Shareholders Wealth Consequences for Defeating Hostile Takeovers - Case Study Example

Evaluating the Shareholders' Wealth Consequences in Defeating Hostile Takeovers of UK Companies One of the most threatening crises that could strike an organisation or a firm is a hostile takeover attempt. This occurs when one company wants to acquire a competitor or a firm that will add new markets or products. Often the acquiring has neither the intention nor the capability of operating the company. The objective is to obtain its asset value by selling off the company in pieces. The impact of takeover on the acquired company is likely to be complex and the effects are unlikely to be fully revealed from an analysis of company accounts or other data on company performance. Changes in the structure and organisation of a company's operations may be reflected in performance data, but these data provide little indication of the nature and extent of the structural changes. Changes in the functions performed within the company, the product mix, the availability of finance, input sources, industrial relations and many more qualitative aspects of the company's operations may also have significance for the long-run development of the acquired company which would not be reflected in relatively short-run performance data (Ashcroft & Love, 1993, p. 39). An example of a company's effort to substantiate changes through a hostile takeover is that of Olivetti. This Italian industrial giant was long known as a typewriter and office machine company, which almost failed in the 1980s. With the entry of several US competitors in the late 1980s, Olivetti found itself in hot water as it is being toppled down by IBM, Dell, Toshiba, and Compaq. The solution was not obvious, though one business that Olivetti entered in the 1980s, telecommunications, has turned out to be the one in which the company is trying to bet its future. With the bold bid for Telecom Italia in 1998, Olivetti launched one of the first major hostile takeover bids in Europe. After successfully overcoming the strong opposition of Telecom Italia's board and an attempt to recruit Deutsche Telekom as a white knight, Olivetti did take control of the telecommunications company. Now it remains to be seen if Olivetti really can remake itself as a leading telecommunications company moving into the twenty-first century (Raghavan and Naik, 1999). In occasions of hostile takeovers, the final decision of whether to allow it rests with the stockholders. In an earlier time, they were largely individuals whose purpose in investing was to earn dividends and hope the stock would appreciate in value so they could sell it at a gain for their retirement. Such "little investors" in our era have been replaced by giant investment funds managed by shrewd professionals with sophisticated computer programs to guide their decisions. They work for mutual funds, pension funds, and other large-volume investors with billions of dollars that they must "keep working" for the benefit of their shareholders or members (Loughran & Vigh, 1997). As there are already strong takeover defences presently available to corporations, shareholders do not have claim to decide whether or not proposed takeover offers are in the best interests of the company. Unfortunately, managerial decision-making may become conflicted for any number of reasons when the company becomes a target for takeover. The burden of proof to show there's no conflict of interest is clearly on the shoulders of the management of the target company. Fact is that any expenditure to "defend" the company from a hostile takeover need to be ultimately justified by enhanced shareholder value. Apparently, during takeovers, the management represents the company, regardless of whether or not it would be more beneficial if shareholders accepted a takeover offer and reinvested the offer value (Neis, 1997). It could also happen that management could overestimate its own ability to create value for shareholders and mistakenly turn down superior offers. Another dilemma that deserves more careful review is that management owning a substantial number of the outstanding share, how does the company respect the fiduciary responsibility to truly minority shareholders Thus, the aim of this study is to evaluate shareholders' wealth consequences from defeating hostile takeovers in target companies. Literature Review Although there is more negative connotations that hound hostile takeovers, these are not necessarily considered as unethical, particularly if they target firms that are underperforming their industry. Such underperformance is often exemplified through assets that are undervalued by the market. However, when firms that are performing well are targeted, one could question the ethical status of such actions. Also, there may be times when it is appropriate for the management to take actions to forestall a hostile takeover, especially when the reasons for such a takeover are not in the best interests of the firm's stakeholders. Boards of directors should be encouraged to consider not only the stockholders' interests but also those of other stakeholders, such as employees, customers, and communities in which the firm operates (Short &. Keasey, 1999). Another issue that is worth to be considered during hostile takeovers are the expenses as an acquiring company makes a tender offer to buy shares in the target company from some or all of the latter's shareholders. If the target's board determines a takeover is not in shareholders' best interests, defensive measures generally are taken, possibly including the search for a white knight (Arnold, 1998). The target company incurs expenses to evaluate a tender offer. Directors often retain an investment banking firm to value the stock and issue a fairness opinion. Also, the directors typically retain legal counsel. If the board decides to resist the takeover, it incurs expenses for defensive actions (Hume & Larkins, 1992). In UK, hostile takeovers can serve as a drastic governance mechanism of the last resort. Under the potential threat of takeover, managers cannot take their control of the company for granted (Walsh & Rita, 1993). However, conclusive evidence in the UK has expressed misgivings on the belief that hostile takeovers bring in more efficient managerial team brings improved performance, resulting in higher returns to shareholders and improved prospects for employees' pay and security. A research by Frank and Mayer (1996) unveiled that the profitability of firms that are taken over is no worse than other quoted companies. This suggests that takeovers are not a mechanism for correcting managerial failure. Even more importantly, the performance of merged companies frequently fails to deliver the expected benefits and, indeed, worse performance more commonly results. In an article by European Industrial Relations Observatory (EIRO) online, they purported that takeovers are often followed by significant numbers of redundancies in the short term. This is for that fact that in influencing shareholders to agree on takeovers is in their interests, managers in the bidding firm often promise that cost savings will result from the merger, and shedding staff is a principal way in which this is achieved. EIRO cited as an example when Diageo, the food and drinks group formed in December 1997 following the merger of Grand Metropolitan and Guinness, announced having 850 job losses in the UK with another 1,000 redundancies overseas expected after six months.. In other cases, the hostile takeovers were unsuccessful because of actions taken by the firm. However, those actions sometimes entailed the use of significant amounts of debt or other steps that required a substantial reduction in expenses, often accomplished through employee layoffs or asset sales (Hanly, 1992). This has led EIRO to believe that this pattern is most evident at present in the financial sector, where a wave of mergers is associated with large-scale job losses Consequently, a research by Cory Bromby (2002) suggested one way to determine whether or not management acts in the best interests of shareholder wealth, in the case of hostile takeovers, is to compare the actual returns of a target company's stock to the returns that could have been achieved had the tender offer been accepted. This could be applicable if the management has, for some reason or another, successfully defeated a takeover attempt and the tender offer by the acquiring firm was either withdrawn or expired, it is interesting to see if any patterns emerge from the consequences shareholders must face. Bromby (2002) concurred that the major premise is to discover whether a stockholder would be better off to accept a take over bid and reinvest the payoff in an index fund or resist a take over and stick with the return on the original amount invested in the target company. To accomplish this study, Bromby (2002) used the Security Data Corporation (SDC) database to compile a list of companies (with market values greater than two hundred million dollars) involved in mergers and acquisitions from 1990 through 1998. This database was limited the results to "hostile" and "tender" offers or takeover attempts including a large percentage of cash in the offer for the majority of the target company's stock. In order, to control for possible variations in wealth consequences, Bromby narrowed down applicable companies further by the number of parties involved for the duration of the offer. The results of the abovementioned research suggested that for the period from 1990 through 1998, defeated hostile takeover offers were not in the best interests of shareholder wealth. With all ten cases examined out of the original sample of fifty-five, returns of the target company's stock were significantly less than expected returns from reinvesting takeover premiums offered in the S&P 500 index. Bromby (2002) concluded that this phenomenon raises interesting controversy over the role of management in both maximizing shareholder value and acting with due diligence in regard to shareholder wealth. Brief Description and Justification of Methodologies Using the SDC Platinum database, our research will try to compile a list of companies in the UK involved in mergers and acquisitions from 1997 through 2004. The year range was chosen because there were major UK takeovers that occurred in 1997. Same as Bromby's (2002) research, our results will be limited to "hostile" and "tender" offers or takeover attempts including a large percentage of cash in the offer for the majority of the target company's stock. From this list of companies, each individual deal will be scrutinised to see which ones involved only one acquirer and one target throughout the duration of the offer, with no third party disruptions. To accomplish this, news articles about these companies will be researched using the internet and other online databases. If possible, the companies to be chosen will be limited to ten firms that have experienced major hostile takeovers. After the UK firms were chosen, the next step was to track each firms' stock performance against the FTSE 100, an index of blue-chip stocks on the London Stock Exchange, beginning forty days before the takeover was announced (40-day prior), when the takeover was announced (Initial price), half way between announcement and withdrawal (Mid price), when the offer was withdrawn (End price), and two years after the offer was withdrawn (2-yr after). The final step in the research will be accounting for takeover offers by assuming these premiums could be reinvested in the FTSE 100 index at some point in time had the hostile takeover been accepted by management. Bibliography Arnold, G.C. 1998. Corporate Financial Management, London: Financial Times Pitman. Ashcroft, B., & Love, J. H. 1993. Takeovers, Mergers, and the Regional Economy. Edinburgh: Edinburgh University Press. Bromby, C. 2002. An analysis of shareholder wealth consequences from defeating hostile takeovers, Journal of Undergraduate Research, 6 (9), July. Retrieved last April 5, 2006 from University of Florida Website: http://www.clas.ufl.edu/jur/200207/papers/paper_bromby.html EIRO. Corporate mergers and takeovers: lessons from the UK. Retrieved last April 5, 2006 from EIRO Website: http://www.eiro.eurofound.eu.int/1998/07/feature/uk9807136f.html. Franks, J. and Mayer, C. 1996. Do hostile takeovers improve performance Business Strategy Review, 7(4). Hanly, K. 1992. Hostile takeovers and methods of defense: A stakeholder analysis. Journal of Business Ethics, 11: 895-913. Hume, E. C., & Larkins, E. R. 1992. Takeover Expenses: National Starch and the IRS Add New Wrinkles. Journal of Accountancy, 174(2), 87. Loughran, T. and Vigh, A.M. 1997. Do long-term shareholders benefit from corporate acquisitions Journal of Finance (December): 1765-90. Neis, A.1997. Who protects the shareholders Financial Executive13(4), July-August:48-51. Short, H., and Keasey, K. 1999. Managerial ownership and the performance of firms: Evidence from the UK. Journal of Corporate Finance 5: 79-101. Walsh, J.P. and Kosnick, R.D. 1993. Corporate raiders and their disciplinary role in the market for corporate control, Academy of Management Journal, 36(4), August: 671-700. Read More