What Sort of Companies are Jumping on the Anti-Takeover Measure Bandwagon?
With mergers and acquisitions (M&As) becoming increasingly common in Japan, the number of hostile takeover attempts has clearly risen, notably in the wake of the Livedoor-Fuji TV battle in 2005 over the control of Nippon Broadcasting System (NBS). Particularly after May 2005 when the government released Takeover Defense Guidelines for Protecting and Enhancing Corporate Value, a number of Japanese companies, following the criteria set forth in the guidelines, have moved to adopt takeover defense measures similar to "poison pills" in the United States. Under this particular defense plan, a company issues stock acquisition rights to its existing shareholders and, if a bidder acquires more than a certain percentage of the outstanding shares, these rights - exercisable by all but the bidder - are automatically exercised and new shares issued to all rights holders except for the bidder, thus reducing the bidder's percentage of shares held. The number of Japanese companies adopting such tactics increased from 47 in fiscal 2005 to 150 in fiscal 2006, then to 362 as of the end of June 2007. One out of every seven companies listed on the Tokyo Stock Exchange (TSE) has adopted the plan. I would like to discuss the pros and cons of the introduction of takeover defense plans by analyzing the characteristics of companies that have adopted them. In doing so, I will refer to findings from a joint study conducted by Miho Takizawa, Kaoru Hosono, and myself1.
Two ways of viewing hostile takeovers
There are two conflicting ways of viewing hostile takeovers. One is that the threat of a hostile takeover works to improve the efficiency of the target company through a disciplining mechanism on management. Management's continuous failure to maximize corporate value leads to undervaluation of the company's stock. Thus, it is quite possible that corporate value can be increased by acquiring a company and installing a new management team to run it more efficiently. Conversely, this means that the threat of hostile takeovers motivates the incumbent management, which naturally wishes to stay on, to work harder and run the company in a way that makes it "unattractive" to bargain hunters. Based on this way of thinking, the maximization of corporate value through strenuous management efforts is the only true defense against hostile takeovers. According to this idea, the adoption of anti-takeover measures is an indication of the incumbent management's attempt to save its own necks and results in the preservation of inefficient companies.
The other view is that hostile takeovers damage the value of acquired companies. Displacement of incumbent management tends to make vulnerable the implicit contracts that have been formed between the company and its employees and other stakeholders. This "breach of trust" may result in the company's deteriorated competitiveness and decreasing corporate value by undermining stakeholders' incentives to make firm-specific investments. Also, "predatory" takeovers may result in damaged corporate value. Such would be the case when an acquirer employs "scorched-earth" tactics by temporarily taking control of the acquired company to transfer intellectual property and other valuable assets to another company. Based on this way of thinking, adoption of defense measures against potentially harmful hostile takeovers, (those likely to damage corporate value), constitutes a "legitimate defense."
One way to determine the validity of these two conflicting views on hostile takeovers and applying defense measures against them is to analyze the characteristics of companies that apply them. If anti-takeover measures are introduced for the incumbent management to save its own necks, a greater tendency to adopt such measures will be seen in inefficiently managed companies that are likely takeover targets and inward-looking companies that show little consideration for their shareholders. On the other hand, if anti-takeover measures are implemented to defend against takeovers such as those resulting in damaged corporate value, then these measures show no correlation with self-protective corporate managers or with inefficient corporate management.
Self-protectiveness and conflicts of interest affect decisions about defense measures
To verify the above hypotheses, we analyzed data and sought to determine the motives of 197 companies that introduced anti-takeover measures between April 2005 and March 2007. Specifically, the analysis was conducted by classifying observed characteristics into three categories: 1) management inaction on poor performance, 2) self-protective nature in management and/or the company, and 3) other factors affecting the probability of being taken over. We made the following findings:
- Anti-takeover measures are not necessarily introduced by companies with poor business performance measured by return on assets (ROA) or Tobin's q. That is, the measures are not necessarily adopted as a "shield" or "trench" against a hostile takeover threat that is rising as a result of management's negligence.
- Companies with a longer history, lower management ownership, and a higher cross-shareholding ratio exhibit a greater tendency to adopt anti-takeover measures. This indicates that corporate decisions about the measures are influenced by management's self-protective attitudes and the conflict of interest between management and outside shareholders. Particularly, the finding that companies with a higher cross-shareholding ratio are more inclined to introduce anti-takeover measures is clear evidence of management's self-protective nature. With all other conditions equal, companies with a higher cross-shareholding ratio are supposed to be more difficult to take over. The very fact that these companies nevertheless are more inclined to adopt anti-takeover measures shows just how strong their self-protective tendency is.
- Companies with lower controlling shareholder ownership and higher institutional ownership are more inclined to adopt anti-takeover measures, as are companies prone to becoming takeover targets because of their ownership structure allowing for high liquidity of their stock. Also, a strong tendency to adopt anti-takeover measures is observed in companies with a higher liquid asset ratio and lower debt ratio, thus attractive in the eyes of potential acquirers.
Negative impact on capital market and increased cost burdens on companies
The practice of cross-shareholding among Japanese companies has been found to be reemerging in recent years with hostile takeovers becoming a reality in Japan. Companies that have already dug a trench by means of cross-shareholding exhibit a tendency to further deepen that trench by adopting anti-takeover measures. The recent court ruling on Bull-Dog Sauce Co.'s defense against a hostile bid by a U.S. fund explicitly emphasized the need to win shareholder approval in introducing any sort of defense measure. This may further impel Japanese companies' to move to establish or strengthen cross-shareholding arrangements in order to build a strong base of stable shareholders, increasing the likelihood of substantiating anti-defense measures. This could, however, impede the sound development of an efficient M&A market (market for corporate control).
Our analysis also found that larger companies have a greater tendency to introduce anti-takeover measures. This indicates that enacting these measures involves a certain scale of fixed costs that are a considerable financial burden for small companies. In the Bull-Dog Sauce case - though perhaps an extreme example - a company that was assuming an after-tax net income of ¥230 million in its earnings forecasts as of May of the first half of the current fiscal year will incur some ¥680 million in attorney fees alone to introduce the defense measures.
Given such cost burdens and side effects, including the negative impact on the capital market, an alternative approach needs to be reconsidered, such as preventing abusive hostile takeover attempts by strengthening the takeover bid (TOB) rules in general and the mandatory bid rule in particular, rather than letting individual companies adopt poison pill type defenses2.
- See "Baishu boeisaku donyu no doki: keieihoshin kasetsu no kensho" [Motivation for adopting defense measures: Testing of self-protection hypothesis for corporate managers], RIETI Discussion Paper 07-J-033.
- See Tsuru, K. Nihon keizai sisutemu kaikaku: 'ushinawareta 15-nen' wo koete [Japan's Economic System Reform: Beyond the 'Lost 15 Years'], Chapter 3, Section 4, Nihon Keizai Shimbunsha, 2006, for detailed discussion on the significance of the mandatory bid rule and other takeover regulations under the City Code of the United Kingdom and their implications for Japan.
August 28, 2007
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