Takeovers and Mergers

The theory f how defenses reduce firm value is a simple application f agency cost analysis: agency costs make defense adoption possible and likely, and defenses in turn increase agency costs by making it harder for principals (shareholders) to replace or otherwise discipline agents (directors) through a takeover. [2] But the academic conviction that agency cost theory is the lens through which to view takeover defenses has been reinforced by empirical studies. Legal academics widely believe that those studies show that firms’ stock prices fall on average when firms adopt defenses. Without that evidence, the theoretical case against defenses remains, but is much less compelling, particularly for policy making.
Practitioner support for defenses no doubt stems in part from the fact that defense adoption (and litigation over defenses) provides legal practitioners with profits. But practitioners have also looked to economic theory and empirical evidence for support in convincing boards f directors that they are justified in adopting defenses and in persuading lawmakers not to intervene against defenses. The evidence in favor f defenses has been produced for the most part not by academics but by investment banks and proxy solicitors, and it shows that defenses, such as pills, increase the premiums target shareholders receive in takeovers. This evidence is consistent with the theory that well-motivated (or adequately constrained) boards use defenses not to entrench themselves or defeat advantageous bids, but to seek better alternatives or bargain for target shareholders and extract a greater share f deal synergies than they otherwise could do.
Recently, both academics and practitioners have been confronted with a new source f evidence on takeover defenses, and the results are decidedly mixed, supporting neither group’s view with certainty. Several recent and ongoing studies show that prior to initial public offerings (IPOs), a significant number f firms adopt terms making takeovers more difficult than does default law, [3] which seems to fly in the face f the academic belief that defenses reduce firm value. [4] Even sophisticated pre-IPO shareholders (such as venture capitalists and leveraged buyout firms) permit their adoption, [5] and firms with defenses are more likely to be represented by higher-quality investment banks in an IPO. At the same time, institutional investors routinely oppose proposals by firms to adopt defenses midstream, and studies f IPOs show that defenses vary significantly, contrary to the beliefs f legal practitioners that a full set f defenses is privately optimal for all firms. These surprising and mixed results make a reassessment f prior empirical evidence on takeover defenses worthwhile, both to examine the methods used and to assess the strength f support the evidence provides for the opposing academic and practitioner positions on takeover defenses.
A better understanding f defenses is given some urgency by the strength f the market for corporate control in the 1990s. Despite widespread adoption f defenses, nearly seventy