Question

Provide an example of a company where the anti-takeover defence would benefit management but not shareholders. Explain the mechanism or type of contract that shareholders can put in place to avoid this situation.

Answer 1

Consider the following scenario: The directors of Company A learn that Company B is about to make a tender offer for 100% of A's shares. The offer is for cash, at a price that represents a 50% of premium over the price at which A's shares have been trading in the market. In response, A's directors adopt an Anti-Takeover Defense, because the defense can only be disarmed by the vote of a majority of A's directors, B must win control of A's board before it can proceed with its hostile offer. This is made far more difficult by the fact that A's corporate charter includes a second antitakeover device, a "staggered board" clause that allows directors to serve three-year terms and provides that only a third face reelection in any single year. To win control, B accordingly must win not one but two proxy contests, spaced a year apart. Faced with A's antitakeover provisions and its board's resistance, B decides to withdraw its tender offer. B's plans to acquire A evaporate-and with them, the A shareholders' opportunity to sell at a premium.

Mechanism or type of contract that shareholders can put in place to avoid this situation:

1. Golden parachutes: These referred to as clauses in the employment contracts of the target company’s managers that award the managers substantial benefits or bonuses if their contract is terminated. The goal of the golden parachutes is to put a bigger financial burden on a potential hostile bidder.

2. Supermajority provisions: These are amendments in the corporate charter of a target company that require a substantially large percentage of shareholders (generally between 70% to 90%) to approve important corporate matters such as an acquisition of a company. The supermajority provisions modify the generally accepted majority provisions that require the approval of only more than 50% of the company’s shareholders. Generally, the amendments aim to increase the total cost of an acquisition, as the acquirer must purchase many more shares in order to establish effective control of the target company.

3. Staggered board of directors: A staggered board of directors is a practice in corporate governance in which the board is divided into separate groups, with different service terms. Such a governance structure implies that the whole board of directors cannot be replaced at once. Thus, even if a corporate raider acquires a substantial interest in a target company, it will not be able to exercise its voting power sufficiently to override the target’s board.

4. Strategic incorporation: A company may strategically select the jurisdiction of its incorporation to prevent the possibility of a hostile takeover. The strategic incorporation strategy involves choosing a jurisdiction for incorporation with considerable restrictions on merger and acquisition deals. The most notable examples of such restrictions are anti-competition laws.