Shareholder Centric vs. Stakeholder Centric - Mylan and Teva

So let me ask you a question?  As a person or institution about to invest in common stock, what do you expect of the board and management?  I'll give you my own answer: I expect them to maximize the value of my shares.  If I didn't have that expectation, I'd never invest.

My response reveals a shareholder centric attitude - that management works first and foremost for shareholders.  While such a view is overwhelmingly favored by independent experts in  corporate governance, it is by no means without some legal, management and even some academic dissent.  The alternative view is stakeholder centric - that management must consider the well being of all of its stakeholders when making decisions.  Stakeholders other than shareholders include employees, bondholders, customers, and even the community in which a firm operates.

Stakeholder centric requirements in the United States vary with State Law and Corporate Charters.  Different countries around the world take different viewpoints with some (Ireland) being more shareholder friendly and others (The Netherlands) being more stakeholder centric.

This was borne out with Mylan's recent rejection of a $40 billion takeover by Teva.  (For interesting details, see Mylan). Mylan, formerly a Pennsylvania corporation became dutch based in February as part of an inversion - where companies merge with other companies to change the location of their headquarters.  Typically this is done for more favorable tax treatments but it also has other repercussions for shareholders - in this case enabling management to espouse a stakeholder approach to the takeover and find support under Dutch law.  What are the repercussions of a stakeholder centric view?  I'll mention three:

First, companies that could be run more efficiently under new management are protected under existing management.  It can be cost advantageous - and beneficial to society as a whole to have the company acquired.  In some cases it is beneficial to society as a whole to lay off employees and focus the company in more efficient ways.  Companies protecting employees may resist such change.

To be sure, communities can be harmed when companies close plants, lay off employees and perhaps move their location.  But community or state or country protectionism is harmful in the long run.  Subsidizing inefficient operations may prolong the inevitable, but it avoids the obvious - uncompetitive companies will ultimately die and shareholders and ultimately all stakeholders will suffer.  Protectionism and cross-subsidization will ultimately fail.  The employees,  companies and communities that thrive are those that embrace change and continually adapt - keeping themselves competitive in a global marketplace.

Second, situations that can benefit shareholders - the residual claimants in a company can be rejected.  Not only is this unfair to the owners of a company, it is again ultimately destructive.  Few investors would invest in a company that doesn't look out for their own best interests.

To be clear, stakeholders are important and they deserve every consideration by management.  Even under a shareholder centric view, the best companies are conscious of the needs and obligations of their stakeholders and fulfill these claims in consideration of the competitive marketplace.  Usually the claims of stakeholders are also defended by other means including contracts, union, and laws.  Shareholders are not provided the same contractual certainties that stakeholders enjoy.  They are the residual claimant of a firm's profits.  They are entitled to everything that is left after all other expenses and claims have been paid - if there is anything left.  Shareholders are not guaranteed a profit, but have the benefit of knowing management and the board are looking out for their best interests.

Third, boards that take a stakeholder centric approach are answering to more than one master - not an optimal situation.  It is never clear whose interests should be pursued or which direction to follow.  The typical result is stagnation.

To be sure, laws that permit boards to reject takeovers based on stakeholder theory can also insulate management from needed change.

Thus, Mylan's shareholders have lost the opportunity to sell their shares at a substantial premium.  Share prices fell 14%.

All the best,

Ralph

Drexel's 8th Academic Conference on Corporate Governance

As I mentioned before, last month we hosted our 8th Academic Conference on Corporate Governance at Drexel.  I say academic, because we also host specific practicioner events including our Director's Dialogue.  I'll recap that in a subsequent post.

This year's conference featured five top papers from over sixty submissions.  Many good papers didn't make the cut.  The audience features top researchers in Corporate Governance from around the world.

The five papers this year addressed issues in executive compensation (CEOs getting bonuses when corporate pensions are frozen and curious firm behavior in contract years) , Norway's gender quotas on boards (suggesting previous work was mistaken);  the role of passive institutional investors (hint, they aren't passive in terms of governance), and takeover defenses (what works, what doesn't).

The complete program along with links to the papers is available here.

All the best,

Ralph

The Evolution of Takeover Defenses and Managerial Entrenchment

In the wake of the DuPont - Trian outcome (DuPont retaining all 12 board seats), it is interesting to examine the impact of takeover defenses and outcomes in general.  Here is an interesting article examining the subject.  The article, refers to takeover attempts instead of activist proxy fights but is nonetheless interesting.

Have changing takeover defense rules and strategies entrenched

management and damaged shareholders? The case of defeated

takeover bids

by

Michael Ryngaert , Ralph Scholten 

"Using the Delaware Supreme Court's Time-Warner decision of July 1989 as a focal point,we study

defeated takeover bids before and after July 1989 to assess the direct effects of stronger takeover

impediments on takeover defense tactics used to defeat bids and the resulting shareholder wealth

outcomes and managerial turnover. We find that firms that defeated takeover bids after July 1989

shifted away from the use of active takeover defenses (repurchases, special dividends, greenmail,

and leverage increases). Nevertheless, shareholders of firms that defeat a takeover experienced

slightly better wealth outcomes in the 1990s than in the 1980s.We also find increased managerial

turnover rates after defeating a takeover bid post Time-Warner, suggesting that managers

that defeat hostile takeover bids did not become more entrenched due to greater takeover

impediments relative to prior years."

The complete article can be downloaded here.

All the best,

Ralph

European Private Equity Deal Activity 2014 update; Darden's Takeover Defenses

A key focus of our acquisition finance course is understanding the nature of changing deal markets and incorporating that knowledge into deal structure.  Pitchbook is out with their latest PE report on European Activity and it provides useful updates.  Just a few of the highlights:

For the 6th quarter in a row PE investment in Europe has exceeded 50 billion euros.  Also, the popularity of bolt on investments is increasing, now representing 44% or European buyout activity.  A bolt-on investment is one made through an existing portfolio company rather than a direct investment of funds in a new industry.  Whereas direct investments generally involve new areas of investment, bolt-ons are typically in the same or related industries as the portfolio company.   Further details on these and other highlights can be accessed here.
--
Also, in last week's post regarding Allergan and Valeant we noted:

"The Best Takeover Defense: Don't leave Money on the Table.  Anticipate value creating activities and implement them, however painful.  Continuously evaluate your firm's strategy, particularly in light of a changing environment.  Consider Are You a Takeover Target? Take the corresponding action before external markets force change upon you. Don't wait for a hostile bidder to force you into action.  Indeed, Do Unto Thyself."

Allergan was taking a page from their suitors book and slashing R&D.  Another great example is in Bloomberg today.  Darden Restaurants, long facing hostile activist investors, has retired its chairman and CEO and opened the board for activist representation, all actions desired by the activists.  According the story, however, the actions may have been too little, too late.  

As we said, 'Don't wait to implement value increasing actions.'

All the best,

Ralph

Astrazenca-Pfizer: Bird-in the Hand or Just the Bird?

Ordinarily we focus on buyer value destruction. The Astrazenca (AST) – Pfizer (PF) Drama illustrates sellers are also capable of snatching defeat from the jaws of victory. PF offered $120B - 45% in cash- representing a 45% premium to AST’s pre bid price. PF’s premium was based on cost synergies and tax savings from a planned Tax Inversion. AST claimed the bid undervalued the value of their drug development pipeline and the firm by at least 7% and rejected the offer. AST’s stock price dropped 11% upon the rejection while PF’s rose slightly. (This post will focus on the valuation issues of the bid and ignore the political issues of potential Job Cuts and U.S. taxes.)

AST’s sales and income have fallen from $33.5B and $12.7B in 2011 to $25.7B and $3.7B, respectively, in 2013. The large decline is due to the Patent Cliff faced by many firms in the big phrama industry. AST alleges –warning: hockey stick alert - its new drug pipeline will return sales to 2011 levels by 2017. Furthermore, 2023 sales will increase to $45B - a 75% increase over current levels.

This raises a classic valuation duel. Is a $120B bird in the hand now worth more than a bush containing the promise of something –TBD - larger in 10 years? All valuation questions involve three questions:

1)   How Much: what are the cash flows - not just revenues but the costs and investments associated with a 75% sales increase over 10 years?

2)   How Long: gets to the time value of money- more dollars are needed in 10 years to offset a current dollar.

3)   How Sure: how risky are the cash flows?

The market response to these questions for AST was reflected in the lower pre bid price. Clearly the market did not share AST’s optimistic view of its product pipeline. AST can respond by stating the market did not understand the pipeline - but whose fault is that - investors or AST for not explaining it well enough? More likely, investors are concerned with the high-risk nature of developing drugs as reflected in the continued decline in AST revenues since 2011. So what is going on here? My belief is management is trying to preserve its jobs by staying independent - the shareholders be damned.

Hopefully, shareholder outrage over management’s rejection of a valuable bird in the hand in exchange for receiving a management bird in the face will result in one of the following:

1)   Shareholder Action will force management to reconsider the bid

2)   Replace management and the board - bring in the lawyers

3)   Tie management’s compensation to the targets they believe justify the rejection. If management wants shareholders to roll the dice on the new drug pipeline, then management should join the shareholders and put its money where its mouth is and wager their future compensation - ante up boys.

OMG you can’t make this stuff up-

J

Do Bad Bidders Become Good Targets?

We all have our favorites, from food to songs and so it is with titles to academic articles.  Today’s post features one of my favorites, “Do Bad Bidders Become Good Targets?”  The answer, in a very interesting article by Mark Mitchell and Ken Lehn, is yes. 

We’ve argued before that the best takeover defense is to not leave money on the table.  The analysis of this article follows this logic.  Companies that lose money through bad acquisitions are wasting shareholder value and are likely to be targets themselves.  The complete article can be downloaded here.  The abstract is shown below.

“Do Bad Bidders Become Good Targets?”

by Mark Mitchell and Ken Lehn

This paper empirically examines one motive for takeovers: to change control of firms that make acquisitions that diminish the value of their equity. Firms that subsequently become takeover targets make acquisitions that significantly reduce their equity value, and firms that do not become takeover targets make acquisitions that raise their equity value. Within the sample of acquisitions by targets, the acquisitions that reduce equity value the most are those that are later divested either in bust-up takeovers or restructuring programs to thwart the takeover. This evidence is consistent with theories advanced by Robin Marris (1963), Henry G. Manne (1965), and Michael C. Jensen (1986) concerning the disciplinary role played by takeovers. 

All the best,

Ralph