Corporate Structures and Corporate Governance of Cadbury - Essay Example

Introduction In late August 2009, the Chairman and CEO of US based confectionery, Kraft met the Chairman of the Board of Directors of Cadbury, the British confectionery company with a takeover bid on the agenda. Krafts offer included cash and shares for the acquisition of Cadbury. Cadbury shares were valued at £7.55. Krafts bid was £3.00 and 0.2589 new Kraft shares for each Cadbury share1. However, the chairman of Cadbury rejected the bid. Kraft then went public with the bid and the value of Cadbury shares fell to £7.45 worth £10.2 billion The Cadbury chairman rejected the bid and said it was an unappealing prospect and Kraft was a slow-growing conglomerate business. Warren Buffet, a significant shareholder in Kraft who owned 9.4% of shares in Kraft warned the company not to overpay Cadbury. This led to a series of talks behind closed doors. Cadbury gave Kraft up to November 9, 2009 to make a formal offer. In October 2009, Cadbury posted high profit targets and they promised to increase profits in the quarter by 7%. This was obviously meant to increase interest and the price of Cadbury shares. However, the public did not react to this and the price remained somewhat stable. In November 2009, the results of this was disappointing and Kraft refused to overpay Cadbury. Kraft formalised their bid on November 9 and maintained their original offer of £3 and 0.2589 per new Kraft share in exchange for the purchase of every Cadbury share. This was then valued at £7.17. All of a sudden, Italian group, Ferrero and Hershey showed interest in buying Cadbury but they both gave no assurance. In the end of November, the shares of Cadbury moved up to £8.19 due to speculations of the competing firms interest in purchasing it. On December 4, Kraft put in an offer and commenced a legal battle with the UK authorities due to high barriers and limits set by UK takeover rules and regulations. Kraft agreed on a bid of £7.13p per share or £10.1 billion. Cadbury changed its structures and issued its defence document and promised bigger demands. Craft increased the bid with 60p more per share but the price remained the same. Cadbury rejected the valuations of Hershey and Ferrero. Kraft finally sealed the deal in January 19, 2010 with a consideration of £11.5 billion. Clearly, the whole case provides a number of issues that merits critical legal analysis and other regulatory requirements and expectations. First of all the bids and fluctuations of shares were very regular. Secondly, artificial estimates cause the value of share prices to move up and down. There are also paperwork requirements that proved problematic due to tough takeover rules and politics from interest groups. This paper will therefore undertake a critical review of the complications of acquisitions. In the attainment of this end, the following objectives will be explored: 1. A critical review of the breaches and challenges that Cadbury failed to honour according to the City Code on takeovers and mergers. 2. Outline the changes to the Code in September 2011 and the reasons these changes were made in relation to the complications in the Kraft takeover bid of Cadbury Legal Position and its Implication In order to evaluate the relevant rules related to acquisitions and its important components, there is the need to point out some important and significant elements and aspects of corporate governance and how it intersects with contract law and stock market rules. This gives a broad framework of the necessary regulations and lays the appropriate foundation for the critical evaluation of the relevant rules that can be used to analyse the takeover issues in the Kraft-Cadbury acquisition case in question. Corporate Structures and Corporate Governance Corporate governance refers to the way businesses and organisations are run2. This implies that corporate governance relates to the top level managers and the top level staff members who are empowered to take decisions on how to use the organisations resources. Hence, corporate governance involves the kind of systems and structures meant to deal with the basic functions of setting the overall tone and strategy for the conduct of business. Corporate entities are unique because they are made up of individuals who pool their resources to establish an entity for the purpose of gaining profits for them3. Shareholders expect profits that are commensurate with the level of shares that they hold. Being owners of an entity, shareholders are the ones who own the organisation and hence, they appoint the directors themselves according to the rules of the Companies Act and other relevant legislations. Shareholder dynamics are quite unique and distinct and hence, there is the need for them to participate in some fundamental decision making processes like sale of the company amongst other things. In order to do this, there are some considerations that are very important and relevant. Offer and Acceptance in the Corporate Take Overs Offer and acceptance is a basic element of all commercial contracts4. An offer is where a person intending to create a legal relationship places an item of interest before another party, the offeree. In cases where the offeree accepts the offer, there is a binding contract in English law. However, between offer and acceptance, there are various possibilities that include: 1. Request for further information and 2. Invitations to treat Numerous cases in the law of contract demonstrates that a bid or request for information does not actually constitute an acceptance nor rejection. It is a mere request for further clarifications and more information about a given offer or arrangement. An invitation to treat is more or less a system of attracting another person to make an offer. In other words, it is not an offer in itself but a mere act that gets a potential offeror interested in a given arrangement that has the likelihood of evolving to a contract5. It is neither an offer nor an acceptance. Information and the Corporate World Most corporate entities are listed on public stock markets. These public stock markets are entities where shares are traded and they are sold and purchased according to their individual and/or relative strengths. However, a stock market is strongly influenced by information about what goes in in various entities. Since flexibility is a the core of the activities of stock markets and there is free entry and free exit into the ownership structures and systems, there are is a general tendency for people to buy shares in companies that are cheap and sell them when the prices go up in order to attain a profit. In that wise, most people seek to buy shares in organizations that show promise and avoid organisations that seem to be crises ridden. The efficient market hypothesis states that a weak financial market is one where the prices of assets traded on it reflects past publicly disclosed information6. This means that buyers are rational and they act on decisions that are in public domain once it becomes available. There is also the semi-strong markets where prices reflects publicly available information as and when it unfolds7. However, in a very strong form of market, the financial markets prices reflect instant information even those that are hidden and those acquired through insider dealings8. Every stock exchange seeks to become a strong form of market. This is because it will become more competitive and prices will move and reflect the realities on the ground in order to ensure better sales, efficient allocation of resources and the enhancement of the reputation of the market itself9 Sensitivity of Take Overs Since the sale of shares is a very vital aspect and an important method of predicting the future health and the future success or failure of an entity, it is a highly volatile activity. This is because the different phases of the offer and acceptance and the actual takeover comes with various complications and potential issues. First of all, it is prone to the conflict of interest. This is because the directors of both companies are likely to have various interests in gaining some benefits. Hence, they are likely to undertake some negotiations in their interest and impose it on the shareholders. There is therefore the need for some kind of intervention to prevent these abuses. Secondly, there is the chance that some dominant organisations might want to take over the bids of other entities through various means that might not be very healthy. In other words, richer organisations with the power, can use various means like acquiring shares through a very malicious manner in order to control the entity. This might not be very acceptable to the vast majority of shareholders and in most cases, would constitute a fraud or a mischief amongst the minority shareholders of the targeted firm. Thirdly, the taking over of other entities come with a vast wealth of information. This include information that can make people seek inside information. This is because when a person has inside information, particularly in a strong-form efficient market, that individual is likely to acquire shares and this would constitute insider dealings. So there is a case for some kind of control of information amongst the people involved in such transactions. Finally, there is the risk that a firm targeted for takeover would want to do things that would artificially push up the prices of its shares. This would act as an impetus for overvaluing the shares of the company in order to seek higher prices of the shares. Hence, there is also a need for some kind of moderation and some kind of limitation of the propensity of directors to do this. It appears that the main solution to this issue is to find a way of getting business owners and shareholders to sell businesses without tensions. That is why in the UK, there is the independent Takeover Panel which regulates this. Their activities reflect European Unions Takeover Directive which has linkage to antitrust laws that are prevalent in the EUs fundamental codes and principles10. In order to invoke the rules and principles of the Takeover Panel, it will be worth to restate the legal facts and the relevant legal issues in the Kraft-Cadbury Takeover case. Legal Issues of the Kraft-Cadbury Takeover Process Many of the issues and risks identified above were inherent in the take over bid initiated by Kraft on Cadbury in 2009. The main issue is that in March 2011, the Takeover Panel defined the Kraft acquisition of Cadbury as a hostile takeover11. A hostile takeover is defined as “offerors whose offers were not recommended by the board of the targeting company”12. In other words, the offer is made by the purchasing entity and due to the power and dominance of the entity making the acquisition, the target entity cannot really do much, but to play according to the terms of the acquiring entity. This is mainly against the spirit of the law on competitiveness that is held sacred in Capitalist jurisdictions like the European Union and the United States of America. From the case, the following facts are noted and identified in very significant and clear terms: 1. Cadbury was not in a position to defend itself when Kraft made the offer. In spite of the challenges and the efforts made by Cadbury to prevent a forced acquisition, they could do very little to stop Kraft from having its way and paying them what they proposed to them. On some levels this is tantamount to duress and blackmail and can be abused by various entities in the future. 2. Cadbury could not bind Kraft from reneging on its promises. In other words, the UK shareholders of Cadbury argued that Cadbury is a major employer in the UK. And hence, there was the need for Kraft to station its core operations in the UK and not relocate. Although this was the core and fundamental element and and the spirit of the claim made by Cadburys primary stakeholders, they could not stop Kraft from closing down Cadburys Somerdale plant and sending the operations to Poland. This was a negation of the promise they made to Cadbury at the beginning of the purchase. If there is no policy position on this, companies can change things as and how they like when they acquire subsidiaries and this might go against the interest of the public and the interest of citizens of the country that the law seeks to protect. 3. There were vague offers and transactions that caused panic sales and pushed prices up and down. Can one say for sure that the involvement of Ferrero and Hershey was in good faith? Absolutely not, because their involvement caused an artificial increase in the prices of Cadburys shares which could have been abused by Cadbury. Also, the inflation of profits by Cadbury were things that could affect the reputation of the London Stock Exchange since it could be a locus classicus of a case of dominant firms on the exchange using their power to create artificial price hikes in the shares. This is not good for the stock market and not good for all stakeholders. Thus, there is the need for some kind of action to limit such abuses of power and financial information. This could be tantamount to threat and holding the stock market for a ransom. 4. Finally, the dominance of Kraft allowed the company to flex its muscle and dictate terms for Cadbury. Clearly, this was not in good faith because Kraft had the power and the authority to make changes and control the sale. Hence, there is the major problem of the abuse of the negotiation system by powerful and dominant entities. These four pointers indicated that there were some issues and some basic problems with the existing rules and regulations of the Takeover Panel. Although these things happened, there were some basic rules that existed at the time of sale which were binding on the sale. However, due to some loopholes, these issues and problems that the Takeover Panel seeks to deal with were overlooked and all the problems came up. Default Position of the City Code Basically, there were some fundamental rules and regulations that bind the participants of trade and sales in acquisition of firms under the LSE rules. The Takeover Panel is an independent body that is established to administer city codes or takeovers and acquisitions in matters that the codes apply to13. This include laws that ensure that shareholders are treated fairly and are involved in fully in the analysis of takeover bids. The general principles include: 1. All shareholders in the same class of the company must be treated similarly by the offeror and there should be no direct discrimination on the basis of segregating one class. 2. There should not be selective information sharing and all relevant information must be disclosed to all shareholders. 3. The offer should only be announced only after careful deliberations and analysis and there is certainty that the sale would go through. 4. There shareholders must be given sufficient information and advise to ensure that they reach a properly informed decisions. 5. Advise and public information provided to the media and the public must adhere to the highest standards. 6. All parties must ensure that a false market in the securities in the offeree or the offeror company are not created as a result of information about the sale. 7. Action should not be taken by the offeree company without a general meeting. 8. All action must be conducted in good faith and not in order to suppress minority interests. 9. Directors of the offeror and offeree companies must always advise shareholders with no conflict of interest in mind. 10. A general offer to all shareholders are required where control matters are involved in the contract or the sale. From the case at hand, there were clear issues that saw the violation of these fundamental terms and principles. First of all, the directors of Cadbury sought to take all the decisions. There is evidence that the directors sought to push back Kraft and also listen to some interest groups selectively. Also, Kraft listened to a section of its shareholders, like Warren Buffet at the expense of other shareholders. Thus, the decisions taken in both camps were done by some key personnel and not by the whole team of shareholders. There were no diligent discussions and deliberations. Thus, the sale was significantly flawed. There were no proper consultation with the shareholders. The information relevant to the decision making was shared by a handful of influential persons. And this means that the decision taken was not taken in good faith and was done by a small group. This is tantamount to a fraud on the minority and members of the minority shareholding classes could take the case up in court. The shareholders announced deliberations in public before they were allowed to do so. This is because the transactions and offers by Hershey and Ferrero were premature and there was no logical or reasonable grounds to believe that those bids were serious bids, hence they were all given in bad faith. Also, there was some degree of mischief when the directors of Cadbury inflated the prices of their shares through the deliberate increment in profit projections. This is because they sought to increase the prices due to an obviously unethical approach to the acquisition by Kraft. This was done when all these necessary and relevant rules and regulations were in existence. This means that there was the need for the Takeover Panel to deal with some of the loopholes that made this possible. There is the need for an independent entity like the Takeover Panel to promote a healthy environment for the conduct of business and trade. Changes to the Code, September 2011 The City Code on Takeover and Mergers was modified in September 2011 to block the loopholes created by the precedence set by the Kraft-Cadbury takeover bid. In view of the case, a consultation paper was presented that defined hostile offerors to include offerors whose offers were not recommended by the board of the target company who sought to attain gaming or tactical advantages through various ways and means. The approach identified by the investigative committee that sat on the case was that these hostile offerors took positions that rendered the offeree powerless. Thus, there was the need to grant some degree of protection to affected shareholders and potential entities that could fall under the ambit of weaker entities. On Monday September 19, 2011, the panel published as et of rules that sought to rebalance the scales in favour of targeted companies by shifting the markets away from speculative bids14. The main action was to ensure that there was a prohibition on inducements and other elements that could force a bid to be taken by a targeted entity. The therefore instituted a prohibition on early identification of bidders and the automatic put up or shut up period for bidders. There was also a prohibition on offer-related arrangements. This was to prevent speculations and other elements of activities that could cause the prices of shares to shoot up without just cause. There was the need for the Takeover Panels consent in cases where: 1. A hostile bidder announces his intention to enter some kind of an inducement fee arrangement and the target company agrees to it. This would help the Takeover Panel to deal with the case and investigate it before offering an opinion on it. 2. There was the requirement to identify a potential bidder and ensure that there is an announcement to the shareholders for negotiations to go on in a transparent manner. This would reduce the risk of insider dealings. 3. An identified bidder must come up with a bid no more than 28 days after the date of the first bid. This would ensure that there would be a direct and transparent rule or regulation on the matter. The date could be extended by the Panel where necessary 4. There is the requirement for greater transparency requiring advisor fees and other arrangements that relate to the offer. This would ensure that decisions are taken by shareholders and all relevant stakeholders get information where it matters 5. Potential bidders will be required to review their bid targets in light of changes and will have to use better approaching targets within these deadlines which are tighter. These new arrangements therefore make it imperative for bidders to remain more opened and the shareholders will have to get more information and major updates as and when necessary. Conclusion Takeovers are susceptible to major risks of the abuse of information, conflict of interest amongst directors and the abuse of powers by dominant bidders. This was the case in the Kraft-Cadbury acquisition process. This led to major problems and significant breaches. There Takeover Panel has rules and regulations that ensures that firms do not abuse their power and authorities in these instances. However, the companies in transactions like the Kraft-Cadbury case came under such pressures and hence this led to issues and problems. It is required for hostile bids to come under more transparent terms. The amendment and recommendations of September 2011 to the Code defines hostile takeovers and recommends transparency and easy information disclosure. References Barnes, P. (2010) Stock Market Efficiency,: Insider Dealing and Market Abuse Surrey: Gower Publishing Campbell, D. (2011) Mergers and Acquisition in North America, Latin America, Asia and Europe Amsterdam: Kluwer Law Reporting Fox, M. R. and Thompson, M. (2011) Proposed Changes to the UK Takeover Code [Online] Available at: http://www.steptoe.com/publications-7572.html Retrieved: August 12, 2013 Haan-Hamminga, A. (2006) Supervision on Takeover Bids: A Comparison of Regulating Arrangements Amsterdam: Kluwer Law Hunt, M. (2011) Law of Contract London: Sweet and Maxwell Kurth, S. (2011) Critical Review of the Efficient Market Hypothesis Berlin: GRIN Verlag Leeson, T. (2012) UK Takeover Code London: Cornwell Mantysaari, P. (2011) Comparative Corporate Governance: Shareholders as Rule Makers London: Springer Shop Parr, A., Finebone, R. J. and Hughes, M. J. (2012) UK Merger Control: Law and Practice London: Springer Smith, J. (2009) Corporate Governance London: SAGE Publications Telegraph, UK. (2011) Cadbury-Kraft Takeover: Timeline [Online] Available at: http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/8531023/Cadbury-Kraft-takeover-timeline.html Retrieved: August 12, 2013. Williams, M. R. (2008) Value Investings Challenge to the Efficient Market Hypothesis New York: Nyack College Read More