The Case for an Unbiased Takeover Law

The following post comes to us from Luca Enriques, Nomura Visiting Professor of International Financial Systems at Harvard Law School and Professor of Business Law at LUISS University (Rome), Ronald J. Gilson, Charles J. Meyers Professor of Law and Business at Stanford Law School and Marc and Eva Stern Professor of Law and Business at Columbia University School of Law, and Alessio M. Pacces, Professor of Law & Finance, Erasmus School of Law, Rotterdam.

Takeovers remain the most controversial corporate governance mechanism. According to pro-takeover commentators, takeovers are generally beneficial for corporate governance. Takeovers can displace poorly performing managers and facilitate corporate restructuring. From this perspective, regulation should encourage takeovers. On the opposite side of the debate, those who oppose hostile takeovers argue that they can disrupt well-functioning companies and encourage short-termism. From this point of view, policies that hamper takeovers are favored.

In our paper The Case for an Unbiased Takeover Law (with an Application to the European Union), we reject a categorical pro- or anti-takeover position. While hostile and friendly takeovers may be efficient in the aggregate, individual takeovers and individual companies’ exposure thereto are efficient or inefficient depending on a variety of factors. These factors include the production functions of companies, the conditions in the relevant industry, the problems confronting the corporation and the best response to those problems. Because these all may differ from company to company and over time, so also may the appropriate stance to takeovers differ. Consequently, we posit that takeover regulation should sanction the efforts by individual companies to devise a takeover regime appropriate to their own, mutable circumstances. In other words, takeover regulation should be limited to a set of optional rules.

In the debate over takeovers, the pro- and anti-takeover positions are typically framed as a simple question: who should decide whether a hostile takeover goes forward? We argue that individual companies should be able to decide “who decides.” Deferring to the choices of individual companies, however, implies more than mere advocacy of freedom of contract in takeover law. In a world of positive transaction costs, the selection of the default rules matters, as do the procedures by which they can be changed. Selecting the right default rules based on the conditions for opting out at different points in time facilitates efficient, as opposed to inertial or opportunistic, choices at the company level. Default rules matter both for newly public companies (“IPO companies”) and for those companies that are already public when a new default regime is introduced (“installed-base companies”). In the former, setting the default rules that suit the majority of IPO companies helps ensure optimal bargaining outcomes. This generally speaks in favour of defaults that do not restrict takeovers. Takeover-unrestrictive defaults are also easier to change if they turn out to be inefficient down the road.

From an economic perspective, takeover-unrestrictive defaults would be also preferable for installed-base companies in general. However, the matter stands differently from a political economy perspective, as the introduction of takeover-unrestrictive default rules is bound to be opposed by those having an interest in existing takeover-restrictive rules. These vested interests may successfully oppose regulatory change, thereby depriving IPO companies of the opportunity to benefit from the establishment of an unbiased takeover law. To address this problem, we suggest to reform takeover law based on a model of regulatory dualism. Regulatory dualism implies that reform will make two regimes available. The new, unbiased defaults will apply to IPO companies. Installed-base companies will instead remain subject to the existing regime, unless those having an interest in the status quo agree to opt out. This solution seeks to mute the opposition of incumbents to regulatory change by conferring upon them the right to veto a move away from the status quo at the company level.

Because the direction and magnitude of the impact of political economy on takeover reform is inherently local, the “right” strategy with respect to default rule selection depends on conditions in a particular country. To illustrate how an unbiased regime would work, we contrast our approach with the current European Union (EU) takeover regime whose main rules are included in the Takeover Bid Directive. We start with the core policy choice on whether the board or the shareholders should make the final decision on a hostile bid. We argue that, differently from the current regime in most EU member states, the rule should be that shareholders decide unless IPO companies choose otherwise. We then extend the unbiased approach to the provisions that are more important in the presence of a controlling shareholder. In this context we argue that the rules mainly affecting takeovers (i.e. the controlling shareholder’s freedom to decide whether to sell control) should be pro-minority shareholders by default, not because we believe that minority shareholders will more often be in need of protection, but because at the IPO stage they can be persuaded to give up protection only if this is efficient. Finally, we contend that menu rules are an important complement of default rules in an unbiased takeover regime. The reason is twofold. First, the existence of menu rules facilitates opt-out by those companies for which the default regime is inefficient. Second, menu rules established at the EU level would displace, if chosen, incompatible mandatory rules set at the member state level. We finally sketch out two examples of EU menu rules for takeovers: one is a menu poison pill, a device currently unavailable in many EU jurisdictions; another example is a time-based control enhancement mechanism that commits companies choosing dual-class shares to revert to a one-share, one-vote voting structure within a certain deadline.

The full paper is available for download here.

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One Comment

  1. Patrick
    Posted Wednesday, May 22, 2013 at 1:35 pm | Permalink

    I find the idea of opt out rules intriguing. While not providing any undue protections to minority shareholders, it does offer a sort of elevator approach. Allowing for exiting at different thresholds. The paper is well thought out and offers a variety of new views on takeovers.