Chapter 11 - The Market for Corporate Control

Question 1

What is the market for corporate control?

When does the market for corporate control occur?

Answer 1

External governance mechanism consisting of potential owners seeking to acquire undervalued firms and earn above average returns on their investments.

It occurs when an active firms internal controls fail.

Question 2

What are the three reasons why external mechanisms are needed like the market for internal control?

Answer 2

1. Addresses weak internal corporate governance
2. Corrects suboptimal performance relative to competitors
3. Disciplines ineffective or opportunistic management.

Question 3

Which mechanism is more precise?

Answer 3

Internal governance mechanisms.

Question 4

What was Henry Manne’s thesis?

What does the price of the stock reflect?

What may the board do if it is not going to remove an executive under suboptimal performance?

What are 3 things that could be changed?

Answer 4

The lower the stock price, relative to what it could be with more efficient management, the more attractive the takeover becomes to those who believe that they can manage the company more effectively.

It reflects the managements performance

They can sell the business to an owner who could manage its assets more profitably.

Changing the strategy, cost structure, and the capital structure.

Question 5

What does the marketplace for corporate control do?

What are the 5 markets for corporate control?

Answer 5

Designed to change the ownership, structure, and / or control of a company

1. Mergers
2. Friendly / Negotiated takeovers
3. Hostile takeovers
4. Leveraged Buyouts (LBO’s)
5. Management buyouts (MBO)

Question 6

What are the six strategic reasons for an acquisition?

Answer 6

1. Financial synergies
2. Diversification
3. Change in ownership
4. Economies of Scale
5. Economies of Scope
6. Human Capital or Intellectual property

Question 7

Describe the advantage of the financial synergy in an acquisition

• What are the three ways it can improve the revenue?
• What does this logic represent?

Answer 7

The acquiring firm believes that it can increase profits through revenue improvements, cost reduction, or vertical integration.

This logic represents the strategic buyer

Question 8

Describe the advantage of diversification in an acquisition

• Which entities have reduced risk profiles?
• What does this logic represent?

Answer 8

Two companies whose earnings are uncorrelated might benefit by relying on the capital generated when one business is thriving to help the other when it is struggling.

• The larger entities
• Conglomerate structure

Question 9

Describe the advantage of change in ownership?

• What are 4 resources they may have better access too?
• What does this logic represent?

Answer 9

New owner groups might have superior access to capital, managerial expertise, technology, or other resources.

• Private equity buyer

Question 10

Describe the economies of scale advantage?
- What does this logic represent?

Answer 10

The acquiring firm believes it can increase profits through producing goods at a higher volume.

• The strategic buyer

Question 11

Describe the economies of scope?
- What does this logic represent

Answer 11

Savings from utilizing the marketing and distribution capabilities for a broad product offering.

• This represents the strategic buyer

Question 12

Describe the human capital or intellectual property advantage?

-What is this a rationale for?
- What does this logic represent?

Answer 12

New owner group might desire human ideas and capabilities. Rationale for many technological deals.
- Represent the strategic buyer

Question 13

What are the 4 non strategic reasons for an acquisition? Describe them.

Answer 13

1. Empire building - The acquirer purchases a target primarily for the sake of managing a larger enterprise
2. Hubris - Overconfidence on the part of management that it can more efficiently manage the target than the current owners can
3. Herding behaviour - The senior management of one company pursues an acquisition because its competitors have recently completed acquisitions.
4. Compensation Incentives - The management of the target company agrees to an acquisition primarily because it stands to receive a large payment upon change in control.

Question 14

What are the 3 different acquisition processes in Canada?

What is the main concern regarding the different acquisitions?

Who are the two parties?

• Who has the more complicated takeover process?

Answer 14

1. Mergers
2. Solicited takeover (Negotiated/ Friendly)
3. Unsolicited takeover (Hostile)

• Every M&A requires two parties, thus they all have a different process and governance issues.

The acquiror and the target

• The acquiror had a more simple process from a governance standpoint, the target is more complex based on the receptivity.

Question 15

What are the 3 parts of the acquiror process?

• Similar too? Requires who’s approval?

Answer 15

1. Like any large investment decision, the board must approve
2. Valuation work must be done in advance.
3. May require a fairness opinion from an investment bank

Question 16

Describe the basics of the target process for a a takeover?

Answer 16

It is a different process depending on whether the process is initiated by the target (solicited) or hostile (unsolicited), or via a merger.

Question 17

What is the definition of a merger?

• Describe the negotiations. Who is involved?
• Who is it supported by and what role does it fulfill?
• Approved by who and through what process?
• What are the new shareholders offered in the merger? Price of the merger?
• What happens with the management team and the shares?

Answer 17

A merger is a friendly combination of two firms to create a new legal entity - usually with a new name.

• They are exclusive, private, where there is reciprocal due diligence between the companies, where both management teams are involved.
• It is supported by the board of directors, with fairness opinions in order to fulfill the respective board fiduciary duty. It is approved by the shareholders via a proxy vote.
• Equivalent holdings in the new company. There is a small to no premium compared to the market price.
• The management is combined and the old shares are delisted, and the shares of the new firm are put on the market.

Question 18

What is the first step of a solicited (negotiated friendly) acquisition? Who is it run by?

What does this fulfill?

Describe the negotiation process?

What happens to the targets management?

What is the role of the board after the negotiation process? What do they mail?

What do the shareholders do?

Answer 18

• The target/ seller will request bids through a broad or narrow auction process, run by an investment bank.

The auction fulfills the Boards fiduciary duty.

• The management will negotiate with one or more bidders/acquirors,

The target management will receive their compensation in the form of a golden parachute.

• They will accept and recommend the bid that will provide the greatest shareholder value, they mail the board circular.

The shareholders will vote whether to accept the offer or not.

Question 19

What is the first step of the unsolicited (hostile) acquisition?

How does the management typically reply?

What is the legal obligation of the target?

What are 4 things that happens if the bid is successful?

What happens if the bid seems unsuccessful?

Answer 19

The bidder make an offer directly to the shareholders going against the wishes of the targets management and board.

Management will typically reply by rejecting the bid after evaluation and implementing takeover defences - Like a white knight search or a poison pill.

Legally the target must provide the bidder with the contact information of the shareholder list so the offer can be made directly to the shareholders.

If it is successful the bidder will take over the corporation - Delist the stocking, corporation becomes a wholly owned subsidiary, fires the management, and replaces the boards.

If it is unsuccessful, the bidder can raise its offer and / or negotiate a higher price and terms in order to turn the deal friendly.

Question 20

Which critical case has set the rules for the boards main duty in a takeover situation in Canada?

What is the fiduciary duty in a takeover situation? What does this reject?

What is another duty of the directors?

What did the BCE case affirm?

Answer 20

BCE case

The fiduciary duty is owed to the corporation as a whole rather than interests of any particular shareholder, groups of shareholders, or other stakeholders. This rejects revlon.

To understand the other stakeholders and their interests.

The business judgement rule as it applies to the directors.

Question 21

What do boards typically have to respond to in the USA?

What is the name of the main duty and the critical case that is set in the United States for a takeover?

What are the Revlon duties?

What is the Unocal case?

Answer 21

Judicial scrutiny also called the Revlon duties?

Revlon duties and the Unocal case

The Revlon duties require, if a change of control is going to occur than directors must seek highest value for shareholders.

When a board takes defensive actions, the actions cannot be coercive or designed to preclude a deal.

Question 22

What is the boards other 4 duties in a takeover process?

• What 3 areas has the duty 1 been established
• What 2 cases has the duty 2 been established?

Answer 22

1. Disclose the conflicts of interest - Established in the common law, statues, and MBO cases
2. Corporate opportunities - Established from the Canaero and Peso Silver cases - Opportunities are owned by the corporation but fact specific.
3. Duty of confidentiality - Keep secrets of the corporation - Insider trading, tipper/tippee rules
4. Duty of disclosure - Do not keep secrets from the corporation (You know of a potential bid for the corporation.)

Question 23

What are two criteria that would classify a takeover as hostile?

• What do changes in control result from?
• What is a major issue for the bidder in a hostile attack?

Answer 23

1. The board rejects the offer, but the bidder continues to pursue it.
2. If the bidder makes the offer without informing the board before hand.

• They result from hostile takeovers and / or proxy contests
• The lack of inside information to accurately value the target

Question 24

What are the two reasons management may resist the takeover bids? What are these theory’s called?

Answer 24

1. Increase the purchase price (Shareholder Interests Theory)
2. Ensure the longevity with the firm (Management Entrenchment Theory)

Question 25

What are two things that the takeover may do? - Minimize - Transfer

Answer 25

1. Minimize the agency cost 2. Transfer control to those who can more efficiently manage the acquired assets.

Question 26

What are 6 common characteristics of a typical target firm? - What us the best takeover defense

Answer 26

1. Weak financial performance - An ROE of 5% or lower in its peer group 2. A stock that has significantly under performed the peer group within the past 2 years 3. Managers who hold little or no stock in the firm. 4. Underutilize assets that are not readily apparent 5. Low debt levels 6. In an industry with heightened merger activity. - Run your firm well and earn good returns for your shareholders

Question 27

What are 6 reasons why we do not often see the hostile takeovers

Answer 27

1. Public fights can damage a company's reputation and brand 2. Hostiles are usually more expensive (Costs and premiums) 3. Too many effective defences against the takeover 4. The initial bidder in a hostile usually loses the battle to a White Knight bidder found by the target. 5. Post deal integration a bigger problem in hostiles. 6. Lack of inside information and due diligence process makes hostile acquisitions riskier.

Question 28

According to the research who does the incremental value of an acquisition flow too? What is the impact on a friendly takeover? What is the impact on a hostile takeover? What is the impact on an all cash deal?

Answer 28

The target rather than the acquirer. 1. Target receives double digit takeover premium offer - Friendly transactions result in average abnormal returns to target shareholders of 20% 2. experiences greater excess returns in hostile deals - Hostile transactions result in average abnormal returns to target shareholders of 30-35% 3. Experiences greater excess returns in all cash deals.

Question 29

What is the impact of a friendly takeover to the shareholders of the acquiror? What is the impact of a hostile takeover on the shareholders of an acquiror? What is the impact of an equity financed bid on the shareholders of the acquiror

Answer 29

1. Experiences no excess returns following the bid. - Bidders shareholders earn on average abnormal returns that are 0 or slightly negative, often positive in some situations. 2. Experiences negative excess returns for hostile bids 3. Experiences greater declines if equity-financed bid

Question 30

What does the research show regarding the realized value of a takeover?

Answer 30

The research shows that the acquirer realizes less value following a takeover / merger than originally expected.

Question 31

What are three negative effects on the acquirer for the realized value of a takeover? - Underperforms - Performs - Decreases

Answer 31

1. Underperforms peers on a 1-3 year basis 2. Performs worse if acquisition was financed with equity 3. Decreases investment in working capital and capital expenditure

Question 32

What are the two ways that acquisitions are disruptive?

Answer 32

1. They require a significant amount of management attention. 2. They lead to elevated turnover rates for up to 10 years following consummation of the deal.

Question 33

What is the purpose of an anti takeover defense? What does the anti-takeover defense - Give - Enhance - Raise - Increase

Answer 33

To not become a target of an unsolicited takeover, it may adopt mechanisms to discourage or prevent the bid - Give a company time to pursue long term value creation without threat of takeover - Enhance bargaining power to secure a higher bid - Raise the overall cost of the takeover to the acquirers shareholders - Increase the time required for the acquirer to complete the transaction to give the target additional time too develop an anti-takeover strategy.

Question 34

What are the 8 anti takeover defences?

Answer 34

1. Poison pill 2. White knight 3. White squire 4. Golden parachute 5. Dual class shares 6. Staggered boards 7. Recapitalization 8. Regulatory approval

Question 35

What is a poison pill? What are white squire? What are golden parachutes? - Who does this only typically work for?

Answer 35

Rights offering to existing shareholders that makes the deal so expensive that the Bidder walks Passive investor(s) purchases blocks of stock to frustrate the bid Extremely lucrative severance packages - only works for small firms

Question 36

What are staggered boards? What are dual class shares? What are regulatory approval

Answer 36

Staggered terms for board members that makes a proxy fight to change the board difficult Different classes of shares with different number of votes per share Fight the deal at the regulatory level, for regulated industries.

Question 37

What are white knights? What is recapitalization?

Answer 37

Search for a friendlier company to acquire the target Change the capital structure, usually with debt to make the deal look unattractive.

Question 38

What type of right is granted through a poison pill? When is the poison pill triggered? What happens if the threshold is exceeded? Are they commonly used?

Answer 38

Grants the holder of the company's shares the rights to acquire additional shares at a steep discount to market (0.01 per share) It is triggered when a shareholder accumulates an ownership position about a threshold (15-20%) When the threshold is exceeded, the market is flooded with new shares, making it prohibitively expensive to gain control. No they are rarely actually triggered.

Question 39

Why are poison pills not common in Canada?

Answer 39

The security regulations changed the time a company has to approve a deal to 105 days. This removes managements main reason for instituting a poison pill, namely they need more time to evaluate potential shareholder enhancement measures.

Question 40

When do US markets respond positively to a poison pill? For company's that adopt a plan, what is the rate of success for deterring an unsolicited offer? What happens to the premium if the deal is accepted and what happens if the deal is unaccepted?

Answer 40

If the company's board is majority outside director, and negatively otherwise. 2 times as likely. If the deal is accepted, the premium is 5% to 10% higher. If the deal is defeated the targets stock price declines by 14%

Question 41

Describe the staggered board. How does this act as an anti takeover defense? What advantage does this bring? What anti takeover defense should this not be paired with?

Answer 41

Directors are grouped into three classes, each of which are elected to a three year term. Only one class stands for an election in any given year. This makes not such that the raider must win two elections, one year apart, to gain majority representation. This brings greater stability to the board. It should not be paired with the poison pill, as it acts as an obstacle.

Question 42

With regards to the staggered boards what happened between 1996 and 2000? What is the benefit of a staggered board? Do companies with a staggered board receive significantly higher takeover premiums?

Answer 42

No corporate raider had gained control of a staggered board through a proxy contest. They are significantly more likely to defeat a bid. No they do not, it is about a 54% to 50%

Question 43

What are dual class shares. - What does each class have and not have what is a wedge? How does the dual class share act as a anti takeover mechanism?

Answer 43

A company with dual class shares has more than one class of common share, each class typically has proportional ownership interests but disproportional voting rights. The difference between the economic interest and the voting rights. The class with favorable voting rights does not trade in the market but is instead held by insiders, founders, or another shareholder that is friendly to the management. Thus it helps to stop the takeovers.

Question 44

What are the three reasons that a company with dual class shares have lower governance quality?

Answer 44

1. Shareholders are more negative of acquisitions. 2. Shareholders are more negative of large capital expenditures 3. CEO compensation is higher as the size of the wedge increases

Question 45

What are 7 other anti takeover provision?

Answer 45

1. Shark repellent 2. Greenmail 3. Standstill agreement 4. Pac Man Defense 5. Share buyback plans 6. Litigation 7. Just say no

Question 46

What does research say about the impacts on abnormal shareholder returns by anti takeover provisions? What if the defense is put in place prior to an IPO? What happens to the bondholders if there are ineffective defenses? What happens to the governance quality and shareholder value when an antitakeover provision is implemented. Who do the hostile takeover attempts benefit? Which type of takeover is preferrable?

Answer 46

1. Takeover defenses have small negative impacts on abnormal target shareholder returns 2. Benefits the target shareholders 3. Bondholders that have ineffective defenses may lost value. Governance quality and shareholder value is reduced. They benefit target shareholder substantially more than the acquirers shareholders by putting the target into play. Consequently, the acquirers generally consider friendly takeovers preferable.

Question 47

Are takeovers a governance mechanism? Are they effective? What are the three reasons that they are not effective?

Answer 47

yes they are a type of governance mechanism, but it is unclear as to whether they are effective or not. 1. Acquirer may have to pay too much for the target 2. Takeovers might occur for the wrong reasons 3. Even if the acquirer is able to pay a fair price for the target, the amount is usually significant.

Question 48

What is a leveraged buyout? Who is typically involved? What is used to make the purchase?

Answer 48

It is where a small group of investors buys all publicly held stock, makes the firm private, and usually includes management. Then they make it public to cash it out. They use the large amounts of high yield debts

Question 49

What is a management buyout? - What do owners want to do - What is the business no longer considered? - What challenges may the business be facing and what would they want to do? - How does an MBO happen, what type of payments are used?

Answer 49

It is the purchase of a company or business by all or some of its existing management. The owners of the business , may wish to retire. the business may no longer be considered as core to the whole company or the group. the business may be having financial difficulties and thus the owners want to sell off its assets to improve the cash flows. An MBO is quite substantial and is usually a combination of debt and equity, that is derived from buyers, financiers, and sometimes even the seller.