Bargaining in the shadow of takeover defenses.

Author:Subramanian, Guhan

    For decades, practitioners and academic commentators who believe that target boards should have broad discretion to resist hostile takeover attempts have put forward the "bargaining power hypothesis" to support their view. (1) This hypothesis states that a target with strong takeover defenses will extract more in a negotiated acquisition than a target with weaker defenses, because the acquirer's no-deal alternative, to make a hostile bid, is less attractive against a strong-defense target. The hypothesis helped usher in the modern era of takeover defenses: In endorsing the poison pill in Moran v. Household International, Inc., the Delaware Chancery Court framed the question as a balance between "the unrestricted right of shareholders to participate in nonmanagement sanctioned tender offers" and "the right of a Board of Directors to increase its bargaining powers." (2) The bargaining power hypothesis has been voiced more frequently over the past few years (3) as other shareholder-focused arguments in favor of takeover defenses, such as protection against "structural coercion" and protection against "substantive coercion," (4) have been rendered less important through federal and state intervention (5) or challenged by recent empirical evidence. (6) Yet despite its venerable heritage and recent revitalization, the bargaining power hypothesis has generally been asserted by defense proponents and conceded by defense opponents, (7) never subjected to a careful theoretical analysis or a comprehensive empirical test.

    This Essay attempts to fill this gap. I use negotiation-analytic tools to construct a model of bargaining in the "shadow" of takeover defenses. (8) This model identifies the conditions that must exist in order for the bargaining power hypothesis to hold in a particular negotiated acquisition. I demonstrate that the bargaining power hypothesis only applies unambiguously to negotiations in which there is a bilateral monopoly between buyer and seller, no incremental costs to making a hostile bid, symmetric information, and loyal sell-side agents. These conditions suggest that the bargaining power hypothesis is only true in a subset of all deals, contrary to the claim of some defense proponents that the hypothesis applies to all negotiated acquisitions.

    I confirm the features of this model with evidence from practitioner interviews. It is interesting to note that while the bargaining power hypothesis lies squarely at the intersection of law and business--namely, legal rules on takeover defenses influencing the business issue of price--to my knowledge the businesspeople who actually negotiate price have been silent on this question. In order to better understand practitioner views, I interviewed the head or co-head of mergers and acquisitions at ten major New York City investment banks. (9) Collectively these firms represented either the acquirer or the seller, or both, in seventy-two percent of negotiated acquisitions by number, and ninety-six percent by size, during the 1990s deal wave. (10) The evidence compiled from these practitioner interviews is consistent with the theoretical model presented here.

    I then test the bargaining power hypothesis against a database of negotiated acquisitions of U.S. public company targets between 1990 and 2002 (n = 1692). If the hypothesis is correct, then premiums should be higher in states that authorize the most potent pills (Georgia, Maryland, Pennsylvania, and Virginia), and lower in the state that provides the least statutory validation for pills (California), relative to Delaware, which takes a middle ground on the pill question. Consistent with the predictions of my model, however, I find no evidence that premiums are statistically different across these states, either overall or in those subsamples in which bargaining power is most likely to manifest itself. I further test for intrastate differences using the Maryland Unsolicited Takeovers Act of 1999 as the basis for a natural experiment, and also find no empirical support for the bargaining power hypothesis.

    These findings have implications for the current antimanagerial, pro-takeover trajectory of Delaware's corporate law jurisprudence in the aftermath of Enron. Proponents of the status quo warn that such doctrinal movements will weaken targets' bargaining power in negotiated acquisitions, which will in turn reduce overall returns for target shareholders. But by unpacking the "black box" of negotiated acquisitions and examining the microlevel underpinnings of the bargaining process, this Essay suggests that a return to the original promise of intermediate scrutiny articulated in Unocal Corp. v. Mesa Petroleum Co. (11) is unlikely to yield significant negative wealth consequences for target shareholders. Rather, as I and others have argued, (12) a controlled revitalization of the hostile takeover marketplace can help to improve overall corporate governance, an objective that has become only more important in the post-Enron era.

    The remainder of this Essay proceeds as follows. Part II provides relevant background, including the origins of the bargaining power hypothesis and the evidence put forward to support it. Part III constructs a theoretical model of bargaining power in the negotiated acquisition context, beginning with a baseline case in which the bargaining power hypothesis clearly holds, and then adding real-world complexities that make it less plausible in many negotiated acquisitions. In addition, Part III uses evidence from practitioner interviews to illustrate the features of the model. Part IV provides new econometric evidence on the validity of the bargaining power hypothesis. Part V discusses implications of these findings. Part VI concludes.


    1. The Modern Arsenal of Takeover Defenses

      Among the takeover defenses that have been developed over the past thirty years, the poison pill is by far the most important defense today. A pill gives target shareholders the right to buy shares of the target (a "flip-in" provision), the acquirer (a "flip-over" provision), or both at a substantially discounted price in the event that a single shareholder, or an affiliated group of shareholders, acquires more than a specified percentage of the company's shares (typically between ten and twenty percent). If triggered, the pill provides target shareholders with a sizeable stake in the potential acquirer (flip-over) or dilutes the potential acquirer's stake in the target (flip-in), thus making a hostile takeover considerably more expensive. Since the pill was invented in 1983, it has never been deliberately triggered and is generally understood to be a complete barrier to a direct attack in the form of a conventional tender offer. (13) Because a pill (as a formal matter) is a dividend of rights to purchase stock, and the board has the exclusive authority to issue dividends, (14) a pill can be adopted without a shareholder vote, in a matter of hours if necessary. Therefore, most companies that do not already have pills in place have "shadow pills" that can be, and usually are, adopted after a hostile bid is launched. (15)

      While their basic mechanics are generally the same, pills vary in their potency due to important differences in the background state corporate law. Delaware, which is home to approximately fifty percent of U.S. public companies, (16) originally adopted a middle ground position on the pill. In 1985, the Delaware Supreme Court upheld the pill in Moran v. Household International, Inc., but cautioned that the ability to maintain a pill under Unocal was not absolute:

      The ultimate response to an actual takeover bid must be judged by the Directors' actions at that time, and nothing we say here relieves them of their basic fundamental duties to the corporation and its shareholders. Their use of the [poison pill] will be evaluated when and if the issue arises. (17) In a line of late-1980s cases, the Delaware Chancery Court took up the invitation issued in Moran, invalidated defensive tactics that were not "reasonable in relation to the threat posed" under Unocal, and confirmed that the right to use a pill against a hostile bidder was not absolute. (18)

      In the 1990s, however, the Delaware Supreme Court endorsed more potent pills by approving the "Just Say No" defense. In Paramount Communications, Inc. v. Time Inc., the court upheld Time's defensive tactics to preserve a strategic merger between Time and Warner, despite a clearly superior hostile takeover offer for Time from Paramount. (19) Many commentators interpreted the court's language--that a hostile takeover target could protect its friendly merger "unless there is clearly no basis to sustain the corporate strategy" (20)--to mean that a target could "Just Say No" to a hostile bidder by refusing to redeem its poison pill. (21)

      Six years later, in Unitrin, Inc. v. American General Corp., the court read Unocal's reasonableness requirement to mean that defensive tactics, provided they are not "coercive" or "preclusive," must fall within a "range of reasonable responses." (22) This restatement of Unocal's proportionality requirement is "operationally similar to the business judgment rule: An action will be sustained if it is attributable to any reasonable judgment." (23) Thus, Unitrin "makes clear how limited an 'enhancement' to the business judgment rule Unocal really is." (24) According to then-Chancellor William Allen of the Delaware Chancery Court, a prominent New York City practitioner remarked to him after Unitrin: "So it looks like we're back to business judgment review, aren't we?" (25) Thus the limited-use pill identified in Moran was transformed into a more potent "Just Say No" pill.

      A standard pill, even a "Just Say No" pill, is still vulnerable to a proxy contest: If a bidder can gain control of the target's board, it can usually redeem the pill and proceed with its tender offer for a majority of the...

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