Fall 2022 Class Quiz on Company’s Defense Measures in Unexpected Takeover Bids- Temple University
The below class quiz was tested in Fall 2022 semester and it was based on the topic; the art of defense against unwanted takeover bids. We have provided some detailed solutions that can both help you revise for your future tests and also act as a reference if you have any assignments on the subject. You can also hire one of our qualified finance exam helpers that provide professional finance exam assistance.
Exam Question
Explain some of the actions a company can take to repel an unexpected takeover bid
Exam Solution
These measures are those for which some preparation is normally required (although some may, in an emergency, be attempted after a bid has been announced) but which management would probably not undertake except in anticipation of some hostile move. They, therefore, fall into a kind of twilight zone where the immediate benefit to shareholders may be questioned. On the other hand, management may argue that it is part of their duty to protect the company in a wider sense and that they are therefore justified in taking measures that have the effect of safeguarding their position so that they may carry out their responsibilities without extreme short-term pressure.
The actions are divided into five categories:
- Changing the rules.
- Building obstacles into the financial or commercial structure.
- Creating defensive shareholdings.
- Making critical disposals or acquisitions.
- Pre-empting the bidder.
The specific actions which fall into these five categories will change as laws, market sentiment, or public opinion about their legitimacy change. However, the principles of how to repel a bid remain the same although they may appear in different guises at different times.
Exam Question
To defend itself against an unexpected takeover, a company’s management may change the rules of the company’s affairs. State four such ways in which the rules can be changed
Exam Solution
Procedures for managing a company's affairs are set out in the articles of association or bylaws. The rules of the game may be changed by management initiative (sometimes without reference to shareholders) in a number of ways:
- Place of incorporation of company
- Directors
- Proceedings at meetings
- Voting rights
The directors may take steps to move the place of incorporation of the holding company to a jurisdiction that has more favorable rules from the point of view of incumbent directors. This process normally involves the merger of the existing holding company with a new company incorporated for the purpose. The State of Delaware is favored in the US. Occasionally, the country of incorporation has been changed for reasons which may include factors relating to control. Examples are moves from the UK to Malaysia and from Hong Kong to Bermuda or the Cayman Islands.
Rules concerning the nomination and election of directors not currently on the board may be tightened. For example, a lengthy period of notice and disclosure of candidates' personal, financial, and business interests may be required. Election of directors may also be staggered calling for, for example, one-third of the directors to be elected every three years, a move which would prevent a new controlling shareholder from obtaining a majority on the board for two years.
Existing directors may be given long-term service contracts. This does not prevent them from being fired but may make it a very expensive process to do so. Such arrangements are sometimes referred to as 'golden parachutes' but can backfire by making directors appear more concerned for their welfare than the shareholders' interests. Amounts paid to retire directors are often disclosed. They can receive wide publicity and prove deeply embarrassing to individuals.
Rules may be introduced banning special meetings except with the consent of the board or requiring extended notice for resolutions to be put to meetings of the company without management's blessing. Higher majorities may be required for certain critical motions, such as those approving mergers or repurchasing of shares from a holder who has recently assembled a significant stake.
Under the articles or bylaws of a company, classes of shares may be issued with different voting rights. A class of preferred shares for example may carry a multiple of the votes applicable to ordinary shares: Ordinary shares may be issued with different par values and dividend rights but the same number of votes Most stock exchanges are tending to refuse or cancel listings for shares in companies if different voting rights of this type are being introduced for the first time. Companies with such a voting structure already in place are normally permitted to maintain it.
Exam Question
Explain some of the obstacles that may be erected through the financial structure of the company or its commercial arrangements to prevent a takeover bid from happening.
Exam Solution
- Authorized share capital
- Loans and loan stocks
- Commercial arrangements
Sufficient authorized but unissued share capital should be maintained to give management the ability, often without further reference to shareholders, to issue new shares. This gives scope for issues of new shares to supportive parties and to dilute a threatening shareholding
New classes of shares with particular rights to be designated by management may be authorized, the basis for the 'poison pill' defense. In this maneuver, the defending company may declare a special dividend or bonus issue of a new class of share capital or rights to subscribe for such capital. In some cases, the rights are only exercisable after a third party acquires more than a certain percentage of the outstanding share capital. The holders of the new shares may be entitled to receive payments or purchase shares in a newly merged entity after a bid in such a way that the bid would be rendered prohibitively expensive for a bidder.
The terms of listed convertible or unsecured loan stocks may include a provision that the stock becomes immediately convertible or repayable at par in the event of a change of control of the issuing company
The origin of this type of provision was as a legitimate protection for the providers of long-term loan capital. It allows them to obtain repayment if the borrower's management changes in such a way that the loan stockholders' confidence is lost. However, the provision has sometimes been built in by the issuer itself in order to increase the cash requirements of the bidder. The terms of some syndicated bank loans also contain a provision that the loan may be callable in the event of a change of control of the borrower In many instances, a default or early repayment of one loan may through cross-default clauses trigger wholesale repayments of a company's borrowings.
Companies may have valuable agency or license agreements which are liable to be terminated in the event of a change of control. As in the case of bank loans, this practice has a legitimate commercial basis in that a licensor or other principal wants to know the party with whom he is dealing. However, it can also be used by a company entering into such agreements to erect further obstacles to a takeover.
Exam Question
What are the measures that a company can take to form solid voting support (defensive shareholding) to defend itself from an unexpected takeover?
Exam Solution
As ultimately it is the votes that count, measures to form solid voting support are very effective
- Voting pacts
- Allied shareholdings
- Cross-shareholdings
Voting trusts or other voting agreements or arrangements between shareholders may be established. Sometimes family members, for example, or groups of associates, may agree that their shares should be held by a single company which votes for them as a block. This prevents an outsider from picking off individual members of the group or driving a wedge between groups who may not always see eye to eye
An allied shareholding may be created by placing a block of shares in hands considered to support existing management. This might be done for cash or by the purchase of assets from a group or individual with long-standing connections with the company. The consideration would be satisfied by way of an issue of its shares. However, the asset or business acquired may not be ideal in commercial terms. There is also the danger of a change in the attitude of the holder or an approach by an aggressor with an offer which cannot be refused
Cross-shareholdings, where two (or more) companies take substantial shareholdings in each other, have been commonly used to protect control. The position may be created originally by an exchange of shares, purchases in the market, or other types of transactions. In a case where a third person has a substantial shareholding in one of the companies concerned, control of a large pool of assets may be secured for a relatively small investment Cracks in this structure may appear if any of the companies develop financial weaknesses. The interlocking nature of the shareholdings considerably hampers the making of issues of voting capital to third parties to raise further equity The companies may therefore be locked into a vicious circle where new capital becomes increasingly difficult to obtain.
Exam Question
Explain in detail the concept of making critical disposals or acquisitions during takeover bids as a defense measure
Exam Solution
- Disposals
- Acquisitions
It is part of sound management policy to review and, if appropriate, dispose of underperforming businesses. However, businesses or assets which cannot be sold easily or at an acceptable price but which may have great potential value to shareholders may require a different approach. They may, for example, be spun off through a distribution of shares to the existing shareholders of the company. In this way, shareholders have distinct shareholdings in two separate entities. This may serve to sharpen investor focus on both companies by unbundling a package of interests, in which case, the combined share prices of the two holdings should be higher than the share price of the group before the spin-off.
The value of certain assets, such as oil or forestry reserves, may be made more directly accessible to shareholders by putting them in trust and distributing units in the trust to shareholders. In this way, the shareholder can participate in the benefits of the income generated by the asset without the intervening layer of the corporate structure.
If there is one particular asset (sometimes referred to as a 'crown jewel') which is thought to be of particular interest to a potential bidder, it may be put outside the control of the company by one of the above methods or other arrangements whereby the management of that particular asset passes to other hands. In this way, the attraction of the company to a bidder is reduced.
A program of acquisitions if properly planned will promote the growth of a company and improve the market rating of its shares. However, as sheer size is felt by many managements to be a barrier to a hostile bid, acquisitions may be made partly to render the enlarged group too large for a predator to swallow. If such an acquisition is made for cash, it will also increase the level of gearing of the enlarged group which may be a further deterrent to an aggressor. Acquisition of a business in a specialized or sensitive area which involves government or other regulatory approvals can be an effective ploy of this type.
Exam Question
In what ways can a company preempt a bidder to ‘force’ them to drop their takeover bid
Exam Solution
- Greenmail
- Defensive merger
Management may be inclined, where the law permits, to use the company's own resources to buy off a shareholder who has built up a potentially threatening stake. In cases where the price paid to such an aggressor is above the prevailing market price, this practice has been dubbed 'greenmail' and comes uncomfortably close to a management using shareholders' money to protect their own interests. It seems particularly blatant where a third party may have had as its principal to be bought off at a dealing profit rather than to seek control of the company or to take a long-term investment. A number of companies in the US have introduced measures preventing the payment of greenmail, on the assumption that this will dissuade an aggressor motivated by short-term profit. As a defense, it has had the drawback of displaying weakness, so that management which pays greenmail once is likely to find itself faced with a similar demand soon afterward.
On a better the devil you know the principle, some managements form understandings with a similarly-sized group to whom they can turn in the event a less agreeable suitor seems likely to press his case. This appears to be the driving force behind some mergers which lac