JEFFREY MACINTOSH
The well-venerated 1965
report of the “Kimber Committee” set the stage for the legal
paradigm of takeover regulation
that now prevails across Canada.
Under this paradigm, the purpose
of takeover bid legislation is protection of the bona fide interests
of the shareholders of the target
company. These include giving
these shareholders enough time
and information to intelligently
decide whether to tender, preventing “coercive” tactics by bidders, and (so far as possible)
ensuring equal treatment of target shareholders. The implicit
foundation on which the legal
paradigm is constructed is the
notion that target shareholders
are entitled to a fair premium for
their shares. Modern takeover bid
regulation achieves these goals in
a variety of ways that will be familiar to any securities lawyer.
My colleagues are often surprised, however, if not downright
scandalized, to learn that this
paradigm is widely rejected by
financial economists. This is true
even though there is abundant
evidence that the legislation has
resulted in larger premiums for
target shareholders. Indeed, these
premiums are a key datum in the
argument that the existing
approach is fundamentally flawed.
As Easterbrook and Fischel
pointed out nearly 30 years ago,
focusing on target shareholder
welfare is illogical. Like targets,
most acquirers are public corporations. To the extent that
target shareholders earn a larger premium, it is extracted
from the pockets of the acquirer’s shareholders.
Since a given investor is just as
likely to hold shares in the acquirer
as the target, ex ante, any ran-
domly selected investor will be
indifferent to whether the gains
are captured by the target or the
acquirer. Over time, we would
predict that the average investor
will be a shareholder of the
acquirer as often as the target.
Building a legislative edifice on
the protection of target share-
holders thus merely shuffles
money from one pocket to
another, with no net gain.
“
Takeover bids are...
probably the best tool
we have for displacing
ineffective managers.
Reducing the frequency
of takeover bids is thus
damaging to the
economy at large.
Worse yet, there is good evidence that target shareholders
are actually made worse off. How
can this be, when premiums go
up? The point is really quite simple. Even lawyers deeply suspicious of the Mephistophelian
machinations of economists
(financial or otherwise) will generally agree that demand curves
slope downwards. That is, if the
price of a good goes up, people
usually buy less.
What does this mean for target shareholders? By increasing
target shareholder premiums,
existing legislation raises the
“price” of hostile acquisitions.
We would thus expect to see
fewer of them—a prediction
with strong empirical confirmation. Since you can’t make any
money out of an acquisition that
never happens, the efficacy of the
legislation, from the target shareholder’s point of view, reduces to
an empirical question. Does the
premium effect (the expected
increase in the premium, should
a bid occur) outweigh the probability effect (the diminished
likelihood that a takeover bid
will occur) — or vice versa?
The results are in, and the winner is—the probability effect.
How do we know? Various American states have enacted legislation that gives target shareholders
significant power over acquisitions. These include “control share
acquisition” statutes, which give
target shareholders the power to
approve a change in control, and
the “fair price” and “freeze-out”
statutes, which regulate the ability
of an acquirer to effect the second
step in a two-step acquisition,
and/or its price. These statutes
have both premium and probability effects. Thus, their net effect on
the share prices of subject firms is
good evidence of how these effects
trade off. The evidence overwhelmingly shows that the introduction of these forms of legislation drives share prices down.
In addition, many corporations adopt various forms of
“shark repellent” (of which the
poison pill is now the most prominent) whose net effect is typically to give the target’s board
more time to find a white knight
or some alternative value-produ-cing transaction (consistent with
the goals of the Kimber Committee). Once again, the empirics
overwhelmingly suggest that
such defensive measures cause
share prices to fall.
In like manner, when a target
board wins a court battle over
defensive tactics, its share price
will typically fall. When the
acquirer wins, its share price will
typically rise.
The strongest empirical
datum against the existing paradigm, however, is that takeover
bids are an important mechanism for moving assets to their
highest and best uses—and
probably the best tool we have
for displacing ineffective managers. Reducing the frequency of
takeover bids is thus damaging
to the economy at large.
Indeed, the disciplinary reach
of the takeover bid extends far
beyond what we might initially
suppose. As long as managers of
public companies know that a
hostile takeover bid might occur,
and that such a bid will likely
cost them their jobs, they will
manage more diligently and
effectively. A takeover bid need
not actually occur to have a pervasive and positive effect on corporate governance.
One can only regard it as an
abiding oddity that, at a time
when corporate governance is the
revered mantra of legislators,
regulators, lawyers, and activists
alike, one of the most powerful
tools for setting the corporate ship
of state on an even keel has been
unceremoniously confined to
quarters. There is truly no underestimating the inertial power and
stubborn persistence of a widely
accepted paradigm—no matter
how elementally misconceived. ;
Jeffrey MacIntosh is the
Toronto Stock Exchange Professor
of Capital Markets at the Faculty
of Law, University of Toronto. He
has written extensively in the
areas of securities regulation, corporate law and venture capital.
An oddity in
Business Law
Stereophonic headphone
maker Koss Corp. recently fired its
vice president of finance for an
alleged corporate embezzlement
of a whopping US $20 million
over four years.
Koss had net sales of US$38
million in 2009. Sujata “Sue”
Sachdeva earned an average of
US$190,000, yet allegedly spent
millions at Milwaukee area boutiques and left large piles of clothing in her office with price tags in
excess of US$2,000 attached,
according to Dailyfinance.com.
No one noticed anything until
American Express alerted the
company of large transfers from
its bank account. The U.S. Attorney’s office in Milwaukee has filed
a criminal complaint against
Sachdeva.
It’s a wake-up call to many
companies to monitor top financial executives. — Natalie Fraser
Embezzlement
on a grand scale
CHEN FU SOHE / ISTOCKPHOTO.COM
Clients know what they need, have done the research and want a cost estimate
Value
Continued From Page 9
value to client needs are under
pressure. For a short time, for
those on the cutting edge of an
industry or a new legal innovation,
these services may be so highly
valued as to allow the legal practitioner an open chequebook on
cost, so long as the lawyer can get
the job done. We all wish we could
have clients with legal needs and
financial resources like those.
Much more common is the
situation where the client knows
what they need, has researched on
the Internet or inquired of other
lawyers on how to get what they
want, and will ask you directly for
an estimate of costs and a time-
frame. In many cases, the client
will have a fair idea of the cost
from their earlier inquiries and
they will tell you how long the
transaction can take.
“The only way to
ensure that you get
the file ahead of your
competitors is to have
done your homework
in advance.
well as transactions that we have
not yet done, with checklists, draft
precedent documents and discus-
sion of issues that should be con-
sidered. All lawyers in the group
are responsible for researching
and teaching a topic to the others.
It is a lot of extra non-billable
work, but when a client calls with
that transaction in mind, each of
our lawyers can speak about it
with some knowledge.
Bernard Pinsky is the head of
the Corporate Finance / Securities
and U.S. Practice Groups at Clark
Wilson LLP in Vancouver. His
practice focuses on regulatory compliance for publicly traded companies, cross-border transactions
and financings. He is admitted to
practise law in B.C. and California.
