The Future of Corporate Takeovers in Europe ECGI Session at the Federation of European Securities Exchanges' 6th European Financial Markets Convention Brussels, 31 May 2002

"Should the European Union Adopt the Winter Group's Proposals on Regulating Corporate Takeovers in Europe?" Moderator Richard Lambert Former Editor, Financial Times Panel Patrick Bolton, Princeton University, CEPR & ECGI Michael C. Jensen, Harvard Business School & ECGI Colin Mayer, Saïd Business School Oxford, CEPR & ECGI Marco Pagano, University of Salerno, CEPR & ECGI

Should the EU adopt the Winter Group Proposals? Patrick Bolton Princeton University, CEPR & ECGI

Outline Hostile Takeovers and Takeover defenses The European context The Winter group proposal for EU Takeover Regulation Scope of the break-through right Interaction with other rules How will companies respond? Conclusion

Hostile Takeovers and Takeover defenses (1) Main economic justification for hostile takeovers: to discipline management when share ownership is dispersed In theory hostile takeovers discipline management better if: 1.Higher disclosure thresholds, 2.Can squeeze out and/or `dilute’ minorities 3.There are no defenses

Hostile Takeovers and Takeover defenses (2) But, better discipline may come at the expense of a better price or better minority protection (dual-class share structure can increase firm value) Hostile takeovers may have other motives than replacing or disciplining bad managers They may be inefficient in ‘short-termist’ markets (e.g. Mannesman and Vodafone?)

The Case for regulating Takeover defenses Shareholders may put up too strong defenses in an attempt to appropriate a bigger share of the value added by the raider A fortiori, management may put up too strong defenses

The challenge of Takeover Regulation How to facilitate disciplining takeovers without: 1. undermining control rights 2.Undermining freedom of contracting 3.‘crowding out’ control by blockholders

The European context EU objective of creation of an “integrated capital market in the Union by 2005” Breaking up ‘local business establishment’

The Winter group proposal for EU Takeover Regulation (1) One objective: creating a “level playing field” Two guiding principles: 1.Shareholder decision-making 2.Proportionality between risk bearing and control

The Winter group proposal for EU Takeover Regulation (2) 13 th Takeover bid directive: (board neutrality, mandatory bids, squeeze-out and sell-out rights, equitable price) + New proposed rule: the break-through right

The break-through rule At 75% (maximum) of equity cash-flow rights the bidder can: 1.Impose a one-share-one-vote rule, 2.Remove any ‘pre-bid defenses’ approved by shareholders, 3.Remove voting rights on “non-risk- bearing capital” 4.Amend corporate charter

The break-through rule and shareholder rights The break-through rule violates one of the two stated basic principles: (ex-ante) shareholder decision-making “In the period prior to the bid shareholders will not be able to take into account and weigh all the circumstances which are relevant for their decision”

Scope of the break-through right Open questions: Should holders of ‘risky debt’ or convertible debt be entitled to voting rights? Do ‘supermajority’ or ‘unanimity’ rules (veto rights) apply after the break-through? Are ‘poison pills’ overridden?

Interaction between the break- through right and other rules The mandatory bid rule may discourage takeovers by raising their cost, The threshold for mandatory bids (30% in UK) could undermine the break-through rule, no disclosure requirements of “toeholds” in non-voting equity

How will companies respond? A number of options are open to firms who want to protect their control rights: 1.Substitute ‘EU defenses’ by ‘US defenses’ 2.Incorporate outside the EU, 3.Set up ‘pyramidal structures’ 4.Delist or not go public in the first place

Conclusion (1) Facilitating takeovers in the EU as a way of ‘shaking up’ complacent local business elites or disciplining managers may be desirable By implication regulation of takeover defenses may be desirable, but… The break-through rule goes too far in undermining freedom of contracting,

Conclusion (2) Why not respect (ex-ante) shareholder decision- making? “Proportionality between risk bearing and control” Is not a universal principle in Finance Why not allow for an opt-out clause to be approved by shareholders?

Conclusion (3) Should a “level playing field” be pursued at all cost? Should “harmonization” be pursued at all cost? Why not focus more on EU wide disclosure rules?