Effect of Two Takeover Rules

It is widely acknowledged that the UK and US have adopted different approaches to hostile takeovers. They are these two rules, MBR and NFR, which clearly expose the divergence between the two systems. These two rules are considered as innovations of the City Code in the UK, adopted by the European Union in its Takeover Directive. They apply to control transactions attempting to address conflicts of interest between the target board and shareholders and between the bidder and target shareholders, resulting from the effect of the allocation of decision making on the success or failure of the takeover offer, and the protection of minority target shareholders against opportunism by the bidder or the controlling shareholders.

In particular, the NFR is intended to limit the use of takeover defences by the target board and constrain opportunistic behaviour. A prohibition on the target board’s use of takeover defences without the approval of the target shareholders makes takeover defence less likely to happen, with the effect of raising the number of hostile takeovers. A MBR provides the target minority shareholders with extra protection and the right to exit the company at a fair price. It is argued that providing exit opportunities for minority shareholders allocates more takeover surplus from the bidder to the target shareholders and hence reduces the number of hostile takeovers because bidders have less incentive to make a bid to acquire a poorly performing company and replace its inefficient management.

Therefore, the regulatory choices of these two rules have opposite effect on the efficiency of the market for corporate control. If a takeover regulation that focuses on the conflict of interest between target board and shareholders adopts NFR to restrict managerial decision-making power with respect to the use of takeover defence without shareholder approval, it will improve shareholder protection as it forces directors to satisfy the interests of the shareholders and also promote corporate control by making the takeovers more likely to happen.430 If a takeover regulation that responds to the conflict of interest between bidder and target shareholders introduces MBR and provides exit opportunities for minority shareholders by requiring a bidder to purchase the remaining shares in the target, then the protection of shareholders, in particular, minority shareholders, is similarly enhanced. However, an efficient market for corporate control is discouraged as the private gains to a bidder, which are often an incentive for a takeover bid, are reduced. However, in looking at the regulatory effect on the takeover market of adopting both or neither of these two rules, the conclusion can be different. As was found above, the UK adopts both two rules in order to provide extensive protection to shareholders by restricting the interests of both the bidder and the target board. The bidders are required to share the control premium with the minority shareholders and hence raise the cost of launching a bid. This rule therefore has a chilling effect on the takeover market. The target board is prevented from employing takeover defences against the takeover bid and obstacles from the target board are removed for the bidder. Hence, the impact on the takeover market of these two rules is offset.

On the other hand, the US imposes neither of these two rules, giving both bidder and target board room to manoeuvre. From the bidder’s perspective, it is allowed to pay a

premium above the market price for control and launch a much less favourable term in the subsequent offer. Although this system mitigates the shareholders’ free-riding problem in a tender offer and hence stimulates the takeover market, it also forces shareholders to tender even if they believe the bid is inadequate. To solve this problem, the target board is given the discretion to resist the unwanted tender offer (including the coercive offer) by freely employing takeover defences.431 Without doubt, resistance from the target board will reduce the likelihood of a bidder’s success. Hence, it can also be argued that the impact of absence of these two rules on the takeover market is offset.

Table 4-1 Effect of NFR and MBR

Choice of Takeover Rules

Effect on Market for Corporate Control

Effect on Protections of Target Shareholders

Only NFR Promoted Shareholders have the right to decide whether to accept the tender offer

Only MBR Discouraged Shareholders have the right to share the premium and to exit the company

NFR and MBR Balanced Shareholder protection is strengthened Neither NFR

nor MBR

Balanced Shareholders are coerced to tender but the coercion is reduced by the takeover defences

It is widely accepted that the market for corporate control functions well in both the UK and the US. The effects of a combination of NFR and MBR as well as the absence of these two rules seem to balance their positive and negative impacts on the takeover market and achieve a similar level of corporate control. As Ventoruzzo has pointed out, although the UK and US have adopted different provisions and underlying philosophies

in their respective takeover regulation, when measured in terms of their economic effect, these two regimes are closer than at first appears and may have the same function of facilitating the market for corporate control and protecting minority shareholders.432