Several years ago, the Delaware Supreme Court held, in Revlon v. MacAndrews & Forbes Holdings, that when a “sale” or “break-up” of a company becomes “inevitable,” the duty of the board of directors is not to maintain the independence of the company or otherwise give priority to long-term considerations, but rather to obtain the highest price possible for the shareholders in the transaction (that is, to maximize short-term value). To satisfy that duty, when confronted with these situations, the board is generally supposed to conduct an auction (or, as clarified in subsequent decisions, a “market check”) that ensures that the final buyer is, in fact, the best bidder available. In the words of the court, in this “inevitable” “break-up” or “sale” scenario (which, however, the court did not precisely define), the directors’ duties shift from “defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders.”
Posts Tagged ‘Target firms’
Many factors drive banks toward acquisitions, including increasing efficiency due to size, loan/deposit growth opportunities, or expansion of geographical footprints. However, one consideration is always dominant—improving return on investment, or ROI. Whether short, intermediate, or long-term, ROI is the most critical factor in the M&A decision.
Prior to the recession, bank M&A had settled into a well-established, time-proven approach. Bank management established targets and criteria, while investment bankers, lawyers, and accountants facilitated the M&A structure and process, weighing tax and accounting issues. Accretive to earnings gained acceptance as one of the primary justifications for a transaction.
In the paper, No Free Shop: Why Target Companies in MBOs and Private Equity Transactions Sometimes Choose Not to Buy ‘Go-Shop’ Options, which was recently made publicly available on SSRN, my co-authors (Adonis Antoniades and Donna Hitscherich) and I study the decisions by targets in private equity and MBO transactions whether to actively “shop” executed merger agreements prior to shareholder approval.
We construct a theoretical framework for explaining the choice of go-shop clauses by acquisition targets, which takes account of value-maximizing motivations, as well as agency problems related to conflicts of interest of management, investment bankers, and lawyers. On the basis of that framework, we empirically investigate the determinants of the go-shop decision, and the effects of the go-shop choice on acquisition premia and on target firm value, using a regression methodology that explicitly allows for the endogeneity of the go-shop decision. Our sample includes data on 306 cash acquisition deals for the period 2004-2011.
We allow many aspects of target firms to enter into their go-shop decision, including the nature of their legal counsel, their ownership structure, their size, and various other firm, and deal characteristics. We find that legal advisor characteristics, ownership structure, and the extent to which the transaction was widely marketed prior to the first accepted offer all matter for the go-shop decision.
In the paper, International Corporate Governance Spillovers: Evidence from Cross-Border Mergers and Acquisitions, which was recently made publicly available on SSRN, we investigate whether the change in corporate control following a cross-border M&A leads to changes in corporate governance of non-target firms that operate in the same country and industry as the target firm. We focus on the strategic complementarity in governance choices between the target firm and its rival firms in the local market. We take the view that corporate governance is affected by the choice of other competing firms as in the models developed by Acharya and Volpin (2010), Cheng (2010), and Dicks (2012).
To provide guidance for our empirical analysis, we develop a simple industry oligopoly model, which captures the idea that rival firms operating in a given industry change their governance in response to competitive forces. The spillover effect occurs as firms in an industry recognize that corporate governance is used more efficiently by the target firm and therefore strengthen their own governance as a response. The model has two decision stages and builds on the work of Shleifer and Wolfenzon (2002) and Albuquerque and Wang (2008). In the first stage, outside shareholders choose firm-level governance (i.e., how much to monitor and limit of managerial private benefits), given the governance choices of other firms. In the second stage, firm managers choose output and the level of private benefits that they extract in the context of a symmetric oligopolistic industry. In the Nash equilibrium outcome, managers have an incentive to “overproduce” (because their private benefits increase with revenues) and industry-level profits are not maximized.
Shareholder activism in the U.S. has increased significantly over the past several years, with activist campaigns increasingly targeting well-known, larger market capitalization companies, such as Apple, Hess, Procter & Gamble and Sony. In 2013, the number, nature and degree of success of these campaigns has garnered the attention of boards of directors, shareholders and the media. While the continued level of success of activists is uncertain, and the longer-term impact of activism is unknown, at the moment shareholder activism is exerting considerable influence in the M&A and corporate governance arenas. In this evolving landscape, public company boards and their managements need to be aware that virtually any company is a potential target for shareholder activism.
Key Factors Influencing the Current Paradigm
Activism has become a viable and increasingly applied (arguably mainstream) tool for shareholders to seek to influence corporate policy. Several changes have occurred over the past few years that have contributed to the heightened — although not universal — success now being enjoyed by activism, including factors related to the activists, institutional investors and corporate defenses.
Weil surveyed 40 sponsor-backed going private transactions announced from January 1, 2012 through December 31, 2012 with a transaction value (i.e., enterprise value) of at least $100 million (excluding target companies that were real estate investment trusts).
For United States transactions to be included in the survey, the transaction must have closed or such transaction remains pending.
Twenty-four of the surveyed transactions in 2012 involved a target company in the United States, 10 involved a target company in Europe, and 6 involved a target company in Asia-Pacific. The publicly available information for certain surveyed transactions did not disclose all data points covered by our survey; therefore, the charts and graphs in this survey may not reflect information from all surveyed transactions.
The 40 surveyed transactions included the following target companies:
In our paper, Do Investors Understand ‘Operational Engineering’ before Management Buyouts?, which was recently made publicly available on SSRN, we use a sample of management buyouts (MBOs) from 1985-2005 and a matched subsample of post-MBO firms to examine three questions. First, we examine whether firms undertake different types of activities to lower earnings before MBOs. Second, to see whether outside investors and the market understand such ‘operational engineering’ activities, we study the impact of these activities on target firms’ stock returns and MBO deal characteristics including deal premium and likelihood of deal completion. Third, we examine the relation between pre-MBO earnings-reducing activities and the post-MBO operating performance.
With the Great Recession of 2007-2009 exposing deficiencies of the world’s most advanced financial markets, leveraged buyouts (LBOs) have ‘reemerged’ as a solution to the many challenges facing corporate sectors. Unlike publicly listed firms, LBO firms are characterized by concentrated ownership, active monitoring and high leverage. A growing strand of literature shows that LBO firms can create value through ‘financial, operational and governance engineering’ (Kaplan and Stromberg, 2009). In fact, Jensen (1989) argues that LBOs should replace publicly held corporations as the dominant corporate organizational form.
The topic of this outline is mergers and acquisitions where the target company is “distressed.” Distress for these purposes generally means that a company is having difficulty dealing with its liabilities—whether in making required payments on borrowed money, obtaining or paying down trade credit, addressing debt covenant breaches, or raising additional debt to address funding needs.
Distressed companies can represent attractive acquisition targets. Their stock and their debt often trade at prices reflecting the difficulties they face, and they may be under pressure to sell assets or securities quickly to raise capital or pay down debt. Accordingly, prospective acquirors may have an opportunity to acquire attractive assets or securities at a discount. This outline considers how best to acquire a distressed company from every possible point of entry, whether that consists of buying existing or newly-issued stock, merging with the target, buying assets, or buying existing debt in the hope that it converts into ownership.
Some modestly distressed companies require a mere “band-aid” (such as a temporary waiver of a financial maintenance covenant when the macroeconomy has led to a temporary decline in earnings, but the company is able to meet all of its obligations as they come due). Others require “major surgery” (as where the company is fundamentally over-levered and must radically reduce debt).
In my article on Inefficient Results in the Market for Corporate Control: Highest Bidders, Highest-Value Users and Socially-Optimal Owners, I argue that, unlike in most other markets, in the market for corporate control allocating resources to the highest bidder will often not produce an efficient result. That is, because of unusual features of that market, the party willing to pay the highest price to acquire the target (the highest bidder), the party who would derive the greatest private benefit from owning the target relative to the status quo (the highest-value user), and the party whose ownership of the target produces the greatest net social benefit (the socially-optimal owner) need not be, and often will not be, the same party. Consequently, allocating the target to the highest bidder will often produce an inefficient result.
The argument begins from the observation that, for most target companies, there are multiple potential strategic acquirers. In general, such parties are willing to pay to acquire the target because ownership of the target’s assets will confer on them a competitive advantage in their product markets and thus increase their future profits. Each such bidder will thus value the target at the present value of the incremental future profits that it expects to earn if it acquires the target, with the bidder having the highest such valuation being the highest-value user of the target.
With litigation now an inevitable feature of the deal landscape, boards evaluating the sale of their company would be well-advised to understand the variety of claims that are being made by plaintiffs in these cases, and in particular those that have gained traction with the courts. While directors taking appropriate steps to address the underlying issues will by no means ensure that litigation will not be brought, the risk of an adverse outcome can be significantly reduced by advance preparation and proactive engagement. With the ever-changing nature of claims and creativity of the plaintiffs’ bar, the outline below is not intended to be exhaustive, but rather to offer some practical guidance to target boards as they structure their sale process.