1. The Corporate Takeover Market
Common Takeover Tactics, Takeover Defenses, and Corporate Governance

2. Treat a person as he is, and he will remain as he is.
Treat him as he could be,
and he will become what he should be —Jimmy Johnson

3. Course Layout: M&A & Other Restructuring Activities
Part IV: Deal Structuring & Financing
Part II: M&A Process
Part I: M&A Environment
Payment & Legal Considerations
Public Company Valuation
Financial Modeling Techniques
M&A Integration
Business & Acquisition Plans
Search through Closing Activities
Part V: Alternative Strategies
Accounting & Tax Considerations
Business Alliances
Divestitures, Spin-Offs & Carve-Outs
Bankruptcy & Liquidation
Regulatory Considerations
Motivations for M&A
Part III: M&A Valuation & Modeling
Takeover Tactics and Defenses
Financing Strategies
Private Company
Valuation
Cross-Border
Transactions

4. Current Lecture Learning Objectives
Providing students with an understanding of
Corporate governance and its role in protecting stakeholders in the firm;
Factors external and internal to the firm affecting corporate governance;
Common takeover tactics employed in the market for corporate control and when and why they are used; and
Common takeover defenses employed by target firms and when and why they are used.

5. Alternative Models of Corporate Control
Market model applies when:
Capital markets are liquid
Equity ownership is widely dispersed
Board members are largely independent
Ownership & control are separate
Financial disclosure is high
Shareholder focus more on short-term gains
Prevalent In U.S. and U.K.
Control model applies when:
Capital markets are illiquid
Ownership is heavily concentrated
Board members are largely “insiders”
Ownership & control overlap
Financial disclosure limited
Shareholder focus more on long-term gains
Prevalent in Europe, Asia, & Latin America

6. Factors Affecting Corporate Governance: Market Model Perspective
External to Firm
Legislation:
Securities Acts
Dodd-Frank Act of 2010
Sherman Anti-Trust Act
External to Firm
External to Firm
Internal to Firm
Board of Directors
Management
Internal Controls
Incentive Systems
Takeover Defenses
Regulators:
SEC
Justice Department
FTC
Market for Corporate Control:
Proxy Contests
Hostile Takeovers
External to Firm
Institutional Activism:
Pension Funds (Calpers)
Mutual Funds
Hedge Funds

7. Internal Factors: Board of Directors and Management
Board responsibilities include:
--Review management proposals/advise CEO
--Hire, fire, and set CEO compensation
--Oversee management, corporate strategy, and
financial reports to shareholders
Good governance practices include:
--Separation of CEO and Chairman of the Board
--Boards dominated by independent members
--Independent members serving on the audit and
compensation committees

8. Internal Factors: Controls & Incentive Systems
Dodd-Frank Act (2010):
-- Gives shareholders of public firms nonbinding right to vote on executive compensation packages
--Public firms must have mechanism for recovering compensation 3-yrs prior to earnings restatement
Alternative ways to align management and shareholder objectives
Link stock option exercise prices to firm’s stock price performance relative to the overall market
Key managers should own a significant portion of the firm’s outstanding shares

9. External Factors: Legislation
Federal and state securities laws
Securities Acts of 1933 and 1934
Williams Act (1968)
Insider trading laws
Anti-trust laws
Sherman Act (1890)
Clayton Act (1914)
Hart-Scott-Rodino Act (1976)
Dodd-Frank Act (2010)

10. Dodd-Frank Act of 2010: Governance & Executive Compensation
Say on Pay: In a nonbinding vote, shareholders may vote on executive pay every 3 yrs.
Say on Golden Parachutes (executive severance packages): Proxy statements seeking shareholder approval of M&As or sale of most of a firm’s assets must disclose pay agreements with target or acquirer executives
Clawbacks: Public firms must disclose mechanisms for recovering incentive pay paid during 3-yrs prior to earnings restatements.
Proxy Access: SEC has authority to require public firms to include nominees submitted by shareholders in proxy materials.
Broker Discretionary Voting: Stock exchanges must prohibit brokers from voting shares without direction from owners in election of directors and executive compensation.

11. Dodd-Frank Act of 2010: Systemic Regulation and Emergency Powers
Financial Stability Oversight Council (FSOC): Monitors U.S. financial markets to identify banks and nonbank banks exhibiting “systemic” risk.
New Fed Bank/Nonbank Supervisory Powers: Banks/nonbanks with total assets ≥ $50 billion must
Submit plans for their rapid dissolution in event of failure
Limit their credit exposure in any unaffiliated firm to 25% of its capital
Conduct semiannual stress tests to determine capital adequacy
Provide advance notice of intent to buy voting shares in financial firms
Leverage Limitations: Fed may require banks with assets ≥ $50 billion to maintain debt-to-equity ratio of no more than 15 to 1.
Size Limitations: No bank or nonbank can hold deposits > 10% of deposits nationwide; does not apply to mergers involving failing banks.
FDIC Guaranty Powers: May guaranty liabilities of solvent banks if FSOC and Fed determine appropriate to do so.
Orderly Liquidation Authority: FDIC may seize and liquidate banks threatening U.S. financial stability
New Bank Capital Requirements: At discretion of regulators.

12. Dodd-Frank Act of 2010: Capital Markets
Office of Credit Ratings: Sets rules for transparency, conducts audits and makes it easier to sue rating agencies.
Securitization: Issuers of asset-backed securities must retain an interest of at least 5% of any security sold to third parties.
Hedge and Private Equity Fund Registration: Must register with SEC as investment advisors if assets ≥ $100 million; those with < $100 million subject to state regulation.
Clearing and Trading of OTC Derivatives: Must be traded on formal exchanges to provide real time data reporting to market participants (e.g., CDS-lender insurance).

13. Dodd-Frank Act of 2010: Financial Institutions
Volcker Rule: Prohibits insured banks from buying and selling securities with their own money (i.e., proprietary trading) or sponsoring or investing in hedge funds or private equity funds; banks may do so if they have no control over funds. Does not apply to U.S. banks with foreign operations.
Consumer Financial Protection Bureau: Writes rules governing financial institutions offering consumer financial products.
Federal Insurance Office: Monitors insurance industry and recommends which firms should be considered systemically important.

14. External Factors: Regulators
Securities and Exchange Commission
Justice Department
Federal Trade Commission
Public Company Accounting Oversight Board
Financial Accounting Standards Board
Financial Stability Oversight Council

15. External Factors: Institutional Activism
Pension funds, mutual funds, and insurance companies
Ability to discipline management often limited by amount of stock can legally own in a single firm
Investors with huge portfolios (e.g., TIAA-CREF, California Employee Pension Fund) can exert significant influence
Recent trend has been for institutional investors to simply withhold their votes

16. External Factors: Market for Corporate Control
Changes in control can result from hostile takeovers or proxy contests
Management may resist takeover bids to
Increase the purchase price (Shareholders’ Interests Theory) or
Ensure their longevity with the firm (Management Entrenchment Theory)
Takeovers may
Minimize “agency costs” and
Transfer control to those who can more efficiently manage the acquired assets

17. Discussion Questions
1.Do you believe corporate governance should be narrowly defined to encompass shareholders only or more broadly to incorporate all stakeholders? Explain your answer.
2.Of the external factors impacting corporate governance, which do you believe is likely to be the most important? Be specific.

18. Market for Corporate Control: Alternative Takeover1 Tactics
Friendly (Target board and management supports bid)
Hostile (Target board and management contests bid)
1A corporate takeover refers to a transfer of control from one investor group to another.

19. Market for Corporate Control: “Friendly” Takeover Tactics
Potential acquirer obtains support from the target’s board and management early in the takeover process before proceeding to a negotiated settlement.
The acquirer and target firms often enter into a standstill agreement in which the bidder agrees not to make any further investments for a stipulated period in exchange for a break-up fee from the target firm.
Such takeovers are desirable as they avoid an auction environment.
If the bidder is rebuffed, the loss of surprise gives the target firm time to mount additional takeover defenses.
Rapid takeovers are less likely today due to FTC and SEC pre-notification and disclosure requirements.1
1The permitted reporting delay between first exceeding the 5% ownership stake threshold and the filing of a 13D allowed Vornado Realty Trust to accumulate 27% of J. C. Penny’s outstanding shares before making their holdings public.

20. Market for Corporate Control: Hostile Takeover Tactics
Limiting the target’s actions through a “bear hug”
Proxy contests in support of a takeover
Purchasing target stock in the open market
Circumventing the target’s board through a tender offer
Litigation
Using multiple tactics concurrently

21. Market for Corporate Control: Pre-Offer Takeover Defenses
Poison pills to raise the cost of takeover1
Shark repellants to strengthen the target board’s defenses
Staggered or classified board elections
Limiting when can remove directors
Shark repellants to limit shareholder actions
Limitations on calling special meetings
Limiting consent solicitations
Advance notice and super-majority provisions
Other shark repellants
Anti-greenmail and fair price provisions
Super-voting stock, re-incorporation, and golden parachutes
1Note that poison pills could also be classified as post-offer defenses as they may be issued by the board as dividends without shareholder approval.

22. Poison Pill: Cash for Share Purchase
Target Price Share D S S2 P3
A B P1
Target shareholder Profit/Share on Poison Pill Conversion P2
DD reflects relationship between shares outstanding and price/share for given level of expected earnings & interest rates. D
C D
Q Q Target Shares Outstanding
P1 = Pre-offer equilibrium price/target share
P2 = Poison pill conversion price/target share
P3 = Offer price/target share
Q1 = Pre-offer target shares outstanding
Q2 = Target shares outstanding following poison pill conversion
ABCD = Incremental acquirer cash outlay due to poison pill conversion

23. Poison Pills: Share for Share Exchange
Acquirer Shareholder Ownership Dilution Due to Poison Pill
New Company Shares Outstanding1
Ownership Distribution in New Company (%)
Without Pill
With Pill
Target Firm Shareholders
Shares Outstanding
Total Shares Outstanding
1,000,000
2,000,000 50
673
Acquiring Firm Shareholders
New Shares Issued
Total Shares Outstanding4
2,000,0002
3,000,000 33
1Acquirer agrees to exchange one share of acquirer for each share of target stock.
2Poison pill provisions enable each target shareholder to buy one share of target stock at a nominal price for each share they own. Assume all target shareholders exercise their rights to do so.
32,000,000/3,000,000
4Target shares are cancelled upon completion of transaction.

24. Market for Corporate Control: Post-Offer Takeover Defenses
Greenmail
Standstill agreement
Pac-man defense
White knights
Employee stock ownership plans
Recapitalization
Share buy-back plans
Corporate restructuring
Litigation
“Just say no”

25. Discussion Questions
Discuss the advantages and disadvantages of the friendly versus hostile approaches to corporate takeovers. Be specific.
Do you believe that corporate takeover defenses are more motivated by the target’s managers attempting to entrench themselves or to negotiate a higher price for their shareholders? Be specific.

26. Impact on Shareholder Value
Friendly transactions result in average abnormal returns to target shareholders of 20%
Hostile transactions result in average abnormal returns to target shareholders of 30-35%
Bidders’ shareholders earn average abnormal returns that are zero or slightly negative; however, often positive in certain situations
Recent studies suggest
Takeover defenses have small negative impact on abnormal target shareholder returns
Defenses put in place prior to an IPO may benefit target shareholders
Bondholders in firms with ineffective defenses (i.e., vulnerable to takeover) may lose value

27. Things to remember...
Hostile takeover attempts and proxy contests affect governance through the market for corporate control
Hostile takeover attempts tend to benefit target shareholders substantially more than the acquirer’s shareholders by putting the target into “play.” Consequently, acquirers generally consider friendly takeovers preferable.
Anti-takeover measures share two things in common. They are designed to
Raise the overall cost of the takeover to the acquirer’s shareholders and
Increase the time required for the acquirer to complete the transaction to give the target additional time to develop an anti-takeover strategy.