(James Saft is a Reuters columnist. The opinions expressed are
By James Saft
Sept 14 It may be time for corporate boards
which reject takeover offers to get more skin in the game.
Hostile takeover attempts have become much more common in
recent years, accounting for 16 percent of the $126 billion of
U.S. takeovers in the year to August, according to Dealogic
While activist investors and their hostile bids have
generally been shown to create value for shareholders, their
actions, and the responses of company boards, can cut both ways.
On the one hand, as corporate boards are paid to serve
rather than to sell at the highest price, they have a built-in
bias against accepting offers and relinquishing control.
Conversely, activist investors, who generally themselves are
being judged on yearly performance, can have a short-term focus
which destroys value. Boards may, in an effort to buy off
hostile bidders, take steps like buying back shares or cutting
back on research which may prove myopic.
It is also hard for courts to hold corporate boards
accountable. They are expected to act on subjective and inside
information which courts find difficult to judge from outside.
Therefore we have a system under which it seems likely that
boards are often, out of self-interest, rejecting offers they
ought to accept or making conciliatory gestures with high
Nitzan Shilon, of the Peking University School of
Transnational Law, proposes a novel solution: encouraging
outside directors of boards to put "their money where their
mouths are" in rejecting bids.
In brief, the idea is to encourage outside board members to
pledge, at the same time as they reject a bid, to buy shares in
the company at the bid price and hold them for a pre-agreed
"The systemic failure in protecting shareholders in takeover
situations is not all due to the conflict of interest between
target boards and their shareholders or to the lack of judicial
tools to review board decisions effectively; it is also due in
part to the legal rules prohibiting boards from showing their
genuine opposition to the bid by committing to buy, if the bid
fails, some shares of the target firms," Shilon writes in an
August paper. (here)
Boards may decline to put an offer to shareholders,
asserting that owners will wrongly accept an inadequate offer. A
board whose outside directors pledge to use one third of their
cash compensation to purchase stock from the corporation, for
example, and hold it for at least three years, would send a very
clear and valuable signal to shareholders.
Rejections can be costly for shareholders, who on average
see the value of their stock fall 28 percent in the immediate
aftermath of a rejected bid. Targets which stay independent for
30 months see stocks returns which are, on average, 53 percent
lower than targets which were acquired.
As it stands, shareholders, knowing where boards' bread is
buttered, may disbelieve them if they advise against a bid,
making it more likely that they accept an underweight offer, and
more likely that boards decline to let them vote or resort to
takeover defense measures like poison pills.
An arrangement, if allowed, where outside directors put up
cash to back their analysis would make them more credible and
have a lot of benefits.
"The potential improvement in information embedded in the
arrangement is expected not only to enhance markets'
informational efficiency but also to improve asset allocation
efficiency," Shilon writes.
Not only would shareholders get a better read on boards'
actual views on the intrinsic value of the company, but so would
bidders and potential bidders. A virtuous circle of information,
feedback and capital allocation can follow.
It might also help companies wanting to make long-term
investments and create long-term value, with the information
from a board stock purchase counterbalancing the information
contained in a hostile bid. Consultation with long-term
shareholders as part of the process would help, another point
Shilon advocates, and might counterbalance pressure from
activists and arbitrageurs with shorter attention spans.
To be sure, this wouldn't work in every instance, and should
not be allowed in nuisance bids or those which aren't fully
Interestingly, a case can be made that such a provision, if
it became popular, might actually cut down on activist
investment but ironically improve shareholder returns long term.
Activists exist in large part because insiders' interests
are misaligned with shareholders. Activists generally seek to
lower the gap between market and intrinsic value by some amount
and then move on to the next deal.
Using hostile bids as a means to pressure boards to be more
honest about their views will ultimately help to improve
(Editing by James Dalgleish)