Transfers of corporate control in firms with noncontrolling blockholders

• Date: 01 June 2019
• Author: Sergey Stepanov
• Published date: 01 June 2019
• DOI: http://doi.org/10.1111/1756-2171.12276

RAND Journal of Economics

Vol.50, No. 2, Summer 2019

pp. 453–480

Transfers of corporate control in firms

with noncontrolling blockholders

Sergey Stepanov∗

I model the choice between a negotiated block trade and a public tender offer as means of

acquiring control in a firm with a large minority blockholder. Potential acquirers differ in their

(privately known) value-creation ability. In equilibrium, block trades are made by lower ability

acquirers compared to tender offers. The equal opportunity rule (EOR) and the “freezeout” rule

are complements in promoting efficiency of control transfers. Stronger investor protection may

hamper value-increasing takeovers whenthe EOR is present. The model also delivers predictions

about announcement returns and the incidence of block trades and tender offers under different

legal regimes.

1. Introduction

Although the literature on takeovers is huge, insufficient attention has been devoted to the

choice of the control transfer mode in firms with large shareholders.1According to empirical

observations, most public companies in the world have blockholders, and in most of them, the

largest owner has less than 50% of votes.2If someone is considering acquiring control in such

a firm, she/he would often be faced with a natural choice: buying the share of the dominant

blockholder versus implementing a full-scale takeover. Whereas acquiring a large block does not

probably bring as much control as a full takeover, it still provides the acquirer with substantial

control, which is supported by evidence.3Empirical observations suggest that both types of

∗National Research University Higher School of Economics, Russian Federation; sstepanov@hse.ru.

The study has been funded within the framework of the Basic Research Program at the National Research University

Higher School of Economics (HSE) and by the Russian Academic Excellence Project “5-100.” I am very grateful to the

Editor, two anonymous referees, Mike Burkart, Mehmet Ekmekci, Sergei Izmalkov, Andrey Malenko, Silvia Rossetto,

Carsten Sprenger, seminar participants at Stockholm Institute of Transition Economics, Centre for Studies in Economics

and Finance (Naples), Higher School of Economics (Moscow), and New Economic School (Moscow)for comments.

1Several models consider the choice between a friendly merger and a hostile tender offer, where the former

means that the deal is privately negotiated with the target’s management (e.g., Berkovitchand Khanna, 1991; Schnitzer,

1996; Betton, Eckbo, and Thorburn, 2009; Calcagno and Falconieri, 2014). However, this literature does not consider

block trades.

2Among 5232 European companies in Faccio and Lang (2002), about 92% of firms had a shareholder with at

least 5% of voting rights, and the median largest block had 30% of votes. See Claessens, Djankov, and Lang (2000) and

Holderness (2009) for similar evidence on East Asia and the United States, respectively.

3Block purchasers pay substantial “control premiums” (Dyck and Zingales, 2004) and frequently initiate changes

in the management and board of directors compositions (Barclay and Holderness, 1991).

C2019, The RAND Corporation. 453

454 / THE RAND JOURNAL OF ECONOMICS

control transfer occur in companies with blockholders (Barclay and Holderness, 1991; Holm´

en

and Nivorozhkin, 2012).4

My main contributions are as follows:

1. I develop a model that explains the choice between a block trade and a full-scale acquisition

via a public tender offer. Most articles have not considered such a choice at all, and those that

did—Burkart, Gromb, and Panunzi (2000) and Zingales (1995)—predicted only block trades

in equilibrium. In contrast, I obtain both types of transactions in equilibrium, with tender offers

being chosen by acquirers with higher value-generation abilities. Thus, the model explains

why targets’ announcement returns are higher in tender offer deals compared to block trades.

2. The model delivers a number of results about the effects of takeover regulation and the

quality of investor protection on the outcomes of the market for corporate control. Some of

them constitute new testable predictions, whereas others help to explain existing empirical

observations.

3. I show that the “equal opportunity rule” (EOR, also called “mandatory bid rule”), forcing a

block purchaser to extend her offer to other shareholders, and the “freezeout rule,” allowing

a bidder who has acquired a majority of the shares to buy out the remaining shares at the

tender offer price, are complements in promoting efficiencyof the market for cor porate control;

introducing one without the other may be detrimental to efficiency. I also show that, whenthere

is the EOR and no freezeout possibility, tightening constraints on private benefit extraction by

a controlling party may hurt efficiency by hampering value-increasing tender offers.

Thus, my analysis suggests that the effects of the freezeout rule, the EOR, and investor

protection are interdependent and, thus, cannot be analyzed in isolation from each other.

I consider a firm with a dominant, yet minority, blockholder (“incumbent”). Other share-

holders are atomistic, so that the incumbent effectivelycontrols the company. A potential acquirer

(raider) can first try purchasing the incumbent’s share. If the negotiations fail, the acquirer can

make a public tender offer.The incumbent can launch a counter offer. The dispersed shareholders

decide noncooperatively whether to tender their shares and to whom. If the incumbent does not

counter, he also makes his tendering decision.

The incumbent and the raider are characterized by the total value each party generates

being in control. A controlling party can also divert a fixed proportion of the total value for

his/her own private benefits at no cost. For simplicity, I assume that this proportion is the same

for both the raider and the incumbent and is determined by the quality of legal protection of

investors (unrelated to takeover regulation). The rest of the value is security benefits accruing

to all shareholders. Potential acquirers differ in their value-generation ability. As private benefit

extraction involves no cost, the first-best solution is characterized by control transfers occurring

if and only if the acquirer generates higher total value than the incumbent.

The baseline model is first solved under the assumption of having the freezeout rule but no

EOR. The freezeout rule eliminates the well-known free-rider problemin tender offers (Grossman

and Hart, 1980; Bradley, 1980), effectively improving the raider’s bargaining position vis-`

a-vis

dispersed shareholders. Namely,the raider does not need to match her bid to the expected security

benefits she will generate, she only needs to outbid the incumbent.

I first consider the case when the raider’s ability is common knowledge. In a tender offer

contest, each party is prepared to bid up to the total value it generates. Thus, provided that a bid

contest occurs, the company is taken over if and only if the raider generates a greater value. The

dispersed shareholders then obtain the equilibrium bid,which is equal to the value generated by the

incumbent. In contrast, if a block trade occurs, they receive the post-transaction security benefits

generated by the acquirer. If those are higher than the equilibrium bid, the dispersed shareholders

4In the US sample of Barclay and Holderness (1991), a full acquisition (either following or simultaneously with a

block trade) occurred in 41 out of 106 control transactions. Holm´

en and Nivorozhkin (2012), in their Swedish sample,

documented 62 block trades and 28 nonpartial tender offers in companies with blockholders.

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