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The Corporate Takeover MarketCommon Takeover Tactics,Takeover Defenses,and Corporate GovernanceThe Corporate Takeover MarketCTreat a person as he is,and he will remain as he is.Treat him as he could be,and he will become what he should be.Jimmy JohnsonTreat a person as he is,and hExhibit 1:Course Layout:Mergers,Acquisitions,and Other Restructuring ActivitiesPart IV:Deal Structuring and FinancingPart II:M&A ProcessPart I:M&A EnvironmentCh.11:Payment and Legal ConsiderationsCh.7:Discounted Cash Flow ValuationCh.9:Financial Modeling TechniquesCh.6:M&A Postclosing IntegrationCh.4:Business and Acquisition PlansCh.5:Search through Closing ActivitiesPart V:Alternative Business and Restructuring Strategies Ch.12:Accounting&Tax ConsiderationsCh.15:Business AlliancesCh.16:Divestitures,Spin-Offs,Split-Offs,and Equity Carve-OutsCh.17:Bankruptcy and LiquidationCh.2:Regulatory ConsiderationsCh.1:Motivations for M&APart III:M&A Valuation and Modeling Ch.3:Takeover Tactics,Defenses,and Corporate GovernanceCh.13:Financing the Deal Ch.8:Relative Valuation MethodologiesCh.18:Cross-Border TransactionsCh.14:Valuing Highly Leveraged Transactions Ch.10:Private Company Valuation Exhibit 1:Course Layout:MergCurrent Lecture Learning ObjectivesProviding students with an understanding ofCorporate governance and its role in protecting stakeholders in the firm;Factors external and internal to the firm affecting corporate governance;Common takeover tactics employed in the market for corporate control and when and why they are used;andCommon takeover defenses employed by target firms and when and why they are used.Current Lecture Learning ObjecAlternative Models of Corporate ControlMarket model applies when:Capital markets are liquidEquity ownership is widely dispersedBoard members are largely independentOwnership&control are separateFinancial disclosure is highShareholder focus more on short-term gainsPrevalent In U.S.and U.K.Control model applies when:Capital markets are illiquidOwnership is heavily concentratedBoard members are largely“insiders”Ownership&control overlapFinancial disclosure limitedShareholder focus more on long-term gainsPrevalent in Europe,Asia,&Latin AmericaAlternative Models of CorporatFactors Affecting Corporate Governance:Market Model Perspective Internal to FirmBoard of DirectorsManagementInternal Controls Incentive SystemsCorporate Culture&ValuesTakeover DefensesBond CovenantsExternal to Firm External to Firm External to Firm External to Firm Legislation:1933-34 Securities Acts Dodd-Frank Act of 2010 Sherman Anti-Trust ActRegulators:SEC Justice Department FTC Institutional Activism:Pension Funds(Calpers)Mutual Funds Hedge FundsMarket for Corporate Control:Proxy Contests Hostile TakeoversFactors Affecting Corporate GoInternal Factors:Board of Directors and ManagementBoard responsibilities include:-Review management proposals/advise CEO-Hire,fire,and set CEO compensation-Oversee management,corporate strategy,and financial reports to shareholdersGood governance practices include:-Separation of CEO and Chairman of the Board-Boards dominated by independent members-Independent members serving on the audit and compensation committeesInternal Factors:Board of DirInternal Factors:Controls&Incentive SystemsDodd-Frank Act(2010):-Gives shareholders of public firms nonbinding right to vote on executive compensation packages-Public firms must have mechanism for recovering compensation 3-yrs prior to earnings restatementAlternative ways to align management and shareholder objectivesLink stock option exercise prices to firms stock price performance relative to the overall marketKey managers should own a significant portion of the firms outstanding sharesInternal Factors:Controls&Internal Factors:Corporate Culture&ValuesCorporate culture refers to a common set of values,traditions,and beliefs that influence management and employee behavior within a firm.The desired culture for the new organization can be promoted throughClear and consistent communication to all employees of what is appropriate and what is notSenior management consistently displaying the desired behaviorsReward systems that foster desired behaviors while penalizing undesirable conduct Trust in a new organization is undermined when there is ambiguity about the new organizations culture/identity.Internal Factors:Corporate CuExternal Factors:Legislation Federal and state securities lawsSecurities Acts of 1933 and 1934Williams Act(1968)Insider trading lawsAnti-trust lawsSherman Act(1890)Clayton Act(1914)Hart-Scott-Rodino Act(1976)Dodd-Frank Act(2010)External Factors:Legislation External Factors:RegulatorsSecurities and Exchange Commission(SEC)Justice DepartmentFederal Trade Commission(FTC)Public Company Accounting Oversight Board (PCAOB)Financial Accounting Standards Board(FASB)Financial Stability Oversight Council(FSOC)External Factors:RegulatorsSeExternal Factors:Institutional ActivismPension funds,mutual funds,and insurance companiesAbility to discipline management often limited by amount of stock can legally own in a single firmInvestors with huge portfolios(e.g.,TIAA-CREF,California Employee Pension Fund)can exert significant influenceRecent trend has been for institutional investors to simply withhold their votesExternal Factors:InstitutionExternal Factors:Market for Corporate ControlChanges in control can result from hostile takeovers or proxy contestsManagement may resist takeover bids toIncrease the purchase price(Shareholders Interests Theory)orEnsure their longevity with the firm(Management Entrenchment Theory)Takeovers may Minimize“agency costs”andTransfer control to those who can more efficiently manage the acquired assetsExternal Factors:Market for Discussion Questions1.Do you believe corporate governance should be narrowly defined to encompass shareholders only or more broadly to incorporate all stakeholders?Explain your answer.2.Of the external factors impacting corporate governance,which do you believe is likely to be the most important?Be specific.Discussion Questions1.Do you bMarket for Corporate Control:Alternative Takeover1 TacticsFriendly deals(Target board supports bid)Hostile deals(Target board contests bid).Rare due to Target board flexibility in setting up defensesImpact on bid premiumsImpact on postclosing integrationThe threat of hostile bids often moves target boards toward negotiated settlements.1A corporate takeover refers to a transfer of control from one investor group to another.Market for Corporate Control:Market for Corporate Control:“Friendly”Takeover TacticsPotential acquirer obtains support from the targets board and management early in the takeover process before proceeding to a negotiated settlement.The acquirer and target firms often enter into a standstill agreement in which the bidder agrees not to make any further investments for a stipulated period in exchange for a break-up fee from the target firm.Such takeovers are desirable as they avoid an auction environment.If the bidder is rebuffed,the loss of surprise gives the target firm time to mount additional takeover defenses.Rapid takeovers are less likely today due to FTC and SEC pre-notification and disclosure requirements.11The permitted reporting delay between first exceeding the 5%ownership stake threshold and the filing of a 13D allowed Vornado Realty Trust to accumulate 27%of J.C.Pennys outstanding shares before making their holdings public.Market for Corporate Control:Market for Corporate Control:Hostile Takeover TacticsLimiting the targets actions through a“bear hug”Proxy contests in support of a takeoverPurchasing target stock in the open marketCircumventing the targets board through a tender offerLitigationUsing multiple tactics concurrentlyMarket for Corporate Control:Alcoa Aluminum Easily Overwhelms Reynolds Takeover DefensesAlcoas offer to Reynolds Metals consisted of$4.3 billion in cash plus the assumption of$1.5 billion in Reynolds outstanding debt.Alcoas offer letter,which it made public,from its chief executive to the Reynolds CEO indicated that it wanted to pursue a friendly deal but that it would pursue a hostile bid if the two sides could not begin discussions within a week.Reynolds appeared to be highly vulnerable because of its ongoing poor financial performance and because of its weak takeover defenses.Despite pressure from institutional shareholders,the Reynolds board rejected Alcoas bid as inadequate.Alcoas response was to say that it would make a formal offer directly to the Reynolds shareholders and simultaneously solicit shareholder support for replacing the Reynolds board and dismantling Reynolds takeover defenses.Reynolds capitulated within two weeks from receipt of the initial solicitation and agreed to be acquired by Alcoa.The agreement contained a thirty-day window during which Reynolds could entertain other bids.However,if Reynolds should choose to go with another offer,it would have to pay Alcoa a$100 million break-up fee.What was the dollar value of the purchase price Alcoa offered to pay for Reynolds?Speculate as to why Alcoa wanted to pursue initially a friendly rather than hostile approach?3.Describe the various takeover tactics Alcoa employed(or threatened)in its successful takeover of Reynolds.Speculate as to why these tactics may have been employed(or threatened)by Alcoa?4.Why did the Reynolds board reject the initial offer only to accept the bid two weeks later?5.What is the purpose of the breakup fee?Alcoa Aluminum Easily OverwheMarket for Corporate Control:Pre-Offer Takeover DefensesPoison pills to raise the cost of takeover1Shark repellants to strengthen the target boards defensesStaggered or classified board electionsLimiting conditions when directors can be removedShark repellants to limit shareholder actionsLimitations on calling special meetingsLimiting consent solicitationsAdvance notice and super-majority provisionsOther shark repellantsAnti-greenmail and fair price provisionsSuper-voting stock,re-incorporation,and golden parachutes1Note that poison pills could also be classified as post-offer defenses as they may be issued by the board as dividends without shareholder approval.Market for Corporate Control:Poison Pill:Cash for Share PurchaseP1=Pre-offer equilibrium price/target shareP2=Poison pill conversion price/target shareP3=Offer price/target shareQ1=Pre-offer target shares outstandingQ2=Target shares outstanding following poison pill conversionABCD=Incremental acquirer cash outlay due to poison pill conversionQ1 Q2 Target Shares OutstandingTarget Price Share D S1 S2DP3P1P2Target shareholder Profit/Share on Poison Pill ConversionA BC DDD reflects relationship between shares outstanding and price/share for given level of expected earnings&interest rates.Poison Pill:Cash for Share PuPoison Pills:Share for Share ExchangeAcquirer Shareholder Ownership Dilution Due to Poison PillNew Company Shares Outstanding1Ownership Distribution in New Company(%)Without PillWith PillWithout PillWith PillTarget Firm Shareholders Shares Outstanding Total Shares Outstanding1,000,0001,000,0002,000,0002,000,00050673Acquiring Firm Shareholders Shares Outstanding New Shares Issued Total Shares Outstanding41,000,0001,000,0002,000,0001,000,0002,000,00023,000,00050331Acquirer agrees to exchange one share of acquirer stock for each share of target stock.2Poison pill provisions enable each target shareholder to buy one share of target stock at a nominal price for each share they own.Assume all target shareholders exercise their rights to do so.32,000,000/3,000,0004Target shares are cancelled upon completion of transaction.Poison Pills:Share for Share Market for Corporate Control:Post-Offer Takeover DefensesGreenmailStandstill agreementPac-man defenseWhite knights Employee stock ownership plansRecapitalizationShare buy-back plansCorporate restructuringLitigation“Just say no”Market for Corporate Control:Discussion Questions1.Discuss the advantages and disadvantages of the friendly versus hostile approaches to corporate takeovers.Be specific.2.Do you believe that corporate takeover defenses are more motivated by the targets managers attempting to entrench themselves or to negotiate a higher price for their shareholders?Be specific.Discussion QuestionsDiscuss thImpact on Shareholder ValueFriendly transactions realized abnormal returns to target shareholders of about 25%during the 2000sHostile transactions often result in even larger average abnormal returns to target shareholders Acquirers shareholders earn average abnormal returns of 1%to 1.5%;however,they may be negative for deals involving large public firms and those using stock to pay for the dealRecent studies suggest Takeover defenses have small negative impact on abnormal target shareholder returns Defenses put in place prior to an IPO may benefit target shareholdersBondholders in firms with ineffective defenses(i.e.,vulnerable to takeover)may lose valueImpact on Shareholder ValueFriThings to remember.Hostile takeover attempts and proxy contests affect governance through the market for corporate controlAlthough relatively rare,hostile takeover attempts tend to benefit target shareholders substantially more than the acquirers shareholders by putting the target into“play.”Consequently,acquirers generally consider friendly takeovers preferable.Anti-takeover measures share two things in common.They are designed to Raise the overall cost of the takeover to the acquirers shareholders andIncrease the time required for the acquirer to complete the transaction to give the target additional time to develop an anti-takeover strategy.Things to remember.Hostile t
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