Does the Mandatory Bid Rule Add Value to Target Shareholders?

• Date: 01 September 2019
• Published date: 01 September 2019
• Author: Sapnoti K. Eswar
• DOI: http://doi.org/10.1111/fima.12239

Does the Mandatory Bid Rule Add Value

to Target Shareholders?

Sapnoti K. Eswar∗

I investigatewhether implementation of the mandatory bid rule—the rule that grants all sharehold-

ers the right to participate in a takeover transaction at equal terms—affectstarget announcement

returns. I use a difference-in-differences approachand the staggered adoption of the rule across 15

European countries. I find that the rule change leads to higher target returns.In full transactions,

better accounting standards and shareholderprotection norms of the acquirer leads to higher tar-

get returns. In majority transactions, greatervalue transfer from acquirers with weak accounting

standards leads to higher target returns. I find weak evidence of overpaymentby acquirers.

The literature on corporate governance establishesthe takeover market as one of the mechanisms

for implementation of corporate governance policies. Takeover regulation can have a significant

impact on the level of investor protection and the development of financial markets (LaPorta

et al., 1997, 2002; Himmelberg, Hubbard, and Love, 2004; Nenova, 2006).

The mandatory bid rule (MBR) or the equal opportunity rule, a rule within the purview of

takeover regulation, grants all shareholders the right to participate in a takeover transaction at

equal terms. The MBR states that once an acquirer acquires the proportion of voting rights that

confers on her the control over a target, she must offer to buy all remaining shares of the target at

a fair price. In effect, the MBR reduces the likelihood of expropriation of minority shareholders.

Burkart, Gromb, and Panunzi (2000) argue that the MBR can lead to higher target returns through

greater value creation by better acquirers. This paper examines whether the MBR creates value

for target firms.

Countries with higher target returns are more likely to implement the MBR to ensure minority

protection.1This fact poses a challenge to identification of the effects of changes in takeover

regulation. A naive comparison between countries that implement the MBR and countries that

do not would lead to a biased estimate of the impact of the rule itself. To address this concern, I

This paper was circulated earlier under the titles “Private Benefits and Firm Value: Evidence from EuropeanTakeover

Returns” and “Has TakeoverRegulation Altered ValueCreation? Evidence fromEuropean M&A Market.” I am grateful to

my advisors, FrancescaCornelli and Vikrant Vig, for many discussions and suggestions.I also thank Utpal Bhattacharya

(Editor), an anonymous referee,Pat Akey, Shai Bernstein, AndreaBuffa, Lora Dimitrova, Alexander Dyck, Julian Franks,

Brandon Julio, Stefan Lewellen, Miroslav Mateev, Clemens Otto, Stephen Schaefer, Henri Servaes, Rui Silva, Elena

Simintzi, Paolo Volpin, and the seminar participants at the Midwest Finance Association 2015, Northern Finance

Association 2012 meetings, the INSEAD seminar series, the LBS Trans-Atlantic Doctoral Conference 2011, and the

London Business School PhD seminar series for helpful comments and suggestions. I gratefully acknowledge financial

support from the Lindner College of Business. All errorsand omissions are my own.

∗Sapnoti K. Eswar is an Assistant Professor at the CarlH. Lindner College of Business at the University of Cincinnati in

Cincinnati, OH.

The Online Appendix can be found at: https://drive.google.com/open?id=1z0npk6VBTe7ijaLSFZYDOh-Ak5TD0PKv.

1A gradual increase in the number of attempted and completed takeovers during the 1980s led the French legislature to

add a special law to the French Companies Act in 1989. In 1992, MBR encompassing all shares of the target firm was

implemented. In Belgium, a highly publicized takeoverof Soci ´

et´

eG

´

en´

erale de Belgique by Carlo de Benedetti, chairman

of Ing. C. Olivetti & C. S.p.A., in 1988 led to demands for more comprehensive takeoverregulation. A set of regulations

including an MBR was passed in 1989 (Skog, 1997).

Financial Management •Fall 2019 •pages 739 – 771

740 Financial Management rFall 2019

exploit the staggered implementation of the MBR across European Union (EU) member countries

as a quasi-experimental setup. This approach improves upon existing literature, whichhas looked

mostly at cross-sectional correlations.2

The first difference in the difference-in-differences (DID) strategy compares transactions be-

fore and after the MBR implementation. The second difference in the DID strategy exploits

differences in the final shareholding of the acquirer. Treated transactions are those in which the

acquirer’s shareholding in the target exceeds a threshold for target “control,” henceforth majority

transactions. Control transactions are those in which acquirer’s shareholding in the target falls

below the threshold, henceforth minority transactions. Majority transactions are the ones that are

directly impacted by the MBR implementation.

Using data on 1,534 takeovers with targets in 15 EU member countries, I find that target

value increases for majority transactions after MBR implementation. The results are robust to

controlling for target characteristics such as firm size, prof itability, and leverage, transaction char-

acteristics such as type of financing, diversifying transaction, tender offers, hostile/friendly, and

cross-border, and target country characteristics such as market capitalization to gross domestic

product (GDP), average turnover ratio of traded stocks, foreign direct investment–to–GDP ratio,

unemployment rate, and trade imbalance. I also control for time-invariant country-level charac-

teristics (using target country fixed effects) and economy-wide shocks (using year fixed effects).

One concern with the analysis is that systematic differences between majority and minority

transactions could be driving the results. To rule out this concern, I carry out a series of robust-

ness tests. First, I check that minority and majority transactions are comparable on observable

characteristics. Second, I check for pretreatment trends. I find that minority and majority trans-

actions have comparable target returns before the event year. Finally, I use alternative definitions

of majority transactions to address the selection bias.3

Another potential concern is that differences between cross-border and domestic transactions

could be driving the results. The relation between cross-border transactions and target returns is

well-documented (Bris and Cabolis, 2008). To rule out this concern, I control for cross-border

transactions using an indicator variable, and I run each of the specifications for domestic and

cross-border transactions separately. I find that the MBR implementation leads to higher target

returns in both domestic and cross-border transactions.

As additional tests of robustness I check various subsamples within the data; include potentially

omitted variables such as variablesof political economy; and use different clustering techniques.4

In the robustness tests, the main result continues to hold.

2Nenova (2003, 2006) empirically document the relation of takeover regulation to private benefits of control, and

financial development in the country. Humphrey-Jenner (2012) provides tests related to the EU Takeover Directive,

which is followedby the MBR implementation in many countries in the EU.

3In the baseline specification, I define majority transactions as those in which the acquirer has less than 30% shareholding

in the target before the transaction and more than 30% after the acquisition. In a second specification, I follow the literature

and define majority transactions as transactions in which the acquirer had less than 50% shareholding in the target before

the transaction and more than 50% after the acquisition. In a third specification, I use the actual control threshold level

in each target country to define majority transactions. In a final specif ication, I use 25% as the threshold for control to

define majority transactions. All results are reported in robustness tests.

4Although the variable of interest in the empirical specification is based on changes in takeover regulation, which is

beyond the control of individual firms, a possible concern is that the year of the change in regulation may be driven

by lobbying action. Existing political economy literature suggests a number of potential determinants of shareholder

protection regulation: electoral rules (majoritarian vs. proportional), tenure of democracy, political orientation of the

executive, and ownership concentration. Pagano and Volpin (2005) predict that higher shareholder protection is more

likely in countries with majoritarian (as opposed to proportional) electoral rules. Bebchuk and Roe (1999) argue that

initial ownership structure may determine whether shareholder protection regulation is implemented.

Eswar rDoes the Mandatory Bid Rule Add Value to Target Shareholders? 741

Finally, I examine the potential channels behind the MBR-target returns relationship. One

potential channel to explain this result is value creation. Within value creation, I focus on

acquirer accounting standards and acquirer shareholder protection channels. The argument is as

follows: The increase in shareholder protection following the MBR implementation results in

better acquirers completing transactions. Such acquirers create greater value through synergies.

A second potential channel is value transfer or the overpayment channel—the increase in target

shareholder protection leads to a transfer of value away from acquirer to target shareholders.

Cross-border mergers in which the acquirer obtains 100% of target shares, or full transactions,

leads to a change in nationality of the target. This change implies that the target adopts the ac-

counting standards, disclosure practices and governance structures of the acquirer firm. Adoption

of better accounting standards and better governance can lead to higher target returns (Bris and

Cabolis, 2008). I use firm-specif ic, time-varying data on accounting standards and test whether

differences in accounting standards in full transactions has a higher, incremental impact after the

MBR implementation. I find strong support for the hypothesis.

Next, I examine the acquirer shareholder protection channel. If better shareholder protection

increases firm value, then a full transaction by a well-governed acquirer can lead to higher target

returns. I use three proxies for shareholder protection: Dyck and Zingales (2004), Nenova (2003),

and LaPorta et al. (1998). I find that better governed acquirers in full transactions create more

value after the MBR.

Bris and Cabolis (2008) document that in the absence of consolidation, target returns do not

increase with better acquirer accounting standards. More transparent acquirers penalize target

shareholders for lower accounting standards, whenever these targets are not fully consolidated

into the acquirer. I find strong support for this hypothesis. Put together, these results suggest that

the MBR implementation is associated with more full transactions and fewermajority transactions

by better acquirers.

As a final channel test, I check whether transfer of value awayfrom acquirers due to overpayment

or acquirer agency issues results in higher target returns. I find weak evidence to support this

hypothesis.

This paper is closely related to the work of Humphrey-Jenner (2012). The author documents

an increase in managerial entrenchment after the announcement of the EU Directive due to

continuing legal uncertainty.In this paper, I focus on the MBR and document how the rule creates

target value.

This paper makes two contributions. First, I document a new channel by which takeover

regulation creates target value. The MBR is associated with better acquirers completing full

transactions. These acquirers with stronger governance and more transparent accounting create

value for target firms.

By focusing on one of the most high-impact rules within the purview of takeover regula-

tion, the paper adds to the literature on corporate governance. A significant body of literature

looks at the impact of corporate governance on firm value.5A number of papers document the

trade-off associated with takeover regulation.6Further, a number of papers provide evidence of

5LaPorta et al. (1998, 2002), Shleifer and Vishny(1997), Gompers, Ishii, and Metrick (2003), Dyck and Zingales (2004),

Bris and Cabolis (2008), Bebchuk, Cohen, and Ferrell (2009), and Lemmon and Lins (2003), among others.

6Theoretical arguments are provided by Kahan (1993), Bebchuk (1994), and Burkart et al. (1998, 2000). Humphrey-

Jenner (2012) provides tests related to the EU Takeover Directive, whichis followedby the MBR implementation in many

countries in the EU. Nenova(2003, 2006) empirically document the relation of takeover regulation to private benefits of

control, and financial development in the country.