White Knights and Black Knights – Does the Search for Competitive Bids always Benefit the Shareholders of “Target” Companies? –
Abstract: According to the EC Directive on Takeover Bids, defensive measures should be authorised by the general meeting of the target company. The incumbent board can, nonetheless, search for a competing bid, a so-called “white knight”. The rationale underpinning this exception is that competing bids always benefit target’s shareholders. In this paper I will tackle this rationale, arguing that even competing bids could generate a pressure to tender on target’s shareholders and, therefore, in this case should not be considered as a benefit for them.
Summary (3 min read)
- According to the EC Directive on Takeover Bids, defensive measures should be authorised by the general meeting of the target company.
- The rationale underpinning this exception is that competing bids always benefit target’s shareholders.
1. The general issue
- Any decision of target shareholders on the merit of an offer is affected by collective action problems 7, as it happens in every case when more persons should take individually a decision on a certain problem without having the ability to coordinate among themselves and the utility of each person depends on the choices made by the others.
- The following arguments are based on the assumption that shareholders behave rationally in order to maximise their utility.
- Preferences are transitive in this case: if some good “A” is preferred to a good “B”, and this latter good “B” is preferred by the same person to a good “C”, then should follow that also “A” is preferred to “C”.
- Thus, after a takeover bid is launched, shareholders compare the price of the bid with the expected value of minority shares if the bid succeeds.
- But a shareholder can not know what other fellow shareholders are going to decide on the merit of the offer, and coordination among them is too costly and almost impossible.
- If the expected value of minority shares under the new controlling shareholders is considered by the majority of shareholders as higher than the value under the incumbent shareholders, then it is rational for shareholders to hold their shares, hoping that other shareholders will sell them.
- The success of the bid is not impeded by the fact that a minority of shareholders, or even only one of them, did not sell their shares 8.
- If every shareholder behaves in this way, however, none of them will tender, hoping that fellow shareholders will sell their shares.
3. Pressure to tender
- If the expected value of minority shares after a successful bid is presumed to be lower than the price offered, shareholders are forced to sell, although under an ex post point of view this is not the best choice for them (so-called pressure to tender); in this case a value-decreasing takeover bid is going to succeed 10.
- If the bid succeeds shareholders risk to lose the price of the offer, bearing only under-priced minority shares; hence, the decision to tender is 8 Goshen, “Voting in Corporate Law”, 2 Theoretical Inq. L. (2001) 815.
- Shareholders cannot coordinate themselves and they do not know whether fellow shareholder will tender or not tender.
III. Seeking a white knight
- The general meeting is competent on decisions which could indirectly influence the composition of share ownership21; the board can nevertheless seek a competing bid without the need to be authorised by shareholders.
- The goal of this “white knight exception” seems clear.
- An auction on target shares pursues shareholders’ interests; hence it is not necessary to attribute to the competence of the general meeting the decision to seek for a potential bidder and to transfer to him any useful information.
IV. Black knights
- In the former section I have shown the argument supporting the “white knight exception”.
- In the next section I will point out that some defensive takeover-bids could be coercive, or more coercive than the first hostile bid.
- I will make firstly two examples which do not consider any specific set of rules.
1. The power of “two-tiered” defensive bids
- The authors can begin depicting the following example, where a defensive “two-tiered” bid is launched against a first 100% all-cash hostile takeover-bid.
- The listed company A has 10 outstanding shares.
- The blended price of this competing takeover bid is therefore 9€, which is lower than the price offered by the first offeror B.
- Target shareholders face a heavy pressure to tender.
2. “Two-tier” vs. “two-tier”
- After this bid, the board of the target company seeks a third person, C, for launching a competing tender offer.
- Shareholders will rationally choose to tender to the competing offer.
- The reason is that the difference between the “front-end” price and the “back-end” price of the first offer is lower than the same difference in the second offer; hence the latter is more coercive than the former28.
1. A world with the mandatory bid rule
- As the authors have seen in the second section, the EC Directive provides for a general mandatory bid rule, according to which if a person purchases the control of a company, she should then launch an offer for all the outstanding shares.
- The payout of the competing game depends on the price which should be paid for the mandatory bid.
- The hostile bid launched by B on A’s shares is followed by a competing partial bid; both bids are conditioned upon the fact that the majority of shareholders will tender.
- Austrian law changed relating to this issue in order to comply with the Directive: see the new § 26 Übernahmegesetz, as changed by the law 75/2006.
- The authors should not forget that the mandatory bid rule at the highest price paid for crossing the relevant threshold faces a significant drawback under the viewpoint of social welfare.
3. Drawbacks of the auctions
- A regulation which allows the incumbent board to seek competing bids has a significant drawback in terms of social welfare and efficiency.
- This outcome does not change even if the board has a duty to provide the hostile bidder with the same information given to the white knight, as this duty does not help the first bidder to gain information for discovering and assessing a potential target.
- The authors can make following simplified example.
- Assume that N is the cost suffered by the first bidder (B) for discovering the target A; the expected value of the target after the bid succeeds is V1.
- In other words, this is a so-called “common value auction”, where all competing bidders attach the same value to the target; this is the case if takeover-bids are motivated by mismanagement of the incumbent board, not by synergy gains, which would be different for each bidder38.
- The purpose of the present work was to address the question whether seeking a competing bid should be allowed to the incumbent board without any limitation and without being approved by the general meeting.
- If a competing bid is coercive depends also on the applicable law, which can mitigate or eliminate the “pressure to tender” through a mandatory bid rule or allowing the first bidder to increase the offered price.
- In all other cases, Member States are free to hold their own conflict rules also for takeover law43, which usually refer to the law of the country where the company is listed, being the regulation of competing takeover-bids part of the market regulation, not of company law44.
- The incumbent board would be able to seek for a coercive competing bid that would force shareholders to tender even if this is not in their interests under an ex post viewpoint.
- Indeed, the rationale of the “white knight exception” is to allow the incumbent board to enhance shareholders’ wealth, putting their shares up for auction; seeking a coercive bid does not fit the ratio of the “white knight exception”, and the exception has no reason to be applied.
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