The Biases of an “Unbiased” Optional Takeover Regime

The conundrum of the perfect balance between mandatory and enabling rules and the role of private ordering in takeover regulation is one of the most relevant and interesting issues regarding the optimal regime for acquisitions of listed corporations. The issue is rife with complex questions and implications, both from a more technical legal perspective and in terms of public choice.

In a recent and compelling article (available here and published in the Harvard Business Law Review in 2014, and discussed on the Forum here), Luca Enriques, Ron Gilson and Alessio Pacces have argued the desirability of an optional, default regime to regulate takeovers particularly in the European Union. According to this approach, which the proponents call “unbiased,” listed corporations should be allowed to opt out of the default regime and use private ordering to tailor more desirable rules on the “pillars” of the European approach: mandatory bid, board neutrality, and breakthrough. More precisely, they suggest a dichotomy, distinguishing already listed corporations and new IPOs: for the former, the default regime should be the one currently in place; for the latter, a regime crafted against the interests of the existing incumbents should be introduced. With adequate protections and procedural rules, the theory goes, it would be easier to achieve a more efficient regulatory structure.

European legislators and policy makers (and, in a different context, also US ones) are also intrigued by contractual freedom to regulate takeovers. A recent and interesting example whose theoretical and practical interest goes well beyond the dimensions of the market, is offered by an Italian reform that allows corporations to determine more freely the trigger event of the mandatory bid.

In a recent paper I wrote with Johannes Fedderke, entitled The Biases of an “Unbiased” Optional Takeover Regime: The Mandatory Bid Threshold as a Reverse Drawbridge, we consider critically these proposals and recent reforms with a focus on the mandatory bid rule. In short, we suggest caution in considering broad contractual freedom as a desirable solution for the following reasons:

1. No matter what the procedural protections in place (supermajority requirements, appraisal rights, etc.), broad contractual freedom in this area is likely to result in a market failure and allow incumbents to entrench themselves or extract private benefits from the corporation, especially in systems with a strong controlling shareholder and if markets are not perfectly efficient due to information asymmetries, collective action problems, bargaining costs, etc. An additional problem is also that, in light of different ownership structures, it is very complex to define general protections for minorities that would effectively work in most situations;
2. To identify the optimal “default” regime, and specifically one crafted against the interests of the incumbents, is extremely difficult if not impossible: depending on a lot of variables, the mandatory bid rule, for example, can protect minority shareholders offering them a fair way out when control changes, but can also be a formidable defensive measure protecting incumbents by raising the cost of hostile acquisitions. While an optional, non-optimal regime is obviously preferable to a mandatory, non-optimal one, the free rein advocated by Enriques, Gilson and Pacces could easily morph into a free reign of the most powerful incumbents, especially controlling shareholders;
3. The proposal focuses primarily, if not exclusively, on the welfare and preferences of shareholders (and, indirectly managers). We doubt that it is desirable, let alone politically realistic, for legislatures not to consider other stakeholders and interests that are affected by the market for corporate control, from creditors to employees, from reciprocity with other countries to industrial policy. These other stakeholders and interests might legitimately suggest approaches not entirely dependent on issuers’ choice;
4. The proposal, in our opinion, underestimates the importance of (relative) harmonization and standardization in the area of financial markets, especially in Europe vis-à-vis the need to further the common market. In addition, when regulatory competition is not particularly effective, as it is the case in Europe, it has convincingly been observed by Ehud Kamar and Marcel Kahan that policy makers tend to favor incumbents, something that reinforces the concerns for excessive reliance on private ordering and legislative discretion at the single Member State level.

We are however aware of the risks of the mandatory bid rule and, in particular, of how it can hinder the market for corporate control by raising the costs of acquisitions. In this perspective, we suggest a more limited, but we think effective reform aimed at (further) reducing, at least in some situations, the rigidity of the rule.

The paper is organized as follows. After a short overview of the European rules on mandatory bids and their theoretical framework, we concentrate on three issues: the recent “experiments” of the Italian legislature introducing greater contractual freedom on mandatory bids; a critical discussion of the above mentioned proposal to further enhance this freedom in Europe; and an explanation of our proposal, intended as a sketch for future research, on how to reform the mandatory bid rule in a way that might be more beneficial to minority investors at least in some jurisdictions.

The full paper is available for download here.