The takeover market and corporate governance - Essay Example

The corporate takeover market is the market for corporations which have been weakened by poor management or systemic risks, the prices of which have therefore fallen, and which present opportunities for buy-out by stronger, cash rich firms. The approach to corporate takeovers may be either friendly or hostile, but the intention is the same – to gain control over a productive enterprise. Other than this basic definition, there have been certain characteristics popularly attributed to corporate takeover bids, among which are that they are, according to De Pamphilis (2010, p. 86): (1) motivated by excessive greed; (2) reviled as a job destroyer; (3) praised as a means of dislodging incompetent management; and (4) heralded by shareholders as a source of windfall gains.

While these may be true, the corporate takeover market serves two important purposes in a free market economy, which are, according to De Pamphilis (2010) that: (1) The corporate takeover market facilitates the efficient allocation of resources to sectors where they may be needed more and where they can be used more efficiently; and (2) The corporate takeover market provides a mechanism by which underperforming corporate managers may be held accountable for their inefficiencies and to discipline them for their poor management of their corporations.

Corporate takeover would sometimes take the form of hostile takeovers or proxy fights, the successful conduct of which may replacing incompetent and unreliable managers, and thereby promote good corporate governance practices. . 87) When mechanisms for corporate control internal to the firm are relatively weak, then it is possible for a hostile takeover of the firm to take place. In such cases, the corporate takeover market performs the function of a “court of last resort” (Kini, Kracaw & Mian, 2004 in DePamphilis, 2009, p. 94). In a hostile tender offer, the potential acquirer bypasses the board and management of the target firm, and makes a direct offer to the shareholders to purchase their shares at an attractive price.

A study of nearly 8,000 acquisitions between 1980 to 1999 showed evidence that the corporate takeover market tends to impose discipline on managers of larger firms more effectively than on managers of smaller firms (Offenberg, 2009). Two theories that have evolved to explain why managers resist takeover attempts are the management entrenchment theory, and the shareholders’ interest theory. Management entrenchment theory states that managers defend against takeover attempts in order to prolong their stay with the firm (it will be recalled that takeovers result in new and better management replacing the old and incompetent one).

Shareholders’ interest theory, on the other hand, posits that management may resist takeovers as a bargaining strategy to raise the proposed purchase price for the benefit of the shareholders of the target firm. Companies have developed several defenses against takeover bids, such as poison pills (these are plans that give shareholders the right to buy the company’s shares below the prevailing market price, in the likelihood of a takeover bid). However, in order to improve transparency and meet shareholders’ demands for more responsive corporate governance practices, many of these firms