Question

Many firms have devised defenses that make it more difficult or costly for other firms to take them over. How might such defenses affect the firm’s agency problems? Are managers of firms with formidable takeover defenses more or less likely to act in the shareholders’ interests rather than their own? What would you expect to happen to the share price when management proposes to institute such defenses?

Answer 1

Organization follow various strategies to make it more difficult or costly for other firms to take them over.

These strategy is mostly used by Target company to discourage the acquiring company.

For example, if Company A is planning to acquire Company B and company B doesn't want to get acquired, then they can use the defense strategy. In which company B will increase the cost of takeover to such extend at which company A will not afford to buy it.

These strategy involves shareholders to buy the additional shares at a discount price which dilutes the equity shares and resulted in higher bid price than expected. So through all these means target company is discouraging acquirer company.

Firm's agency problem:

Here, agency problem is difference in objectives of company's management and shareholders interest. If management or manager is looking for wealth creation and expansion then shareholders also looking for the same then there is no issue but if management wants to take some steps which will not add value to shareholders then there is an issue. Hence while defensing the takeover if company has ability, capacity and vision to grow on their own then both company and shareholders are in win win situation. But if company is not capable enough to manage the business on their own and still avoiding the takeover by a good company then it is a loss for both.

Managers Role:

Manager plays an important role in this process. Manager acts as an agent of management and face of company for shareholders. If he takes decision wisely in favor of company, it will be in favor of shareholders indirectly. But if manager looks for his own interest than company then the company and shareholders may end up in making losses.

Share prices:

In such scenario where takeover is done with good company share prices may increase and if defense strategy is used for takeover then share prices may decrease for some time period.

Conclusion:

Defense strategy for takeover is good if current company situation, position, management is good and capable to carry on and grow the business, if not, then it should not be used as it may affect the company, shareholders and market value of the company.