BREACH OF TRUST IN HOSTILE TAKEOVERS

By- Diksha Gupta & Adhish Saxena

Introduction

Corporate restructuring is an important aspect of the corporate world. A company might do it either in an ethical way or in a playful manner. The common examples among the business of such companies include hostile takeovers, mergers, or management buyout is wealth boosts the asset of the acquiring company.[1]

Bitterly fought contests for corporate control have become a familiar spectacle as business entities have aggressively sought to extend their economic dominion by making unsolicited tender offers for other commercial enterprises.

When confronted with unsolicited tender offers, directors of target corporations sometimes respond by adopting far-reaching defensive measures that drastically alter the character or capital structure of their corporations.

In implementing these defensive tactics, target corporations frequently incur onerous indebtedness or sell off some of their most valuable and essential assets. As a result of these defensive manoeuvres, the continued financial viability of the corporation may be put at considerable risk.

Hostile acquisitions have an approximately equal negative impact on labour demand as that compared to friendly takeovers.

The Mechanism of Takeovers

The term takeover is a process in which one corporate entity acquires another entity by taking the effective control of the business entity.[2] It might be done by taking the acquisition of some or all of the target’s capital stock or assets.

But, at the same time the process might be perilous as the target’s board of director’s resists, the takeover is described as a “hostile” or “unfriendly” takeover. The usual method of attempting a hostile takeover is for the acquisitive entity to make a tender offer to the shareholders of the target corporation.

The bidder may believe that a target corporation contains unrealized values because of the less than optimal performance of its current management. In such a case, the bidder’s intent is to increase both profits and share prices by installing new and it is hoped more adept management, thereby capturing the target’s unrealized values.[3]

On the other hand, the bidder may view the target corporation as being efficiently run, but believe that a successful takeover would result in a business combination resulting in synergistic commercial gains for both parties.

A closely related, but certainly less laudable, motive for affecting a takeover is the monopolistic desire to increase the market share of the acquirer through the acquisition of a competing business.[4]

Still another explanation for a takeover bid may be the offeror’s ego-enhancing pursuit of raw power, irrespective of any economic benefits that may be gained from the acquisition.

An additional explanation for making a tender offer is that the offeror seeks to stimulate the interests of other investors by putting the shares of the target corporation into market play. If competitive bidding then develops, the original offeror will profit through the sale of its shareholdings at a bid-up price level.[5]

Breach of Trust in Hostile Takeovers

The most elemental part of doing business is the trust which stakeholders hold within the company and with their shareholders. The primary facet of trust depicts that the trustworthiness is correlated with other personal characteristics and actions.

The situation of hostility arises when the contract between shareholders and the stakeholders becomes burdensome. The obligatory managers are a prerequisite to realizing the gains from the breach.[6]

As soon as these managers are removed after the takeover, control reverts back to the bidder company and their administration captures the effective control of the company. Therefore, such hostile takeovers thus enable shareholders to redistribute wealth from stakeholders to themselves.

The elemental breach of trust comes from an implicit contract. For breach to be an important source of gains, hostile takeovers must not be anticipated by the stakeholders, who entered into implicit contracts expecting the firms to be run by trustworthy managers.[7]

Effect of Hostile Takeovers on Employment

If the merger of two firms results in a different optimal employment size to that previously obtaining for them as separate entities, then a profit-maximizing management will need to effect an adjustment in the labour force.[8]

However, movement to the newly desired level of employment is unlikely to be instantaneous, and the process of adjustment will depend on the balance of costs between changing employment levels and being away from the optimum.

Different specifications of a dynamic labour demand function may be derived depending on the assumptions that are made concerning the form of adjustment costs, the production function, the predetermination of production and the capital stock.[9]

It has been widely contended that hostile takeovers have adverse employment consequences. Firstly, hostility has been interpreted as signalling a disciplinary acquisition whose objective is the substitution of a new set of managers to raise the return on corporate assets.

Such transactions are considered likely to be associated with increased labour productivity and job losses. Secondly, it has been conjectured that a hostile acquisition offers a unique opportunity for employers to renege on the explicit and implicit terms of employment of workers in the acquired company.[10]

This would allow a transfer of value from labour to capital, at least some of which will take the form of job losses.

Conclusion

Andrei Shleifer puts it as, “Hostile Takeovers are external means of removing the managers who uphold the stakeholder’s claims. Takeovers then allow the shareholders to appropriate stakeholders ex post rents in the implicit contract.

The games are split between the shareholders of the acquired and the acquiring firm. At least, in part, therefore, the gains are wealth redistributing and not wealth creating.” [11]

In a nutshell, the breach of trust generally takes place in case of a hostile takeover as the incumbent management is replaced who used to comply with the implicit contracts by a new management, who will find it easy to breach the implicit contract instead of complying with it so as to carve out the costs incurred on takeover.

Therefore, the most critical question that revolves around the hostile takeover is whether the takeover premium is a result of value creation or wealth redistribution and hence, it is wealth redistribution.


[1] Andrei Shleifer & Lawrence H. Summers, Breach of Trust in Hostile Takeovers, https://scholar.harvard.edu/files/shleifer/files/breach_of_trust.pdf

[2] Richard C. Brown, The Role of the Courts in Hostile Takeovers, 93 Dick. L. Rev. 195 (1989).

[3] Richard C. Brown, The role of courts in Hostile Takeovers, https://heinonline.org/HOL/Page?collection=journals&handle=hein.journals/dlr93&id=205&men_tab=srchresults

[4] Curtis J. Milhaupt, In the shadow of Delaware? The rise of Hostile Takeovers in Japan, https://heinonline.org/HOL/Page?collection=journals&handle=hein.journals/clr105&id=2221&men_tab=srchresult

[5] Richard C. Brown, The Role of the Courts in Hostile Takeovers, 93 Dick. L. Rev. 195 (1989).

[6] Andrei Shleifer & Lawrence H. Summers, Breach of Trust in Hostile Takeovers, https://scholar.harvard.edu/files/shleifer/files/breach_of_trust.pdf

[7] Id.

[8] Anthony Niblett, Hostile Takeovers and Overreliance, https://heinonline.org/HOL/Page?collection=journals&handle=hein.journals/sealr38&id=614&men_tab=srchresults

[9]  Id.

[10] Id.

[11]  Andrei Shleifer & Lawrence H. Summers, Breach of Trust in Hostile Takeovers, https://scholar.harvard.edu/files/shleifer/files/breach_of_trust.pdf


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