by Harald Baum
1. Regulatory frame and economic analysis
The purpose of takeover law is the regulation of takeovers of companies, or more precisely, of the transfer of control over the manifold resources bundled up in the company. Whether the company is taken over as a whole or only in parts is of secondary interest from a regulatory perspective. The transfer of control takes place on the so-called ‘market for corporate control’. It was the American lawyer and economist Henry G Manne who developed the concept of the market for corporate control in a path-breaking article of the same title in 1965. The optimal level of regulation and the formation of a law on takeovers—and thus of the market for corporate control—depends on the economic role takeovers play on the one hand and on the risks inherent in these on the other. Both aspects were, and partly still are, subject to controversial discussion.
From an economic point of view, though unfortunately not necessarily from a political perspective, an active takeover market’s potential for creating positive economic gains has (by now) been almost generally recognized. This potential results from efficiency enhancing synergy effects caused by corporate acquisitions. In this regard takeovers are a vehicle for external corporate growth. Conversely, takeovers may also aim at reducing an excessive free cash flow in the company taken over or may reverse by way of dis-investment earlier bloated mergers that led to ‘corporate empires’ where size and over-diversification have detrimental effects on efficiency. This second functional alternative of takeovers is often discredited by local politicians and trade unions as ‘corporate destruction’.
The different roles takeovers can play show that they are part of the dynamic process of adaptation to groundbreaking technological changes that in turn redefine the shifting optimal size of companies as organizational entities in relation to the market under the criteria of efficiency. These structural adaptations may happen in the form of a hostile takeover against the will of an incumbent management. The acquisition of control will lead to a change of management and thus allows the bidder to make better use of the resources bundled up at the target company. In this respect, the general threat of potential hostile takeovers already has an important disciplinary function. Seen in this way, (hostile) takeovers are an instrument of external corporate governance.
Opponents of the concept of the market for corporate control claim that it is afflicted by inherent structural deficits. However, these asserted deficits cannot be proven empirically. This is especially true for the assertion that takeovers systematically exploit minority shareholders by making use of market inefficiencies. No empirical evidence exists that would show that capital markets principally undervalue corporations and thus allow for arbitrage. Rather to the contrary, the announcement of a takeover bid leads, as a rule, to a rise of the share prices of the target company and thus to profits for the shareholders selling out. Neither is an intentional exploitation of other interest groups (stakeholders) as a structural problem empirically proven. There are no grounds apparent for the claim that long-term interests are sacrificed in favour of short-term interests in the context of takeovers. Negative implications for employment are routinely claimed but, again, have not been proven empirically as a phenomenon of any significance. Nor is a systematic damage of creditors by leveraged takeovers evident. In sum, on average takeovers create real economic gains that result from actual improvements of efficiency and not from unwelcome transfers of wealth among different groups of stakeholders.
2. Normative implications
As a matter of policy, these economic findings suggest that the dynamics of an active market for corporate control should be impeded as little as possible and that existing obstacles to takeovers should be reduced to the greatest extent possible. Nevertheless, the legislature is bound to set up a regulatory frame for minimizing the risks of individual cases of abuse. Potential fields of conflict in this regard are asymmetries in information, problems of collective actions for the shareholders confronted with a takeover bid, the danger of an abuse of a dominant position by the bidder after the acquisition of control as well as the frustration of a takeover by the management of the target pursuing its own agenda. Furthermore, it is disputed who should be entitled to obtain the takeover premium usually offered by the bidder to block holders: the selling block holder or all shareholders willing to sell out.
The central normative challenge to any takeover regulation is the decision over the distribution of the profits to be gained by the transfer of ownership. That can be allocated either mostly with the bidder or mostly with the owners of the target company. The legal assignment of the possible gains shifts—by changing the incentives—the precarious balance between the institutional protection of an effective market for corporate control, depending on the activities of bidders looking for profits, and the individual protection of shareholders by confidence-ensuring investor protection measures which encourage investment activities by the public. The contradictory nature of these aims is the principal dilemma confronting every takeover law. The assumption, directly or indirectly underlying many if not all takeover laws, that it is possible to principally prevent value destroying takeovers by regulation without simultaneously frustrating or at least impeding value creating takeovers, appears to be illusionary. Rather, a negative correlation exists between a highly developed minority protection by takeover law and the frequency of takeovers. Making takeovers more expensive and thus less lucrative for the bidder has the same negative effect on ‘good’ (value enhancing) takeovers as on ‘bad’ (value decreasing) ones. Furthermore, raising the costs of takeovers by regulation has inevitably negative implications on external corporate governance.
3. Prototypical regulatory models
Takeover regulation as a field of law in its own right has a comparatively short history dating back to the late 1960s. Almost all modern industrial nations have responded to the increasing use of takeovers over the last three decades with specific takeover laws that put the transfer of shares of publicly traded companies under regulatory control. International comparison shows that, basically, two fundamentally different regulatory models exist. Both came into force in the same year, in 1968, and both served as regulatory prototypes for later takeover laws. One is the British City Code on Takeovers and Mergers, later renamed the Takeover Code, and the other is the US Williams Act. Similar capital market structures and a business model usually characterized as related—predominance of listed companies with dispersed ownership—in the United Kingdom and the United States notwithstanding, both takeover regimes are pursuing highly dissimilar regulatory strategies. The reasons for these differences can be found in the political economies of the respective rulemaking procedures. Whereas the interests of institutional investors shaped the outcome in the United Kingdom, it was the interests of employed managers that dominated the legislative process in the United States.
The British model’s central concern is the protection of shareholders in the case of a change of control. The means for this is the so-called ‘mandatory bid rule’ that imposes the obligation to acquire all shares offered if a person or company acquires one-third of the voting rights in public companies and to pay the same and appropriate price to all shareholders willing to sell. The aim is to guarantee an exit route for minority shareholders and to secure equal treatment of all shareholders in substance, ie a financial participation in any takeover premium paid. To avoid evasion a regulation of coordinated activities of shareholders (acting in concert) is necessary. This control oriented approach is characterized by high regulatory intensity and an accordingly high level of interference in the market.
In marked contrast, the US model incorporated on the level of federal regulation in the Williams Act of 1968 can be characterized as a light regulation of purely procedural nature which focuses on disclosure. It applies if and when a bidder makes a tender offer to purchase shares regardless of whether this leads to a change of control. The aim of the Act is to protect and to guarantee an equal treatment of all shareholders with respect to information and procedure so as to prevent a premature and under-priced selling of shares. Thus, in effect, rather than facilitating the exit of shareholders as in the British takeover regime, the US regulation seems to encourage shareholders to stay invested in the target company.
A second substantial difference exists with respect to the question with whom rests the ultimate power to decide about the acceptance or refusal of a takeover bid and thus a possible change of control. The Takeover Code entails a strict neutrality principle that essentially binds the hand of managers of the target in this regard (‘non-frustration’ rule). This ensures that the decision rests firmly with the shareholders as the residual risk takers. The Williams Act is silent about management’s role in the acquisition process but the various ‘anti-takeover statutes’ enacted by most of the states in the United States allow bid-frustrating defensive actions to a large extent. Thus, in effect, the decision about the change of control rests to a large extent with management in the United States and not with the shareholders as in the United Kingdom.
A third major difference between both takeover regimes can be found in the nature of regulation. Whereas the United Kingdom chose from the beginning a highly flexible and most efficient self-regulatory regime, the United States opted for a piece of government implemented legislation. This different regulatory nature together with the fact that the power to decide on the change of control rests to a large extent with management leads to the result that in the United States virtually every hostile bid is challenged in court with ensuing costly and lengthy legal battles whereas in the United Kingdom court actions do not play any significant role in practice at all.
These fundamental conceptual differences make clear that, in contrast to a widely spread and erroneous assumption, no ‘Anglo-American’ model of takeover regulation exists. Rather the restrained procedurally oriented approach of the Williams Act offers an alternative to the control oriented approach of the Takeover Code with its high regulatory intensity. However, for the more recent takeover laws of continental Europe as well as EU law, the British concept with its characteristic mandatory bid rule was more or less the exclusive model.
4. Acquis communautaire
The pertinent acquis communautaire consists so far only of the Takeover Directive (Dir 2004/25) of 30 April 2004. Presupposing a broad interpretation, the various decisions by the European Court of Justice (ECJ) dealing with the permissibility of so-called ‘golden shares’ can be added. The term refers to special rights of national governments kept in privatized former state enterprises after these become listed companies. Golden shares guarantee in effect direct or indirect veto rights for the governments involved with a chilling effect on investors and thus function—and are intended to function—as barriers against (hostile) takeovers. The ECJ qualified almost all of these special rights as a violation of the principle of free movement of capital within the European Union laid down in Art 63 TFU/56(1) EC. The Takeover Directive does not prohibit golden shares but only requires disclosure (Art 10).
Attempts to harmonize, or rather to introduce, a takeover regulation within the EU started with a report by the British company lawyer Robert R Pennington published in 1974 on behalf of the European Commission. The report proposed a takeover law in many ways shaped after the UK City Code (Takeover Code). Thus the tone was set for the following 30 years of discussion. Neither the US procedurally oriented concept nor the German law of corporate groups (Konzernrecht) had any serious chance in that discussion, although many regard the latter as specially fit for the continental enterprise landscape characterized, in contrast to that of the British, by block holdings, conglomerates and pyramid schemes. After various futile attempts by the Commission, also the Common Position adopted by the European Council and the European Parliament (EC/1/2001) failed spectacularly with a hung vote in Parliament in 2001.
Thereafter the Commission appointed a group of European company jurists, the High Level Group of Company Law Experts, and asked it to investigate the framework for takeovers in Europe. In October 2002 the Commission presented a new proposal for a Takeover Directive based on the report of the expert group. A highly controversial point was the multiple voting rights allowed in some—but forbidden in other—Member States since these rights posed a major obstacle for the intended level playing field for takeovers in the EU. After intense negotiations in the Council and the Parliament a compromise was found in the form of an option model. The Commission’s rejection notwithstanding, the compromise was adopted on 30 April 2004 in the form of the Takeover Directive.
The predominant goal of the Takeover Directive, already implemented by almost all Member States, is to guarantee equal treatment of all shareholders of a company that is the target of a takeover bid (offeree company) (Art 3(1)(a)). An offeror (bidder) who gains or intends to acquire control has to make a bid to all the holders of securities carrying voting rights in the company for all their holdings at an equitable price (Art 5(1)). The highest price paid for the same securities by the offeror, or by persons acting in concert with him, over a period (to be determined by Member States) of not less than six nor more than 12 months before the bid is regarded as the equitable price (Art 5(4)). In this way, minority shareholders have an exit route as well as a right to participate in a control premium which is offered. Furthermore the Takeover Directive provides for a number of procedural rules concerning information duties and minimum periods to enable shareholders to make an informed decision without undue time pressure. The control oriented approach of the directive follows the British model described above. However, there is one central difference if one takes its implementation by the Member States into account:
In the Takeover Code we find a major functional counterbalance between on the one hand the high costs incurred by a bidder as a result of the mandatory bid rule—which has a detrimental effect on takeovers—and the strict neutrality rule on the other. As already mentioned, this rule hinders the board of the target company from frustrating the bid or substantially raising the costs for the bidder, as defence measures such as poison pills are only allowed with express and up-to-date approval of the shareholders, and these must be sought after the bid has been made public. This non-frustration rule has the potential of keeping the cost of a bid controllable for a potential bidder and thus has a positive effect on takeover activities. At least in principle, the Takeover Directive still adheres to the neutrality rule (Art 9(2), (3)) that is even supplemented by a breakthrough rule which stipulates that under certain circumstances, restrictions on the transfer of securities and/or restrictions on voting rights provided for in the articles of association of the offeree company or specific contractual agreements shall not apply vis-à-vis the offeror during the time allowed for acceptance of the bid (Art 11(2), (3), (4)). However, Art 12(1) of the directive gives the Member States the right to opt out of the neutrality principle codified in Art 9 and to not implement the breakthrough rule of Art 11. Member States that make use of this option only have to grant companies which have their registered offices within their territories the option of voluntarily applying Art 9 and/or Art 11 (opt-in, Art 12(2)). Also, Member States may exempt companies which have opted in from applying Art 9 and/or Art 11 if these become the subject of an offer launched by a company which does not apply the same articles as they do (Art 12(3), ‘reciprocity rule’). This effectively means that each Member State may allow its companies to keep their anti-takeover defences legal under their pertinent national laws, which in turn potentially grants management a major influence in deciding on the acceptance of a bid in Europe. And this is indeed what has happened.
According to a survey by the European Commission published in 2007, almost all Member States made use of the option not to implement the breakthrough rule. Furthermore, with the exception of Malta, no Member State newly introduced a neutrality rule. Of those states which already had introduced a neutrality rule at an earlier stage, most restricted it by implementing the reciprocity rule. Various Member States even extended the authorization of the management of an offeree company to adopt defence measures. These findings fundamentally contradict the original intention of the Commission to facilitate takeovers in Europe by harmonizing the pertinent law. In the Commission’s view, which had opposed the option model for this reason, takeovers as a rule have positive effects for companies, investors and the European economy as such. The Commission sees a real danger that the number of obstacles against takeovers in the EU may have risen instead of receded as a result of implementing the Takeover Directive. Such an outcome of the political process could indeed be regarded as a substantial failure.
Henry G Manne, ‘Mergers and the Market for Corporate Control’ (1965) 73 Journal of Political Economy 110; Roberta Romano, ‘A Guide to Takeovers: Theory, Evidence, and Regulation’ (1992) 9 Yale Journal on Regulation 119; also in Klaus J Hopt and Eddy Wymeersch (eds), European Takeovers. Law and Practice (1992) 3; Ronald J Gilson and Bernard S Black, The Law of Corporate Acquisitions (1995); Bernard Black, ‘The First International Merger Wave (and the Fifth and last U.S. Wave)’ (2000) 54 University of Miami Law Review 799; High Level Group of Company Law Experts, Report of the High Level Group of Company Law Experts on Issues Related to Takeover Bids (2002); Harald Baum, ‘Funktionale Elemente und Komplementaritäten des britischen Übernahmerechts’ (2003) RIW 421; Eric Berglöf and Mike Burkart, ‘European Take-over Regulation’ (2003) 36 Economic Policy 171; Jeffrey N Gordon, ‘An American Perspective on Anti-Takeover Laws in the EU—The German Example’ in Guido Ferrarini, Klaus J Hopt, Jaap Winter and Eddy Wymeersch (eds), Reforming Company and Takeover Law in Europe (2004) 541; John Armour and David A Skeel Jr, ‘Who Writes the Rules for Hostile Takeovers, and Why’ (2007) 95 Georgetown Law Journal 1727; Paul Davies and Klaus J Hopt, ‘Control Transactions’ in Reinier R Kraakman and others (eds), The Anatomy of Corporate Law—A Comparative and Functional Approach (2nd edn, 2009) 225; Robert Hingley, Stephen Hewes and Andy Ryde, A Practitioners Guide to the City Code on Takeovers and Mergers 2010/2011 (2010).