Prevention of Hostile Takeovers in Japan: U.K. City Code Shows the Direction

TSURU Kotaro
Senior Fellow, RIETI

As the threat of hostile takeovers becomes a reality in Japan, many people point to a U.S.-style "poison pill" tactic as a means to fight back against takeover bids. The poison pill prevents a hostile takeover by automatically triggering the issuance of new shares of the target company when a bidder acquires a certain percentage of shares of that company, effectively diluting the stake held by the bidder.

Although the majority of American companies resort to the poison pill statute as a legal basis for their defense against hostile takeovers, this statute itself is the creation of courts in the state of Delaware -- through the accumulation of precedents. Because of this, it has been pointed out that the statute has a pro-management tilt reflecting Delaware's desire to attract businesses.

Against all these odds, the poison pill scheme seems to have functioned fairly well in the U.S. However, we must not forget that the U.S. also has a very powerful counterbalancing mechanism that does not allow corporate managers to engage in self-protection tactics. This mechanism is the presence of active shareholders such as institutional investors -- i.e. those who demand corporate managers to fully account for each of their key management decisions -- as well as the presence of independent outside directors who represent shareholders' interests. None of these infrastructures has been sufficiently developed in Japan.

Strict conditions for the application of takeover defense measures

The U.K. City Code on Takeovers and Mergers (known as the City Code), which provides protection against takeovers through restrictions over takeover bids, can be more easily transplanted into Japan. The City Code has served as a basis in drafting the European Directive on Takeover Bids, a unified legislative framework agreed upon and enacted by the European Union. Some Asian countries such as Malaysia and Singapore have adopted similar takeover statutes. As such, the City Code is a mechanism that might deserve more to be defined as a "global standard" than the poison pill of the U.S.

Under the City Code, a board of directors is, in principle, required to obtain approval of the shareholders in general meeting before taking any action to frustrate a takeover offer. (This requirement is called the "duty of neutrality." Under this rule, a company that has introduced a certain takeover defense measure applicable under ordinary situations would have to obtain further approval of the shareholders for invoking the measure in an emergency.) Compared to the U.S. statute under which a board of directors is allowed to take various defense measures, the City Code is far stricter on the application of takeover defense measures.

Mandatory bid rule

Meanwhile, a partial acquisition is basically prohibited under the City Code that sets out the mandatory bid rule, under which an offerer having acquired 30 percent or more of the voting shares of a company must make an offer (normally, a cash offer) to buy all the remaining shares of the company. Through the presence of this restriction, the City Code effectively eliminates the possibility of hostile takeovers that are apparently harmful to the interests of shareholders and the target company such as two-tier takeover attempts, a scheme that forces shareholders to accept an initial takeover bid by setting less favorable conditions for the second bid, as well as of those without sufficient financial backing such as the "greenmail" practice in which an offerer puts in a takeover bid with the intention of forcing the target company to repurchase at a substantial premium.

Curtis J. Milhaupt, Fuyo Professor of Law at Columbia University, also says that the City Code, which is a simpler and easier to understand rule compared to the poison pill statute of the U.S., would be easier to adopt and implement in Japan.

In the U.K., an independent body known as the "Takeover Panel" administers the City Code thereby judging which specific cases should be excepted from the mandatory bid rule. This characteristic of letting a public organization -- not the judicial authority -- judge the right or wrong of a takeover is similar to the Japanese traditional way of implementing economic regulations. As such, the City Code has more in common with the Japanese regulatory approach.

Japan must not be fixed on the idea of importing a U.S.-made institutional system or mechanism that it perceives as a global standard. What is important instead is to carefully examine alternative mechanisms and institutions implemented in other countries, analyzing both the merits and demerits of each option. The same holds true in establishing institutions for takeover defense measures.

>> Original text in Japanese

* Translated by RIETI.

September 12, 2005 FujiSankei Business i

October 20, 2005