Sunday, 14 August 2016

The role of governments in hostile takeovers

Maximilian Rowoldt and Dennis Starke discuss "The role of governments in hostile takeovers – Evidence from regulation, anti-takeover provisions and government interventions" in the latest issue of the International Review of Law and Economics (Volume 47, August 2016, Pages 1–15).

The abstract reads:
This paper addresses the role of governments in hostile takeovers by analysing 263 hostile takeover bids in Europe and North America during 2000–2014. Our results suggest that governments may influence the openness of the domestic hostile takeover market through takeover regulation, potentially implementing protectionism. The corresponding features of the regulatory regime may in turn stimulate the deployment of anti-takeover provisions by entrenched target managers. Rather than increasing takeover premiums, anti-takeover provisions are associated with lower success rates of hostile bids, and may thus harm corporate governance. Governments’ direct intervention in hostile takeovers is more likely in case of a foreign bidder, large transactions, high unemployment and high GDP growth rates, pointing to both protectionist and populist motives. The hostile bid failed in all cases of government intervention identified in our sample. Direct government intervention may thus serve as ultimo ratio in order to block unwanted transactions.

Rowoldt and Starke write
Hostile takeover bids emphasise the conflicting interests of shareholders, managers and governments (Romano, 1988; Shleifer and Vishny, 1997). While targets’ shareholders are interested in maximising their return on investment, targets’ management may seek to entrench themselves and protect their job position by deploying anti-takeover provisions (ATPs). The misalignment of shareholder and management interests is especially pronounced in the case of hostile takeover bids (Armour and Skeel, 2007; DeAngelo and Rice, 1983; Jensen and Meckling, 1976). Against this background, the role of governments is of particular importance as they define the playing field for hostile takeovers through takeover regulation. Furthermore, governments may directly intervene in corporate takeovers. Takeover regulation and direct intervention in hostile takeovers may therefore follow national interests.
One is left wondering exactly what the "national interest" is. Interestingly the French takeover regulations were amended in 2014 in ways that help block unwanted foreign takeover bids. In particular, the French government eliminated mandatory board neutrality and shifted to a system which enables managers to deploy ATPs without shareholder approval.
A neutrality rule provides restrictions on board activity once a bid has been commenced or is imminent. These restrictions prevent a unitary board of directors or a management board from using corporate powers provided to them to frustrate the bid without obtaining shareholder approval for using the powers for such a purpose. The term ‘neutrality’, whilst widely used, is somewhat misleading as the requirement is not that the board remains neutral. In all Member States the board is required to give its views – whether in favour or against – on the hostile bid, and can legitimately search for an alternative and, in their view, more favourable suitor. It is only in relation to the use of board power to defend a bid where such a rule neutralises or disempowers the board in the absence of contemporaneous shareholder approval. (Gerner-Beuerle, Kershaw and Solinas 2011)
Rowoldt and Starke continue
In this paper we examine the role of governments in hostile takeovers and its implications on corporate governance. We focus on hostile takeover bids as they pronounce the conflict of interest between strong corporate governance and protection of the domestic industry. Our analysis involves three steps. First, we focus on the direct effects of takeover regulation. We analyse whether national takeover regulation is a potential protectionist tool for governments. In particular, we test whether the existence of a board neutrality rule (BNR) affects the openness of the domestic hostile takeover market to foreign bidders as measured by the likelihood of cross-border hostile bids and the deployment of ATPs by the target’s management. Second, we turn to the implications of takeover regulation on corporate governance by examining whether ATPs stimulate management entrenchment as measured by the success rate of hostile bids or benefit shareholders by strengthening their bargaining power. We measure bargaining power as the likelihood of bid increases and the final takeover premium. Third, we analyse determinants of direct government intervention in hostile takeovers and its consequences on the bid success.

Our results indicate a lower probability of cross-border hostile bids in case no BNR is considered in takeover regulation of target countries. Takeover regulation may thus limit the openness of the domestic hostile takeover market to foreign bidders. This supports the notion that takeover regulation may serve protectionist motives of governments as indicated by the implementation of the European Takeover Directive 2 (Davies et al., 2010). As board neutrality is only one feature of the legal environment, we additionally use alternative measures of shareholder protection in our analysis and find similar results. Thus, our results may be driven by the general legal environment and not necessarily the BNR alone. However, the recent reform of the French takeover law and the implementation of the European Takeover Directive emphasise the particular importance of board neutrality as a potential protectionist tool (Hopt, 2009). Moreover, not only board neutrality but also the general regulatory environment fall into governmental responsibility and may thus be used by governments to implement protectionism.

With this respect, the regulatory choices made by governments may affect corporate behaviour. In specific, board neutrality determines whether target managers are able to deploy ATPs without shareholder approval. Our results show a negative association between BNR and the application of ATPs by targets’ management, confirming that if takeover regulation grants the option to deploy ATPs to the targets’ management, they are likely to exercise it.

Regarding the role of ATPs in corporate governance, our results indicate that the application of ATPs does neither increase the likelihood of bid increases nor the final takeover premium offered. On the contrary, ATPs seem to decrease the likelihood of a successful completion of a transaction. This finding supports the management entrenchment hypothesis. A regulatory framework that favours ATPs may therefore increase managerial power and in turn decrease the effectiveness of the corporate government system (Humphery-Jenner, 2012; Masulis et al., 2007).

Finally, our results suggest that direct government intervention is more likely in case of a foreign hostile bidder, pointing to protectionist motives for government interventions and supporting prior evidence provided by Dinc and Erel (2013). Additionally, we find positive associations between negative government interventions and transaction size as well as the unemployment rate in the targets’ nation supporting the idea that government intervention follows populist motives in search for votes (Hopt, 2009).

Besides, the hostile takeover bid failed in all of the identified cases of negative government intervention. Due to this missing variation in the bid outcome in case of a negative government intervention in our sample, we are unable to empirically assess the corresponding relationship. However, this observation potentially points to the role of direct interventions for governments as ultimo ratio to block hostile takeovers of domestic companies.
  • Gerner-Beuerle, Carsten, David Kershaw and Matteo Solinas (2011). Is the Board Neutrality Rule Trivial? Amnesia About Corporate Law in European Takeover Regulation, LSE Law, Society and Economy Working Papers 3/2011 .

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