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Oct 31, 2009

M&A Focus: Good governance

Are shareholders at risk follwoing the disappearance of anti-takeover measures

Advocates of good corporate governance have welcomed the disappearance of anti-takeover measures over the past 10 years. But have these changes left companies exposed and shareholders with a poor deal when hostile bidders come knocking?

The answer is ‘yes’, according to the research team in Citi’s New York-based financial strategy group. The team completed a study of hostile acquisition attempts in the US between January 1, 2001 and July 31, 2009 for bids that were at least $1 bn in value. They found premiums offered by acquirers were typically higher for firms with a ‘strong defense profile’, such as a shareholder rights plan or staggered board.

The report, titled ‘M&A: hostility on the horizon’, comes as hostile M&A threatens a comeback. Deal activity in general has been weak this year, due to volatility in equity markets, a lack of available credit and the inability of buyers and sellers to agree on prices. But with markets experiencing a sustained rally and banks looking to take on more risk, the chances are M&A activity will rebound. Kraft’s recent £10.2 bn ($16.3 bn) bid for UK confectioner Cadbury is just one example.

In the report, Citi researchers note that the adoption of shareholder rights plans has slowed since 2002, while an increasing number of companies have let existing plans expire, according to data from ‘As a result, fewer firms have a shareholder rights plan in place,’ Citi writes. ‘In 2002, 300 S&P 500 companies had a shareholder rights plan but only 94 companies in the S&P 500 have one today.’

Meanwhile, the number of staggered boards – another traditional takeover defense – has also fallen, from 302 among S&P 500 companies in 2002 to 164 today. ‘The weaker level of takeover protection today provides further impetus for potential bidders to pursue their acquisition goals through hostile or unsolicited M&A when the target’s management may be unwilling to sell the business,’ notes the report.

The decline of these takeover defenses is certainly good for corporate governance – and shareholder power. But there appears to have been a cost. In its study of deals from the start of 2001 to July this year, Citi finds a strong defense profile tends to result in higher offers: initial takeover premiums in hostile M&A were about 29 percent when either a shareholder rights plan or a staggered board – or both – were present. By contrast, initial offer premiums averaged only 23 percent when neither form of protection was there. The revision of prices during a takeover was also higher when defensive measures were in place.

The report concludes: ‘In today’s corporate governance environment, we recognize that it is not possible to stagger a board due to shareholder vote requirements, and it is also difficult to implement shareholder rights plans without a clear threat to the firm. Yet our analysis suggests companies with one or both of these measures in place are well positioned to deliver superior value to their shareholders in hostile takeover situations.’

The rollback of staggered boards and shareholder rights plans was supposed to empower investors, particularly in the US where shareholder engagement has traditionally been less widespread than elsewhere. But there seems to be a significant cost to shareholder value. The report is a useful retort for those who maintain defensive measures that some consider controversial.