Column 2 - Takeover Defense Measures and Enhancement of Corporate Value

Assistant Director, Industrial Organization Division, Economic and Industrial Policy Bureau, METI

Lately, not a day passes without the term "M&A" appearing in Japan's newspapers, which emphasizes the magnitude of Japan's latest mergers and acquisitions (M&A) boom. To name only a few from a series of recent M&A activity, the United States-based Citigroup Inc. launched a takeover bid for Nikko Cordial Corp. prompted by a major accounting scandal at the Japanese brokerage, while negotiations toward business integration are underway between two major players in the retail sector - Daimaru Inc. and Matsuzakaya Holdings Co. Elsewhere, as exemplified by U.S. activist hedge fund Steel Partners' recent unsolicited takeover bid to acquire Sapporo Holdings Ltd., hostile takeover attempts are no longer a rarity in Japan.

Setting criteria for fair and reasonable takeover defense

When a company becomes the target of a hostile takeover bid, the typical management response is to use every possible anti-takeover measure to try and block the bid. However, corporate managers should not be allowed to block takeovers that would raise corporate value, even hostile ones, solely for the sake of protecting their own positions. Thus, in May 2005, the Ministry of Economy, Trade and Industry (METI) and the Ministry of Justice (MOJ) jointly formulated Takeover Defense Guidelines for Protecting and Enhancing Corporate Value and the Interests of Shareholders as a Whole (hereafter "Guidelines"). The Guidelines are meant to set criteria for fair and reasonable takeover defense measures based on the idea that takeovers which are likely to raise corporate value should succeed and only those perceived as detrimental to corporate value should be eliminated.

The Guidelines set forth three principles for takeover defense measures that must be adhered to in order for the defense to be considered legitimate and reasonable:

1) Principle of protecting and enhancing corporate value and the interests of shareholders as a whole: Corporate managers must commit to ensuring that takeover defense measures are designed and implemented for the purpose of protecting and enhancing corporate value and the interests of shareholders as a whole, and not for the sake of protecting the managers' own interests.

2) Principle of prior disclosure and shareholders' will: Details of any proposed takeover defense measure must be disclosed in advance in order to increase predictability for investors, and the final verdict on introducing or maintaining the measure be made in accordance with a reasonable consensus from among the shareholders.

3) Principle of ensuring the necessity and reasonableness of defensive measures: A mechanism will be introduced for preventing corporate managers from continually resisting takeover proposals that are likely to enhance corporate value. Defense measures should be limited to those considered both necessary and reasonable in preventing takeovers that would impair corporate value.

The Guidelines have clarified, among other things, the requirements for shareholder rights plans (the use of stock acquisition rights as a form of takeover defense) to be considered legitimate and reasonable. Consequently, the number of companies adopting this plan increased from around 10 prior to the issuance of the Guidelines to some 220, or about 5% of listed companies, as of the end of March 2006. This indicates that shareholder rights plans are gradually gaining recognition as an effective defense against takeovers detrimental to corporate value.

Shareholder rights plans as a tool to increase corporate value

Shareholder rights plans were developed in the United States as a means to protect companies against hostile takeovers during the M&A boom of the 1980s. At that time, the U.S. was being swept by a wave of poorly conceived takeovers which hurt the value of target companies and the common interests of shareholders. Included in such harmful tactics were: corporate raids, in which the buyer purchases the target company through a hostile leveraged buyout (LBO) and, upon completion of the deal, splits the company and sells off all the assets to secure gains; and coercive takeover tactics - two-tiered offers, creeping stock accumulation, etc. - in which shareholders at large are forced to quickly sell their shares. Rights plans were introduced primarily as a means to deter these types of takeover attempts or to secure better terms for the target company. Subsequently, the legality of rights plans was established in court rulings.

Two broad types of rights plan are currently being implemented in Japan - "trust style" and "advanced warning style." In either plan, a company issues to all of its shareholders special stock acquiring rights that, upon a hostile bidder's attempt to forcibly acquire control over the company, are exercisable by all but the bidder so as to dilute the value of shares held by the acquirer. The two types differ in the timing at which the stock subscription rights are issued. Under the trust style, a company issues rights upon adoption of a rights plan and entrusts them to a trust bank or similar institution for distribution to all shareholders upon the occurrence of a triggering event. In contrast, under the advanced warning style, a company determines and announces the specific scheme of a plan upon adoption while stock subscription rights are issued directly to all shareholders upon a triggering event. Most companies that have introduced rights plans so far have opted for the advanced warning style, with only about 10 companies adopting the trust style.

Even within the same type, whether trust or advanced warning, rights plans are diverse depending on the needs of each company. Various patterns can be observed in specifics such as the ways of soliciting the will of shareholders, and preventing corporate managers from using the rights plan as a means to protect their positions. For instance, some companies seek their shareholders' approval for a specific scheme by way of a resolution at a general shareholders meeting at the time of adopting a rights plan while some others do so when invoking the plan. Yet other companies seek to ascertain the will of shareholders, not in the form of an explicit approval, but through the reappointment or dismissal of board directors who have proposed the plan.

These variations in plans can be seen as footprints of companies trying, in their respective ways, to obtain shareholder approval while enhancing the legality of their proposed rights plans. Needless to say, such an approach is quite important in obtaining shareholders' approval for these plans. But, equally important is to seek shareholder understanding of how corporate managers intend to increase corporate value and why the plan is necessary. For that, managers need to actually run their businesses in a way that maximizes corporate value. In addition, sincere discussions about corporate value and rights plans must take place between corporate managers and shareholders. Thus corporate managers must vigorously undertake investor relations (IR) activities. Yet it would also be desirable if shareholders, for their part, acknowledged the benefits of properly designed rights plans as a means of enhancing corporate value and shareholders' common interests, instead of flatly opposing the idea, and engage in positive dialogue with management to find ways to use rights plans as a tool to enhance corporate value.

April 18, 2007

April 18, 2007

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