Takeover defenses work. is that such a bad thing?

• Author: Gordon, Mark

INTRODUCTION

In The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence, and Policy, (1) Professors Lucian Arye Bebchuk, John C. Coates IV, and Guhan Subramanian (BC&S) purport to demonstrate that hostile takeover targets that have a poison pill rights plan and an "effective" staggered board can--"and most of the time do" (2)--remain independent rather than sell themselves to the initial raider or another buyer. As presented, their findings turn conventional wisdom on its head and justify, in their view, significant "reconsideration" of the law regarding takeover defenses. Are they on to something here? Should we, indeed, be shocked--shocked!--to learn that takeover defenses work?

The BC&S Study has caused a minor stir among the tight knit group of academics and M&A practitioners who have sparred over the efficacy of takeover defenses on and off over the past twenty years. (3) "Takeover defenses are good because they help decent, hard-working companies fend off structurally coercive and opportunistically timed raids." "No, they're bad because they discourage would-be acquirers from pursuing economic efficiency-enhancing transactions." "Yes, they're good because they provide companies with the time and the leverage to negotiate better deals from their suitors." And so on. Ultimately, the conventional wisdom--at least among practitioners--has come around to a pragmatic view that in the "real world," the legal, practical, and economic considerations tend to even out in a rough justice sort of way: that is, when a public company receives a hostile takeover offer at a price that is attractive to a majority of its stockholders, it may leverage its takeover defenses to get a better deal or find a better offer, but its days of independence are probably numbered.

This is not mere theory. M&A lawyers routinely advise public company boards that while the "just say no" defense (4) exists as a legal matter, it may not be available as a practical matter, especially in the face of a determined bidder with a premium bid that is favored by a significant majority of stockholders. The reason for this should be obvious. Public company directors represent, and have a fiduciary duty to act in the best interests of, the company's stockholders. (5) If someone makes a bid at a price that is attractive to a majority of stockholders, directors will be pressured to (1) accept the bid (after attempting to negotiate it upward), (2) find a better bid from another party, or (3) take affirmative steps to show that the company can achieve greater value through independent growth. If the directors cannot succeed at option (3)--and do so in a hurry--the directors should expect to find it difficult to justify in their own minds (and to stockholders, in court, and in the court of public opinion) that remaining independent is in stockholders' best interest. This logic is thought to apply with equal force to companies with staggered boards (6) because if a raider were to succeed in removing one-third of the directors and replacing them with directors friendly to the raider, the remaining directors would be expected to fold rather than continue to hold out against the expressed preference of the stockholders whose interests the directors are supposed to represent. The point of the advice is not that directors must or even should fold when faced with a hostile bid, but that directors should be under no illusion that the fabled concept of "just say no" somehow changes the nature of their obligation to act in the manner they reasonably believe to be in the best interest of stockholders.

That is how the balance works, or is thought to work, in practice. As a legal matter, the balance works something like this: A target board of directors may maintain a poison pill defense and effectively block a hostile takeover as long as the directors continue to believe that doing so is in the best interests of stockholders and as long as the directors actually remain in office. The BC&S Study correctly points out that since the Delaware Supreme Court's decision in Paramount Communications, Inc. v. Time, Inc. (7) no Delaware court has ever ordered a board of directors to redeem its poison pill. (8) Therefore, the bidder can only be sure of obtaining control over the target directors' objections if the bidder can wage an election contest to remove the incumbent directors and replace them with ones that will redeem the pill. BC&S call this the "ballot box safety valve." (9) BC&S argue that companies with an effective staggered board (ESB) (10) are essentially immune to the removal threat because virtually no bidders are willing to commit themselves to or to endure the minimum delay of at least one year created by the ESB. Therefore, in their view, the ballot box safety valve is illusory for an ESB target. Whether this is true, or whether in fact the ESB--which provides a clear (but lengthy) path to victory--actually helps set precisely the right balance depends in significant measure on whether the conventional wisdom described above is correct. Can boards be trusted to make the right choice, even if they have the freedom not to?

The BC&S Study says the conventional wisdom is wrong, and that boards cannot be trusted if protected by an ESB defense. Unfortunately, there is less to the Study's empirical findings than meets the eye, and, as a result, the Study fails to convince on its key points and fails to convince that the broad, inflexible new rule BC&S would propose is indeed more appropriate and more value-enhancing than the existing balance of power. It also fails to convince that it has accomplished anything other than to identify the extreme exceptions to a set of rules that otherwise works just fine.

The following proceeds in three Parts. In the first, I identify a handful of analytical problems with the Study intended to demonstrate that the Study provides an insufficient foundation for its broader conclusions and policy prescriptions. In the second, I look at BC&S's broad and inflexible policy prescription--that the ESB effect be taken away from public company boards in the takeover context (11)--and argue that, to the contrary, ESBs can be and often are used in a responsible and value enhancing manner, and that before we take away or lessen the effectiveness of these tools for everybody, we ought to invest some effort to find a more focused solution that separates the users from the abusers. In the third, I offer a short conclusion in which I argue that the BC&S Study has not succeeded in proving either that (1) the costs of ESBs outweigh the potential benefits, particularly when we move from considering the effect of the background legal rules only on hostile takeovers to considering their effect on all public company merger and acquisition activity, or (2) a broad, inflexible rule that upsets the existing balance of power between bidders and targets is, in fact, necessary, especially when more focused solutions may be available. Because of these shortcomings, all the BC&S Study really succeeds in proving is that ESBs work very well. Maybe this is not such a bad thing after all.

1. ANALYTICAL CONCERNS

   The BC&S Study contains three basic findings. The first is that companies with an ESB are much more likely to remain independent after receiving a hostile takeover bid than are companies without an ESB. (12) Specifically, of ninety-two companies that were the targets of hostile takeover bids from 1996 through 2000, those that had an ESB remained independent roughly half of the time, or about twice as often as those without an ESB. (13) Second, remaining independent in the face of a hostile bid makes stockholders worse off compared with selling to the initial suitor or to another buyer. (14) Third, the aggregate harm to stockholders of those companies that receive hostile takeover bids but remain independent because of an ESB outweighs any countervailing benefit (in the form of an increased premium) to stockholders of hostile takeover targets that allow themselves to be acquired, but, perhaps, use the ESB to get a better price. (15) Based on these findings, the Study concludes that the presence of ESBs reduces overall returns for stockholders of hostile bid targets. (16)

   A powerful conclusion, to be sure, but there are a few problems. (17) The first is that the authors stack the deck in favor of their conclusion by using an overly narrow data set. The Study looked at ninety-two hostile (unsolicited) bids from 1996 to 2000. But if what we are doing is trying to determine whether adopting an ESB is a good thing or bad thing for public companies in general, there is no particular basis for limiting the data to hostile transactions. The BC&S Study points out that ESBs have a negative effect on stockholder wealth because they allow hostile takeover targets to remain independent more often, and remaining independent, according to their data, is "generally rather bad for target shareholders." (18) But, as the BC&S Study also points out, ESBs also have (or may have) a positive effect, in that ESBs provide target managers greater bargaining power to negotiate a higher price (usually thought of as a higher premium to the target's pre-bid trading price) from the acquiror in those cases where the target company does not remain independent. (19) The overlooked point is that if ESBs give targets additional leverage to negotiate a better premium in hostile transactions, it stands to reason that ESBs should have the same effect in friendly transactions as well (because the target can more effectively counter the acquiror's implicit threat to "go hostile" if its various demands are not met). Therefore, before drawing any conclusion about the overall effect of ESBs on shareholder value, BC&S need to look at all deals in any given time period to determine whether companies with ESBs receive higher premiums than those without. If so, the aggregate...