The shareholder wealth effects of the Pennsylvania fourth generation anti-takeover law.
INTRODUCTION
On October 20, 1989, only nineteen days after Pennsylvania's "third generation"(1) of corporate anti-takeover law(2) went into effect, the "fourth generation"(3) statute was introduced in the Pennsylvania General Assembly at the request of Armstrong World Industries, Inc.
During the past fifteen years, most states have adopted some form of takeover legislation.(7) The passage of these laws has led to a great deal of scholarly debate as to who benefits from hostile takeovers and who benefits from the protective anti-takeover statutes.(8) For example, takeovers have been touted as promoting market efficiency by threatening the removal of incompetent managers.(9) On the other hand, it has been argued that the protective legislation creates delays that help shareholders by allowing management time to establish defenses to hostile and coercive takeover bids.(10) Supporters of such laws maintain that takeovers reduce overall wealth in the economy due to numerous adverse effects on employees and the community.(11) One author, noting that anti-takeover statutes are passed primarily as a result of lobbying by large firms who desire protection from hostile takeovers, observes that these laws "are inconsistent with the core goal of corporate law - the maximization of equity share prices."(12)
What then is the standard to review the impact of anti-takeover statutes? The traditional view is that such measures "should be assessed based on their beneficial impact on shareholders."(13) Using this standard, empirical studies have tested the shareholder wealth effects of anti-takeover legislation and other anti-takeover constraints. The results of these studies are conflicting, although few have examined statutes as protective as Pennsylvania's.(14)
With the recent boom in corporate mergers and hostile takeovers,(15) it is not inconceivable that state legislatures may soon choose to revise current anti-takeover laws to include the restrictive provisions of the fourth generation Pennsylvania statute.(16) The economic effects of such a revision should be taken into account in making this decision. The purpose of this article, accordingly, is to analyze the shareholder wealth effects of this legislation for firms incorporated in Pennsylvania.
To conduct this analysis, event study methodologies based on the efficient market theory hypothesis were performed on four test groups of Pennsylvania firms.(17) Unlike studies that have focused on the shareholder wealth effects of anti-takeover laws in other states, our study examined a statute that came as a complete surprise to investors, and one of the very few for which data is available concerning firms that elected to opt out of its provisions.(18) As our study results indicate, the passage of the Pennsylvania statute had a substantial negative effect on the share prices of most Pennsylvania firms, while that of firms electing to opt out of the statute slightly increased following its enactment. As these findings appear to support the contention that protective anti-takeover laws are harmful to shareholder wealth, they constitute important economic evidence that state legislatures should consider in deciding whether to make their current anti-takeover laws more restrictive.
To set the stage for the empirical study, a brief history of the development of anti-takeover laws will be presented, followed by a description of the fourth generation Pennsylvania statute. The article then reviews the theoretical debate on whether anti-takeover laws increase or decrease shareholder wealth, and presents an overview of the efficient market hypothesis. These discussions are followed by a description of the methodology for this study and then an analysis of the data collected.
HISTORY AND DEVELOPMENT OF TAKEOVER LAWS
Before the 1960's, the primary method of hostile takeover was the proxy fight.(19) By the 1960's, corporate raiders learned to avoid the expense and risk of federal regulation under proxy rules by purchasing the stock instead of soliciting its vote.(20) Cash tender offers fell into a gap between the regulations of the Securities Act of 1933(21) and the proxy rules(22) of the Securities Exchange Act of 1934(23) because such offers did not involve the issuance of securities or the solicitation of proxies.(24) The tender offer(25) emerged as the method of choice for raiders to obtain control of a publicly held corporation.(26) Corporations developed "colorful" defenses(27) to respond to the coercive tender offer tactics while both congress and the states enacted legislation to govern the tender offer process.(28) The federal response was the Williams Act of 1968.(29)
Even though the stated intent of the legislation was "to avoid tipping the balance of regulation in favor of management or in favor of the person making the takeover bid,"(30) the Williams Act clearly protected target shareholders by providing detailed disclosure requirements, an antifraud system, and other protective provisions designed to reduce the inherent pressures in the takeover. Disclosures were required if the bidder was attempting to acquire shares that would make it the beneficial owner of more than five percent of a class of securities.(31) The disclosures, including such information as the identity of the filer, the source of funds, and any plans for the company,(32) had to be filed with the SEC and copies sent to the target firm and the exchanges where the shares were registered. The management of the target company was also required to give its shareholders a statement of its position relative to the takeover bid.(33) The antifraud provision provided a remedy for misrepresentations or failure to satisfy disclosure requirements during the course of the tender offer.(34) Time provisions were also included that required the offeror to keep the offer open for at least twenty days(35), and a withdrawal period allowing shareholders to change their minds before purchase.(36) Purchase of shares on a pro rata basis was required when more shares were tendered than the offeror wanted to purchase.(37) Finally, shareholders who tendered early were protected by requiring the offeror to pay the higher price in a circumstance in which the initial price was subsequently raised by the offeror.(38)
The initial regulatory response to the tender offer process at the state level has become known as the first generation of anti-takeover legislation.(39) When the Williams Act was adopted, only Virginia had an anti-takeover statute, which had been enacted in March 1968.(40) By June 1982, thirty-seven states had adopted first generation statutes(41) "which typically built upon the foundation laid by the Williams Act, supplementing its disclosure provisions and requiring the bidder to give pre-offer notice of the bid to a state official."(42) Most states added provisions that made tender offers more difficult, such as administrative hearings to determine the adequacy of disclosures or the substantive fairness of an offer.(43) The first generation of takeover statutes also extended the jurisdictional reach of such legislation far beyond those corporations incorporated in the enacting state.(44) As a result, these laws were found to be unconstitutional in almost every case by the lower federal courts.(45)
The Supreme Court considered the validity of state anti-takeover statutes for the first time in Edgar v. MITE Corporation.(46) The MITE Corporation, a Delaware corporation with its principal office in Connecticut, challenged the constitutionality of the Illinois Business TakeOver Act(47) under the Supremacy and Commerce Clauses of the U.S. Constitution.(48) In January 1979, MITE initiated a cash tender offer for the shares of Chicago Rivet & Machine Co., an Illinois corporation, by filing with the Securities and Exchange Commission the schedule required by the Williams Act. MITE also brought suit in federal district court questioning the validity of the Illinois Act.(49) MITE wanted a declaratory judgment that the Illinois Act was preempted by the Williams Act and was unconstitutional under the Commerce Clause.(50)
The terms of the Illinois Act required any tender offer for the shares of a target company to be registered with the Secretary of State.(51) The definition of a target company was broad and included any corporation that had ten percent or more of its shareholders located in Illinois, or met two of the following three conditions: its principal office was in Illinois, it was organized under the laws of Illinois, or ten percent of its stated capital and paid-in surplus were within the state. Following registration of the tender offer, the Secretary of State could call a hearing during the twenty day waiting period to adjudicate the fairness of the offer.
With respect to the Supremacy Clause issue, the court of appeals had ruled that the Illinois Act was in conflict with the Williams Act and, therefore, unconstitutional. The Supreme Court did not make a definitive statement on this issue as only three justices agreed with the lower court's Supremacy Clause analysis.(52) Justice White did note that "Congress did not explicitly prohibit States from regulating takeovers."(53) The Supreme Court, however, agreed with the court of appeals' ruling that the Illinois Act was unconstitutional under the Commerce Clause as an excessive burden on interstate commerce in relation to the local interests served by the statute.(54) The Supreme Court believed that the local interests of protecting resident security holders and regulating the affairs of Illinois corporations were insufficient to offset the burdens on interstate commerce created by the "nationwide reach" of the Illinois statute.(55)
The Court's ruling in MITE, therefore, was a death sentence for the first generation of takeover statutes.(56) Nonetheless, one author indicated that "by focusing its analysis primarily upon the jurisdictional breadth of the Illinois Act, the MITE decision seemed implicitly to invite the states to correct the constitutional infirmities of their takeover states ... [and many] responded to the invitation by enacting a 'second generation' of takeover legislation."(57) Besides responding to the Commerce Clause concerns raised by MITE, this second generation of statutes charted new territory in the regulation of cash tender offers. Not only did the new statutes limit their jurisdictional reach to firms organized in their state, they also purported "to focus upon the traditional concerns of state incorporation law - the structure of the corporation and the rights of shareholders,"(58) rather than on the mechanics of the tender offer process that was the concern of the pre-MITE statutes.
Second generation statutes had four primary forms or features: control share acquisition, fair price, right of redemption, and business combination.(59) The first three have been defined as follows:
(1) control share acquisition statutes that require acquisitions of stock that constitute control, or the voting rights of such shares, to be approved by a majority of disinterested shareholders, (2) fair price statutes that require either a supermajority shareholder vote, disinterested board approval, or payment of a fair price for the second step of a two-tier acquisition, and (3) redemption rights statutes that give all shareholders cash redemption rights against any acquirer of at least thirty percent of the firm's stock.(60)
Business combination statutes, the fourth type, were designed "to discourage highly leveraged takeovers by bidders who intend to finance the transaction through total or partial liquidation of the target's assets."(61) Under these laws, acquirers who obtained twenty percent of the voting power were prohibited from engaging in a business combination with the target for five years unless the purchase of the shares or the combination was first approved by the target's board.(62) Of these four, fair price statutes proved to be the most popular type of second generation statute, as evidenced by the fact that they were adopted by fourteen of the twenty-one states enacting such laws.(63)
Second generation statutes basically codified "tactics that firms could undertake by self-help through charter provisions and permit[ted] firms to opt out."(64) These "second-generation statutes were almost invariably struck down as unconstitutional,"(65) but to the surprise of most of those interested in the subject, the U.S. Supreme Court upheld Indiana's statute(66) in CTS Corporation v. Dynamics Corporation of America.(67) In this case, CTS Corporation had challenged the holdings of the district court and the Seventh Circuit Court of Appeals that the Indiana Statute was preempted by the Williams Act and violated the Commerce Clause.(68) The Supreme Court did not agree with these rulings and reversed.(69)
The Indiana Act was a control share statute that denied voting rights to acquirers of twenty percent or more of a firm's shares unless a resolution was passed by a majority vote of "disinterested" shareholders. The law's effect was that a takeover could not occur without the approval of a majority of the pre-existing shareholders.(70) On March 10, 1986, the Dynamics Corporation of America announced a tender offer for enough shares of CTS Corporation (an Indiana corporation) to raise its ownership interest above the twenty percent threshold.(71) On March 27, the board of directors of CTS elected to be governed by the provisions of the Indiana Act.(72) When Dynamics challenged CTS's use of the Act in court, both the district court and the court of appeals followed the plurality opinion in the MITE decision, holding that the Indiana Act was preempted by the Williams Act and violated the Commerce Clause.(73) With respect to the Supremacy issue, Justice Powell, writing for the majority, stated that "absent an explicit indication by Congress of an intent to pre-empt state law, a state statute is pre-empted only 'where compliance with both federal and state regulations is a physical impossibility' ... or where the state 'law stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress.'"(74) The Court held that it was possible for entities to comply with both the Williams Act and the Indiana Act, and that the Indiana Act did not frustrate the purposes of the federal law.(75) With respect to the Commerce Clause issue, the Supreme Court held that the Indiana Act did not discriminate against interstate commerce,(76) finding that "[t]o the limited extent that the Act affects interstate commerce, this is justified by the State's interest in defining attributes of shares in its corporations and in protecting shareholders."(77)
The impact of the CTS decision on the state takeover statutes was "dramatic ... [and] breathed new life into [them]."(78) Although the case was not without ambiguity, states were at least encouraged and given some guidance in how to regulate corporate takeovers. Some states responded by enacting statutes similar to the Indiana Act,(79) while others tested the limits of CTS by enacting laws containing "broader jurisdictional and substantive provisions."(80) Still others adopted a third generation of takeover statutes that placed various restrictions on the rights of acquirers once they obtained a controlling number of shares. For example, some states enacted a type of "freezeout" statute precluding "an acquiror from participating in any corporate decision making or voting for a certain period of time, subject to the approval by either the board or disinterested shareholders."(81) The most recent Pennsylvania statute, referred to by some as a fourth generation of takeover statute,(82) goes farther than any prior state law in protecting target companies from hostile takeovers.
THE PENNSYLVANIA LAW
The 1990 statute was not the first takeover statute to be adopted in Pennsylvania. Pennsylvania had previously enacted second and third generation statutes that followed the share redemption model, the fiduciary duty model, and the business combination model.(83) The share redemption statute, in order to discourage two-tier, front-loaded tender offers, requires a buyout of the remaining shares at a fair value upon demand when any shareholder acquires a certain percentage of the shares.(84) The fiduciary duty statute(85) "authorizes the board of directors to consider the effects of any of the board's actions on employees, suppliers, and customers of the corporation and the communities in which the corporation is located ... [allowing] directors to employ legitimately any defensive strategy to resist hostile tender offers that negatively impact on corporate constituencies other than shareholders."(86) The business combination statute, modeled after New York's law, prohibits firms from engaging in business combinations with shareholders who own at least twenty percent of the firm's shares unless approved by all of the other shareholders.(87)
The fourth generation Pennsylvania statute took yet another step in granting protections against hostile takeovers.(88) This law contained four major provisions. The first required short-term shareholders who dispose of their shares within eighteen months after attempting to acquire control of a firm to disgorge their sales profits to the firm.(89) The second withheld voting rights from acquirers of controlling shares until restored by the vote of a majority of preexisting, disinterested shareholders.(90) The third provision redefined the fiduciary duty of the board of directors.(91) Though prior law allowed directors to consider non-shareholder constituencies, this statute provided that directors were not required to consider shareholder interests "dominant or controlling" when considering the effect of any action on the welfare of the corporation.(92) The fourth provision mandated severance pay and labor contract protections in the event of a hostile takeover.(93) The law additionally granted affected firms a ninety day period following enactment to "opt out" of all or any of these provisions.(94) Given these considerable restrictions, it is evident that no prior state anti-takeover law was as broad or as protective as Pennsylvania's fourth generation statute.
THE EFFECT OF ANTI-TAKEOVER CONSTRAINTS ON SHAREHOLDER WEALTH: THE
THEORETICAL DEBATE
Since the adoption of the Williams Act in 1968, most states have adopted some form of protective anti-takeover legislation.(95) Whether such laws and other anti-takeover constraints increase or decrease shareholder wealth has generated a great deal of theoretical debate.(96) The primary competing theories in this debate are the management entrenchment hypothesis and the stockholder interests hypothesis.(97)
The Management Entrenchment Hypothesis and the Agency Cost Model
Under the agency cost model,(98) the separation of the roles of management and ownership in the corporate structure leads to a conflict of interest between managers and shareholders.(99) For example, managers, who are employees of the firm, have personal incentives to divert corporate assets for their own benefit, whether to maximize salaries, fringe benefits or other perks, to preserve their jobs, or to engage in "empire-building."(100) Shareholders, on the other hand, who are the firm's owners, seek to maximize firm value and to realize the best possible returns on their investment. As these interests are not aligned, shareholders must monitor the managers and replace them in the event that losses in firm value caused by managers' self-dealing become too great.(101) These losses, together with the expenses that shareholders incur by engaging in such monitoring, are collectively referred to as agency costs.(102)
Shareholders may not be effective monitors, however, particularly those who own shares in publicly held corporations that have large numbers of investors.(103) Such shareholders are not actively involved in management(104) and thus are not in a position to detect instances of self-dealing or the agency costs associated with it.(105) Also, when ownership interests are widely dispersed, no one shareholder has the financial incentive to individually bear the costs of monitoring, since any resulting gains must be shared with shareholders as a group.(106) In addition, shareholders who detect high agency costs may not be able to do very much about it--their right to vote and elect directors gives them (in practice) very little leverage over managers for a variety of reasons, including collective action problems, high information costs, and management's power to set and control the agenda of shareholders' meetings through the use of proxies.(107)
Under the agency cost model, hostile takeovers are viewed as being beneficial to shareholders since they provide a means of reducing agency costs and promoting market efficiency.(108) A hostile takeover attempt, which occurs when a tender offer opposed by a target firm's management is made directly to its shareholders, provides shareholders with an opportunity to replace management that, whether for reasons of dishonesty, opportunism, or incompetence, has failed to maximize firm value and has become entrenched.(109) Bidders are likely to make such attempts when they believe that they will be able to manage the assets of the target firm more efficiently than its current management.(110) The opportunity to profit in these situations creates incentives for outsiders to monitor management's efficiency.(111) Knowing this, a firm's management has incentives not to divert assets for personal gain but to manage the firm efficiently and to maximize firm value so as to raise stock prices and thus reduce the threat of a takeover attempt.(112) Such behavior increases shareholder wealth and aligns the interests of management with those of shareholders, reducing agency costs. Reduction in such costs frees up resources that may be used more productively, again increasing efficiency and firm value.(113) Since all firms are subject to such monitoring by prospective bidders, market efficiency is promoted, and all shareholders benefit to the extent that the threat of a takeover remains a viable one.(114)
Anti-takeover legislation, defensive tactics,(115) and other constraints that make it more costly or difficult for takeovers to occur reduce the likelihood of successful takeover attempts, and decrease the incentives that potential bidders have to monitor firms' management.(116) As takeover threats become less viable and potential tender offers are deterred, management entrenchment is facilitated and agency costs continue unchecked. Managers have more license to divert corporate assets for their own use and less incentive to maximize firm value.(117) As a result, stock prices tend to be lower throughout the market, shareholder wealth is reduced(118) and market inefficiency is increased.(119) Under this management entrenchment hypothesis, the adoption of anti-takeover laws and other constraints should negatively impact stock prices due to these effects.(120)
The Stockholder Interests Hypothesis and Related Theories
Although anti-takeover statutes and other takeover constraints may reduce the number of takeover attempts, the stockholder interests hypothesis holds that such constraints increase shareholder wealth since they operate to maximize the premium price that shareholders of target firms will receive in the event of a successful takeover.(121) This result is achieved by reducing the coercive effects of hostile takeover bids. Such effects are most evident in the typical two-stage tender offer. In this scenario, the bidder initially makes an offer to buy shares in the target firm at a price that is higher than the current market value. The bidder also discloses that once enough shares have been acquired to control the target firm, it intends to merge the target into the bidder or another firm it controls and force the remaining minority shareholders to sell their shares at a much lower price.(122) Such a strategy creates a "prisoner's dilemma" that compels shareholders to tender at the initial bid price in order to get the most value for their shares, even if a higher price could be obtained or if they think the shares will be worth more than the bid price in the long run.(123)
Anti-takeover laws and other constraints reduce these coercive effects by giving the management of the target firm an opportunity to organize and coordinate shareholder response to the initial bid.(124) By requiring bidders to keep their offer open for a certain period of time, for example, such laws delay the takeover process and give management time to employ defensive tactics, make counter tender-offers, or implement other measures designed to resist the take-over bid.(125) These laws effectively force the bidder to negotiate with management as agents for the shareholders rather than going directly to the shareholders with the takeover bid.(126) As a result, a collective shareholder response to the tender offer can be made, reducing coercive pressures on individual shareholders to tender at the initial bid price and allowing shareholders as a group to hold out for a higher price.(127)
Anti-takeover constraints also reduce coercive effects of hostile tender offers by enhancing competitive bidding for the firm and by facilitating the development of an auction market.(128) By delaying the takeover process, these constraints give management and other potential bidders a chance to prepare alternative offers, and shareholders time to consider these alternatives.(129) Many anti-takeover laws also require persons who acquire a certain percentage of a firm's stock to publicly disclose their ownership and intentions within a short period of time after acquisition.(130) If the acquirer's intent is to make a takeover bid, this disclosure informs other potential bidders that the acquirer has concluded that the target firm is undervalued or is otherwise desirable, which reduces their research costs and increases the possibility that alternative bids will be made.(131) The more bidders involved, of course, the higher the price paid for the target by a successful bidder, and the greater the gains realized from the transaction by the target's shareholders.(132) By maximizing the takeover premium that is paid to target shareholders through reduction of coercive effects and facilitation of auctions, anti-takeover constraints increase shareholder wealth, and their adoption should raise the stock prices of affected firms.(133)
Other economic arguments have been made to support the contention that anti-takeover constraints increase shareholder wealth. One such argument contends that they prevent management from wasting firm resources in the resistance of takeover attempts.(134) Another claims that they protect managers who wish to devote resources to research, planning, and other long-term projects rather than focus exclusively on the short term bottom line, which may result in greater economic productivity for the firm over the long term.(135) Both of these arguments, in effect, claim that to the extent anti-takeover constraints deter takeover attempts, productive allocation of the firm's assets is enhanced, thus maximizing firm value and raising shareholder wealth.(136)
EFFICIENT MARKET HYPOTHESIS
During the past decade, questions about stock prices and whether capital markets are efficient have been tested by the efficient market hypothesis. According to the hypothesis, share prices fully reflect all past, present, and even future information about the firm, industry, and the economy.(137) The theory postulates that large numbers of profit-maximizing individuals are constantly analyzing and valuing securities so that prices rapidly reflect information that comes to the market in random fashion. Shares of "undervalued" firms and short shares of "overvalued" firms are sought out and purchased, thereby moving security prices to correct levels in a very short period of time.(138)
The efficient market hypothesis comes in three forms. The weak form states that the current price of a security reflects all past information (historical data) about that security. The semi-strong form states that the current price of a security reflects all information that is publicly available about that security. Publicly available information includes data such as earnings and dividend announcements, stock splits, and economic or political news. The assumption is that investors who base their decisions to buy, sell, or hold a security upon the receipt of information that has been made public will not be able to earn above average (or abnormal) returns. The strong form contends that stock prices reflect all information - public and private. Hence no group of investors (including top management of firms and specialists on the floor of stock exchanges) can earn above average returns since security prices already reflect both published and unpublished (or private) information.
Extensive research during the past decade attempting to test the three versions of the efficient market hypothesis has produced results supporting both the weak and the semi-strong forms of the efficient market hypothesis, though some evidence contrary to the semi-strong theory exists. To date, minimal support has been found for the strong form hypothesis.
The semi-strong form of the efficient market hypothesis will be utilized in analyzing takeover statutes. Factors such as whether security prices adjust before, during, or after public announcement of the statute are considered. In an efficient market, the expectation is that price changes will occur either prior to the public announcement due to a news leak, or during the period of announcement. In addition, whether an investor who acquires a security after public announcement will experience above-average, risk-adjusted returns compared to those following a buy-and-hold strategy will be examined. The expectation is that no excess profits will accrue.
Event studies are a principal means to test for market efficiency. Initially an event -- the announcement and activities leading to the passage of a takeover statute -- is selected. This is followed by an identification of all firms likely to be affected by the event.(139) Following identification of the takeover statute to be studied, the date of the first public announcement of the statute is determined.(140) An event window period (typically 30 days surrounding the event) and an estimation period are identified. The objective is to identify abnormal returns, which are the difference between actual stock returns on a given day and the expected stock returns on that day.(141)
Although the evidence is not conclusive, event studies indicate that takeover statutes exert a negative effect on shareholder wealth. For example, studies show the Indiana statute with both positive and negative effects while studies of statutes in other states show negative, but statistically insignificant, results.(142)
STUDY METHODOLOGY
Sample Selection
A list of firms incorporated in the state of Pennsylvania as of the end of 1990 was first obtained from several data sources: Disclosure Incorporated, Compustat Data Tapes, Moody's Industrial Manual, Investor Responsibility Research Center, and Standard & Poor's Stock Reports. These sources were the starting point for our data collection and provided a sample of 215 firms. Next, only firms for which daily trading data was available on the CRSP (Center for Research in Security Prices) tape over the period of the study with a market capitalization of at least five million dollars were retained.(143) The CRSP data tape used in the study contains daily stock return data for over twenty years for all firms that trade in the New York or the American Stock Exchanges, so the study was limited to these stocks. It also contains return data for the stock market index, which provides a measure of overall market return on a continuous basis. The study excluded banks, savings and loans, and public utilities, as these firms tend to be subject to other regulations and, in many instances, are specifically exempted from anti-takeover legislation. As a result of this filtering, the sample included 140 firms.
We next screened our sample to exclude firms for which there were other firm-specific news items occurring around a period of five business days on either side of the event day (i.e., a total of ten days). Information such as earnings, dividend declarations, and other important corporate announcements are made on a regular basis by firms. By eliminating firms for which such announcements were made, the effect of the event in question on the stock returns of the remaining firms in the sample can be isolated. Otherwise, the study results could be contaminated by multiple events.(144) This screening resulted in a final sample of 63 firms.
Next, the sample was divided into four groups. The first group consisted of the overall sample of sixty-three firms. The second group consisted of firms that elected to opt out of all of the provisions of the Pennsylvania statute, a total of eighteen firms. The third group consisted of firms that only chose to opt out of the control share and the profit disgorgement provisions of the Pennsylvania statute, a total of twenty-four firms. The fourth group consisted of firms identified as among America's largest firms in the 1989 FORTUNE 500 list, a total of twenty-two firms.(145) The purpose of isolating the larger firms was to determine whether the law's effect on share prices varied with the size of the affected firm. We expected that such variance might exist due to findings in several studies indicating that certain events tend to affect small firms differently than larger firms.(146)
Data Collected
Equally weighted portfolios were then constructed for each of the four groups and the standard event methodology previously described was applied to each portfolio. Using the 1990 year CRSP tape, we next collected information on stock returns for the firms in each group for each of the following event dates: a) October 13, 1989, the date on which the earliest information concerning the Pennsylvania takeover bill was made public; b) October 20, 1989, the date the bill was introduced in the Pennsylvania Senate; c) January 2, 1990, the date of introduction in the Pennsylvania House; d) April 27, 1990, the date the bill was signed into law by the governor; and e) July 26, 1990, the last date firms were allowed to opt out of the Pennsylvania statute.
In an efficient market, investors are constantly evaluating all the information concerning securities, making informed judgments about the value of the information, and incorporating it in pricing securities -- activity that is performed quickly and efficiently. For an event like the passage of a law, as more information filters into the market during the deliberations by the various legislative bodies, investors will modify their expectations about its passage, the final form in which the law will appear, the types of firms likely to be affected by this law, and the nature of its impact on these firms. Hence, unless some dramatic or unexpected development took place, we would not expect to find any significant movement in the stock prices of affected firms on the date that the law actually becomes effective, as the market should have already reacted and adjusted to this event.
Hypotheses Tested
Two hypotheses were tested during the course of our study:
Hypothesis No. 1: On average, the abnormal return on any day (such as day "0", the event day) is not significantly different from zero.
Hypothesis No. 2: Abnormal returns cumulated over an "event window" (such as the period -30 to -2 (thirty days prior to the event day in question to two days prior to the event day)) are not significantly different from zero.
RESULTS AND ANALYSIS
In the interest of brevity, the tables provided below correspond only to event dates in which significant reaction in the market was detected.(147)
Overall Sample
Table 1 shows the results of the overall sample, while Figure 1 provides a graphic display of the abnormal returns over the event period. Part A in Table 1 shows the daily excess return over the period -15 to +15 days, while Part B shows the cumulative excess returns over selected intervals along with corresponding test statistics. As shown in Table 1, there was a statistically significant negative reaction on day "0," the date of the first news wire report about the takeover law. In other words, investors in the stock market evaluated the information contained in the news wire report announcing the takeover bill and generally considered the effect of the anti-takeover law on share price to be negative. There was no statistically significant reaction on any other day immediately prior to or past day "0." Also, there seemed to be a drift in the abnormal returns during the thirty-one day event window. During the period following day "0," most of the abnormal returns were negative, while during the preevent period, most of the returns fluctuated around zero percent and moved in a random manner. On a cumulative basis, during the two day interval +1 to +2, there was a significant negative reaction as well. This finding indicates that as the message contained in the electronic news wire release became more widespread, investors continued to react negatively to the content of the proposed bill. These reactions indicate that investors in the market generally anticipated the bill to be enacted (in one form or another) and viewed such legislation as not being in the best interests of the affected firms or the shareholders of those firms.(148)
[ILLUSTRATION OMITTED]
TABLE 1 GROUP I: OVERALL SAMPLE
EVENT DATE: 10-13-89: DATE OF FIRST NEWSWIRE REPORT ON THE BILL
A: DAILY EXCESS RETURNS
B: TESTS OVER INTERVALS
DATES EXCESS T-VALUE INTERVALS CUMULATIVE F-VALUE
RETURNS (DAYS) EXCESS
RETURN
-15 -0.00174 -0.355
-14 -0.00049 -0.101
-13 -0.00658 -1.343 -30 TO 30 -0.0416 0.902
-12 0.00247 0.504
-11 0.00504 1.025
-10 0.00399 0.814 -30 TO -2 0.0046 0.027
-9 0.00254 0.519
-8 0.00366 0.744
-7 -0.00829 -1.691 -3 TO -2 0.0027 0.148
-6 -0.00123 -0.251
-5 -0.00103 -0.210
-4 0.00122 0.250 -1 TO 0 -0.0069 0.817
-3 -0.00062 -0.127
-2 0.00331 0.674
-1 0.00678 1.381 1 TO 2 -0.0251 2.764(*)
0 -0.01370 -2.384(*)
1 -0.02180 -1.319
2 -0.00319 -0.650 1 TO 10 -0.0431 1.389
3 0.01010 1.061
4 -0.00112 -0.226
5 -0.01400 -0.860 1 TO 30 -0.0300 1.094
6 -0.00506 -1.031
7 0.00015 0.031
8 0.00293 0.599
9 -0.00346 -0.700
10 -0.00752 -1.529
11 -0.00035 -0.073
12 -0.00719 1.453
13 -0.00257 0.525
14 -0.00802 -1.629
15 -0.01120 -1.300
(*)Significant at 5% level
What do these results mean in dollars and cents? Based on the one day drop on day "0," there was a 1.37% loss in share value, and based on the immediate two day significant drop, there was a 2.51% loss in share value. Based on an average share price of $30 at this time for firms incorporated in Pennsylvania, these drops represent a per share loss of $0.41 on the one day period and $0.75 over the two day period. Given the number of firms affected and the total number of shares outstanding at the time of the event, this amount is not trivial. As the total market capitalization for Pennsylvania firms at this time totaled around $80 billion, the 2.5% drop over the two day period represents a loss of $2 billion.(149)
The average stock price reaction for the other four event dates selected were approximately zero and non-significant. The abnormal return on these four event dates ranged from -0.014 to 0.0015, and the t values ranged from -0.226 to 0.331 (all non-significant values at standard levels of significance). These results indicate that valuation effects of the legislation occurred primarily in response to the very first public announcement that the takeover bill was being considered.
The steep decline in share price following the announcement of this law is strong evidence that shareholders view this type of legislation as being inconsistent with their best interests. Such a loss is especially significant in light of several factors. First, Pennsylvania already had fairly restrictive anti-takeover laws in effect at the time that the 1990 law was proposed.(150) The observed loss might have been far greater if Pennsylvania had not adopted any such legislation prior to announcement of the 1990 law. Second, the share price of firms with anti-takeover charter provisions in place at the time the 1990 law was proposed presumably would not be nearly as affected as the share price of firms that did not.(151) Accordingly, the loss in value for firms with no internal takeover restrictions was likely far greater than the per share losses observed.(152) Third, studies have found that the average loss in value for firms that become subject to anti-takeover laws is about 0.5 percent.(153) According to the results of this study, then, firms subject to the Pennsylvania statute suffered a loss in value about five times greater than the average, perhaps indicating that more restrictive statutory schemes result in greater declines in share price for affected firms.
Firms Opting Out of All Provisions of the Pennsylvania Law
Table 2 shows the results of the event study on the group of firms that opted out of all the provisions of the anti-takeover law. Firms had until July 26, 1990, to opt out of all or part of the provisions in the bill, but most firms did not actually opt out until the middle of July 1990. Eighteen firms out of our total sample of sixty-three opted out of all the provisions.
TABLE 2 GROUP 2: FIRMS OPTING OUT OF ALL PROVISIONS OF THE ANTI-TAKEOVER
LAW
EVENT DATE: 04-27-90: DATE BILL WAS SIGNED INTO LAW
A: DAILY EXCESS RETURNS B: TESTS OVER INTERVALS
DATES EXCESS T-VALUE INTERVALS CUMULATIVE F-VALUE
RETURNS (DAYS) EXCESS
RETURN
-15 -0.0037 -0.371
-14 -0.0180 -1.063
-13 -0.0005 -0.058
-12 0.0014 0.147 -30 TO 30 0.0604 0.635
-11 0.0036 0.362
-10 -0.0029 -0.297
-9 -0.0083 -0.831
-8 -0.0075 -0.754 -30 TO -2 -0.0286 -0.243
-7 -0.0084 -0.838
-6 0.0094 0.937
-5 -0.0150 -1.496
-4 -0.0048 -0.477 -3 TO -2 -0.0185 -1.596
-3 -0.0180 -1.640
-2 -0.0005 -0.051
-1 -0.0130 -1.324
0 0.0188 2.965(*) -1 TO 0 0.0058 1.368
1 0.0026 0.268
2 0.0014 0.147
3 0.0120 1.195
4 -0.0016 -0.262 1 TO 2 0.004 0.007
5 0.0100 1.041
6 0.0110 1.191
7 0.0013 0.131
8 0.0210 1.103 1 TO 10 0.0875 0.056
9 0.0110 1.103
10 -0.0060 -0.592
11 0.0031 0.315
12 0.0200 1.061 1 TO 30 0.0832 2.677(*)
13 -0.0001 -0.012
14 0.0094 0.944
15 0.0092 0.917
(*)Significant at 5% level
The results indicate that no statistically significant reaction in the market occurred on the date that the first news wire was released, the date the bill was introduced in the Senate, the date the bill was introduced in the House, or on the deadline to opt out of the law's provisions. On April 27, 1990, the date the bill was signed into law by the governor, however, there was a positive statistically significant reaction (abnormal return: 0.0188). Also, abnormal returns were generally positive during the post event period, and the test performed over the cumulative interval of +1 to +30 indicates a positive significant excess return (cumulative excess return of 0.0832).(154) Figure 2 tracks the excess returns over the event window and illustrates the market reaction to this group of firms during the event period.
[ILLUSTRATION OMITTED]
Curiously, these firms experienced no significant drop in share price following the release of the initial news wire report.(155) Their share value gained slightly in value, however, at the time the statute was enacted and during the thirty day period following enactment. This rise in share price occurred during the time period when many of these firms publicly announced or otherwise indicated that they intended to opt out of the statute.(156) Shareholders apparently perceived this decision to be in their best interests.
Firms Opting Out of Only the Control Share and the Profit Disgorgement
Provisions
The Pennsylvania law's control share provision, which withholds voting rights to acquirers of controlling shares until such rights are restored by a vote of shareholders who are not affiliated with the acquirer, makes it easier for management to block merger attempts even if they are supported by an acquirer who owns a majority of the firm's voting shares. The profit disgorgement provision discourages takeover attempts by requiring unsuccessful bidders to surrender profits generated by the bid to the target firm. We identified a sample of twenty four firms that elected to opt out of these two provisions, but not the rest of the statute.(157) Again, most of the firms in the sample that made this election waited until the middle of July 1990 to do so.
Table 3 shows the results of the analysis, which were very similar to those found for the second group. Again, no significant reaction in the market occurred around the date that the first news wire was released, the date the bill was introduced in the Senate, the date the bill was introduced in the House, or on the deadline to opt out of the law's provisions. There was a significant positive reaction on day "0," the date the bill was signed into law by the governor, with an abnormal return of 0.0155, slightly less than the abnormal return on day "0" for the second group. Most of the abnormal returns during the post event period were positive, and for the interval +1 to +30, the cumulative excess return was 0.0666, statistically significant at the 5 percent level.(158) Figure 3 plots the excess returns over the event window, showing market reaction to the third group of firms during the event period.
TABLE 3 GROUP 3: FIRMS OPTING OUT OF CONTROL SHARES AND PROFIT
DISGORGEMENT CLAUSES OF THE ANTI-TAKEOVER LAW
EVENT DATE: 04-27-90: DATE BILL WAS SIGNED INTO LAW
A: DAILY EXCESS RETURNS B: TESTS OVER INTERVALS
DATES EXCESS T-VALUE INTERVALS CUMULATIVE F-VALUE
RETURNS (DAYS) EXCESS
RETURN
-15 -0.0038 -0.691
-14 -0.0028 -0.513
-13 0.0020 0.369
-12 -0.0100 -1.483 -30 TO 30 0.0752 0.0032
-11 -0.0119 -2.126(*)
-10 -0.0004 -0.081
-9 -0.0092 -1.042
-8 0.0160 1.016 -30 TO -2 -0.0042 0.017
-7 -0.0120 -1.148
-6 -0.0052 -0.923
-5 -0.0077 -1.366
-4 0.0063 1.118 -3 TO -2 -0.0063 -0.013
-3 -0.0036 -0.650
-2 -0.0027 -0.490
-1 -0.0027 -0.485
0 0.0155 1.997(*) -1 TO 0 0.0128 1.097
1 0.0071 1.270
2 0.0019 0.341
3 0.0130 2.351(*)
4 0.0070 1.251 1 TO 2 0.0090 0.429
5 0.0049 0.882
6 0.0050 0.895
7 0.0029 0.521
8 0.0030 0.548 1 TO 10 0.0458 1.977(*)
9 -0.0006 -0.005
10 0.0010 1.189
11 0.0038 0.675
12 0.0012 0.225 1 TO 30 0.0666 2.216(*)
13 0.0022 0.406
14 0.0064 1.154
15 0.0052 0.929
(*)Significant at 5% level
[ILLUSTRATION OMITTED]
Although the magnitude of the increase was not as great as that for the second group, the results show that the share value of these firms also gained slightly in value at the time the statute was enacted and during the thirty day period following enactment. Opting out of these two provisions makes it far easier for the firm to become the target of a hostile takeover attempt, and this decision appears to have been viewed positively by shareholders, though not quite as positively as a decision to opt out of the statute entirely might have been. The difference in results between the second and third group of firms is apparently attributable to the latter's decision to become subject to the statute's fiduciary duty provisions, a choice that shareholders understandably would not view favorably.
FORTUNE 500 Firms Incorporated in Pennsylvania
The fourth group consisted of Pennsylvania firms large enough to be included in the FORTUNE 500 list as of 1989. Our sample contained twenty two firms in this group.
Table 4 shows the results of our analysis, which were very similar to those found for the overall sample. There was a statistically significant negative reaction on the date that the first news wire report was released, but there was no significant reaction on the other four event dates. On day "0," the date of this announcement, there was a 0.30% loss in share value and during the succeeding two day period (+1 to +2) there was a 0.60% drop in share value. Figure 4 illustrates the abnormal returns over the event period.
TABLE 4 GROUP 4: FORTUNE 500 FIRMS INCORPORATED IN PENNSYLVANIA
EVENT DATE: 10-13-89: DATE OF FIRST NEWSWIRE REPORT ON THE BILL
A: DAILY EXCESS RETURNS B: TESTS OVER INTERVALS
DATES EXCESS T-VALUE INTERVALS CUMULATIVE F-VALUE
RETURNS (DAYS) EXCESS
RETURN
-15 0.0110 0.926
-14 -0.0027 -0.222
-13 0.0240 1.096
-12 0.0028 0.230 -30 TO 30 -0.0733 0.676
-11 -0.0160 -1.322
-10 0.0013 0.106
-9 -0.0061 -0.503
-8 -0.0110 -0.960 -30 TO -2 0.0045 0.004
-7 -0.0180 -1.498
-6 0.0067 0.545
-5 -0.0020 -0.167
-4 0.0090 0.734 -3 TO -2 0.0020 0.007
-3 -0.0150 -1.264
-2 0.0170 1.382
-1 0.0150 1.271
0 -0.0030 -2.828(*) -1 TO 0 0.0120 0.034
1 -0.0042 -0.489
2 -0.0018 -0.188
3 -0.0130 -1.055
4 0.0066 0.535 1 TO 2 -0.0060 2.235(*)
5 -0.0160 -1.314
6 -0.0045 -0.367
7 -0.0092 -0.747
8 -0.0100 -0.818 1 TO 10 -0.0516 0.001
9 0.0015 0.127
10 -0.0010 -0.086
11 -0.0093 -0.755
12 -0.0046 -0.371 1 TO 30 -0.0898 1.545
13 -0.0030 -0.245
14 -0.0230 -1.182
15 -0.0270 -1.269
(*)Significant at 5% level
[ILLUSTRATION OMITTED]
Although the magnitude of the decrease was considerably less than that for the first (overall) group, the results show that the share value of these firms also dropped around the time the first news wire report was released. The difference in results between the fourth group and the overall sample is perhaps attributable to the fact that larger firms are less likely to be significantly affected by the passage of a restrictive anti-takeover statute. For one thing, larger firms are more likely to have adopted anti-takeover charter provisions. Due to the collective action problems facing shareholders in a large firm, it is easier for managers, through their control of the proxy machinery, to propose and enact such provisions. Also, larger firms are generally less likely to be acquired by hostile takeover due to the fact that their management has more resources on hand to combat takeover attempts. As the possibility of hostile takeover is already more remote for these firms, the enactment of such a law should not impact them as greatly as it would other firms.
CONCLUSION
This article has examined the effect of passage of the Pennsylvania anti-takeover statute, one of the most restrictive in the country, on the wealth of shareholders of firms incorporated in Pennsylvania. The effect of anti-takeover laws on shareholder wealth has lead to much theoretical debate. Advocates of the management entrenchment hypothesis argue that these laws harm shareholders since they reduce the possibility of successful takeovers, thus making it more difficult to check management inefficiency and self-dealing. As a result, they predict that passage of such a law will negatively impact share prices of affected firms. Those supporting the stockholder interests hypothesis, on the other hand, claim that these laws benefit shareholders since they facilitate competitive bidding for target firms, leading to higher premiums for the shareholders of those firms. Accordingly, they predict that enactment of such a law will have a positive effect on share prices of affected firms.
In order to test these hypotheses in the case of the Pennsylvania statute, this study examined the stock returns of Pennsylvania firms from the time that the law was initially proposed until the final date by which firms were allowed to opt out of the statute. The study sample consisted of four groups of firms. The first group was an overall sample of firms incorporated in Pennsylvania, the second group consisted of firms that elected to opt out of all the provisions of the Pennsylvania statute, the third group consisted of firms that only chose to opt out of the statute's control share and profit disgorgement provisions, and the fourth group consisted of Pennsylvania firms identified as being some of America's largest in the 1989 FORTUNE 500 list.
Overall, the results of the study indicate that the share price of Pennsylvania firms was greatly reduced by the passage of the Pennsylvania statute, while that of firms that chose to opt out of the law's coverage gained slightly in value. Such results are consistent with, and appear to furnish additional evidence in support of, the management entrenchment hypothesis. Also, the magnitude of loss suffered by firms in the overall sample is much greater than that observed in studies on shareholder wealth effects of anti-takeover laws enacted in other states,(159) which could mean that the passage of extremely restrictive statutes (such as the Pennsylvania law) leads to larger losses for affected firms. In any event, these results should sound a cautionary note to state legislatures that are considering whether the follow the Pennsylvania model in adopting anti-takeover legislation.
(1)See infra notes 39 and 59.
(2)15 PA. CONS. STAT. ANN. [sections]1101 (Purdon Supp. 1989). For a discussion of this statute, see Frank Fogl, Comment, An Analysis of Pennsylvania's Third Generation Anti-Takeover Legislation, 27 DUQ. L. REV. 721 (1989).
(3)See infra notes 82-94 and accompanying text.
(4)See Vindu P. Goel, Pennsylvania's New Anti-takeover Law Fuels Controversy, Faces Fight in Court, WALL ST. J., Apr. 30, 1990, at A16.
(5)Id.
(6)Act of April 27, 1990, No.36, 1990 Pa. Laws 36, 15 PA. CONS. STAT. ANN. [sections][sections]102, 511-12, 1721, 2502, 2542, 2561-67, 2571-76, 2581-83, and 2585-88 (Purdon Supp. 1991) [hereinafter Act of April 27, 1990]. See also, Gary M. Holihan, Pennsylvania's Antitakeover Statute: An Impermissible Regulation of the Interstate Market For Corporate Control, 66 CHI.-KENT L. REV. 863 (1990).
(7)More than forty states have adopted some form of anti-takeover statute. John H. Matheson and Brent A. Olson, Shareholder Rights and Legislative Wrongs: Toward Balanced Takeover Legislation, 59 GEO. WASH. L. REV. 1425, 1439 (1991). For a discussion of the different types of antitakeover statutes that states have adopted, see id. at 1439-52; Richard A. Booth, The Promise of State Takeover Statutes, 86 MICH. L. REV. 1635, 1670-81 (1988); infra notes 39-82.
(8)See infra text accompanying notes 95-136. See generally Roberta Romano, The Political Economy of Takeover Statutes, 73 VA. L. REV. 111 (1987). For a discussion of policy arguments for and against anti-takeover legislation, see Holihan, supra note 6, at 865.
(9)See Booth, supra note 7, at 1638-39; Jo W. Hackl & Rosa A. Testani, Second Generation State Takeover Statutes and Shareholder Wealth: An Empirical Study, 97 YALE L. REV. 1193, 1197 (1988).
(10)Hackl & Testani, supra note 9, at 1193. See infra notes 122-133, and accompanying text.
(11)See Clifford L. Jones, Stricter Corporate Raider Bill Needed, PA. L. J. REP., Feb. 12, 1990, at 2.
(12)Romano, supra note 8, at 113.
(13)Alan E. Garfield, Comment, Evaluating State Anti-takeover Legislation: A Broad-minded New Approach or "A Race to the Bottom"? 1990 COLUM. BUS. L. REV. 119, 119-20.
(14)For an analysis of prior studies, see Hackl & Testani, supra note 9, at 1209-12; see also infra note 142. A summary of some of the studies follows: Harry DeAngelo & Edward M. Rice, Antitakeover Charter Amendments and Stockholder Wealth, 11 J. FIN. ECON. 329 (1983) (study of anti-takeover charter amendments including supermajority shareholder approval, consolidations, sales of assets, and fair price in a second-step freeze-out; found weak preliminary evidence that adoption of the amendments entrenched management to the detriment of shareholders; insignificant abnormal returns, but the authors could not control for the signalling effects of adopting the amendments); Hackl & Testani, supra note 9 (study of the direct effects of takeover statutes on tender offers - increase or decrease and success; they calculated control premiums and cumulative abnormal returns for one test group and two control groups. Id. at 1212-15 for methodology; result: an increase in the number of attempted takeovers under all three types of second generation statutes and in states without second generation statutes; however, the increase in takeovers attempted for second generation was smaller than for non-second generation states - 38.4% compared to 85.71%; this study also examined the different forms of second generation: control share, fair price, and shareholder demand.); Gregg A. Jarrell & Michael Bradley, The Economic Effects of Federal and State Regulations of Cash Tender Offers, 23 J. L. & ECON. 371 (1980) (study examined the effects of the Williams Act and the first generation of state statutes, finding that the average control premiums paid to target shareholders increased from 32.47% to 52.87% after the Williams Act was enacted and to 73.1% if state regulation was also present, and concluded that state and federal regulation had a deterrent effect on tender offers); Gregg A. Jarrell & Annette B. Poulson, Shark Repellants and Stock Prices: The Effects of Antitakeover Amendments Since 1980, 19 J. FIN. ECON. 127 (1987) (statistically significant abnormal negative returns experienced by firms adopting anti-takeover amendments due to the market's characterization of them as detrimental to shareholder interests); Scott C. Linn & John J. McConnell, An Empirical Investigation of the Impact of "Antitakeover" Amendments on Common Stock Prices, 11 J. FIN. ECON. 361 (1983) (found no support for the management entrenchment hypothesis; found significantly positive average abnormal returns consistently over the periods between board announcement, board approval, and shareholder authorization); John Pound, The Effects of Antitakeover Amendments on Takeover Activity: Some Direct Evidence, 30 J. L. & ECON. 353 (1987) (market regression and portfolio analysis to compare returns for target firms with either supermajority or classified-board amendments to returns earned by those without these amendments; result: insignificant effects on control premiums, takeover bids deterred despite their signalling effects, and companies made more likely to resist and succeed in resisting takeover attempts); Romano, supra note 8 (event study of Connecticut's fair price, Missouri's control share, and Pennsylvania's shareholder demand statutes on shareholder wealth; negative effect on stock prices was found to be statistically insignificant.); Guerin-Calvert, McGuckin, & Warren-Boulton, State and Federal Regulation in the Market for Corporate Control (Jan. 21, 1986) (Economic Analysis Group Discussion Paper on file with Yale Law Journal) (examined the effects of federal and state regulation on cash tender offers from 1962-80; results: the Williams Act and state statutes increased both the average control premiums paid and the number of tender offers with multiple bidders.); Laurence Schumann, State Regulation of Takeovers and Shareholder Wealth: The Effects of New York's 1985 Takeover Statutes, Bureau of Economics Staff Report to the Fed. Trade Comm'n. (Mar. 1987) (on file with Yale Law Journal) (event study measuring the effects of the proposed and enacted New York takeover statute on stock prices of New York firms; first bill, not enacted, had control share and shareholder demand provisions; insignificant abnormal negative returns that accompanied announcement of the first bill were followed by significant positive abnormal returns when the bill was vetoed; after the bill with the business combination provision was announced, significant negative abnormal returns were observed; overall loss as a result of enactment was found to be 1% or $1.2 billion); Office of the Chief Economist, Securities and Exch. Comm'n, Shareholder Wealth Effects of Ohio Legislation Affecting Takeovers (May 18, 1987) (on file with Yale Law Journal) (event study measuring the stock price reactions of Ohio firms to the enactment of the Ohio control share acquisition statute; study observed a statistically significant decline in the stock price of 1.68% (or $754 million) for the three days surrounding passage).
(15)It has been reported that during the first six months of 1994 the value of announced mergers and acquisitions totaled $ 171.5 billion, an increase of 46 percent over the total announced during the first six months of 1993. Pamela Yip, Many Factors Spawn New Takeover Frenzy, HOUSTON CHRON., Aug. 5, 1994, at B1. Should this pace continue, 1994 will be the third consecutive year that both the number and dollar amount of merger and acquisition deals have risen. Daniel Kadlec, Rumor Mill Churns About Merger Mania, USA TODAY, July 28, 1994, at 3B (noting that the dollar value of 5,542 deals in 1992 totaled $149 billion, the dollar value of 6,334 deals in 1993 totaled $242 billion, and projecting a total of 7,365 deals worth $255 billion for 1994). This "merger mania" has affected a variety of industries, including drug manufacturing, banking, utilities, software, and the health care industry. See Edmund L. Andrews, Another Round of Merger Mania Hits the Information Industry, N.Y. TIMES, July 3, 1994, at Sec. 4, p. 2; Maggie Canon, Merger Mania: Acquisition and Merger Trends in the Software Industry, MACUSER, July 1994, at 17; Drug Firms' Buyout Mania; S.F. EXAMINER, May 8, 1994, at C1; Samuel Fromartz, Merger Mania Takes Root in Notion That Size Breeds Success, CHI. SUN-TIMES, Aug. 5, 1994, at 45; Chris Kraul, Merger Mania: Profits, Efficiency Fuel Frenzy of Bank Consolidations, L.A. TIMES, Feb. 7, 1994, at D1; Merger Mania Moves Drug Stocks, WASH. TIMES, Aug. 4, 1994, at B7.
(16)Most state anti-takeover statutes were either adopted or significantly revised in the mid- to late 1980's in response to the frenzied merger and takeover activity of that period. These laws tended to become more restrictive with each succeeding generation of anti-takeover statute, as states provided more protection to firms incorporated in their states. See infra text accompanying notes 39-94. Due to the lull in mergers and related activity during the early 1990's, firms became less concerned with takeover defense and the adoption by states of such legislation ceased. It has been reported, however, that due to the recent surge in mergers and takeovers, the number of firms adopting takeover defenses is rising for the first time in five years, indicating that firms are becoming more concerned about becoming the target of a hostile takeover. Kadlec, supra note 15, at 3B. Such firms may again pressure state legislatures to adopt anti-takeover legislation that is more protective than what is currently provided. It may well be that such states will look to the restrictive Pennsylvania statute as a model for revising their existing anti-takeover laws or for drafting new legislation.
(17)See infra notes 147-58 and accompanying text.
(18)See infra notes 154-58 and accompanying text.
(19)See Philip N. Hablutzel & David R. Selmer, Hostile Corporate Takeovers: History and Overview, 8 N. ILL. U. L. REV. 203 (1988). See also Robert A. Prentice, The Role of States in Tender Offers: An Analysis of CTS, 1988 COLUM. BUS. L. REV. 1, 5 (1988) (where the growth of takeovers after World War II is discussed together with the listing of four methods of acquiring a corporation: (1) purchase its assets, (2) merge with it, (3) solicitation of proxies, and (4) purchase a majority of its shares through a tender offer).
(20)Hablutzel and Selmer, supra note 19, at 205.
(21)15 U.S.C. [sections][sections] 77a to 77kk (1992).
(22)17 C.F.R. [sections][sections]240.14 to 240.14d (1990).
(23)15 U.S.C. [sections][sections] 14(a)-(e), 78n(a)-(e) (1992).
(24)Hablutzel and Selmer, supra note 19, at 205.
(25)No legal definition of tender offer has been adopted by Congress or the SEC. See James R. Pagano, Note, The Constitutionality of Second Generation Takeover States, 73 VA. L. REV. 203, n.1 (1987) (citing Note, The Developing Meaning of "Tender Offer" Under the Securities Exchange Act of 1934, 86 HARV. L. REV. 1250, 1251 (1973) (defining such an offer as a publicly made invitation addressed to all shareholders of a corporation to tender their shares for sale at a specified price)); Prentice, supra note 19, at 4 (defining tender offer as an offer to purchase large portions of the securities of a target corporation directly from the target's shareholders).
(26)See Pagano, supra note 25, at 203. See also Daniel R. Fischel, Efficient Capital Market Theory, the Market for Corporate Control, and the Regulation of Cash Tender Offers, 57 TEX. L. REV. 1 (1978).
(27)One commentator has described these defenses as follows:
Common defenses include the "poison pill," which is designed to inflict significant loss on a potential acquirer; the "scorched earth" defense, whereby the target company's assets are liquidated; the "Pac Man" defense, in which the target company makes a tender offer for the bidder's stock; the "white knight" defense, in which a large portion of the company's shares are sold to a friendly party; the "crown jewel" defense, which involves selling the most attractive assets of the company to a friendly party; the "leg-up" defense, involving a grant of favorable options for purchase of treasury stock; and the "greenmail" defense, in which the target self-tenders for only the hostile bidder's shares.
Gregg M. Fishbein, Three Generations of State Anti-Takeover Statutes: Their Legitimacy in Relation to Their Effects on Interstate Commerce and the Supremacy Clause, 38 DRAKE L. REV. 437 (1988-89) (citing Kirk R. Crowder, Note, Recent Developments in the Use of the Poison Pill Antitakeover Defense: Limiting the Business Judgment Rule, 31 ST. LOUIS U. L. J. 1083, 1083 n.2, 1083-84 n.4 (1987)). See also Booth, supra note 7, at 1659-66.
(28)Pagano, supra note 25, at 203-04 (noting that within 10 years of the passage of the Williams Act by Congress, 37 states had adopted takeover legislation).
(29)15 U.S.C. [sections][sections] 78m(d)-(e), 78n(d)-(f) (1992). The Williams Act added Sections 13(d), 13(e), and 14(d)-(f) to the Securities Act of 1934.
(30)S. REP. NO. 550, 90th Cong., 1st Sess. 3 (1967). Justice White also remarked in Edgar v. MITE Corp., 457 U.S. 624, 633 (1982) (White, J., plurality opinion) that the purpose of the Act was "to avoid favoring either management or the takeover bidder." One author has stated that shareholder protection was the sole goal of Congress. See Fischel, supra note 26, at 24.
(31)15 U.S.C. [sections] 78m(d) (1992).
(32)15 U.S.C. [sections] 78m(d)(1) (1992).
(33)17 C.F.R. [sections] 240.14e-2 (1990).
(34)15 U.S.C. [sections]78n(e) (1992).
(35)Rule 14e-1(a), 17 C.F.R. [sections]240.14e-1(a) (1990).
(36)Rule 14e-1b, 17 C.F.R. [sections]14e-1(b) (1990).
(37)Rule 14d-8, 17 C.F.R. [sections]240.14d-8 (1990).
(38)Rule 14d-8, 17 C.F.R. [sections]14d-8 (1990).
(39)In considering the history of the takeover statute, the chronology of the statutes is most important. The use of the cash tender offer was followed by the Williams Act, the first generation of takeover statutes, the MITE case, the second wave of statutes, the CTS case, the third wave of takeover statutes, and then the Pennsylvania statute that is the subject of this article.
The first generation of state takeover laws has been described as those that were adopted in the wake of the Williams Act, whose primary features included additional disclosure requirements, fairness hearings, and time period extensions. See Arthur R. Pinto, Takeover Statutes; The Dormant Commerce Clause and State Corporate Law, 41 U. MIAMI L. REV. 473, 474 (1987). Most of these statutes were found unconstitutional after the Supreme Court decided Edgar v. MITE Corp., 457 U.S. 624 (1982), holding that such laws were an unreasonable burden on interstate commerce. The second generation, which followed MITE, narrowed the jurisdictional focus and dealt more directly with the acquisition of shares. The third generation was described as affecting "the ability of the acquiror to vote or use" the shares acquired. For further explanation, see Prentice, supra note 19, at 28, in which the shareholder approval model, the second tier model, the shareholder redemption model, the fiduciary duty model, and the full disclosure model are described as second generation statutes. Professor Prentice states, "Like the pre-MITE first generation, these provisions seek to block - or have the primary effect of preventing - the tender offer from occurring." Id. He lists the voting rights model and the business combination model as third generation "because they do not seek ... to block the tender offer from occurring ... but limit the offeror's rights in the shares purchased." Id.
(40)See Edgar v. MITE Corp., 457 U.S., 629, 630-31 n.6. See also Hablutzel and Selmer, supra note 19, at 210; Pagano, supra note 25, at 207; Prentice, supra note 19, at 9.
(41)See Hablutzel and Selmer, supra note 19, at 210. See also Romano, supra note 8, at 113, in which the author states, "The popularity of takeover legislation is impressive. First generation takeover statutes were enacted across the states at a quicker pace than all other innovations in corporation codes in recent history."
(42)Pagano, supra note 25, at 207.
(43)Id. at 207.
(44)See Prentice, supra note 19, at 10.
(45)See Pagano, supra note 25, at 207.
(46)457 U.S. 624 (1982).
(47)ILL. REV. STAT., ch. 121 1/2, [sections][sections]137.51-70 (1979)(repealed 1983).
(48)MITE, 457 U.S. at 626.
(49)Id. at 627-28.
(50)Id. at 628.
(51)Id. at 626-27.
(52)Chief Justice Burger and Justice Blackmun joined Justice White, who wrote the opinion.
(53)MITE, 457 U.S. at 631.
(54)Id. at 643. There was a majority only in Part V-B dealing with the excessive burden on interstate commerce because of the extraordinary jurisdictional reach of the Illinois Act using the balancing test from Pike v. Bruce Church, Inc., 397 U.S. 137 (1970). See J. Gregory Sidak & Susan E. Woodward, Corporate Takeovers, the Commerce Clause, and the Efficient Anonymity of Shareholders, 84 NW. U. L. REV. 1092, 1093 (1990), noting that "[t]he Supreme Court has long interpreted the commerce clause of the Constitution to limit a state's power to regulate or impede interstate commerce. This doctrine, which plainly does not arise from the text of the commerce clause (which simply empowers Congress 'To regulate commerce among the several States'), has come to be called the doctrine of the 'dormant' or 'negative' commerce clause." In Pike, the balancing test was stated as follows: "Where the statute regulates evenhandedly to effectuate a legitimate local public interest, and its effects on interstate commerce are only incidental, it will be upheld unless the burden imposed on such commerce is clearly excessive in relation to the putative local benefits." Pike, 397 U.S. at 142.
(55)MITE, 457 U.S. at 643-44.
(56)Every first generation state statute reviewed in the lower federal courts after MITE was invalidated. See Fishbein, supra note 27, at 443 and Pagano, supra note 25, at 204 n.9.
(57)Pagano, supra note 25, at 204.
(58)Id. at 207-08. See also Romano, supra note 8, at 114-15, noting that the shared characteristics of the second generation statutes include tightening of the jurisdictional requirements, substantive features that are less burdensome on interstate commerce, shareholder approval required rather than state agency approval, and provisions allowing firms to opt out of the statutory protections.
(59)The first three are discussed in Roberta Romano, The State Competition Debate in Corporate Law, 8 CARDOZO L. REV. 709, 725-26 (1987). See also Hackl & Testani, supra note 9, at 1202-08. The fourth type, business combination, has been classified as a second generation statute, Pagano, supra note 25, at 208 and 211-12, and as a third generation statute. Pinto, supra note 39, at 474. Fishbein, supra note 27, at 455, uses the name "freeze-out," and describes the "new breed" as a third generation statute. The first three were exemplified by the statutes of Ohio, Maryland, and Pennsylvania, while New York adopted a business combination approach that restricted the usefulness of voting power for five years.
(60)Romano, supra note 59, at 725.
(61)Pagano, supra note 25, at 211.
(62)Id.
(63)See Romano, supra note 59, at 725.
(64)Id. at 726.
(65)Booth, supra note 7, at 1639.
(66)Control Share Acquisitions Chapter of the Indiana Business Corporation Law, IND. CODE [sections][sections] 23-1-42-1 to -11 (Supp. 1986).
(67)481 U.S. 69 (1987). See generally Henry N. Butler, State Takeover Legislation, The Market for Corporate Charter, and the Scope of Federal Intervention: A Comment on Hitzeman, Indiana's Control Share Acquisition Statute, 27 AM. BUS. L. J. 291 (1989); Steven D. Hitzeman, Indiana's Control Share Acquisition Statute Held Constitutional: CTS Corp. v. Dynamics Corp. of America, 26 AM. BUS. L. J. 129 (1988); Prentice, supra note 19.
(68)CTS, 481 U.S. at 76.
(69)Id. at 86-87 and 94.
(70)Id. at 73-74.
(71)Id. at 75.
(72)Id.
(73)Id. at 76.
(74)Id. at 78-79 (citations omitted).
(75)Id. at 79 and 86-87.
(76)Id. at 88.
(77)Id. at 94. The Court applied this reasoning even though the Pike balancing test was not expressly mentioned.
(78)W. Thomas Conner, Note, Sword or Shield: The Impact of Third Generation State Takeover Statutes on Shareholder Wealth, 57 GEO. WASH. L. REV. 958 (1989). See also Prentice, supra note 19, at 63-81, discussing the impact of CTS on six specific types of takeover statutes: the shareholder approval model, the second tier model, the shareholder redemption model, the fiduciary duty model, the full disclosure model, and the business combination model.
(79)See Conner, supra note 78, at 959; Fishbein, supra note 27, at 455.
(80)Conner, supra note 78, at 959. The author states:
For example, Massachusetts and North Carolina have enacted statutes extending jurisdiction to tender offers of nondomestic as well as domestic target companies. Minnesota, on the other hand, has passed an act with expanded substantive provisions that require an accquiring person to deliver an extensive 'information statement' to the target and reach a 'definitive financing agreement' with one or more 'responsible' financial backers before a control share acquisition vote will be scheduled.
Id. at 959-60.
(81)Fishbein, supra note 27, at 455.
(82)Kevin B. Blackistone, Dangers of Anti-Takeover Fever, DALLAS MORNING NEWS, May 24, 1990, at 1D.
(83)See Pinto, supra note 39, at 480. See generally Fogl, supra note 2; Paul D. Weller, Note, Pennsylvania Says, "Not in My House", 34 VILL. L. REV. 739 (1989).
(84)15 PA. CONS. STAT. ANN. [integral of][integral of]1408B, 1409.1(c)(1)-(3), 1910 (Purdon 1986).
(85)15 PA. CONS. STAT. ANN. [integral of]1408 (Purdon Supp. 1984-1985).
(86)Pinto, supra note 39, at 480.
(87)15 PA. CONS. STAT. ANN. [integral of] 1101 (Purdon Supp. 1989).
(88)Act of April 27, 1990, supra note 6. See Jason M. Shargel & Meredith Mitchell, Pennsylvania's New Anti-Takeover Legislation, 24 REV. OF SEC. & COMMOD. REG. 7 (1991). See also Goel, supra note 4.
(89)See 15 PA. CONS. ANN. [integral of][integral of] 2571-76 (1994). Such a provision discourages takeover attempts by requiring unsuccessful bidders to surrender profits generated by the bid to the target firm. See Goel, supra note 4.
(90)See 15 PA. CONS. STAT. ANN. [integral of][integral of] 2561-68 (1994). See Shargel & Mitchell, supra note 88, at 7.
(91)See 15 PA. CONS. STAT. ANN. [integral of] 515(B) (1994).
(92)Id. The effect of such a provision is to permit the board, when confronted with a takeover bid, to implement defense strategies even when doing so would not be in the best interests of shareholders, so long as some other constituency would be benefitted. See Shargel & Mitchell, supra note 88, at 10.
(93)See PA. CONS. STAT. ANN. [integral of][integral of] 2581-83 (severance pay), 2585-88 (labor contract protections) (1994).
(94)Act of April 27, 1990, supra note 6. Firms could opt out of these provisions merely by amending their bylaws on or before July 26, 1990, the date that the 90 day period expired. More than 65 of Pennsylvania's publicly traded corporations (about 21%) chose to opt out of all or a part of this statute. See Vindu P. Goel, Many Top Pennsylvania Firms Opt Out of Provisions in State Anti-Takeover Law, WALL ST. J., July 27, 1990, at A3.
(95)See supra note 7.
(96)Due to the variety of economic factors that are relevant to this debate, and the inconclusiveness of the empirical evidence it has generated, a number of economists and legal scholars have contributed to the literature in this area. For a discussion of the primary competing theories, see generally DeAngelo & Rice, supra note 14. See also, e.g., FRANK H. EASTERBROOK & DANIEL R. FISCHEL, THE ECONOMIC STRUCTURE OF CORPORATE LAW 1 (1991); Barry D. Baysinger & Henry N. Butler, Antitakeover Amendments, Managerial Entrenchment, and the Contractual Theory of the Corporation, 71 VA. L. REV. 1257 (1985); Lucian A. Bebchuk, The Case for Facilitating Compting Tender Offers, 95 HARV. L. REV. 1028 (1982); John C. Coffee, Jr., Regulating the Market for Corporate Control: A Critical Assessment of the Tender Offer's Role in Corporate Governance, 84 COLUM. L. REV. 1145 (1984); Ronald J. Gilson, A Structural Approach to Corporations: The Case Against Defensive Tactics in Tender Offers, 33 STAN. L. REV. 819 (1981); David D. Haddock, Jonathan R. Macey & Fred S. McChesney, Property Rights in Assets and Resistance to Tender Offers, 73 VA. L. REV. 701 (1987); Jonathan R. Macey, State Anti-Takeover Legislation and the National Economy, 1988 WIS. L. REV. 467; Dale A. Oesterle, Target Managers as Negotiating Agents for Target Shareholders in Tender Offers: A Reply to the Passivity Thesis, 71 CORNELL L. REV. 53 (1985); Roberta Romano, A Guide to Takeovers: Theory, Evidence, and Regulation, 9 YALE J. ON REG. 119 (1992); Alan Schwartz, Search Theory and the Tender Offer Auction, 2 J. L. ECON. & ORG. 229 (1986).
(97)These theories were originally proposed to explain the effect of antitakeover charter amendments on shareholder wealth. See DeAngelo & Rice, supra note 14. Under the management entrenchment hypothesis, these provisions harm shareholders since they make current management less accountable for decisions that do not maximize firm value. See id. at 332-35. The stockholder interests hypothesis, however, holds that such amendments are beneficial since they enable shareholders to resist individual incentives to tender immediately at the initial bid price and to hold out for a higher price. See id. at 335-44. As discussed infra, these theories have been extended to explain the effects of antitakeover laws and other takeover constraints on shareholder wealth.
(98)The agency cost model was initially introduced by Michael C. Jensen and William H. Meckling to describe certain costs arising from the conflict of interest inherent in the relationship between principals and their agents, which is useful for understanding organizational behavior in business firms and other cooperative ventures. See Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. FIN. ECON. 305 (1976). This model, which underlies the management entrenchment hypothesis, is used by Easterbrook and Fischel to support their thesis that managers should not resist or otherwise try to obstruct hostile takeover attempts. For a discussion of the agency cost model and its relationship to tender offers, see EASTERBROOK & FISCHEL, supra note 96, at 171-74.
(99)This conflict of interest, as a characteristic of the modern publicly held corporation, was initially observed by Berle and Means in 1932. ADOLF A. BERLE & GARDINER C. MEANS, THE MODERN CORPORATION AND PRIVATE PROPERTY 119-125 (1932).
(100)"Empire-building" refers to a corporation's acquisition of firms that are motivated by management's desire for prestige or other reasons unrelated to increasing firm value. See Diana L. Fortier, Hostile Takeovers and the Market for Corporate Control, 13 ECON. PERSPECTIVES 2, 4 (1989). Empire-building may be the reason why some takeover attempts occur, as managers of the bidder have personal incentives to make the acquisition "(1) because their compensation is linked to firm size, or (2) because they prefer to control large amounts of corporate assets, or (3) because controlling a large firm provides them with greater job security." Macey, supra note 96, at 483 (citations omitted). See also Bebchuk, supra note 96, at 1033; Coffee, supra note 96, at 1167-69.
(101)See EASTERBROOK & FISCHEL, supra note 96, at 112-15.
(102)See Jensen & Meckling, supra note 98, at 305, 308-10 (1976). Agency costs also include "bonding costs," which are resources expended by managers to assure shareholders that they will not shirk their responsibilities, or engage in self-dealing or other detrimental actions. See id. at 308. See also Victor Brudney, Corporate Governance, Agency Costs, and the Rhetoric of Contract, 85 COLUM. L. REV. 1403, 1427-43 (1985) (critiquing the agency cost model in the corporate context).
(103)As the enterprise and the number of shareholders grows, the costs of monitoring become greater due to the increasing difficulty of detecting managerial inefficiency. The costs of informing and persuading also rise due to the larger number of shareholders and the problem of overcoming increasing shareholder ignorance and passivity. See DeAngelo & Rice, supra note 14, at 334; Frank H. Easterbrook and Daniel R. Fischel, The Proper Role of a Target's Management in Responding to a Tender Offer, 94 HARV. L. REV. 1161, 1166 (1981).
(104)Unlike shareholders in closely held corporations, the principal means of participation in management for shareholders of publicly held corporations is through exercising their rights to elect and remove directors, which is often delegated by proxy to the firm's management. See, e.g., REVISED MODEL BUSINESS CORP. ACT [integral of][integral of] 7.28, 8.08 (1984). It is the board of directors, of course, who manage the firm, set policy, and hire officers to conduct the day-to-day business and implement board decisions.
(105)EASTERBROOK & FISCHEL, supra note 96, at 171. Due to their diversified investment interests and the belief that their vote alone will not be determinative of a shareholder election, shareholders in a large firm are not likely to keep themselves informed about managerial decisions or other matters that affect corporate business. See Easterbrook & Fischel, supra note 103, at 1170-71. Such "rational ignorance" is a significant barrier to the effectiveness of shareholder monitoring. See Macey, supra note 96, at 489 n. 73 (defining rational ignorance as "the situation in which the costs of becoming informed about a particular issue are sufficiently high as to dwarf the benefits of acquiring the relevant information"); DeAngelo & Rice, supra note 14, at 334.
Self-dealing by management, though perhaps the most egregious example, is not the only instance when managerial behavior can cause agency costs. Any time that management's actions fail to maximize firm value, agency costs result. Other instances might include those occasions when management is incompetent or inefficient, or reluctant to engage in needed corporate restructuring out of loyalty to the work force or the community, or committed to long term projects at a time when the market places a premium on short-term earnings in valuing the firm's stock. See Fortier, supra note 100, at 3-4.
(106)DeAngelo & Rice, supra note 14, at 333-34; Easterbrook & Fischel, supra note 103, at 1170-71. The incentive to incur these costs is also reduced by the ease with which shares may be sold if shareholders become dissatisfied.
(107)These problems and the resulting apathy of shareholders in large public corporations have been much discussed. See generally ROBERT C. CLARK, CORPORATE LAW 357-400 (1986); EASTERBROOK & FISCHEL, supra note 96, at 63-72; Lucian A. Bebchuk, Limiting Contractual Freedom in Corporate Law: The Desirable Constraints on Charter Amendments, 102 HARV. L. REV. 1820, 1837-38 (1989); John C. Coffee, Jr., The Mandatory/Enabling Balance in Corporate Law: An Essay on the Judicial Role, 89 COLUM. L. REV. 1618, 1675 n. 234 (1989); Melvin Aron Eisenberg, The Structure of Corporation Law, 89 COLUM. L. REV. 1461, 1474-80 (1989).
The emergence of mutual funds, pension funds, and other institutional investors, which own large blocks of shares, may make management more responsive to shareholder concerns since these investors have the expertise to monitor management and more incentive to do so. See generally Matheson & Olson, supra note 7, at 1477-81; Lyman Johnson & David Millon, Corporate Takeovers and Corporate Law: Who's in Control?, 61 GEO. WASH. L. REV. 1177, 1178 n.6 (1993), and sources cited therein. Nevertheless, these problems remain a significant barrier to effective shareholder monitoring. Matheson & Olson, supra note 7, at 1481-82. See also LEO HERZEL & RICHARD W. SHEPRO, BIDDERS AND TARGETS: MERGERS AND ACQUISITIONS IN THE U.S. 27-28 (1990) (discussing the short term outlook of institutional investors).
(108)EASTERBROOK & FISCHEL, supra note 96, at 171-73.
It is virtually a given that takeovers benefit shareholders of the target firm, due to the increase in the target's stock price following the takeover announcement in anticipation of the large premiums that are typically paid for shares acquired during the takeover attempt. See Romano, supra note 8, at 122-23, and sources cited therein. Many theories have been advanced to explain why takeovers occur and their effect on share prices of the acquirer. See generally EASTERBROOK & FISCHEL, supra note 96, at 171-90; Romano, supra note 8, at 122-55; Coffee, supra note 96, at 1162-75. One theory holds that takeovers are undertaken so that the acquirer can achieve certain efficiencies through the transaction, either by obtaining synergy gains or reducing agency costs. Romano, supra note 8, at 125. Synergy gains, such as economies of scale, are realized when the combination of two firms results in a value that is greater than the sum of the values of the firms prior to such combination. See Bebchuk, supra note 96, at 1031-32; DeAngelo & Rice, supra note 14, at 336-40; Coffee, supra note 96, at 1166-67. Reduction of agency costs also can be realized by replacing the target firm's inefficient or incompetent management. EASTERBROOK & FISCHEL, supra note 96, at 171-74; Gilson, supra note 96, at 841-45. These gains in efficiency should result in an increase in the acquirer's share price.
A related theory holds that takeover attempts occur when the bidder believes that the market value of the target firm's stock is undervalued. See Hackl & Testani, supra note 9, at 1198 n. 23, and sources cited therein; Bebchuk, supra note 96, at 1032-33. However, the efficient market hypothesis holds that the market price of a firm's stock reflects all currently available information about that firm. See Eugene F. Fama, Efficient Capital Markets: A Review of Theory and Empirical Work, 25 J. FIN. 383 (1970). See also infra notes 137-152 and accompanying text. As some commentators have observed, if the efficient market hypothesis is correct, it is improbable that a great deal of takeover attempts occur as a result of the target's stock being undervalued. See, e.g., Macey, supra note 96, at 471-72. In fact, existing empirical evidence furnishes very little support for this theory. See EASTERBROOK & FISCHEL, supra note 96, at 199-200, 201-02; Romano, supra note 8, at 144-45.
Other theories hold that takeover attempts are made in order to benefit the managers of acquiring firms at the expense of their shareholders. For example, empire building has been suggested as a motive for many takeovers, or the acquirer may simply have overestimated the value of the target firm or its ability to use the target's assets more efficiently. See EASTERBROOK & FISCHEL, supra note 96, at 184-85; Romano, supra note 8, at 150-52. See also supra note 100. Since such transactions do not benefit the acquirer's firm value, the share price of the acquirer should decrease.
Following a survey of the various empirical studies that have been undertaken to test these theories, Roberta Romano found that, while not conclusive, the evidence most strongly supported theories holding that takeovers are undertaken in order to realize synergy gains or to reduce agency costs, efficiencies that should positively impact shareholder wealth of the acquiring firm. See Romano, supra note 8, at 122-55.
(109)EASTERBROOK & FISCHEL, supra note 96, at 171-73. Replacement of top management is a fairly common occurrence following a successful hostile takeover. See, e.g., Macey, supra note 96, at 472 (citation omitted) (observing that "[s]ixty-two percent of top managers lose their jobs within three years of a hostile takeover compared with a rate of 21% every three years in firms with no change in control").
(110)See supra note 108. If the bidder has analyzed the target correctly, the difference between the target's potential value and its value under existing management creates a profit opportunity for the bidder, which may benefit others as well.
When [this] difference becomes too great, an outsider can profit by buying the firm and making changes. The outsider, after acquiring a majority of the shares, has superior incentives at the margin. All parties benefit in this process. The target's shareholders gain because they receive a premium over the market price. The bidder obtains the difference between the new value of the firm and the payment to the old shareholders. Nontendering shareholders receive part of the appreciation in the price of shares.
EASTERBROOK & FISCHEL, supra note 96, at 172-73.
(111)Id. at 172-73.
(112)Id. at 173. This beneficial view of hostile takeovers relies to a certain extent on the efficient market hypothesis. Under this theory, increased productivity and improved earnings potential should be reflected by a rise in the firm's stock price. See infra notes 137-52 and accompanying text.
(113)Hackl & Testani, supra note 9, at 1199. Indeed, Easterbrook and Fischel argue that the premium paid to the target's shareholders is part of the reduction in agency costs realized by the acquirer as result of its replacement of the firm's prior inefficient management. Easterbrook & Fischel, supra note 103, at 1173-74. This premium could also result from the realization of synergy gains by the bidder, the undervaluation of the target's stock by the market, or the overvaluation of the target's value by the bidder. See supra note 108. Whatever the reason, the effect is significant, as the average premium paid to target shareholders in successful tender offers is about 50% of the pre-bid value of the shares acquired. See, e.g., EASTERBROOK & FISCHEL, supra note 96, at 194 (summarizing results of prior studies). For an overview of the relevant empirical studies, see Robert Comment & Gregg A. Jarrell, Two Tier and Negotiated Tender Offers. The Imprisonment of the Free-riding Shareholder, 19 J. FIN. ECON. 283 (1987); Michael C. Jensen & Richard S. Ruback, The Market for Corporate Control: The Scientific Evidence, 11 J. FIN. ECON. 5, 10-16 (1983).
(114)Easterbrook & Fischel, supra note 103, at 1174 (citation omitted); Hackl & Testani, supra note 9, at 1199.
(115)For purposes of this article, defensive tactics refer to antitakeover devices adopted by the corporation. These devices include those that require shareholder approval, such as antitakeover charter amendments (i.e. supermajority voting requirements and fair price provisions), and those that may be adopted by the board without shareholder consent, such as poison pills, green mail, and their equivalents. For a discussion of these devices, see generally EDWARD R. ARANOW, HERBERT A. EINHORN, & GEORGE BERLSTEIN, DEVELOPMENTS IN TENDER OFFERS FOR CORPORATE CONTROL 193-202 (1977); Herzel & Shepro, supra note 107, at 76-86.
(116)By raising the costs of successful takeover attempts, such constraints reduce the profit that bidders would otherwise realize, thus decreasing the bidder's incentive to monitor and insulating management from the consequences of inefficiency. Easterbrook & Fischel, supra note 103, at 1173; Macey, supra note 96, at 474.
(117)It has been observed that the conflict of interest between shareholders and management is never more evident than during a takeover attempt. Matheson & Olson, supra note 7, at 1483-84. Moreover, the presence of outside or independent directors on the board is not likely to significantly affect the conflict of interest in this situation. See id.; EASTERBROOK & FISCHEL, supra note 96, at 104-05.
(118)See DeAngelo & Rice, supra note 14, at 332-35. The enactment of such laws or adoption of defensive tactics decreases the possibility of a takeover bid, thus increasing the probability that inefficient management will not be checked and decreasing the likelihood that a takeover premium will be paid to shareholders. See id.; J. Kenneth Moritz, Note, Toward Standards for Managers Subject to Hostile Bids: The Tri-Level Model, 50 U. PITT. L. REV. 269 (1988). Under the efficient market hypothesis, these events should be reflected in the firm's stock price, causing it to drop. See id. See also infra notes 137-52, and accompanying text.
Most of the empirical studies that have been conducted to determine the effect of antitakeover laws and defense tactics on the market value of the stock of affected firms have concluded that their adoption reduces shareholder value, although some studies have found that such adoption did not have a statistically significant effect. For an overview of these studies and their results, see supra note 14, and infra note 142; EASTERBROOK & FISCHEL, supra note 96, at 209-11; Macey, supra note 96, at 485-87; Matheson & Olson, supra note 7, at 1492 n. 448.
(119)See Macey, supra note 96, at 485 (observing that these laws may result in "less efficient deployment of society's resources, and a greater number of corporate bankruptcies and reorganizations"); Hackl & Testani, supra note 9, at 1199.
(120)If the management entrenchment hypothesis is correct, it is perhaps unsurprising that of all the affected interest groups, it is the management of publicly held firms, rather than shareholder, labor, or community activists, that has most heavily lobbied state legislators to enact antitakeover laws. See, e.g., Matheson & Olson, supra note 7, at 1501; Macey, supra note 96, at 470-71; Romano, supra note 8, at 122-38.
Shareholder groups, in fact, have been highly critical of existing antitakeover laws. Matheson and Olson have summarized the principal reasons why such groups object to these laws:
First, to the extent many of these statutes grant ultimate decisionmaking power to the target corporation's board rather than its shareholders, some tender offers will be rejected despite positive shareholder response. Second, by conferring upon the target board authority to consider nonshareholder interests, many of these statutes blur if not eliminate the importance of seeking shareholder input. Third, these statutes' 'ex ante chilling effect on the frequency of hostile tender offers may counteract' the benefits of management's stronger ex post bargaining position. Fourth, because coercive offers today are all but extinct, there is little justification for many of these statutes. Furthermore, this anticoercion policy is overbroad; business combination statutes are generally not confined to those situations where coercion is possible. Fifth, by substantially reducing the threat of takeovers, these statutes diminish management's incentive to maximize ongoing shareholder value. Sixth, as with fair-price statutes, many of these statutes foster shareholder passivity. Finally and most fundamentally, by couching these statutes in terms of 'shareholder protection acts' (and similar proshareholder jargon), these acts greatly hamper the reform process by lulling decisionmakers into believing that the statutes do protect shareholders.
Matheson & Olson, supra note 7, at 1454-55 (citations omitted).
(121)See DeAngelo & Rice, supra note 14, at 335-44. This theory, like the management entrenchment hypothesis, also relies on the efficient market hypothesis. As an antitakeover law or other constraint is likely to result in increased premium payments to shareholders in the event of a successful takeover bid, stock prices should rise upon enactment of such a law, in order to reflect this benefit. See id.; Fortier, supra note 100, at 6-7; Moritz, supra note 118.
(122)Although minority shareholders who are forced out have a statutory right to dissent and appraisal if they object to the merger, the "fair value" that they are entitled to receive under such provisions is determined by the price of the shares immediately prior to the merger taking place. See, e.g., REVISED MODEL BUSINESS CORP. Act [sections][sections] 13.01(3), 13.02 (1984). Such a price thus does not include any rise resulting from the takeover bid or the merger, and is almost always less that the premium price paid to shareholders who tender in the first stage of the tender offer. See EASTERBROOK & FISCHEL, supra note 96, at 134, 145-47; Baysinger & Butler, supra note 96, at 1266-67.
(123)See HERZEL & SHEPRO, supra note 107, at 11-15; Michael Bradley & Michael Rosenzweig, Defensive Stock Repurchases, 99 HARV. L. REV. 1378, 1412-13 (1986). See also Booth, supra note 7, at 1640-43; Martin Lipton, Corporate Governance in the Age of Finance Corporatism, 136 U. PA. L. REV. 1, 18-20 (1987). Jonathan Macey explained this "prisoner's dilemma" as follows:
Rational shareholders fear that if they do not tender they will lose any opportunity of realizing a premium for their shares, because a sufficient number of their fellow shareholders will tender to satisfy the requirements of the purchaser. Therefore, shareholders who are offered an immediate premium for their shares have a strong incentive to tender at once in order to ensure that they will receive th