The Law and Economics of Takeovers Prof Alessio M Pacces, PhD Erasmus School of Law Research Associate, ECGI OECD Russia Corporate Governance Roundtable Moscow, 25–26 November 2012 Co-sponsored by Informational partner

Disclaimer: The views expressed in this presentation are those of the author and do not necessarily represent the opinion of the OECD Russia Corporate Governance Roundtable, the OECD or its Member countries, or of the Moscow Exchange. OECD Russia Corporate Governance Roundtable Moscow, 25–26 November 2012 Co-sponsored by Informational partner

Outline 1.What do takeovers do? 2.Freestanding vs. controlled companies 3.The trade-off between investor protection and the market for corporate control 4.The key takeover rules: Who decides Exit rights Compulsory acquisition 5.Conclusion 3

What do takeovers do? a.Takeovers can be good or bad  good takeovers create / uncover extra value  bad takeovers destroy existing value  takeover activity allocate firm resources to the entrepreneur willing to pay the most for them b.Companies can be contestable / non-contestable  contestable companies can be acquired directly from SHLs (hostile takeovers)  takeovers of contestable companies need not be formally hostile  takeovers of non-contestable companies need the consent of controlling shareholder c.Takeover threat matters too  ∆ benefits: management more disciplined  ∆ costs: management more short-termist, less innovative 4

Takeover wealth effects (only SHL value) 5 Value-increasing Incumbent management: ① is incompetent / lazy ② is dishonest ③ lacks vision / innovation ④ is wrong Value-decreasing Acquirer’s management: ① seeks to build an empire ② wants to loot the company ③ is wrong

Takeover of freestanding companies - Acquirer’s gains fundamentally drive takeovers - Is the SHL decision to accept the bid reliable? - Dispersed SHLs cannot coordinate (less problematic if ownership is concentrated) Free-riding: makes value-increasing takeover fail Pressure to tender: makes value-decreasing takeover succeed - There are remedies: o Against free-riding: toehold; squeeze-out o Against pressure to tender: bidding competition; bid reopening; sell-out 6

Board Veto vs Board Neutrality - If SHL choice is potentially distorted, can boards help? - Boards know better?  Board Veto - However, management is self-interested… - … and management can be wrong too! - Board Neutrality still protects SHLs (board can promote competition) as opposed to Passivity (board can do nothing) - … but less mgt opportunism than Board Veto - Note 1: bidding competition benefits target shareholders, but reduces takeover probability ex-ante - Note 2: the problems with Board Veto can be tempered by severance payments 7

Trade-off investor protection (ex-ante) / control allocation (ex-post) - Protection of target SHLs = takeover restriction - Examples include: o Ownership disclosure o Regulation of pre-bid purchases o Regulation of bid structure (e.g. MBR) - Less investor protection, less redistribution from acquirers, takeovers more likely (  benefits investors as a whole) - Requires a floor on investor protection (commitment to no expropriation must be credible) - Forget about this if there is market manipulation 8

Takeovers of controlled companies - Question who decides not so interesting - Gains to acquirer > [  share value + PBC of seller] - Some value increasing takeovers fail to occur o Acquirers’  gains insufficient to compensate incumbent’s PBC (ctrl premium), whether psychic or pecuniary - Some value-decreasing takeovers occur o Control changes hand because the acquirer will extract PBC > ctrl premium from minority SHLs - Need the behaviour of controlling shareholders be regulated? 9

The Mandatory Bid Rule - The MBR forces acquirer to make a bid to minority SHLs - Bid price regulated on equal treatment basis (ctrl premium must be shared) - MBR rules out value-decreasing takeovers (can’t subsidize inefficient acquisition from minority SHLs) - MBR makes value-increasing takeovers more unlikely (ctrl premium must be paid also to minority SHLs) - Both effects are tempered if MBR is tempered / circumvented 10

Again the trade-off ex-ante/ex-post MBR in controlled companies prevents expropriation from increasing MBR neither stops ongoing expropriation (cash flow) nor prevents dilution (equity) / tunnelling (assets) Tunnelling is better countered by regulation of self- dealing MBR is a second best to curb expropriation 11

The other (EU) takeover rules Breakthrough Rule (BTR) ‑ Seeks to reintroduce 1S1V in a takeover contest (ex-post) ‑ Overlooks that founders already paid for deviation from 1S1V ‑ Ex-ante 1S1V regulations may promote stock markets where investor protection is low Squeeze-out ‑ A simple, elegant solution to free-riding ‑ Requires that value-decreasing acquisitions be ruled out ‑ If that is the case, threshold can be below 90% Sell-out ‑ Solves pressure to tender at lower cost than MBR ‑ It is not effective at thresholds above 50% 12

Does investor protection need takeover restriction?  It depends  Need to fix investor protection / credible enforcement first  Commitment not to steal credible  Then perhaps rules can be fitted to individual companies (sometimes opt out of protective rules) 13

Conclusion A vibrant market for corporate control can allocate production resources to the best available entrepreneur Overprotective takeover rules reduce takeover activity However, if investors are not protected from expropriation in the first place, takeovers allocate control to the best ‘thief’ 14