation of scarce economic resources? What is the effect of hostile takeover on the shareholders of the acquiring company?
Whether hostile takeover has adverse consequences on non-shareholder constituencies of the target company? Whether an active market for corporate control is desirable in India? Research Methodology The aim of the paper is to understand the concept of hostile takeovers, understand the implication from the perspective of not only the shareholders but also other stakeholders in the company. The project seeks to examine if the incumbent management should be allowed to defend the existing control structure against a takeover bid.
Scope and Limitations The researchers have excluded the tax implications Of hostile takeovers from the purview of research due to the vast scope of the issue. Sources of Material Both primary and secondary sources have been used for the purpose of the project. The primary sources are the offer documents filed with SIB and regulatory agencies of the other countries. The secondary sources, which have been used, are articles, books and websites.
Research Questions The questions, which have been dealt with in, this paper are: What is a takeover and how is a hostile takeover different from a friendly speaker? What are the issues arising from the perspective of various stakeholders in the company? Is there a conflict of interest be;en the shareholders and the incumbent management? What are the defenses to a hostile takeover? What is the legal regime for takeovers? How do courts interpret disputes regarding hostile takeovers? Style of Footnoting A uniform style of footnoting has been followed throughout the paper.
Chapter I HOSTILE TAKEOVER: A BRIEF CONCEPTUAL EXPLANATION A takeover takes place when one company acquires control of another company, usually a smaller company than the first company. It may be defined as a transaction or series of transactions whereby a person (individual, group of individuals or a company) acquires control over the assets of another company, either directly by becoming the owner of those assets or indirectly by obtaining the control of the management of the company. The company, which acquires control of another company, is called the ‘acquirer’ (offer) whereas the company, which is acquired, is called the ‘target’ (offered). In a case where shares are closely held (I. E. Held by a small number of persons) a takeover will generally be effected by agreement with the holders of the majority of the share capital of the company being acquired. Where the shares are held by the public generally, the takeover may be effected:2 1 .
By an agreement between the acquirer and the controllers of the acquired company; 2. By purchases of shares on the stock exchange; or 3. By means of a “takeover bid”. A takeover bid is a technique for effecting a takeover or a merger 3: in the case of a takeover, the bid is frequently against the wishes of the management of the target company; in the case of a merger, the bid is generally by consent of the management of both companies.
It may be defined as an offer to acquire shares of a company whose shares are not closely held (dispersed shareholding), addressed to the general body of shareholders with a view to obtaining at least sufficient shares to give the offer voting control Of the company. 4 A takeover bid may be undertaken in the form of an offer to purchase shares for cash or of a share-for-share exchange or of a combination of those two forms.
In other words, the consideration part in a takeover bid may be cash, or shares/debentures of the acquiring company, or the shares of a third company, which has nothing to do with the takeover. A takeover may broadly be classified into two categories:6 I) Agreed/Friendly Takeover: where the Board of Directors of the target agree to the takeover, accept the offer in respect of their own shareholdings (which might range from nil or negligible to controlling stake) and recommend other shareholders to accept the offer.
The directors of the target may agree to do so right from the start after early negotiations or even after public opposition to the bid (which may or may not have resulted in an improvement in the terms of the proposed offer); or the directors of the target may actually have approached the offer to suggest the acquisition. In a friendly takeover, the controlling group sells its controlling shares to another group of its own accord.
However, as we shall see later, because of Regulation 12 read with Regulation 3(1 )(c) of the SIB Takeover Regulations, 1997 there is no compulsion to make an open offer in a friendly takeover. Ii) Defended/Hostile Takeover: a takeover bid is hostile if the bid is initially rejected by the target Board. It is sometimes also called ‘unsolicited or unwelcome bid’ because it is offered by the acquirer without any solicitation or approach by the target company.
In a hostile takeover the directors of the target company decide to oppose the acquiring company’s offer, recommend shareholders to reject the offer and take further defensive measures to thwart the bid. The decision to defend may be influenced by a number of factors but more often than not it is with the intention of (a) stopping the takeover (which in turn may be prompted by the genuine belief of the directors that it is in interests Of the company to remain independent or by a desire of the directors to protect their own personal positions or interests); or (b) persuading the bidder to improve the terms of its offer.
There may be different motives/causes behind launching a takeover bid and it is not necessary, as widely believed, that only poorly performing firms are the potential targets of a hostile bid. Bidders seem to pursue companies with strong operating managements as often as they pursue companies that have been clearly mismanaged. 7 In fact bidders seldom seem to be interested in a firm where a turnaround is unlikely. For instance, truly Sick companies – or at least those whose problems do not appear to be easily remedied – become indigestible and survive, immune form takeover, precisely because of their inefficiency.
A bidders offers a premium, often very high, to acquire a target and a rational bidder will offer such a premium over the market price (and incur notoriously high transaction costs as well) only if it believes that the future value of the target’s stock under different management will exceed the price it offered the target’s shareholders within a relatively brief period. There may be a number of objectives behind mounting a hostile bid. It may be a strategic objective like consolidation/expansion of the raider/acquirer.
It may be aimed at achieving ‘economies of scale’/critical mass/reducing costs in a particular product/service market. It may also be aimed at acquiring substantial market share or creating a sort of a monopoly. Following are the primary motive/causes of a takeover:8 1 . Assets at a Discount: this refers to a situation where the offer can acquire the assets/shares of a target at less than the value, which the offer or its shareholders place upon them: a process commonly referred by financial journalists as “acquiring assets at a discount’.
The situations in which assets may be available at a discount are: Where the target has not put its assets to their most efficient use; Where its directors are unaware of the true value of TTS assets; When it has an inefficient capital structure; Where it has followed a policy of limited distribution of dividends; Where the shares have a poor market rating relative to its real prospects; or Where due to any other non-economic reasons, the shares of the target are trading at low prices. 2.
Earnings at a Discount: because the offer can by taking over the target acquire the right to its earnings at a lower multiple than the market places on the offers own profits, a process that can be described as acquiring “earnings at a discount”. 3. Trade Advantage or Synergy: because there is a trade advantage or an element of synergy (I. E. A favorable effect on overall earnings by cutting costs and increase in revenue) in bringing the two companies under a single control which is believed will result in the combined enterprise producing greater or more earnings per share.
This has been found to be one Of the biggest drivers of takeovers in the 1 sass. 9 In a globally competitive environment the companies require a critical mass to be able to survive and prosper and the lexicon of even the most hostile endeavourers is filled with sober phrases like synergy, the global marketplace and accretion to earnings etc. This can be achieved either through a ‘horizontal takeover or a ‘vertical takeover’ 1 1.
The factors leading to this improvement in earnings could include: Economies of scale; Ensuring raw materials/ sales; Marketing advantages; Acquisition of a competitor; Diversification or reduction of earnings volatility; Purchasing management. 4. Method of Market Entry: because it represents an attractive way of the offer entering a new market on a substantial scale. 5. Increasing the Capital of the Offer: Because the offer has particular reasons to increase its capital base.
These include the acquisition of a many a large proportion of whose assets are liquid or easily realizable instead of making a rights issue and the acquisition of a company with high asset backing by a company whose market capitalization includes a large amount of goodwill. 6. Management Motives: Because of motives of the management of one/ other of the Companies, either the aggressive desire to build up a business empire or personal remuneration or the defensive desire to make the company bid- proof.
Takeovers perform following important functions in an economy:12 Successful takeovers help realism efficiencies by reallocating capital and reporter assets to more high-value uses; enabling two entities to generate joint operating efficiencies and providing companies access to financial, management and other resources not otherwise available. It unlocks the hidden value of untilled/understudied assets by transferring them from inefficient management to an efficient management. This function of takeovers is commonly described as the ‘market for corporate control’. 3 The term was coined by Professor Henry Mane in 1965 in his seminal paper on the utility of tender offers and of an active market for corporate control. According to this description’s, there is a market for the rights to manage corporate resources in just the way that there is a market for different kinds of goods and services. Companies are up for auction for those who wish to take control from the existing owners. If bidders attach a higher value to control than the existing owners, then they should be allowed to purchase it. The market in corporate control ensures that companies pass to those who attach highest value to ownership.
Michael Jensen and Richard Rubric, vocal supporters of hostile bids wrote in 1 983: “The market for corporate control is retreating large benefits for the shareholders and for the economy as a whole by loosening control over vast amounts of resources and enabling them move more quickly to their highest-valued use. This is a healthy market in operation … And it is playing an important role in helping the American economy adjust to major changes in competition and regulation of the past decade. “15 They allow companies to realize the benefit of large-scale operations or to achieve what is called ‘economies of scale’.
It is widely believed that hostile takeovers help in policing the management conduct in widely held public corporations. It has a disciplining effect on the incumbent management as the threat Of a hostile takeover keeps them on their toes to perform efficiently and deliver goods to the shareholders. 1 6 Moreover, they help identify undervalued assets and permit shareholders to realism the true value of their investments. Hostile takeover threat can trigger far-reaching changes in corporate strategy resulting in significant gains to the shareholders.
Many have claimed that without a hostile takeover the inertia that exists within many large organizations would have prevented such efficiency-enhancing (and inconsequently, shareholder value en hanging) restructurings from taking place-1 7 According to Weinberg and Blank a takeover may be achieved in the following ways:18 Acquisition of shares or undertaking of one company by another for cash. Qua session of shares or undertaking of one company by another in exchange of shares or other securities in the acquired company.
Acquisition of shares or undertaking of one company by a new company in exchange for its shares or other securities By acquisition of minority held shares of a subsidiary by the parent. Management buyouts. Chapter II POLICY ISSUES ARISING IN A HOSTILE TAKEOVER From a Target Shareholder’s Perspective: From a policy perspective it is important to understand that in a large public company, as the separation between ownership and management/control widens, the interests of the controllers/managers of the company and that of the shareholders increasingly tend to diverge. 9 In the field of takeovers the interests of shareholders of a company are that The company should takeover another company only if in doing so it improves its own profit earning potential, measured by earnings per share, and The company should agree to takeover if and only if the shareholders re likely to be better off with the consideration offered, whether cash/ securities of the other company, than by retaining their shares in the original company.
On the other hand, the interest of the controlling shareholders or promoters or the board may be as varied as the number of companies but more often than not controllers of a company are more concerned with their personal benefits, saving their jobs and earnings and in the process they pay scant attention to the interests of shareholders. Modern theory’ of corporation has a strong tilt in favor Of shareholders and benefit to the shareholders is insider as a benchmark against which the performance of powerful corporate management must be assessed.
Global research, especially studies in countries like US and UK where market for corporate control is sufficiently developed, has shown that hostile takeovers promote efficiency, increase shareholder wealth, and result in greater corporate accountability. 21 Following are the findings with respect to impact aftershaves on target shareholder returns:22 In A Successful Takeover All studies reveal that target company stockholders end up with huge increments in wealth in comparison to the market value of their holdings fore the takeover activity.
The wealth increment can be attributed to the premium paid by the acquiring company, which has ruled around 30 per cent on average in the last few decades. Premiums as high as 100 per cent have also prevailed. Premiums have been inching upwards with time. For instance, premiums in the sass Were nearly twice the amount in the sass, averaging in the 50 to 60 per cent range. Typically, when information about a potential takeover trickles in or rumors pervade the stock markets, the market price of the target company stock moves upwards. The stock price improvement begins fore the takeover is announced, even one month in advance.
The pattern of share price movements differs in the case of a takeover by tender offer and by a merger agreement. Share prices tend to be more buoyant in the case of a tender offer as compared to a merger. For instance, in the case of a tender offer, the share price may be 50 per cent higher than the pre-offer price. Whereas, in a merger it could be just 30 per cent higher. This variance could be attributed to factors like competition and multiple bids, which are fairly common in a tender Offer as against a merger deal, which involves just en party.
Though in India, market for corporate control has hardly begun to develop and after the Takeover Regulations were framed by SIB in 1994, there has not been a single successful hostile takeover, quite a few unsuccessful attempts have been made in the last two-three years. Prominent among these are India Cements Ltd. ‘s bid for Arras Cements Ltd. , which ended in a negotiated sale of promoter’s stake in the company; the raid by Babushka Dalai led Renaissance Estates Ltd. N Geese corporation – a real estate division of Great Eastern Shipping Company and the attempt to takeover Insulin Wad promoted Bombay Dyeing Ltd. By the jute baron Run Bacteria. In all these attempts the shares of target companies appreciated by 30% to 100% after the news of takeover attempt became public. In such scenario shareholders, especially minority, obviously stand to gain by tendering their shares to the acquirer or selling the shares in the market when prices are still ruling high in the wake of a takeover bid.
Therefore, it is beyond doubt that hostile takeovers are in the interests of shareholders of the target company and from a shareholder-centered perspective hostile takeover should be remoter or at least should largely be left unregulated and let the market forces determine restraints, if any, on hostile takeovers. From Other Stakeholders’ Perspective: A company’s responsibility is not restricted only to its shareholders. There are other stakeholders as well – for instance the employees, customers, lenders, etc. Asides the shareholders. And they are as important as the shareholders and it is not necessary that what is in the interest of shareholders is also in the interest of other stakeholders. It has been observed through empirical studies that takeovers, more so when t is hostile, leads to substantial policy changes in the form of changes in control, asset disposals and restructuring of operations. 23 This also involves employee lay-offs, reconstituted board, and new faces in the management positions.
A hostile takeover may have the effect of disrupting local economies by snapping the local supply and demand chain and harming resident non-shareholders dependent on corporate activity. There is, therefore, nothing that ensures that what is in the interests of the shareholders is in the interest of other stakeholders – employees, pensioners, creditors, suppliers etc. If employees cannot be sure that when control changes occur they will be adequately rewarded for past investments that they have made, in, for example, training then they may be unwilling to undertake it in the first place.
For example, the decision of a skilled employee to work for a particular company is an investment decision because he decides to invest his human capital in the specific activities of the company. He will expect the investment to pay off in time: he will want to be rewarded financially, to be promoted and to have continuous employment unless he fails to perform his prescribed duties (he may also have other expectations, such as his pension rights increasing with inflation).