Why do companies reject takeover offers?
Are their CEOs so desperate to hang onto their jobs that they nix deals, even if they would be lucrative for shareholders? Or do they honestly believe the offers are just too low?
That’s the question Thomas Bates, chair of the finance department at the W. P. Carey School, along with David Becher, a finance professor at Drexel University, set out to answer. Though it’s not easy to deal with a question involving motivation, the researchers found a quantitative way to approach the problem: they examined hundreds of contested bids going back to 1990, looking at many variables to establish benchmarks for what constitutes a reasonable offer and what constitutes a bid that is abnormally high or low. Once they determined a ballpark for what an offer price should have been for a given deal, they were able to assess whether a CEO’s response to it was reasonable or not.
The verdict: mostly good apples
In good news for corporate America, the researchers found that most CEOs responded appropriately — that is, they acted in the best interests of their shareholders, whether that meant rejecting a bid that was too low or accepting one that was a good deal. Few turned down a good deal, indicating that they didn’t let concerns about their status stand in the way.
Of course, there are always exceptions. The bad apples make headlines, sowing doubt in the public mind about CEO motives.
A notorious example is Microsoft’s attempted takeover of Yahoo in 2008, which the researchers discuss in a paper about their findings, “Bid Resistance by Takeover Targets: Managerial Bargaining or Bad Faith?” published in June by the Journal of Financial and Quantitative Analysis. Microsoft’s initial bid for the company came in at a whopping $47 billion — more than a 60 percent premium over Yahoo’s stock price at the time. Nevertheless, Yahoo CEO and co-founder Jerry Yang rejected it. Microsoft came back with an offer 14 percent higher, but he rejected that, too.
The business press widely reported the incredible offers and the unsuccessful takeover attempt.
But there was another significant result of that failed transaction. Yahoo’s stock price dropped, angry shareholders complained, and within a few months, Yang was fired.
Yang is a preeminent example of an “entrenched” business leader — one who clings to his position and puts his interests above those of the shareholders. An entrenched leader may succeed, but not for long. Bates’ research showed that Yang’s fate is not uncommon among CEOs who reject good bids — they usually get canned.
“They don’t get to enjoy the fruits of their entrenchment. Their actions present relevant evidence to the board about how ineffective they are as CEOs. Boards act and they’re out the door,” Bates says.
That’s a good thing for shareholders. “If someone is entrenched or too stupid to realize an outstanding offer, you want to get rid of them. And that’s what we see in our data,” Bates says.
On the other hand, CEOs who reject bids that are low by Bates’ benchmark measures usually get to keep their jobs.
“That’s reassuring,” Bates says. “In takeover negotiations, you want the leader to stand firm and negotiate for the full value of the asset.” If the acquiring company won’t budge on price and negotiations grind to a halt, it doesn’t reflect poorly on the target company’s CEO, who saved shareholders from a raw deal.
When a bitterly contested deal like Yahoo’s fails, it hits the headlines. But most takeover attempts are successful. Over the past 30 years, only about 5 percent of the transactions Bates and Becher observed were publicly rejected. Usually, however, negotiations take place in a behind-the-scenes kabuki dance outside the public eye. “You’ll see an announcement about a merger when it’s done,” Bates says.
Does board structure make a difference?
Bates also looked at the effect of corporate boards on takeover attempts. Some boards, known as “classified,” have staggered terms for members. That can become a major factor in a takeover attempt. The acquiring company sometimes reaches out to shareholders at the takeover target, showing them what they stand to gain from being acquired and urging them to influence board members in favor of a deal. If board members resist, the acquiring company encourages shareholders to vote them out at the next opportunity. That’s known as a proxy fight. Acquiring companies sometimes win, stacking the board with supporters who push a merger through.
But if board members’ terms are staggered, it’s impossible for shareholders to vote all of them out in one fell swoop and replace them with acquisition supporters, making it harder for acquirers to win a proxy fight. For that reason, classified boards are known as take-over resistors.
“Classified boards have almost impenetrable takeover defenses. They can be deeply entrenched if they want to be,” Bates says.
Classified boards have been heavily criticized for their entrenchment and resistance to takeovers, and shareholders have put forth a raft of proposals over the past few years to eliminate them. But contrary to popular belief, Bates’ research found that companies with classified boards are just as likely as others to successfully close acquisition deals.
In fact, companies with classified boards are more likely to get higher follow-up bids than others, creating a better deal for their shareholders. That’s because acquiring companies know they have less leverage with a classified board—they can’t just boot out all the naysayers. If they want a deal, they have to negotiate with existing players, which usually means they need to raise their price.
“Classified boards can negotiate hard. If I’m the acquiring company, I’ll probably present a richer initial offer because I know if I lowball them, they’ll put up a fight,” Bates says.
Shareholders may want to rethink their opposition to classified boards. “A change might make them worse off when they’re trying to negotiate takeover bids,” Bates says.
Bates’ research offers positive news for both classified boards and shareholders of takeover targets. While bad CEOs and unscrupulous boards may get a lot of ink in the press, they’re not the norm. Most go to bat for their investors, regardless of the personal impact a deal may have.