Why do takeovers occur

Scherer, for example, fell In a privately negotiated or targeted repurchase, for example, a company buys a block of its common stock from a holder at a premium over market price—often to induce the holder, usually an active or a potential bidder, to cease takeover activity. The managers of target companies also may obtain standstill agreements, in which one company agrees to limit its holdings in another.

Announcements of such agreements are associated with statistically significant abnormal stock price declines for target companies. Because these agreements almost always lead to the termination of an acquisition attempt, the negative returns seem to represent the merger gains lost by shareholders. Again, however, the issue is not clearcut because closer examination of the evidence indicates that these takeover forays by competing managers benefit target shareholders.

The significantly positive increase in stock price that occurs with the initial purchase announcement indicates that potential dissident activity is expected to benefit shareholders even given the chance that the venture will end in a targeted repurchase.

Moreover, this is confirmed by the fact that on average during the period from the SEC filing through the targeted repurchase of the shares, target company shareholders earn statistically significant positive abnormal returns. The stock price decline at repurchase seems due to the repurchase premium that is effectively paid by the nonselling shareholders of the target firm and to the unraveling of takeover expectations with consequent loss of the anticipated takeover premium. Because, on average, target shareholders lose the anticipated takeover premiums shown in Exhibit I when a merger or takeover fails for any reason, we cannot easily tell whether they were hurt by a repurchase.

Such additional price declines might be caused, for example, by the costs of dealing with a disgruntled minority shareholder. Although the issue requires further study, current evidence implies that prohibition of targeted large-block repurchases advocated by some may hurt target shareholders. Moreover, since shareholders can amend corporate charters to restrict targeted repurchases, there is little justification for regulatory interference by the state in the private contractual arrangements among shareholders.

Such repurchase restrictions might well restrict the vast majority of stock repurchases that clearly benefit shareholders. In addition, by reducing the profitability of failed takeovers, such restrictions would strengthen the position of entrenched managers by reducing the frequency of takeover bids.

Doing so would deprive shareholders of some of the stock price premiums associated with successful mergers. The phrase going private means that publicly owned stock is replaced with full equity ownership by an incumbent management group and that the stock is delisted.

On occasion, when going private is a leveraged buy out, management shares the equity with private investors. Some believe that incumbent managers as buyers are exploiting outside shareholders as sellers in these minority freeze outs.

Advocating restrictions on going-private transactions, in Securities and Exchange Commissioner A. Sommer, Jr. The gains apparently arise from savings of registration and other public ownership expenses, improved incentives for decision makers under private ownership, and increased interest and depreciation tax shields. Outside shareholders are not harmed in going-private transactions.

Some companies provide compensation in employment contracts for top-level managers in the event that a takeover occurs—that is, golden parachutes. Much confusion exists about the propriety and desirability of golden parachutes, even among senior executives. But the detractors fail to understand that the parachutes protect stockholders as well as managers.

If the alternative providing the highest value to stockholders is sale to another company and the retirement of the current management team, stockholders do not want the managers to block a bid in fear of losing their own jobs. Stockholders may be asking managers to sacrifice position and wealth to negotiate the best deal for them. Like anything else, however, they may be abused. An analysis of 90 companies shows that adoption of golden parachutes on average has no negative effect on stock prices and provides some evidence of positive effects.

The thing that puzzles me about most golden parachute contracts is that they pay off only when the manager leaves his job and thus create an unnecessary conflict of interest between shareholders and executives. Current shareholders and the acquiring company will want to retain the services of a manager who has valuable knowledge and skills.

But the officer can collect the golden parachute premium only by leaving; the contract rewards him or her for taking an action that may well hurt the business. As the bidder assimilates the knowledge that turnover among valuable top-level managers after the acquisition is highly likely, it will reduce its takeover bid. Another often criticized defensive tactic is the sale of a major division by a company faced with a take-over threat.

Some observers claim that such sales prove that managers will do anything to preserve their tenure, even to the extent of crippling or eliminating major parts of the business that appear attractive to outside bidders. Studies of the effects of corporate spinoffs, however, indicate they generate significantly positive abnormal returns.

In the same way, when an acquirer is interested mainly in a division rather than the whole company, shareholders benefit when target management auctions off the unit at a higher price. Whittaker Corporation made a hostile takeover bid for Brunswick in early Because its main interest lay in acquiring Sherwood, Whittaker withdrew its offer. Moreover, because of the structure of the transaction, the cash proceeds went directly to the Brunswick shareholders through the negotiated tender offer.

While acting in their own interests, however, these specialists also act as agents for shareholders of companies with entrenched managers. Returning to the Marshall Field story, for example, Carl Icahn launched a systematic campaign to acquire the chain after it had avoided takeover. Takeover specialists like Icahn risk their own fortunes to dislodge current managers and reap part of the value increases available from redeploying the assets or improving the management.

Yet the details of how and why this complex institution functions and survives are poorly understood, due in part to the complexity of the issues involved and in part to the political controversy that historically surrounds it. When internal control mechanisms are working well, the board of directors will replace top-level managers whose talents are no longer the best ones available for the job.

This competition can take the form of mergers, tender offers, or proxy fights. Other organizational forms such as nonprofits, partnerships, or mutual insurance companies and savings banks do not benefit from the same kind of external market.

The takeover market also provides a unique, powerful, and impersonal mechanism to accomplish the major restructuring and redeployment of assets continually required by changes in technology and consumer preferences.

Recent changes occurring in the oil industry provide a good example. Yet there is an almost continuous flow of unfavorable publicity and calls for regulation and restriction of unfriendly takeovers. Many of these appeals arise from managers who want protection from competition for their jobs and others who desire more controls on corporations. The result, in the long run, may be a further weakening of the corporation as an organizational form and a reduction in human welfare.

For further analysis, see Leo Herzel and John R. For further insight, see Claude W. The only exception is the nonprofit organization, against which there are no residual claims. For a discussion of the critical role of donations in the survival of nonprofits, the nature of the corporation, and competition and survival among organizational forms, see Eugene F.

Fama and Michael C. For a summary, see Michael C. Jensen and Richard S. The original studies are: Peter Dodd and Richard S. Kummer and R. Brunner, and David W. Mullins, Jr. Easter-brook and Gregg A. Financial economists have used abnormal price changes or abnormal returns to study the effects of various events on security prices since Eugene F.

Fama, Lawrence Fisher, Michael C. Stephen J. Brown and Jerold B. For an introduction to the literature and empirical evidence on the theory of efficient markets, see Edwin J.

Elton and Martin J. Working Paper No. For a further look, see Richard S. This discussion is based on Richard S. For a detailed analysis, see David W. See S. Grossman and O. Harry DeAngelo and Edward M. Linn and John J. Larry Y. Richard S. Ruback and Wayne H. Richard A. Lambert and David F. View shopping cart. View mytutor2u. Account Shopping cart Logout. Explore Business Business Search. Explore Blog Reference library Collections Shop.

Share: Facebook Twitter Email Print page. A takeover or acquisition involves one business acquiring control of another business Takeovers or acquisitions as they are otherwise known are the most common form of external growth , particularly by larger businesses. An acquisition or merger can also make it easier to fend off future competitors.

The drawback to this method for decreasing competition is that the company proposing the acquisition will need to convince the other company's shareholders to agree to the merger, which usually requires paying a large premium.

When mergers and acquisitions take place between companies in foreign markets, the main goal is risk reduction through diversification. Merging with or acquiring a company in a foreign market can reduce risk in two ways. First, it can protect a company from fluctuations in exchange rates. Second, it can shield the company from a recession in either location. Acquisitions and mergers can also provide enticing tax benefits to the companies involved in the deal.

For example, if one company in a merger is dealing with net losses, the profits of the other company can offset these losses. This is obviously enticing to the company with losses, but is only beneficial to the other company if the merger will result in future gains. Mergers can also be a solution for larger companies looking to lower their tax burden. For example, if the larger company is in a country with a high corporate tax rate, they could merge with a company in a location with a lower rate.