Structural Significance of Takeover Regulation - Essay Example

? US and UK Takeover Regulation Introduction One of the fundamental occurrences in the modern corporate environment is the takeover. In business, thetakeover process simply refers to the occurrence wherein one organization purchases another. This process refers to both friendly and hostile takeovers. Friendly takeovers simply occur when one organization tenders an offer to another organization and the board of directors accepts or declines the offer. In the corporate world, where publically traded organizations have a multitude of owners – indeed, in the United Kingdom the takeover only refers to publically traded companies -- the process becomes complicated, and the potential for the hostile takeover emerges. The hostile takeover occurs when managers from the desired organization refuse the acquisition tender or merger request, and the original organization continues to pursue the acquisition through alternative, yet legal means. As one would assume this process occurs within a variety of structured regulations that differ between countries. Notably, in the United Kingdom defensive tactics by managers are prohibited, whereas in the United States, Delaware law gives managers a good deal of room to manoeuvre. The purpose of this investigation then is the critical assessment of the divergent regulatory patterns for defensive actions against takeovers within the United States and the United Kingdom. Additionally, the analysis proposes a means of improving on the current practice. Overview Structural Significance of Takeover Regulation In recent years one of the most comprehensive analyses of the divergent takeover regulatory patterns between the United States and the United Kingdom was presented in Armour and Skeel’s ‘The Divergence of U.S. and UK Takeover Regulation’.1 One of the predominant arguments these writers put forth is the notion that the regulations are not contingent on objective processes of functionality, but instead based on the interests of the specific regulatory body. For instance, in the case of the United Kingdom regulations emerge through self-regulatory processes of the organizations themselves; this, they argue, has led to the establishment of a regulatory environment that favors investor actions. Conversely, in the United States regulations are established by the judicial branch of state government and thus lead to laws that support organizational defense manoeuvres. To a large extent the United States has precluded Wall Street from privatizing takeover’s in the same way that the City of London has because 1930s United States federal regulation pre-empted the self-regulation that occurs in the United Kingdom and hindered the ability of institutional investors to collude towards alternative approaches. United States Regulations In further understanding the intentionality behind takeover regulations it’s necessary to gain a deeper recognition of the history of the regulatory process in both the United States and the United Kingdom. Indeed, Armour and Skeel have argued that the most prominent reasons the United States regulatory process has progressed in this direction, while the United Kingdom’s has progressed in a decidedly pro-shareholder position is because of the history of investor practices. In the United States perhaps the most prominent regulation was established with the 1934 Williams Act. Later amended in 1968 this act was established by the Securities and Exchange Commission and required mandatory disclosure of information related to cash tender offers from companies seeking to acquire another company.2 The 1968 amendment functioned as a means of closing loopholes that had increasingly been exploited in the complex business environment.3 While this regulation seemingly goes against the pervading notion that the United States judicial process favors management intervention, legal interpretation of the Williams Act notes that that the law provides equal opportunity for management and the offeror to present their cases.4 One of the most notable aspects of the Williams Act is its institution, along with a series of other financial reforms such as the Glass-Steagall Act, in the wake of the Great Depression. These reforms were implemented both as a means of shoring up a clearly dysfunctional financial system, while at the same time in the general spirit of New Deal reforms. This is a notable point as one of the tacit undercurrents of Armour and Skeel’s argument is that the United Kingdom’s regulatory environment is a more equitable system as it puts control not in the hands of a select minority of managers, but instead in the broader interests of the shareholders. The glaring omission is the consideration of the organization’s employees or even anti-trust measures. In both instances allowing defensive managerial tactics functions not simply in the interests of the institution’s current board and management, but also in favor of the United States citizenry. In terms of specific functionality, perhaps more notable in terms of legal support of management defense is the recognition that there are no regulations against ‘poison pill’ clauses. This practice became popularized in the United States during the 1980s in conjunction with the trending popularity of corporate takeovers. Poison pills fall under the general definition of clauses that are established by the incumbent managers to adversely impact the bidding organization along with shareholder value in case the takeover bid is successful. The most frequently implemented poison pill is a stock dilution that occurs contingent on the organizational takeover; this dilution is generally as strong as 10-15% of bidder value.5 This specific poison pill is referred to as the shareholder rights plan, as its ultimate function does not adversely impact current shareholders, only the bidding organization. Essentially what occurs with poison pills is that the target company’s management issues a clause that allows current shareholders to purchase or receive additional shares if the bidding organization acquires more than a certain percentage of the organization.6 There have been a number of legal considerations involved in the legitimacy of poison pills. One considers that this practice has been challenged in many United States districts. Still, the Delaware Supreme Court in Moran v. Household International, Inc. upheld an organization’s right for an organization to implement poison pill practices.7 It is not difficult to understand why American judicial law in some areas has allowed such a disruptive practice; namely, this procedure maintains current shareholder value, while allotting the target organization time to seek a higher tender offer. While Moral v. Household International, Inc. is recognized as the seminal case in terms of poison pill law, there are a number of other legal rulings on the issue. In Blasius Industries v. Atlas Corp the court ruled that there must be compelling justification for court intervention; the actions must goes beyond the actions of thwarting the actions of a bidder to take control of the board, but also to “dilute the substantial presence of insurgent director”.8 The Delaware Supreme Court upheld this decision in the case Cos. v. Liquid Audio, Inc.9 In rare instances however the Delaware courts have upheld decisions that ran counter to defensive practices. In Omni Care, Inc. v. NCS HealthCare, Inc.10 the court invalidated a shareholder lockup agreement that had been established as a defensive mechanism. Ultimately the understanding seems to indicate that while the Delaware court system has firmly embraced defensive tactics as a response to hostile takeovers, they have failed to uphold such tactics when they enter an area that disrupts long-term corporate functionality in excess of a mere defensive presence. Research has noted that the implementation of a shareholder rights plan has oftentimes resulted in an increase of the original tender offer.11 Canada too has witnessed significant legal challenges related to poison pill defense mechanisms. Natural resource manufacturer Falconbridge Ltd. implemented a poison pill in response to hostile takeover actions from external organizations, notably Xstrata. Xstrata then applied to the Ontario Securities Commission to halt the poison pill actions; the OSC ruled that the pill could remain in position for a limited period.12 While the shareholder rights plan is perhaps the most prominent of the poison pills United States organizations can implement, it’s recognized that there are additional defense mechanisms managers are able to use. United Kingdom Regulations While Delaware and a number of other states have upheld an organization’s right to implement poison pills, the United Kingdom’s legal process has taken a decidedly different route. The United Kingdom has specially designated a Takeover Panel that oversees matters related to corporate takeover. The panel regularly issues a UK Takeover Code outlining takeover regulation. The Takeover Code explicitly notes that United Kingdom organizations refrain from ‘frustrating action’ that would prevent an organization in the acquisition process.13 Armour and Skeel note that the ‘no frustrating action’ code only goes into affect when a bid for the target organization comes into play.14 This is significant as it leaves open the potential for an organization to structurally incorporate elements that would shield itself from a potential takeover. The potential takeover shields for United Kingdom organizations then become, “issuance of dual-class voting stock, adopting a staggered board appointment procedure, or the use of ‘golden shares’ or generous golden parachute provisions for managers, to the more deeply embedded, such as provisions in bond issues or licensing agreements that provide for acceleration or termination if there is a change of control.”15 These measures come to represent the most overt takeover defense tactics allotted in the United Kingdom. While the United Kingdom Takeover Control Board has prohibited defensive manager tactics, it is recognized that there remains other obstacles potential takeovers may face from shareholders. The overriding recognition, however, is that through the power of large-scale institutional investors in the 1960s the United Kingdom developed a regulatory system that favored both the shareholders and did away with potentially cumbersome forms of red tape. Impact of Divergent Regulatory Practices While regulations theoretically are intended to significantly alter practice, it’s recognized that many times such intentions fall short of their ultimate goal. In terms of the divergence between the United States and United Kingdom regulatory practices it’s clear that in large part they have had a direct impact on the business climate. Mergers and acquisition statistics in the United Kingdom as compared to the United States demonstrate that if a takeover occurs it is more likely to be hostile, and it is more likely to occur. A further important consideration is the recognition that in the 1980s hostile takeovers in the United States reached a peak, but with increased regulatory pressure they declined sharply in the 1990s.16 Analysis Shareholder Value One recognizes that there are advantages and disadvantages to the judicial and self-regulation approaches. In better understanding the underlining advantages and disadvantages it is necessary to consider the purpose and benefits of efficient takeover regulations. Armour and Skeel link these concerns largely to equity value.17 Namely, they objectively indicate the connection between a proper functioning regulatory environment and corresponding shareholder value if the bidding organization is able to reconfigure the target organization after acquisition. Of course, the converse side of this equation holds: if the target organization is acquired and then run inefficiently by the takeover organization, then the shareholders will suffer through decreased equity valuations. While the cause effect relationship put forward here is unassailable one recognizes that there are further questions that need consideration. In the United States these external concerns take perhaps the most prominence in light of the current electoral cycle where soon to be named Republican Presidential candidate Mitt Romney made substantial wealth through the acquisition and ‘renovation’ of organizations. This process involved frequent layoffs and significant change that adversely impacted the lives of many employees. While the organization’s ultimately increased equity value, this did not belay the ethical concerns of the necessary layoffs that led to this increased organizational efficiency. While corporate social responsibility sits in the shadows of the debate, the central focus of most regulation and regulatory research has been the aforementioned shareholder value. As noted, the United Kingdom system has progressed to establish a process with limited judicial regulation, whereas the United States system, through judicial regulation, has allotted managers the ability to implement defensive tactics. While on the out-set such defense may appear to be a means of pure self-preservation, it’s argued that in reality this process can contribute to increased shareholder value, as the target organization can hold out to receive a higher purchase price. Still, in practice even United States law hasn’t upheld this rationality, instead arguing that the organization is controlled by its manager’s not shareholder interests. Such considerations reflect broader concerns in the substantial body of literature devoted to stakeholder theory, the debates of which play out directly in this debate on takeover regulations. While the statistics demonstrate a sharp linkage between regulation and the form and amount of takeovers occurring, the central thorough-put remains the impact these takeovers have on shareholders and the larger economic climate. The consideration largely adopted by Armour and Skeel is shareholder value. Stakeholder theory considers the extent that an organization should solely be responsible to shareholder value, or also be beholden to manager or internal organizational interests.18 While there is no definitive answer it seems some of the most stringent criticisms have a pure stakeholder approach have been levied by theorists that embrace strong corporate social responsibility measures.19 Corporate Social Responsibility In the context of the current investigation one could make a clear claim that the United States regulatory reforms instituted through the Williams Act, as well as Delaware’s 1985 Moran v. Household International, Inc. 500 were motivated less out of a desire to prevent the merger of organizations as a means to protect management, but as a necessary corporate social responsibility tool. The obvious question then becomes why the United States has opted for such a social welfare measures and the United Kingdom has simply thrown their citizens to the barbarians at the gates. It seems to a degree the answer to this question is linked to macro-structural concerns of the United Kingdom; that is, the specific approach to corporate social responsibility regulations between the two countries possibly differs because the United Kingdom has instituted such regulations elsewhere. Another possible explanation for these divergent perspectives can possibly be explained through legitimacy theory. Legitimacy theory argues that an organization’s behavior, and an individual’s for that matter, tends towards the ethical bounds of the specific environment in which it operates.20 While the Williams Act dates back to 1934, one considers that it wasn’t until 1985 that poison pills gained widespread acceptance, as well as approval by the Delaware Supreme Court. The argument then becomes that because of the change in the United States business climate, which came to embrace and legitimize hostile corporate takeovers, it became necessary to allow poison pills to protect employee rights. Advantages There are a number of areas where the United Kingdom’s approach towards takeover regulation has advantages over the United States position. To a large extent the advantages can be linked to improved of the United Kingdom system. The Takeover Code indicates that management or the board of directors cannot take any action that, “would result in any offer or bona fide possible offer from being frustrated”21 Recently this position was challenged by derivatives and hedge fund trading.22 In essence a third party hedge fund would purchase significant shares of a company. Since the hedge fund was not directly associated with the hostile takeover they were not required by United Kingdom law or the Williams Act to disclose their interests in effect allowing the bidding organization to escape defense tactics. While the United Kingdom’s Takeover Code was quickly amended for to restrict such behavior, the United States has been slower to change. Such relative inefficiency has characterized much of the United States regulatory process. Armour and Skeel for instance argue that the legal entanglements associated with a hostile takeover in the United States as compared to the United Kingdom have resulted in significantly higher expenses, as well as unnecessary delays.23 Still, perhaps a more important point is that the United States system of federalism, which grants specific rights to states, has created a race-to-the-bottom where states – particularly Delaware – are beholden to management interests or risk losing out on the organization’s tax revenue. Disadvantages There are a number of potential disadvantages that could occur if the United States were to out rightly adopt the United Kingdom’s shareholder centered regulatory outlook. One of the major arguments that Armour and Skeel make is that the divergent patterns of regulatory reform between the United States and the United Kingdom emerged more because of historical patterns rather than functional measures; specifically in the United Kingdom, for a variety of reasons, large-scale institutional investors emerged before the United States that resulted in improved shareholder negotiating power. Even as there appears to be a strong degree of legitimacy behind this argument, the authors don’t consider it was the United States that first implemented strong anti-trust regulations, and not until the United States pressured Europe that the United Kingdom and Germany adopted fully fledged competition laws.24 One recognizes that the European Union has anti-trust regulation in place, yet the potential for American takeover defenses to act as another roadblock in terms trusts holds strong potential. Also not explored by Armour and Skeel are the potential impact structural changes, such as staggered board appointments or dual-class voting stock have on the organization’s long-term efficiency. While the exploration of the effect of such practices on organizational efficiency would take an expansive effort, one recognizes the importance of general qualitative distinctions between United States and United Kingdom modes of operation. In these respects, while the United States judicial system has implemented practices that create barriers to takeover, to an extent they have also freed the organization from restructuring its business operations; of course, the exact opposite is true in the United Kingdom. Proposal While the United States regulatory stance in relation to takeovers undoubtedly has advantages that Armour and Skeel have failed to mentioned, it seems ultimately clear that they are correct in their assumption that the United Kingdom’s stance is a more effective and efficient mechanism for regulating the takeover process. One of the prevailing notions in these regards is the strong amount of inefficiency that surrounds the American system. One of the dynamic elements of the United States governmental structure is the harmony between the branches of government and the state powers. This metaphor cannot be extended to takeover regulation or the takeover process where entangled legal proceedings, state interests, and cumbersome defense mechanisms collide in a cataclysm of relative futility. Still, this research argues that Armour and Skeel’s criticisms of the United States system are largely logically sound within the frame of their text, it is impossible to consider regulatory reform within a bubble; rather, there must be the recognition that the United States affirmation of management defense tactics is partially contingent on advantages these benefits offer in terms of their structural relationship with the American judicial system, legislative process, and general institutional environment. While the definitive impact a change in regulation, such as overruling Delaware’s affirmation of the poison pill, would have on the economic landscape is difficult to foresee, this proposal advances with a qualitative recognition that the impact would potentially harm lower tier workers, as well as create anti-trust complications. This proposal argues that once a takeover bid is on the horizon corporate takeover regulation should not be vested in the Federalist system, but instead be embedded in the hands of the Department of Justice. While in its infancy corporate social responsibility theorists have argued that specific measures be instituted that would track the extent that an organization adheres to corporate social responsibility practices.25 This proposal argues that bidding organizations should ensure that they will follow socially responsible behavior upon the acquisition, with particular emphasis on the lower-tier works who are the most frequently laid off. As such, this proposal additionally recommends that the Department of Justice be given powers to negotiate with the bidder to gain corporate social responsibility concessions in exchange for restrictions that would be placed on managers and board directors that seek to hinder the hostile takeover through poison pills. Ultimately, it’s believed that such a change to the regulatory system functions as an adequate compromise between bidding organizations and a government that has been tasked with ensuring the fair and equitable treatment of all its citizenry. Conclusion In conclusion, this research has examined the divergent regulatory patterns in relation to United Kingdom and the United States organizational takeover defense maneuvers. Within this context of investigation the research has considered the historical elements that have contributed to the establishment of the divergent regulations; specifically it has argued that the divergent path is related both to the United States commitment to New Deal policies, as well as to the earlier progress United Kingdom institutional investors made that allowed them to negotiate greater shareholder power. The research explored the functional distinctions between the regulations, noting that while Delaware prohibits poison pills, the United Kingdom Takeover Control Board prohibits managers and board members from handicapping the takeover process. Armour and Skeel’s notion that the United Kingdom’s regulatory system is the more functional approach is analyzed and the argument is made that while they appear to be correct in the assumption that in benefits shareholder interests and improves efficiency, they neglect the potential benefit the American system may gain through improved corporate social responsibility and self-regulating anti-trust procedures. Finally, a proposal for a change to the American system is put forth. The proposal argues that once a takeover bid is on the horizon corporate takeover regulation should not be vested in the Federalist system, but instead be embedded in the hands of the Department of Justice. Additionally, it recommends that the Department of Justice be given powers to negotiate with the bidder to gain corporate social responsibility concessions in exchange for restrictions that would be placed on managers and board directors that seek to hinder the hostile takeover through poison pills. 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