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. Part IV: Deal Structuring and Financing
Exhibit 1: Course Layout: Mergers, Acquisitions, and Other
Restructuring Activities
Part IV: Deal Structuring and Financing
Part II: M&A Process
Part I: M&A Environment
Ch. 11: Payment and Legal Considerations
Ch. 7: Discounted Cash Flow Valuation
Ch. 9: Financial Modeling Techniques
Ch. 6: M&A Postclosing Integration
Ch. 4: Business and Acquisition Plans
Ch. 5: Search through Closing Activities
Part V: Alternative Business and Restructuring Strategies
Ch. 12: Accounting & Tax Considerations
Ch. 15: Business Alliances
Ch. 16: Divestitures, Spin-Offs, Split-Offs, and Equity Carve-Outs
Ch. 17: Bankruptcy and Liquidation
Ch. 2: Regulatory Considerations
Ch. 1: Motivations for M&A
Part III: M&A Valuation and Modeling
Ch. 3: Takeover Tactics, Defenses, and Corporate Governance
Ch. 13: Financing the Deal
Ch. 8: Relative Valuation Methodologies
Ch. 18: Cross-Border Transactions
Ch. 14: Valuing Highly Leveraged Transactions
Ch. 10: Private Company Valuation

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
Internal to Firm
Board of Directors
Management
Internal Controls
Incentive Systems
Corporate Culture &
Values
Takeover Defenses
Bond Covenants
External to Firm
Regulators:
SEC
Justice Department
FTC
Market for Corporate Control:
Proxy Contests
Hostile Takeovers
Prof. Notes:
Corporate governance refers to the systems and processes that protect the interests of stakeholders including shareholders, customers, employees, government, lenders, communities, and suppliers.
External factors affecting governance include the following:
Legislation which defines what publicly traded firms can and cannot do.
Regulators who enforce the laws.
Institutional activists such as pension funds and mutual funds which can monitor corporate behavior; however, few do so effectively due to conflicts of interest. Mutual funds and investment banks want to supply firms’ management and boards with administrative services and to underwrite security issues.
Market for corporate control reflects the threat of hostile takeover or the initiation of proxy contests to non-performing managers
Internal factors affecting corporate governance include the following:
The board of directors which oversees major management decisions, approves corporate strategies, hires and fires CEO, and approves annual budgets.
Managers monitor daily operations, approve department budgets, and promote acceptable corporate behaviors.
Internal controls include such things as internal audit and signature approval authorities.
Incentive systems include bonus plans and stock options to encourage desired behaviors.
Takeover defenses are intended to slow down and raise the cost of removing incumbent board members and management through 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. Internal Factors: Corporate Culture & Values
Corporate culture refers to a common set of values, traditions, and beliefs that influence management and employee behavior within a firm.
The desired culture for the new organization can be promoted through
Clear and consistent communication to all employees of what is appropriate and what is not
Senior management consistently displaying the desired behaviors
Reward systems that foster desired behaviors while penalizing undesirable conduct
Trust in a new organization is undermined when there is ambiguity about the new organization’s culture/identity.

10. 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)

11. External Factors: Regulators
Securities and Exchange Commission (SEC)
Justice Department
Federal Trade Commission (FTC)
Public Company Accounting Oversight Board
(PCAOB)
Financial Accounting Standards Board (FASB)
Financial Stability Oversight Council (FSOC)

12. 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

13. 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

14. 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.

15. Market for Corporate Control: Alternative Takeover1 Tactics
Friendly deals (Target board supports bid)
Hostile deals (Target board contests bid). Rare due to
Target board flexibility in setting up defenses
Impact on bid premiums
Impact on postclosing integration
The threat of hostile bids often moves target boards toward negotiated settlements.
1A corporate takeover refers to a transfer of control from one investor group to another.

16. 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.

17. 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

18. Alcoa Aluminum Easily Overwhelms Reynolds’ Takeover Defenses
Alcoa’s offer to Reynolds Metals consisted of $4.3 billion in cash plus the assumption of $1.5 billion in Reynolds’ outstanding debt. Alcoa’s offer letter, which it made public, from its chief executive to the Reynolds’ CEO indicated that it wanted to pursue a friendly deal but that it would pursue a hostile bid if the two sides could not begin discussions within a week. Reynolds appeared to be highly vulnerable because of its ongoing poor financial performance and because of its weak takeover defenses.
Despite pressure from institutional shareholders, the Reynolds’ board rejected Alcoa’s bid as inadequate. Alcoa’s response was to say that it would make a formal offer directly to the Reynolds’ shareholders and simultaneously solicit shareholder support for replacing the Reynolds’ board and dismantling Reynolds’ takeover defenses. Reynolds capitulated within two weeks from receipt of the initial solicitation and agreed to be acquired by Alcoa. The agreement contained a thirty-day window during which Reynolds could entertain other bids. However, if Reynolds should choose to go with another offer, it would have to pay Alcoa a $100 million break-up fee.
What was the dollar value of the purchase price Alcoa offered to pay for Reynolds?
Speculate as to why Alcoa wanted to pursue initially a friendly rather than hostile approach?
3. Describe the various takeover tactics Alcoa employed (or threatened) in its successful takeover of
Reynolds. Speculate as to why these tactics may have been employed (or threatened) by Alcoa?
4. Why did the Reynolds’ board reject the initial offer only to accept the bid two weeks later?
5. What is the purpose of the breakup fee?

19. 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 conditions when directors can be removed
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.

20. 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

21. 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 stock 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.

22. 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”

23. 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.

24. Impact on Shareholder Value
Friendly transactions realized abnormal returns to target shareholders of about 25% during the 2000s
Hostile transactions often result in even larger average abnormal returns to target shareholders
Acquirers’ shareholders earn average abnormal returns of 1% to 1.5%; however, they may be negative for deals involving large public firms and those using stock to pay for the deal
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

25. Things to remember...
Hostile takeover attempts and proxy contests affect governance through the market for corporate control
Although relatively rare, 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.