Corporate Control

Mechanism and
Takeover Defenses
The internal control mechanism includes competition among
managers within the firm, the control function of the board of
directors and the monitoring role of the large shareholders.

The external control mechanism includes tender offers, differential

voting rights and proxy fights.

DIFFERENTIAL VOTING SHARES

Differential voting rights allow investors to earn better returns in

lieu of surrendering their voting rights.
It allows a company to dilute its equity without the matching
dilution in the promoters stake. A company may issue it either due
to corporate governance issues.
Differential voting rights give the holders of a certain class of
shares, higher voting power.
Foreign companies, like Google, Ford Motors and Berkshire
Hathaway, have raised funds through DVR issues.

Tata Motors became the first Indian company to make a rights issue
carrying differential voting rights (DVR), with its offer opening on
September 29, 2008.

DUAL CLASS RECAPITALISATION

Dual class recapitalization is the issue of a second class of common

stock, generally with reduced voting power, in exchange for already
outstanding shares of common stock.

The creation of limited-voting stock represents a deviation from the

normal one share/one vote rule because it separates the ownership
of equity from the ownership of voting rights
Proxy Contests

Proxy contests are attempts for the control of a firm, in which a

dissident group seeks from the firm's other shareholders, the right
to vote their shares in favour of the dissident group's slate of
directors. They are also known as proxy fights.

The factors that make a company vulnerable to a proxy contest

include one or more of the following:
(i) the company has a history of poor performance, whether
compared to others in its industry or broader market indices

(ii) large shareholdings by institutional investors, particularly when

combined with small share ownership by management and/or
the board
(iii) the company is undervalued
The companies which had proxy contests including Avon Products,
Del Webb Corporation, General Motors, Honeywell, Irving Bank, K-
Mart, Lockheed, NCR Corporation, Pic 'N Save, Texaco, UAL
Corporation and USX.
SHARE BUYBACK

Buyback is the reverse of issue of shares by a company, where it

offers to take back its shares owned by the investors at a
specified price. This offer can be binding or optional to the
investors.

The buying back of outstanding shares (repurchase) by a

company happens in order to reduce the number of shares on
the market.
Reasons for Buyback

Increase in promoter share for control purposes:

High cash reserves

Tax gains

Companys perception about the market performance

Exit option

Manipulate Performance
Methods of Buyback

Open offer Purchase

In an open offer, a company can buy its shares back directly from
the stock market through brokers.

Tender offer
A tender offer is made when the number of shares to be bought
back is large. The offer has a fixed price.
Book building process
The book building process is a mechanism of price discovery which
helps determine the market price of securities. If the book building
option is used, a draft prospectus has to be filed with SEBI.
TENDER OFFERS

Tender offer is a term that typically refers to a public, open offer

(usually announced through a newspaper advertisement) by a
company to all stockholders of a publicly traded corporation for
sale at a specified price for a specified time, subject to the
tendering of a minimum and maximum number of shares.

A tender offer may arise from friendly negotiations between the

company and a corporate suitor, or may be unsolicited, and
possibly unfriendly, resulting in counter-measures being taken by
the target firm.

A tender offer to purchase may be for cash or a type of corporate

security of the acquiring company like stock, warrants or
debentures
TAKEOVER DEFENSES

Takeover defenses are means to make a target firm less attractive to

raiders, or more difficult to take over.

Defensive strategies can be divided into pre-bid and post-bid

strategies.
The pre-bid defenses by the target firm fall into two broad
categories.
Internal defenses are those decisions/actions that alter the internal
structure or nature of operations of the firm.

External defenses are actions taken to influence outsiders

perception of the firm and provide warning signals about potential
predators.
These methods are collectively referred to as shark repellents. The
classic poison pill strategy (the shareholders rights plan) is the
most popular and effective defense to combat hostile takeovers.

Financial Defensive Measures

Financial defensive measures include the target company taking on
large debts in an effort to make the debt load too high to be
attractive.

Leveraged recapitalization is a technique of financial restructuring

developed by Goldman Sachs for Multimedia in 1985. In a typical
recapitalization, outside shareholders receive a large, one time cash
dividend and insiders (managers) and employee benefit plans
receive new shares, in place of cash dividend
Leveraged recapitalization is also known as Leveraged Cash Out
(LCO).

Golden Parachutes

Golden parachute is explained as a takeover prevention, or

takeover impact reduction strategy that gives the top management
of the target company large termination packages, if their positions
are eliminated as a result of a hostile takeover

Golden Parachutes envisage a provision in the employment

contracts of top management providing for compensation for loss
of jobs following a change of control.

Golden parachutes are meant to maintain the competitiveness of

the organisations executive compensation
White Knight

The option that the white knight bidder (a third party friendly to
the incumbent management) be brought in to rescue the seller
from an undesired takeover was generally considered when all
defensive tactics proved ineffective.

White Knight may be a corporation, a private company or a person

that intends to help another firm.

White Squire
A white squire is similar to a white knight, except that it exercises
only a significant minority stake, as opposed to a majority stake.
A white squire does not have the intent to take over a company,
but rather serves as a figurehead to the defense against a hostile
takeover.
PacMan Defense

The Pac Man defense is a defensive option to stave off a

hostile takeover. Under this option, a company that is under a
hostile takeover, acquires its would-be buyer.

It is a transaction in which the target company turns the

tables and makes a counter-offer to buy the shares of an
unwelcome suitor.
Macaroni Defense
It is a defensive tactic used by a corporation to defeat the
takeover attempt by a raider or an unfriendly bidder. The
target corporation issues a large number of bonds that must
be redeemed at a mandatory high redemption value if the
company is taken over.
Crown Jewel Defense

The Crown Jewel Defense is an anti-takeover strategy in which the

target firm sells off attractive assets to a friendly third party, or spins
off the valuable assets in a separate entity.

As a consequence, the target company becomes less attractive to

the bidder.
Anti-takeover Amendments
Anti-takeover amendments are popularly known as shark repellants.
These charter anti-takeover amendments must be voted and
approved by shareholders.

Major types of anti-takeover amendments.

1. Supermajority amendments
These amendments require shareholder approval by at least two-
thirds vote, and sometimes by as much as 90% of the voting power
of all outstanding capital stock, for all transactions involving the
change of control.

2. Fair price amendments

These are supermajority provisions with a board out clause and an
additional clause waiving off the supermajority requirement if a fair
price is paid for all purchased shares.

3. Classified board
Staggered or classified board of directors is used to delay effective
transfer of control in a takeover. This is considered an effective
method through which a company might protect itself against an
unwelcome takeover attempt.
Authorization of preferred stock:
The board of directors is authorized to create a new class of
securities with special voting rights.
Poison Pill Defense
It is a strategic move by a takeover target company to make its
stock less attractive to the acquirer.

Under this method, the target company gives existing

shareholders the right to buy stock at a price lower than the
prevailing market price if a hostile acquirer purchases more than
a predetermined amount of target companys stock.

The target company issues a large number of new shares, often

preferred shares, to the existing shareholders.
These new shares usually have severe redemption provisions,
such as allowing them to be converted into a large number of
common shares if a takeover occurs.
Types of Poison Pills

Flip-in
This common poison pill is a provision that allows current
shareholders to buy more stocks at a steep discount in case of a
takeover attempt.

Internet major Yahoo! adopted this form of poison pill in the year
2000, allowing the board to issue up to 10 million shares on new
stock in the event of an acquisition offer.
Flip-Over
A flip-over allow stockholders to buy the acquirers shares at a
discounted price after the merger. The holders of common stock of
a company receive one right for each share held, bearing a set
expiration date and no voting power.
Preferred Stock Plans
It is also known as the original plan poison pill. It is an early poison
pill anti-takeover defense in which the firm issues a dividend of
convertible preferred stock to its common stockholders.

Back End Rights Plans

Under these plans, shareholders receive a rights dividend. If an
acquirer obtains shares of the target in excess of a limit, holders,
excluding the acquirer, can exchange a right and a share of the
stock for senior securities or cash, equal in value to a back-end
price set by the board of directors of the issuing (target) firm.
Voting Plans
A voting plan is implemented by declaring a dividend of preferred
stock with voting rights.
In some cases, if a party acquires substantial block of a firms voting
stock, preferred holders, other than the large block holder, become
entitled to super voting privileges.

Pension Parachute
Pension parachute is a form of poison pill under which a pension
agreement exists that specifies that, in the event of a hostile
takeover attempt, any excess assets in the company pension plan
can be used for the benefit of pension plan participants, such as
increase pension payments.

Japan's Nippon Steel, the world's third largest steel maker after
Mittal Steel and Arcelor, has adopted poison pills to thwart hostile
takeovers in the future.
Poison Pills Related Terms
Activist shareholder
An investor who uses his stake in the company to influence the
management and directors of that company.
Chewable pill
A modified poison pill that can appease investors by permitting them
to ask for a special shareholder vote to determine whether or not a
specific bid can be exempt from triggering the pill.
Suicide pill
A defensive strategy by which a target company engages in an activity
that might actually ruin the company rather than prevent the hostile
takeover.
Poison put
It is a provision in an Indenture, giving bondholders the privilege of
redemption at par if certain designated events occur, such as a hostile
takeover, the purchase of a big block of shares, or an excessively large
dividend payout.
Targeted Share Repurchases (Greenmail)

Greenmail is a practice in corporate mergers and acquisitions that

occurs when a large block of stock held by an unfriendly company or
raider is repurchased by the target company at a substantial
premium to destroy any takeover attempt.

Greenmail involves a corporations attempt to stop a takeover bid by

paying the price above the market value for the stock held by the
aggressor.
Bank Mail
This is an agreement between a company planning a takeover and a
bank, which prevents the bank from financing any other potential
acquirer's bid.
White Mail
White mail is a strategy that a takeover target uses to try and thwart an undesired
takeover attempt. The target firm issues a large amount of shares at below-market prices,
which the acquiring company would have to purchase if it wishes to complete the
takeover.