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Posts Tagged ‘Proxy Fight’

Agency Costs and Institutional dominated share ownership: activists and governance

Summary: Institutional Investors (II) -such as mutual funds- are rational while not doing research and issuing shareholder proposals; activists and hedge funds may have a role issuing those proposals, so that others have an option to increase their voting value. (See (1) and (2) by Gilson, Ronald J. and Gordon, Jeffrey N. and by Bebchuk, Lucian A. and Cohen, Alma and Hirst, Scott respectively.

The fact that property is concentrated in II makes the world of Berle and Means outdated. A new agency problem arises between record owners, (II now) and managers, but also between record owners and beneficial owners, (this is what they call “Agency Capitalism”, where II or agents hold investments on behalf of final or beneficial owners).

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The case for and against Poison Pills

November 11, 2012 Leave a comment

A poison pill can be defined as a security issued by a target company and granted to current shareholders, convertible into ordinary shares in case that a not friendly investor surpasses a certain ownership threshold, and was a 1982 invention by Mr. Lipton, (ML) a partner in Watchell, Lipton, Rosen and Katz. The security can be issued when the investor reaches 10% and may be converted in case he hits 40%, for instance.

In June 2002, Professor Bebchuk (PB) published an article against that practice, that we will follow in its main aspects, as we will follow (ML) Mr. Lipton`s answer, published only a short time after.

The question is whether boards should have the power to block unsolicited takeover bids. PB first argues the existence of mechanisms assuring undistorted choice by shareholders, is a valid argument against that board veto. A poison pill implies a hostile bidder would only succeed if he won a ballot to replace incumbent directors for others that would redeem the pill. The board should only have time to prepare alternatives for shareholders`consideration. Other veto tools often used are staggered boards, dead hand pills, deferred redemption pills, etc.

In 1985, the Delaware Court, in four cases stated the following, in favour of the poison pill, supporting ML`s proposal:

–         Directors would be forced to use a judgement on the value of the corporation, not the market value when deciding on takeover issues,

–         Directors should use an objective business judgement, being responsible for their good faith, when deciding on takeover issues,

–         Directors duty entails maximizing short-term value after deciding for a takeover, not before,

–         A poison pill is said to be acceptable until shareholders decide to replace directors,

Ensuring an undistorted shareholder choice.

PB proposes a “Voting and no Board veto system”:

  1. In a takeover bid, the pressure to tender is huge, as a lonely shareholder can expect the value of his illiquid stock after a bid has succeeded, would be minor than the bid price. Enabling owners to vote separately (i) on a takeover, and (ii) on selling the shares if a takeover takes place, is a clean way to downsize the pressure.
  2. Preventing structurally coercive bids, though restrictive, could also favour undistorted choice. Limiting bids to all-shares offers with a later same price freeze-out, could do, but is still worse than the previous solution, (intertemporal discount rate can`t be optimal for all shareholders).
  3. Actually, a blockholder or bidder sometimes is restricted to a previous ballot by other shareholders, on his capacity to vote his shares, which prevents some bidders to invest. With a poison pill, the vote is really on directors replacement.
  4. In case an undistorted choice system is in place, board should not have a power to veto a shareholders` vote, should not distort the outcome of that vote, nor block the takeover once it is approved. A poison pill is consistent, if a vote on it can be held, even with a system of enough written consent.

The case against or for the Veto

The first thing to be clarified is the perspective under which this topic is considered:

–         Target shareholders` perspective: ex post and ex ante agency costs are against the Board Veto, (BV). BV supporters argue against the efficient capital markets theory, and also point out that directors, given their insider information, are the best placed to decide on whether to accept and offer or not. They also think of veto as a bargaining tool; of excessive short-termism when takeover threat is real; and of compensation schemes as being a valid tool to correct managers`self interest in using the veto.

–         Target`s long term shareholders` perspective: those favouring board veto support the idea that laws should rather favour long-term shareholders, (although empirical evidence that takeover resistance has been positive for them, is not conclusive).

–         Total Shareholder`s wealth perspective: according to this, total corporate wealth including the bidder`s wealth should attract lawmakers. A transfer of a premium can`t be considered a net benefit, and the case of a rejection would bring into the equation the huge costs that failed bidders afford. This perspective does no favour the veto argument.

–         All corporate constituencies` perspective: other stakeholders` interests should be considered. This could justify a veto, but it is perhaps not the best way to protect stakeholders, and the doubt remains as to whether managers would defend them or their own interests, while using veto power.

ML, argues first, that poison pills allow managers not to manage an “always for sale” company, thus avoiding the related costs; second, he considers PB`s proposal is weak: a referendum is not needed, as a proxy fight option is always available; besides, directors have a duty to pursue the best interests of shareholders, and they are accountable for their actions before courts; moreover, a referendum should be strongly conditioned to be operative, (bids should be serious, not excessively conditional, approved by regulatory bodies, and so on).