Ownership and Control

I read an interesting blog recently about ownership and control.  The post (available here) was written entirely from a legal perspective and dealt with courts deciding if there was a controlling shareholder. This makes a difference in legal standards regarding fairness in mergers and acquisitions.  Certainly, one has control of the firm with ownership exceeding 50%. In most of the cases considered, the shareholders held sizeable blocks of shares, often close to, but just below 50% and the courts were trying to decide if there was de facto control.

If we are talking economic reality, there is considerable evidence that even very small  levels of ownership can influence board decisions and corporate behavior.  In fact, the literature is so large, that I couldn't begin to do justice to it in this blog.  Suffice it to say, that it is standard to control for insider and blockholder ownership in analyses of corporate events and substantial research has shown that even small levels of concentrated ownership can affect decisions.   Indeed, even twenty years ago, one article involving executive ownership showed a different relation between CEO turnover and performance in cases where the ownership level exceeded 1%.  Above this level, there was an insignificant relationship between turnover and performance.  The article also found that turnover rates were higher in firms with unaffiliated blockholders and lower in firms where blockholders were associated with management.

In an even older article by the author, we compared resisted and unresisted mergers and asked the question, "Why does management resist?"  It wasn't the bid premia - they were insignificantly different across contested and uncontested deals.  It wasn't the other terms of the deal, they were also similar.  The only factor that differentiated the cases was managerial ownership.  Consider the potential conflicts, if a deal succeeds management is much more likely to lose their jobs.  From a personal standpoint (as opposed to shareholder welfare) it may be optimal to resist.   In cases where management resisted, the only significant differentiating factor was managerial ownership.  Where management had even slightly higher levels of ownership, and hence stood to gain more from the deal in selling their shares, they were significantly less likely to resist.  In other work, we have shown that managerial resistance is the single most important factor in predicting whether a deal is completed. 

Since the time of thoses article, there have been scores of papers finding links between ownership, control and corporate decisions in general.  So yes, ownership matters and it can affect control at levels substantially below any 50% threshold.

All the best,

Ralph

Mitigating Common Deal Risks in Acquisitions

Last week we reviewed some common deal risks in acquisitions.  Today's posts deals with ways to handle these risks.  The original post is copied below along with thoughts on mitigating the risks.  We've written in more detail on many of these items in other posts but provide an overview here.

       One of the topics that draws considerable interest in our Amsterdam, acquisition finance course is mitigating deal risk in acquisitions.  In shortened version, here are some of the major risks involved in acquisitions.   

       1. The deal takes too long to settle (increasing the risk of material changes). The longer it takes to work through a deal the less likely it will be completed.  

     Some of the ways to handle this problem involve using cash (as it is faster than stock due to approvals, etc.).  Of course, deadlines help as well.  Material adverse clauses won't solve this problem but are certainly important in mitigating some consequences of lengthy transactions.

2. The cash flows don’t play out as expected.  We acquire firms assuming a set of cash flows for the future.  In many cases these cash flows don't play out.  It is also common for the seller to have more optimistic expectations about the future than the buyer.  It is necessary to bridge the gap between these expectations to complete the deal. 

       One solution to this problem is the use of contingent payouts.  Earnouts can bridge the gap between seller and buyer expectations and help in completing a deal. But earnouts are also associated with other problems and should be handled with care - especially for sellers who may be giving up control of operations and hence influence on the payouts.  

3. One party abandons the transaction.  This is particularly problematic.  For sellers, it can mean a lost opportunity to cash out.  For bidders, it can mean the loss of time, money and opportunity spent courting a target firm.  

        Termination fees are often used to reduce the pain associated with this problem.  

4. Another bidder acquires the firm.  Similar to the above, this can be problematic for bidders not only because of lost time, money and opportunity but because a rival bidder (likely a competitor) has won and is now stronger. 

       Termination fees are also useful here.  Another solution involves the use of toeholds.  If another party acquires the company, the original bidder gains on the appreciation of shares.

5. The stock price of one of the parties changes before closing.  Particularly problematic in stock deals.  You think you have a deal arranged but at the time of closing find that the share exchange ratio you agreed upon now produces less than optimal terms.  For example, a one for one deal looked fine when the bidder''s stock price was $40, but doesn't look so good at closing when that price has dropped to $30.  

       Collars are useful in protecting against this problem and can give more price assurance to both bidders and sellers.  A typical collar places a ceiling (maximum) and floor (minimum) on the price that will be paid.

         

       All the best,

       Ralph

Common Deal Risks in Acquisitions

       One of the topics that draws considerable interest in our Amsterdam, acquisition finance course is mitigating deal risk in acquisitions.  In shortened version, here are some of the major risks involved in acquisitions.  We outline some of the major problems today.  Next Thursday we'll discuss some simple ways to handle these problems.  

       1. The deal takes too long to settle (increasing the risk of material changes). The longer it takes to work through a deal the less likely it will be completed.

2. The cash flows don’t play out as expected.  We acquire firms assuming a set of cash flows for the future.  In many cases these cash flows don't play out.  It is also common for the seller to have more optimistic expectations about the future than the buyer.  It is necessary to bridge the gap between these expectations to complete the deal.

3. One party abandons the transaction.  This is particularly problematic.  For sellers, it can mean a lost opportunity to cash out.  For bidders, it can mean the loss of time, money and opportunity spent courting a target firm

4. Another bidder acquires the firm.  Similar to the above, this can be problematic for bidders not only because of lost time, money and opportunity but because a rival bidder (likely a competitor) has won and is now stronger.

5. The stock price of one of the parties changes before closing.  Particularly problematic in stock deals.  You think you have a deal arranged but at the time of closing find that the share exchange ratio you agreed upon now produces less than optimal terms.  For example, a one for one deal looked fine when the bidder''s stock price was $40, but doesn't look so good at closing when that price has dropped to $30.  

         Fortunately, there are excellent ways to mitigate these risks.  We'll provide some solutions in next Thursday's post.  

All the best,

Ralph

Dual Ownership, Returns, and Voting in Merger

Among the major events of Drexel's Center for Corporate Governance is our annual academic conference featuring scholarly papers from top researchers around the world.  This year we had over 60 submissions competing for just 5 slots.  

One of the five papers selected for the conference is particularly relevant for our readers.  

Suppose you owned shares of a target firm and you were offered a healthy premia for your shares.  You might be inclined to vote for the deal.  Now suppose you also own the bonds of the target.  Before voting you'd need to consider the effects of the deal on your combined portfolio of the target's stocks and bonds.  The way you vote wouldn't just be influenced by your equity position.  Interestingly, there may be cases where your thoughts on the deal are different from that of a pure equity owner.  In particular, you might be willing to accept a lower premium for the equity if you also gained on the debt.

Now consider the fact that institutions are major  holder of a firms equity (typically more than 70% of a large firm) and that these institutions can also hold the target firm's debt.   You have the motivation for the paper  Dual Ownership, Returns, and Voting in Mergers by Andriy Bodnaruk and Marco Rossi  The abstract of the paper is below.  

 Dual Ownership, Returns, and Voting in Mergers 

Abstract 

We document that in M&As a significant proportion of targets’ equity is owned by financial institutions that simultaneously own targets’ bonds (“dual holders”). Targets with larger equity ownership by dual holders have lower M&A equity premia and larger abnormal bond returns, particularly when dual holders stand to benefit more from appreciation of their bond stakes, e.g., when their bond ownership in the target is large and the target credit rating is non-investment grade. Dual holders are more likely to vote in favor of the merger proposal. Our results suggest the presence of coordination of decisions within dual holding financial conglomerates in M&A targets. 

The complete paper can be downloaded here.

All the best,

Ralph