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Transferring control of corporate assets

The most prominent mode of transferring control of corporate assets is merger. Recall that a merger is a transaction in which one corporation (the acquired) secures title to the stock or assets of another (the acquired). Consummation of a merger requires the approves the transaction, it puts the merger proposal to a stockholder vote. Depending on the percentage of favourable votes required by the state corporate code, the merger is approved or rejected. In effect, though, management has a veto power over all merger proposals and can refuse to put any proposal to a stockholder vote.

Tender offers, by contract, do not require the explicit approval of the incumbent management. A tender offer is a public offer made by the management of one firm (the bidder) to purchase a block of another (the target) firm’s outstanding common stock. Tender offers are made directly to the target’s stockholders. If enough stockholders tender, control of the corporation changes hands. Unlike mergers or tender offers, where control passes to those who can convince stockholders to trade their shares, in proxy contents most stockholders do not transfer ownership of their shares. Their incentive is simply to elect the management team that will enhance the value

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of their investment.

In the first part of my assignment I will write about corporate control. Also I will write about effect on shareholder value through Micheal Porter view. I will focus my work on mergers and de-mergers and how managers and investors manage their own portfolios of shares.

Corporate Control

From even the most casual reference to the popular financial press, it is clear there is an active market where the control of public corporation is traded. Headlines regularly announce proposals of corporate mergers and acquisitions. Tender offers have become a widespread, much publicized means of changing control and the size of the targets is becoming ever larger. Along with these fairly recent developments, the old-fashioned proxy fight now appears to be undergoing a dramatic revival. Once a phenomenon associated almost exclusively with small companies, proxy challenges have just succeeded in outgoing directors of companies as large as Superior Oil and GAF. All these events, together with the less frequent, though increasingly common news of divestitures, spin-offs and leveraged buyouts are signs of the vigorous working of a market for corporate control.

The existence of a well-functioning market for transferring corporate control has important economic implications. To many disinterested viewers, and no doubt to most incumbent managements whose jobs are threatened by such developments, the wave of mergers, acquisitions and tender offers may seem to reflect the spectacle of managerial empire building in which stockholder’s interests are routinely sacrificed in a general management design to enlarge its own corporate domain. And boards of directors doubtless view proxy fights as an unwelcome and unjustifiable nuisance, interfering with their efforts to run the company. But although the scepticism about acquiring managements and dissident stockholders may be justified in some and perhaps many cases, the market for corporate control provide the mechanism by which corporate assets can be channelled to those most efficient in using them. And this, as most economists would agree is essential to the functioning of the economy as a whole.

The threat of takeover is also a crucial means of disciplining inept management and of curbing the inevitable self-interest of those corporate managers who would prefer to pursue more private goals at their stockholder’s expense. In this sense, the existence of an active market for corporate control is perhaps the best replay to the popular corporate criticism declaiming against the “separation of ownership and control”.1 Such a market provides ideally, at least, if not always in practice a self-regulating, monitoring mechanism which ensures that management’s interests cannot diverge too far from those of stockholders. In so doing, an efficient market for changing corporate control increases the wealth of all stockholders.

Such a market also contributes to the general economic welfare by providing the opportunity for firms to combine to form more efficient and profitable entities. Whether through economies of scale, improved access to capital markets, combination of complementary resources, or any of the value creating strategies that come under the term “synergies”, mergers and acquisitions hold out the possibility of gains to stockholders of both acquired and acquiring firms.

Critics of “big business” continue, of course, to view mergers and acquisitions as a net drain on the economy, wasting capital that could be channelled into more productive investment. However, academic studies have demonstrated conclusively that such transactions even after the expense of engaging the apparently non-productive services of lawyers, accountants and investment bankers – significantly increase the net wealth of stockholders.

A more controversial issue, both on Wall Street and academic finance circles alike, concerns the pricing, and thus the profitability of corporate acquisitions to buying companies. The dramatic increase in acquisitions purchase premiums over the past few years has raised questions about both the efficiency of the market in pricing stocks and the motives of managements of acquiring companies.

If stock prices have not significantly understated the value of corporate assets, it is difficult to imagine how DuPont’s recent acquisitions of Conoco at a price that represents a premium of over 100 percent above Conoco’s pre-offer price – can turn out to be a profitable investment.2 More generally, in an efficient market in which current market prices reflect an unbiased estimate of companies market values is there an economic justification for the large acquisition premium over market that are being paid?

This controversy has a direct bearing on larger questions about the effectiveness of the market for corporate control. Some finance scholars have interpreted the large and growing purchase premiums as strong evidence that managements of acquiring companies systematically sacrifice the interests of their own stockholders. Acquisitions and tender offers are viewed as a management strategy to expand its own prestige, increasing their corporate fiefdoms at the expense of their own stockholders. Others have argued that the premiums are justified by the increase in value that can be realized by consolidating control of the assets of the acquiring and acquired firms.

According to this view, the premiums paid to the stockholders of acquired companies represent their “fair share” of the increase in value created by the combination. To be sure, corporate managements have never willingly acquiesced to hostile tender offers, even thought they appear to hold out such benefits to their own stockholders. Any in many cases their resistance appears to have been justified by their willingness to accept higher offers down the road. But the recent adoption of “antitakeover” measures, besides raising academic eyebrows appears to be provoking stockholder unrest. The successful proxy challenge at Superior Oil, which was aimed specifically at removing those barriers insulating management from the discipline of the market, may be only the most visible expression of stockholder disapproval, making the beginning of a new era of stockholder activism.

Management and mergers

Baruch’s hypothesis was that if managers are risk-averse, then holding other things constant, they will prefer investments which reduce firm risk and, in so doing, reduce the risk associated with their own future compensation.3 To the extent a manager is compensated through salary alone, he has fixed claims on the firm which are very similar to those of a bondholder. Viewed in this light, it makes sense for managers to choose the same kind of investments as those which would benefit the firm’s bondholders. That is, if the manager has substantial fixed claims on the firm, we would expect to see him take on investments which decrease cash flow variability.

Of course, one of the most obvious variance-reducing investments is a conglomerate type of acquisition. Baruch’s study reasoned that this kind of problem – that is, the problem of management undertaking investments which are inconsistent with shareholder objectives will occur most frequently in companies where managers do not own much of the stock, and where there are no large blocks of stock outstanding such that a few large investors would have the incentive to closely monitor and control the actions of management. Such companies are typically referred to as manager-controlled firms.

Baruch’s hypothesis was that managers are more likely to seek conglomerate mergers in manager controlled than in owner-controlled firms. The empirical results of this study provide support for the operation of this risk reduction motive in corporate mergers. Baruch finds that the operations of manager-controlled firms are more diversified than those of owner-controlled firms and that manager-controlled firms engage in more conglomerate type of acquisitions- that is, those acquisitions which tend to be diversifying investments. To the extent that these acquiring firms have paid large premiums over market simply to diversity, this diversification comes at the expense of shareholders. This kind of diversification strategy may account for much of the adverse market reaction to announcements of mergers.

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