Merger Tactics and Public Policy

SEP 1 1 1982 Report No. 82-13 E MERGER TACTICS AND PUBLIC POLICY NORTHERN KENTUCKY UNlVERSlN LIBRARY by Carolyn Kay B r a n c a t o S p e c i a l i s t i n Commerce and I n d u s t r y Economics D i v i s i o n F e b r u a r y 17, 1982 HD 2709 U.S. GOVERNMENT DOCUMENfS rnt 8 ~ r ~ t n v ! C 'I'he Congressional Research Ser\.ice works exclusi\-el\.for the Congress, conducting research, analvzing legislation, arid providing information at the request c;t' committees, Jlernbers, a n d their staffs, I'he Ser\.ice makes such research a\-riilable,\.vithout partisari hias, in man\ t 0 r . m ~including studies. reports, cornpilations, digests. and background brietings. ITponrequest. CRS assists cornrriittees in arial!zirlg legislati\.e pr-oposals arid issues, and in assessing the eftects of these PI-oposals and their altt:rriati\es. The Ser~ice'ssenior specialists ;inti subject ar~al\.stsare also a\.aila\,le f o r - personal c~onsi~ltatiorls i r i their respecti\-efields of'expertise. ABSTRACT This report describes the merger process, including types of mergers, motivation for merger and acquisition activity, and offensive and defensive tactics used to implement or thwart a takeover. The Federal oversight func- tions of the Securities and Exchange Commission, the Federal Trade Commission, and the Antitrust Division of the Justice Department are discussed. Finally, the report briefly raises public policy questions concerning how takeover activity relates to equity, efficiency, and concentration of power within the economy and within the firm. ACKNOWLEDGEMENT This report was originally prepared at the request of Honorable John D. Dingell, Chairman, Subcommittee on Oversight and Investigations, Committee on Energy and Commerce, and is herewith reprinted with the permission of the Subcommittee. CONTENTS iii ................................................. v i i INTRODUCTION .............................................................. I TYPES OF MERCERS ACQUISITIONS................................... A . G e n e r i c Types o f Mergers ........................................ E . Methods Used t o Merge o r Take Over .............................. . Waves o f Merger and A c q u i s i t i o n A c t i v i t y ........................ 1 . Mergers During t h e E a r l y 1900s .............................. 2 . The L a t e 1960s Conglomerate Merger Wave .................... 3 . Comparisons Eetween t h e C u r r e n t and P r e v i o u s P e r i o d s o f Merger A c t i v i t y .................................. 4 . C u r r e n t M o t i v a t i o n s t o Merge ................................ I1 . THE TAKEOVER PROCESS: OFFENSIVE TACTICS ............................. . S t r u c t u r i n g t h e Deal ............................................ 1 . The O f f e r o r C o n s i d e r s a Range of I s s u e s ..................... 2 . The S p e c i a l Role o f A r b i t r a g e u r s ............................ 3 . The O f f e r o r Puys a n I n i t i a l Elock o f t h e S u b j e c t ' s S t o c k .... B . Mergers and A c q u i s i t i o n s : S e c u r i t i e s R e g u l a t i o n s ................ 1 . SEC J u r i s d i c t i o n Over a n I n i t i a l P u r c h a s e o f LIST OF TAELES AND CHARTS AND C A C . . . D. . .. . I11 . . ... ............. ......................................... ....................... .. ........... ........................................... .......................... ........... ............................. .............................. ....................................... .................. ............................ ............ ....... WHOSE INTERESTS ARE AT STAKE? ...................... THE TAKEOVER PROCESS: DEFENSIVE TACTICS A The R e s p o n s i b i l i t i e s o f Management B E v a l u a t i n g a Takeover Eid C S t r u c t u r i n g a Defense i n Advance o f a Takeover 1 Elements i n t h e O v e r a l l S t r a t e g y 2 Shark-Repellent T a c t i c s and P o r c u p i n e Amendments D S t r u c t u r i n g a Defense Once t h e Tender O f f e r Has Peen Made . . . . . . IV ............................................ .................................... a Elock of S t o c k The O f f e r o r Makes a Tender O f f e r and T r i g g e r s A d d i t i o n a l SEC O v e r s i g h t A Tender O f f e r May Ee S u b j e c t t o S t a t e Takeover Laws and t o S t a t e Court Review and Is S u b j e c t t o F e d e r a l Court Review Mergers and A c q u i s i t i o n s : F e d e r a l R e s e r v e O v e r s i g h t 1 Margin Requirements 2 C r e d i t P o l i c i e s and F o r e i g n I n v e s t o r s Mergers and A c q u i s i t i o n s : FTC and J u s t i c e Department O v e r s i g h t 1 The FTC and t h e J u s t i c e Department W i l l S c r u t i n i z e t h e Proposed Merger f o r P o s s i b l e A n t i t r u s t V i o l a t i o n s 2 Merger G u i d e l i n e s 3 Premerger N o t i f i c a t i o n Is Required 4 Does t h e Reagan A d m i n i s t r a t i o n P r o p o s e t o Change A n t i t r u s t Enforcement R e l a t i n g t o Mergers and A c q u i s i t i o n s ? . 3. 2 THE BOTTOM LINE: 69 TABLES AND CHARTS Table 1 2 Distribution of Assets Acquired in Large Mining and Manufacturing Mergers by Type for Selected Years: 1948-1979 ........ 17 Large Acquisitions in Manufacturing and Mining. by Pear. 1960-1979 ................................................. 18 3 Total Assets of All Large Manufacturing and Mining Companies Acquired as a Percentage of Total Assets of All Manufacturing and Mining Corporations. 1960-1979 ................................20 Chart 1 2 ........... 19 Sources of Law Affecting Tender Offers .............................4C Large Manufacturing and Mining Firms Acquired. 1948-1979 MERGER TACTICS AND PUBLIC POLICY* INTRODUCTION Debate on the public policy implications of merger and acquisition activity in the U.S. economy has recently intensified in response to several takeover attempts involving large corporations. For example, one of the largest merger battles in recent U.S. corporate history was fought over Conoco, with contenders Mobil Oil and Seagram losing to Du Pont. Seagram attempted to take over St. Joe Minerals Corporation, but Fluor Corporation, a "white knight" more amenable to St. Joe's management, was the victor. Mobil Oil lost to U.S. over the prized oil reserves held by Marathon Oil. Steel in its joust LTV's attempt to take over Grumman was widely publicized, and congressional interest in acquisitions broadened to defense-related firms. While currently there are not as many mergers and acquisitions as occurred in the prior merger wave of the late 1960s, the character of merger activity has changed; there are more mergers among very large blue chip companies in an increasingly hostile atmosphere. A reason frequently cited for the recent mer- ger and acquisition activity is that, with sustained inflation, many corporate * This report is based in part on a CRS Member Breakfast Seminar, held on October 21, 1981, at which three nationally prominent panelists involved as counsels in notable merger and takeover cases spoke. The panelists were: Ira Millstein of Weil, Gotshal & Manges, who discussed the antitrust implications of merger activities; Martin Lipton of Wachtell, Lipton, Rosen & Katz, who discussed management's point of view in attempting to implement or block merger attempts; and Melvyn Weiss of Milberg, Weiss, Bershad & Specthrie, who discussed concerns of shareholders and non-controlling interests. While this report attempts to reflect the panelists' varying points of view, they are not responsible for its overall content. s e c u r i t i e s become u n d e r v a l u e d compared w i t h t h e i n t r i n s i c v a l u e o f t h e company's underlying a s s e t s . T h i s f a c t , combined w i t h p e r s i s t e n t l y h i g h i n t e r - e s t r a t e s and t h e r i s k premium a s s o c i a t e d w i t h new b u s i n e s s v e n t u r e s , may prov i d e more i n c e n t i v e t o p u r c h a s e e x i s t i n g b u s i n e s s e n t i t i e s t h a n t o i n v e s t i n new p l a n t o r i n new e n t e r p r i s e s . N o t w i t h s t a n d i n g t h e c u r r e n t economic c l i m a t e , however, which may b e i n t e n s i f y i n g c o r p o r a t e t a k e o v e r b i d d i n g , a c e r t a i n d e g r e e of merger and a c q u i s i t i o n a c t i v i t y i s t o b e e x p e c t e d i n t h e normal f u n c t i o n i n g of t h e marketplace. Mergers and a c q u i s i t i o n s c a n p r o v i d e f i n a n c i n g , management, and a c c e s s t o r e s o u r c e s o r t o m a r k e t s which m i g h t n o t o t h e r w i s e b e o b t a i n a b l e , o r an o p p o r t u n i t y t o p r o f i t from b e t t e r u t i l i z a t i o n of e x i s t i n g r e s o u r c e s t h a t a r e i n a d e q u a t e l y managed by c u r r e n t management. I n a d d i t i o n , an e n t r e p r e n e u r who h a s b u i l t up a company may s e e k an o p p o r t u n i t y t o s e l l i t , and s h a r e h o l d e r s may h a v e an o p p o r t u n i t y t o r e c e i v e a s u b s t a n t i a l premium r e t u r n on t h e i r investment. On t h e o t h e r h a n d , merger and a c q u i s i t i o n a c t i v i t y may n o t n e c e s s a r i l y produce s u c c e s s f u l b u s i n e s s c o m b i n a t i o n s . g e r s and a c q u i s i t i o n s - - s u c h B a r r o n ' s r e p o r t s t h a t numerous mer- a s Exxon's p u r c h a s e o f R e l i a n c e E l e c t r i c Co. and M o b i l ' s a c q u i s i t i o n o f Marcor ( i t s e l f a c o m b i n a t i o n of Montgomery Ward and Cont a i n e r C o r p o r a t i o n of America)--have been d i s a p p o i n t i n g b e c a u s e t h e a c q u i r e d companies have n o t performed a s w e l l a s a n t i c i p a t e d . 2/ There i s a l s o c o n s i d e r a b l e d e b a t e a b o u t whether m e r g e r s and a c q u i s i t i o n s o c c u r r i n g a s a r e s u l t o f m a r k e t f o r c e s l e a d t o b e n e f i c i a l and e f f i c i e n t a l l o c a t i o n o f r e s o u r c e s 1 / D r u c k e r , P e t e r F. The F i v e R u l e s of S u c c e s s f u l A c q u i s i t i o n . s t r e e t J o u r n a l , O c t o b e r 1 5 , 1981. ... Wall 2/ See B l e i b e r g , Robert M. Too Far A f i e l d ? Some Big O i l Company ~ a k e o v e r sHave Come t o G r i e f . B a r r o n ' s , August 1 0 , 1981. p. 7 . See a l s o Wayne, .Conglomerates f i n d t h e y o f t e n L e s l i e . J o y s of F l e e i n g t h e C o r p o r a t e S t a b l e c a n ' t p r o f i t from t h e a c q u i s i t i o n s of t h e l a s t merger wave, s o t h e y s e l l t h e u n i t s t o t h e p e o p l e r u n n i n g them, who t h r i v e . New York Times, November 1 5 , 1981. p. 2 6 . .. in society or whether resulting corporate entities will be in a better position to thwart competition in the economy. Of particular concern is the question whether the acquiring company in a takeover situation provides "synergistic" benefits or improved management for the acquired company such that the value of the new entity, and thus the value to society, is greater than the value of the separate companies. Also of interest to legislators is the question whether merger and takeover activity leads to a diversion of capital for "non-productive" uses such as buying existing entities rather than for investment in new plant and equipment, deemed more "productive .I1 These considerations about the role of merger and acquisition activity in the economy as a whole are present whether the takeover bid is friendly--that is, acceptable to the selling company--or whether the bid is hostile and opposed by the subject or "target" company. Eut when the merger process and tac- tics employed result in dispute between various interested parties (such as management, shareholders, labor, pension fund holders, etc.), of public policy is exposed. another dimension The merger battle itself gives rise to issues which relate not only to economic efficiency and concentration of power throughout the economy as a whole, but also to equity, economic concentration, and efficiency issues within the individual firm. Several major questions arise in this connection: (1) To what extent should management be free to implement or block a merger? In rejecting a takeover bid--which may be at a substantial premium for shareholders--is management motivated, as many commentators contend, only by a desire to stay in office or has management, as other commentators contend, rejected the bid for sound business planning reasons? What if management simply wants to operate independently for business judgment reasons or because it fears that a parent company will be less concerned about employees or the community in which the company operates? What if these reasons only transparently mask management's self-interest? (2) Can v a r i o u s s u b g r o u p s w i t h i n a c o r p o r a t i o n ( s u c h a s s h a r e h o l d e r s , emp l o y e e s , and p e n s i o n fund r e c i p i e n t s ) p r o t e c t t h e i r i n t e r e s t s i f t h e y c o n f l i c t w i t h t h e p l a n o f d e f e n s i v e t a c t i c s i n s t i t u t e d by management? F o r e x a m p l e , d o e s t h e s h a r e h o l d e r who w i s h e s t o t e n d e r h i s s h a r e s t o a b i d d e r and t h u s r e c e i v e a premium h a v e a d e q u a t e means t o make s u r e he i s n o t d e n i e d t h e a b i l i t y t o t e n d e r and p r o t e c t h i s economic i n t e r e s t s i f t h e y c o n f l i c t w i t h management's d e c i s i o n t o b l o c k a t e n d e r o f f e r ? What r e c o u r s e d o g r o u p s s u c h a s p e n s i o n f u n d r e c i p i e n t s h a v e i f management a r r a n g e s f o r t h e u s e o f p e n s i o n fund money t o buy company s t o c k t o k e e p i t from a b i d d e r ' s h a n d s ? The p u r c h a s e o f t h i s s t o c k i s o b v i o u s l y i n t e n d e d t o t h w a r t t h e t a k e o v e r , and i f t h i s d e f e n s i v e t a c t i c i s s u c c e s s f u l , t h e company's s t o c k and t h e v a l u e o f t h e pen3/ s i o n fund may d r o p . I n a n o t h e r e x a m p l e , i n a s i t u a t i o n w h e r e a b i d d i n g company p a i n s cont r o l o f a t a r g e t b y r e c e i v i n g 51 p e r c e n t o f i t s s h a r e s t h r o u g h t h e means o f a t e n d e r , a r e t h e r e a d e q u a t e means t o p r o t e c t t h e economic i n t e r e s t s o f t h e r e m a i n i n g m i n o r i t y s h a r e h o l d e r s who d i d n o t t e n d e r and a r e t h e n " f r o z e n o u t " by t h e c o n t r o l l i n g company and o b l i g e d t o a c c e p t u n f a v o r a b l e terms f o r t h e i r s h a r e s ? 4/ Another i s s u e r e l a t e d t o "freeze-outs" i s t h e t r e n d i n "going p r i v a t e " t r a n s a c t i o n s , whereby a g r o u p o f c o n t r o l l i n g s h a r e h o l d e r s " f r e e z e " o r " s q u e e z e " o u t m i n o r i t y s h a r e h o l d e r s i n o r d e r t o t a k e t h e company p r i v a t e a t what many b e l i e v e a r e i n a d e q u a t e p r i c e s - - p r i c e s which i f o f f e r e d t o management o r t h e s e c o n t r o l l i n g s h a r e h o l d e r s i n a t e n d e r How c a n t h e c o m p e t i n g i n o f f e r s i t u a t i o n might w e l l be r e j e c t e d . t e r e s t s o f c o n t r o l l i n g and m i n o r i t y s h a r e h o l d e r s b e r e s o l v e d i n t h e s e circumstances? (3) Are t h e t a c t i c s employed by management t o d e f e n d i t s e l f a g a i n s t a h o s t i l e t a k e o v e r bid so i n f l u e n c e d by s e l f - i n t e r e s t a s t o r e s u l t 31 T h i s was r e p o r t e d t o h a v e been one o f G r u m a n ' s d e f e n s i v e t a c t i c s t o Gruman Pension Plan d e f e a t t h e LTV t a k e o v e r a t t e m p t . S e e C a r l e y , W i l l i a m M. Buys More S t o c k i n E f f o r t t o Block LTV, Which P l a n s S u i t . Wall S t r e e t J o u r n a l , G r u m a n , by A c q u i r i n g I t s Own O c t o b e r 1 3 , 1981. S e e a l s o C a r l e y , W i l l i a m M. S h a r e s , Seems t o Be G a i n i n g i n Bid t o Block LTV. Wall S t r e e t J o u r n a l , Octob e r 1 4 , 1981. 4 / T h i s i s r e p o r t e d t o b e a t i s s u e i n t h e U.S. S t e e l t e n d e r o f f e r f o r ~ a r a t F o n . U.S. S t e e l o f f e r e d 125 d o l l a r s p e r s h a r e f o r 51 p e r c e n t o f M a r a t h o n ' s s h a r e s , and t h e n p r o p o s e d t o o f f e r d e b e n t u r e s t h e s t o c k m a r k e t h a s v a l u e d a t l e s s t h a n 80 d o l l a r s p e r s h a r e f o r t h e r e m a i n i n g 49 p e r c e n t o f t h e s h a r e s . U.S. S t e e l F a c e s R i s i n g D i s s e n t Over Bid t o Swap 1 2 . 5 % See O ' ~ o y l e , Thomas. N o t e s f o r R e s t o f M a r a t h o n . Wall S t r e e t J o u r n a l , F e b r u a r y 1 7 , 1982. W h i l e M a r a t h o n e m p l o y e e s owning s t o c k w e r e u r g e d t o t e n d e r t o U.S. S t e e l , t h e r e a r e i n s t a n c e s where management may u r g e e m p l o y e e s n o t t o t e n d e r s o a s t o d e f e a t the tender o f f e r . I n t h i s c a s e , employees c o u l d be i n a s i m i l i a r " f r o z e n o u t " p o s i t i o n along with t h e m i n o r i t y shareholders. in "unproductive" use of resources, or is the public interest served by allowing management to conduct tactical maneuvers in a takeover situation? This report discusses types of mergers and acquisitions, motivations for merger and takeover activity, and offensive and defensive tactics used to implement or thwart a merger or takeover. The role of the various Federal oversight bodies, such as the Securities and Exchange Commission (SEC), the Federal Trade Commission (FTC), and the Antitrust Division of the Justice Department, is explored. Finally, public policy issues raised in connection with takeover activ- ity are very briefly sunrmarized, including equity, efficiency, and concentration of power within the economy and within the firm as various competing groups (management, shareholders, employees) struggle in the takeover process to protect their economic interests. I. TYPES OF MERGERS AND ACQUISITIONS Merger and t a k e o v e r a c t i v i t y h a s tended t o come i n waves and h a s been accomplished i n a v a r i e t y o f forms, some o f which h a v e r e c e n t l y e v o l v e d i n r e s p o n s e t o changing m a r k e t , r e g u l a t o r y , and j u d i c i a l c o n d i t i o n s . There have been f o u r major waves o f merger and a c q u i s i t i o n a c t i v i t y s i n c e t h e t u r n o f t h e 20th century. Each p e r i o d h a s emphasized d i f f e r e n t types of m e r g e r s and i n r e - c e n t p e r i o d s t h e predominant l e g a l form used t o e f f e c t m e r g e r and t a k e o v e r a c t i v i t y has v a r i e d . This s e c t i o n d e s c r i b e s t h e generic types of mergers, t h e predominant f e a t u r e s o f each o f t h e waves, and t h e c o n t r a s t between t h e c u r r e n t wave and p r i o r waves. A. G e n e r i c T v ~ e so f Mergers B r i e f l y , t h e g e n e r i c t y p e s o f m e r g e r s can b e c l a s s i f i e d i n t o t h r e e g r o u p s : (1) - t h e merger o f two o r more c o m p e t i t o r s . The comH o r i z o n t a l merger p a n i e s must produce one o r more of t h e same, o r c l o s e l y r e l a t e d , prod u c t s i n t h e same g e o g r a p h i c m a r k e t . 5 1 P r o d u c t s which a r e s u f f i c i e n t l y i n t e r c h a n g e a b l e i n t h e i r e n d u s e s o r f o r which t h e r e e x i s t s c r o s s e l a s t i c i t y o f demand may b e h e l d t o be w i t h i n t h e same product market. V e r t i c a l merger - t h e amalgamation o f two f i r m s t h a t p r e v i o u s l y functioned a t d i f f e r e n t v e r t i c a l l e v e l s of d i s t r i b u t i o n , i . e . , i n a customer-supplier r e l a t i o n s h i p . The a c q u i s i t i o n i s d e s i g n a t e d forward v e r t i c a l i n t e g r a t i o n when a s e l l e r a c q u i r e s a n a c t u a l o r p o t e n t i a l customer and as backward v e r t i c a l i n t e g r a t i o n when a customer a c q u i r e s an a c t u a l o r p o t e n t i a l s u *v*v l i e r . 6 1 V e r t i c a l i n t e g r a t i o n may b e c o m p l e t e , which o c c u r s when t h e e n t i r e s u p p l y s o u r c e o r o u t l e t system i s c o n t a i n e d w i t h i n t h e new e n t e r p r i s e ; i t i s p a r t i a l when some p u r c h a s i n g o r s e l l i n g c o n t i n u e s t o b e conducted with o u t s i d e firms. 71 - 5 / von K a l i n o w s k i , J u l i a n 0 . A n t i t r u s t Laws and T r a d e R e g u l a t i o n . ~olum; 161, B u s i n e s s O r g a n i z a t i o n s , 573.01. See a l s o F e d e r a l T r a d e Commission. S t a t i s t i c a l Report on Mergers and A c q u i s i t i o n s , J u l y 1974. p. 162. -6 / von K a l i n o w s k i , op. c i t . , 573.01. -7/ von K a l i n o w s k i , op. c i t . , 573.03. - 13) Conglomerate merger a l l m e r g e r s and a c q u i s i t i o n s t h a t a r e not h o r i z o n t a l o r v e r t i c a l . w i t h i n t h i s non-homogeneous c l a s s o f mergers, t h e r e a r e four d i s t i n c t subcategories: - t h e m e r g e r o f companies t h a t manu( a ) P r o d u c t e x t e n s i o n merger f a c u t u r e o r s e l l p r o d u c t s which, a l t h o u g h d i f f e r e n t , a r e so complementary t h a t t h e y c a n b e produced w i t h s i m i l a r f a c i l i t i e s , marketed t h r o u g h t h e same c h a n n e l s , and a d v e r t i s e d by t h e same media. 8/ An example would be t h e merger o f a l i q u i d b l e a c h w i t h a T i q u i d s t a r c h m a n u f a c t u r e r ; i n t h i s c a s e p r o d u c t i o n and d i s t r i b u t i o n f a c i l i l t i e s may be s h a r e d . - a merger i n which t h e (b) Geographic market e x t e n s i o n merger a c q u i r e d and a c q u i r i n g companies m a n u f a c t u r e o r market t h e same p r o d u c t s b u t i n d i f f e r e n t g e o g r a p h i c m a r k e t s , o r , what may amount t o t h e same t h i n g , t o d i f f e r e n t customer c l a s s e s . An example o f a g e o g r a p h i c market e x t e n s i o n merger i s t h e a c q u i s i t i o n by a l o c a l food c h a i n i n New York o f a l o c a l food c h a i n i n Chicago; i n t h i s manner, l a r g e n a t i o n a l o r r e g i o n a l d a i r y and r e t a i l g r o c e r y i n d u s t r i e s have d e v e l o p e d . S i n c e g e o g r a p h i c m a r k e t e x t e n s i o n m e r g e r s c l o s e l y resemble h o r i z o n t a l mergers, t h e y a r e f r e q u e n t l y r e f e r r e d t o a s "chain" h o r i z o n t a l s , 9 / e x c e p t t h a t t h e p a r t i c i p a t i n g f i r m s a r e n o t i n d i r e c t c o m p e t i t i & w i t h one a n o t h e r s i n c e t h e y a r e i n d i f f e r e n t geographic l o c a t i o n s . - a c q u i s i t i o n of a firm ( c ) R e c i p r o c a l d e a l i n g o r l e v e r a g e merger which i s a s u .p p l i e r o r customer of a t h i r d f i r m which s e l l s t o o r buys from t h e a c q u i r i n g f i r m . The merger may c r e a t e an o p p o r t u n i t y t o engage i n " r e c i p r o c a l d e a l i n g , ' ' a term which r e f e r s t o t h e u s e of buying power t o s e c u r e an a d v a n t a g e i n t h e s a l e o f p r o d u c t s . The a c q u i r i n g company may s e e k t o c r e a t e s a l e s o u t l e t s f o r i t s acq u i r e d f i r m o r i t may s e e k t o s e c u r e a s o u r c e of s u p p l y i f i t cond i t i o n s i t s p u r c h a s e s from a t h i r d p a r t y on t h e l a t t e r ' s agreement t o s e l l t h e acquired f i r m ' s products o r t o secure a firm supply f o r t h e acquired firm. - g/ ( d ) P u r e c o n g l o m e r a t e merger - a merger i n which t h e r e a r e no d i s c e r n a b l e economic r e l a t i o n s h i p s between t h e a c q u i r i n g and a c q u i r e d firms. I n a d d i t i o n t o t h e s e g e n e r i c t y p e s of m e r g e r s and a c q u i s i t i o n s , t h e r e a r e j o i n t v e n t u r e s , whereby companies j o i n t o g e t h e r t o form a new c o r p o r a t e e n t i t y 8/ A complementary r e l a t i o n s h i p between s i m i l a r p r o d u c t s e x i s t s when a r i s e Tn t h e consumption o r p u r c h a s e s o f one c a u s e s a r i s e i n t h e demand f o r t h e o t h e r . B o u l d i n g , Economic A n a l y s e s , a s c i t e d i n von K a l i n o w s k i , 573.04. -9/ von K a l i n o w s k i , op. c i t . , 573.05. 101 von ~ a l i n o w s k i ,op. c i t . , S73.06. - w i t h o u t l o s i n g t h e i r own s e p a r a t e i d e n t c t i e s . For example, i n t h e e n e r g y i n - d u s t r y , u t i l i t y and m i n i n g companies and i n t e r s t a t e g a s p i p e l i n e companies have r e c e n t l y formed j o i n t v e n t u r e s f o r c e r t a i n s p e c i f i c p r o j e c t s . Methods Used t o Merge o r Take Over The term "merger" is o f t e n l o o s e l y used t o d e s c r i b e a v a r i e t y o f a c q u i s i A m e r g e r , however, r e f e r s s p e c i f i c a l l y t o " t h e t i o n and t a k e o v e r t r a n s a c t i o n s . c a s e i n which t h e a s s e t s and l i a b i l i t i e s o f t h e s e l l i n g company a r e t r a n s f e r r e d t o and absorbed by t h e buying c o r p o r a t i o n . " appears a s a s e p a r a t e e n t i t y . 111 The s e l l i n g company t h u s d i s - I n a c o n s o l i d a t i o n o r amalgamation, on t h e o t h e r hand, i t i s not s p e c i f i e d who i s buying whom. Mergers a r e s u b j e c t t o S t a t e law p r o v i s i o n s a p p l i c a b l e t o p u b l i c l y h e l d companies r e q u i r i n g a p p r o v a l o f t h e s e l l i n g company's board o f d i r e c t o r s , and i s s u a n c e of F e d e r a l SEC-approved, m a t e r i a l s t o shareholders. and i n some c a s e s S t a t e - a p p r o v e d merger proxy S h a r e h o l d e r a p p r o v a l i s a l s o r e q u i r e d ; i n some S t a t e s a t w o - t h i r d s v o t e i s n e c e s s a r y , a l t h o u g h i n many S t a t e s o n l y a m a j o r i t y of t h e s t o c k h o l d e r s need approve. ons solid at ions r e q u i r e a p p r o v a l o f b o a r d s of d i r e c t o r s a s w e l l a s a p p r o v a l of e i t h e r t w o - t h i r d s o r a m a j o r i t y of shareholders f o r b o t h companies. The t r a d i t i o n a l merger o r n e g o t i a t e d a c q u i s i t i o n might b e accomplished i n c o n s i d e r a t i o n f o r a v a r i e t y o f t e r m s i n c l u d i n g c a s h , s h a r e s i n t h e b u y i n g company, c o n v e r t i b l e d e b e n t u r e s (bonds i s s u e d by t h e b u y e r which a r e c o n v e r t i b l e i n t o s t o c k ) , o r o t h e r debt instruments such a s non-convertible debentures. The n e g o t i a t e d a c q u i s i t i o n p r o c e s s i s more l e n g t h y and g e n e r a l l y l e s s d i r e c t t h a n . 111 B r e a l e y , R i c h a r d , and Steward Meyers ~ i n a n z . New York, McGraw-Hill, 1981. p. 6 7 1 . P r i n c i p l e s of Corporate t h e much p u b l i c i z e d t e n d e r o f f e r t a k e o v e r p r o c e s s . B u t , " a l t h o u g h much of t h e a t t e n t i o n i n r e c e n t y e a r s h a s been d i r e c t e d t o c o n t e s t e d takeovers--now manent and n o i s y p a r t o f t h e a c q u i s i t i o n s scene--most a per- aquisition transactions a r e s t i l l of t h e n e g o t i a t e d v a r i e t y w i t h o n l y two p l a y e r s , a s e l l e r , and a pur- - c h a s e r , a c t i n g v o l u n t a r i l y . " 12/ A takeover bid or tender o f f e r i s : .. . a method of a c q u i r i n g s h a r e s o f a " t a r g e t " o r " s u b j e c t company" i n which a " b i d d e r " makes an o f f e r t o p u r c h a s e s h a r e s d i r e c t l y t o t h e t a r g e t ' s s h a r e h o l d e r s . Although such o f f e r s may be f o r any p e r c e n t a g e o f t h e t a r g e t ' s o u t s t a n d i n g s t o c k and f o r a v a r i e t y of p u r p o s e s , t h e y a r e u s u a l l y d e s i g n e d t o o b t a i n c o n t r o l of t h e t a r g e t . Since the o f f e r i s made d i r e c t l y t o t h e t a r g e t ' s s h a r e h o l d e r s , a t a k e o v e r b i d e n a b l e s a b i d d e r t o a c q u i r e [ c o n t r o l o f ] t h e t a r g e t w i t h o u t a p p r o v a l of t h e t a r g e t ' s board o f d i r e c t o r s and w i t h o u t t h e a p p r o v a l o f t h e t a r g e t ' s shareholders.. 131 .- For a v a r i e t y of t a c t i c a l r e a s o n s d i s c u s s e d s u b s e q u e n t l y i n S e c t i o n I1 A, t h e t a k e o v e r and merger p r o c e s s now f r e q u e n t l y i n v o l v e s a two-step a three-step and sometimes even p r o c e s s whereby a b i d d e r a c q u i r e s a b l o c k of a s u b j e c t ' s s t o c k , makes a t e n d e r o f f e r f o r a p o r t i o n o r a l l of t h e r e m a i n i n g s t o c k , and t h e n f o l l o w s up w i t h a f o r m a l a c q u i s i t i o n t o a c q u i r e t h e r e m a i n d e r of t h e s h a r e s which were n o t tendered i n t h e p r i o r s t a g e . Merger t r a n s a c t i o n s , i n many c a s e s , [ a r e ] used t o "mop up" t h e d e a l , i . e . , t o p i c k up t h e s h a r e s n o t t e n d e r e d a f t e r c o n t r o l o f t h e s e l l e r [ h a s ] p a s s e d t o t h e p u r c h a s e r . The m u l t i s t e p t r a n s a c t i o n was born a s a means o f s e c u r i n g f o r t h e p u r c h a s e r c o n t r o l o f t h e s e l l e r ( o r a t l e a s t a l e g up on any c o m p e t i t i o n which might emerge once t h e n e g o t i a t e d d e a l was announced) much f a s t e r t h a n t h r o u g h t r a d i t i o n a l merger t r a n s a c t i o n s , t h u s h e l p i n g t o a s s u r e t h a t t h e d e a l would u l t i m a t e l y go t h r o u g h . E/ 121 F r e u n d , James C. and Edward F. Greene. S u b s t a n c e Over Form S-14: The B u s i n e s s A ~ro'i;;;sal t o Reform SEC R e g u l a t i o n o f N e g o t i a t e d A c q u i s i t i o n s . Lawyer, v 3 6 , J u l y 1981. p. 1485-6. . T a k e o v e r s : Seminar on B u s i n e s s A c q u i s i t i o n s , 13/ K a t c h e r , Richard D. I l l i n o i s I n s t i t u t e f o r Continuing ~ e n d e r ~ f f e and r s Stockholder L i t i g a t i o n . E d u c a t i o n , C h i c a g o , I l l i n o i s , June 12-13, 1980. p. 4-1. 141 - Freund and Greene , op. c i t . , p. 1486. C. Waves o f Merger and A c q u i s i t i o n A c t i v i t y Four p e r i o d s o f i n c r e a s e d i n t e n s i t y i n m e r g e r s and a c q u i s i t i o n s have occurred s i n c e j u s t before t h e t u r n of t h e 20th century: (1) 1896 t o 1904, c h a r a c t e r i z e d by h o r i z o n t a l m e r g e r s t o a c h i e v e dominant f i r m s and n e a r monopolies ; (2) 1919 t o 1929, c h a r a c t e r i z e d by h o r i z o n t a l m e r g e r s o f l e s s t h a n dominant f i r m s t o form o l i g o p o l i e s ; '(3) 1 9 6 0 s , p e a k i n g i n 1968, c h a r a c t e r i z e d by c o n g l o m e r a t e m e r g e r s t o a c h i e v e l a r g e amalgamations o f g e n e r a l l y u n r e l a t e d b u s i n e s s e s ; (4) l a t e 1970s and c o n t i n u i n g t o i n t e n s i f y i n 1981, c h a r a c t e r i z e d by m e r g e r s among l a r g e , w e l l - e s t a b l i s h e d f i r m s i n an i n c r e a s i n g l y h o s t i l e a t m o s p h e r e , p r i m a r i l y t o p u r c h a s e e x i s t i n g undervalued business e n t i t i e s . 1 . Mergers During t h e E a r l y 1900s The f i r s t wave, e s t i m a t e d t o have i n v o l v e d 1 5 p e r c e n t o f a l l U.S. manuf a c t u r i n g p l a n t s and a n p l o y e e s , i s c o n s i d e r e d t o have begun a s t h e N a t i o n r e covered from t h e d e p r e s s i o n of 1893 and t o have c o n t i n u e d u n t i l t h e r e c e s s i o n of 1904. 151 The predominant f e a t u r e o f t h i s p e r i o d was t h e u s e o f h o r i z o n t a l m e r g e r s t o c o n s o l i d a t e a number of s m a l l f i r m s i n an i n d u s t r y i n t o a s i n g l e near-monopolistic and U.S. dominant f i r m . Companies s u c h a s Du P o n t , American Tobacco, S t e e l (formed from 785 s e p a r a t e p l a n t s ) e p i t o m i z e d t h i s t r e n d . Oddly enough, t h i s a c t i v i t y went on d e s p i t e p a s s a g e o f t h e Sherman Act i n 1890. One argument i s t h a t t h e Sherman Act encouraged m o n o p o l i z a t i o n s i n c e 151 See N e l s o n , Ralph L. Merger Movements i n t h e United S t a t e s . ~ r i n c z o nU n i v e r s i t y P r e s s , P r i n c e t o n , 1959. p . 29, 53; Markhem, J e s s e W. Survey of t h e Evidence and F i n d i n g s on Mergers. N a t i o n a l Bureau o f Economic Research C o n f e r e n c e R e p o r t ; B u s i n e s s C o n c e n t r a t i o n and P r i c e P o l i c y . P r i n c e t o n U n i v e r s i t y P r e s s , 1955. p. 28, 29, 53; Moody, J o h n . The T r u t h About T r u s t s . Moody P u b l i s h i n g , 1904. p. 4 8 6 , 487; a s c i t e d i n U.S. L i b r a r y o f C o n g r e s s . C o n g r e s s i o n a l Research S e r v i c e . A n t i t r u s t P o l i c y Towards M e r g e r s . Report 77-263, by Howard Useem. Washington, 1977. it made collusion illegal (but not mergers) and put an end to the trustee device, thereby forcing industrialists seeking market control to resort to complete fusion of their separate companies. 16/ The second wave occurred from 1916 and ended abrubtly in 1929 with the collapse of the stock market. In this period, firms secondary to the dominant firms frequently undertook mergers which transformed some industries from dominance by a single large firm to oligopoly, dominance by a few large firms. 171 Merger activity was especially intense in the following industries: primary met als, petroleum products, food products, chemicals, and transportation equipment. 2. The Late 1960s Conglomerate Merger Wave The third wave--the "conglomerate" wave--peaked in 1968. It was charac- terized by practical application of the theory that managerial talent was more important than knowledge of any particular line of business and that extremely capable managers could take over any business and improve it. The notion of "synergym--that a new entity is worth more than the sum of its separate parts-was applied not only to combinations based on extending lines of business into profitable areas but also to well-publicized managerial talent attributed to such people as James Ling of Ling-Temco-Vought, whose transactions epitomized the era. Some analysts contend that stricter interpretation of antitrust laws applicable to horizontal and vertical acquisitions was a factor in the growth of the conglomerate trend because it would be difficult under existing antitrust 16/ See Useem, op. cit., p. 29-31. 17/ Stigler, George. ~ c o n o z cReview, May 1950. Monopoly and Oligopoly by Merger. American s t a t u t e s t o c o n t e s t a merger on grounds of market c o n c e n t r a t i o n where s e p a r a t e markets a r e i n v o l v e d . But a c c o u n t i n g t e c h n i q u e s were a l s o r e p o r t e d t o have f u e l e d t h e l a t e 1960s merger wave; t h e s e provided i n c e n t i v e s i n s e v e r a l ways. "Pooling-of-earnings" t e c h n i q u e s p e r m i t t e d companies t o add t h e i r b a l a n c e s h e e t s and income s t a t e m e n t s t o g e t h e r a s i f t h e two companies were one. I f investors t h e n compared t h e r e s u l t i n g pooled e a r n i n g s w i t h e a r n i n g s p r i o r t o p o o l i n g , t h i s would c r e a t e a d i s t o r t e d growth t r e n d which o n l y t h e more s o p h i s t i c a t e d inv e s t o r s might d i s c e r n . 21 Another d i s t o r t i o n o c c u r r e d w i t h t h e s a l e of a s s e t s t h a t were thought t o be "undervalued" ( i . e . , t h e book v a l u e - a s s e t s t h e company's b a l a n c e s h e e t d i v i d e d by t h e number of shares-was market v a l u e ) . shown on l e s s than the "Goodwill" o r i n t a n g i b l e a s s e t s were c r e a t e d i f payment f o r t h e company exceeded t h e book v a l u e of i t s s h a r e s . F a i l u r e t o a m o r t i z e t h i s good- w i l l by a n n u a l c h a r g e s t o income i n f l a t e d e a r n i n g s , t h e r e b y c r e a t i n g a d i s t o r t e d e a r n i n g s t r e n d , which i n t u r n r e q u i r e d f u r t h e r " c h a i n l e t t e r " mergers t o maintain the trend. F i n a l l y , an a r t i f i c i a l boost t o e a r n i n g s under pooling a c c o u n t i n g a r o s e through use i n t h e t a k e o v e r of p r e f e r r e d s t o c k o r c o n v e r t i b l e d e b e n t u r e s (bonds c o n v e r t i b l e i n t o common s t o c k which e n a b l e d t h e i n v e s t o r t o s h a r e i n a p p r e c i a t i o n of s t o c k p r i c e s w i t h o u t t h e r i s k of a f a l l i n t h e conversion rate). Under a c c o u n t i n g r u l e s i n e f f e c t p r i o r t o 1969, e a r n i n g s p e r s h a r e of common s t o c k could a r t i f i c i a l l y i n c r e a s e w i t h f l u c t u a t i o n i n t h e d e b e n t u r e rate. 191 181 A s an example, when Leasco acqu red R e l i a n c e I n s u r a n c e , i t a c q u i r e d a n investment p o r t f o l i o of s t o c k s c a r r i e d on R e l i a n c e ' s books a t a c o s t which was s u b s t a n t i a l l y lower than market v a l u e A f t e r t h e a c q u i s i t i o n , Leasco s o l d t h e s e c u r i t i e s , making i t a p p e a r t h a t t h e merged e n t i t y had r e a l i z e d g r e a t l y increased earninn s when i n f a c t i t was mere y l i q u i d a t i n g s e c u r i t i e s a t t h e same p r i c e s t h a t e x i s t e d on t h e d a t e of a c q u i s i t i o n . (Telephone communication from a t t o r n e y Melvyn Weiss t o CRS, February 12, 1982.) Mergers, Motives, E f f e c t s , P o l i c i e s . Univer191 See S t e i n e r , P e t e r 0. s i t y of Michigan P r e s s , 1975. p. 109-117; and B r i l o f f , A. J. Accounting P r a c t i c e s and t h e Merger Movement. Notre Dame Lawyer, v o l . 4 5 , Summer 1970. p. 604-628. I n an a t t e m p t t o e l i m i n a t e t h e s e k i n d s of d i s t o r t i o n s i n e a r n i n g s , t h e SEC has s i n c e r e q u i r e d e i t h e r r e t r o a c t i v e pooling ( t o i n s u r e c o n t i n u i t y of earnings c o m p a r i s o n s ) o r p u r c h a s e a c c o u n t i n g , whereby a c q u i r e d a s s e t s a r e v a l u e d a t t h e i r m a r k e t p r i c e , e l i m i n a t i n g t h e d i s t o r t i o n s a r i s i n g from u s e and a m o r t i z a t i o n o f goodwill. A l s o , more s t r i n g e n t a c c o u n t i n g f o r e a r n i n g s f l u c t u a t i o n s a r i s i n g from c o n v e r s i o n from p r e f e r r e d s t o c k and d e b e n t u r e s h a s been i n s t i t u t e d . 3 . Comparisons Between t h e C u r r e n t and P r e v i o u s P e r i o d s of Merger A c t i v i t y The c u r r e n t merger wave, which began i n t h e l a t e 1970s and i n t e n s i f i e d i n 1981, d i f f e r s i n s e v e r a l ways from t h a t o f t h e l a t e 1960s. Although f r i e n d l y d e a l s a r e s t i l l t h e dominant form, an i n c r e a s i n g number o f c o m b i n a t i o n s a r e now the r e s u l t of h o s t i l e actions. More l a r g e b l u e c h i p companies and "old l i n e " - i n v e s t m e n t b a n k e r s and banks now v i e w t h e p r o c e s s a s a c c e p t a b l e . 201 While - most o f t h e d e a l s i n v o l v e s m a l l companies, 21/ an i n c r e a s i n g p r o p o r t i o n o f d e a l s t e n d s t o b e l a r g e r i n d o l l a r v a l u e and t o b e c h a r a c t e r i z e d by a h i g h e r f r e q u e n c y o f b i d d i n g w a r s , which r a i s e t h e s t a k e s between competing companies; examples a r e t h e b i d d i n g wars o f t h e ~obil-Conoco-Du Pont and t h e Mobil-Marathon-U.S. Steel contests. W. T. G r i m & Co., which t r a c k s merger announcements, r e p o r t e d t h a t 1981 merger a c t i v i t y i n c r e a s e d 27% t o 2,395 t r a n s a c t i o n s , compared w i t h 1,889 a y e a r earlier. - T h i s r a t e d o e s n o t y e t a p p r o a c h t h e peak of t h e l a s t wave, when o v e r 20/ P h a l o n , R i c h a r d . The Takeover Barons of Wall S t r e e t . S o n s , New York, 1981. p . 90. G. P. Putnam's 211 For a more c o m p l e t e d i s c u s s i o n of t h e c o m p o s i t i o n of r e c e n t t e n d e r o f f e r F b y s i z e and f o r a l l i n d u s t r i e s (beyond t h e l i m i t e d m a n u f a c t u r i n g and m i n i n g sample t h e FTC p r o v i d e s ) , s e e U.S. L i b r a r y of C o n g r e s s . C o n g r e s s i o n a l R e s e a r c h S e r v i c e . C o r p o r a t e Mergers Through Tender O f f e r s : Measurement and Publ i c P o l i c y C o n s i d e r a t i o n s . Report No. 81-260 E , by Kevin F. Winch. Washington, 1981. wa ere in after c i t e d a s Winch, C o r p o r a t e M e r g e r s . ) 6,000 t r a n s a c t i o n s were r e p o r t e d i n 1968. The 1981 t r a n s a c t i o n s , a s measured i n c u r r e n t d o l l a r s , have grown s u b s t a n t i a l l y i n d o l l a r volume. According t o t h e Grim d a t a , t h e t o t a l c u r r e n t d o l l a r v a l u e p a i d f o r a c q u i s i t i o n s s e t a new r e c o r d f o r t h e t h i r d c o n s e c u t i v e y e a r : $82.6 b i l l i o n f o r 1981, a l m o s t d o u b l e - t h e $44.3 b i l l i o n f o r a l l of 1980 22/ and t h e $43 b i l l i o n f o r 1968. While t h e d o l l a r volume o f d e a l s i n c r e a s e d d r a m a t i c a l l y between 1981 and 1980, however, a f t e r a d j u s t i n g f o r i n f l a t i o n , t h e 1981 t o t a l was a c t u a l l y 17% l e s s t h a n t h e 1968 d o l l a r v a l u e ( i n 1981 t h e t r a n s a c t i o n s were v a l u e d a t a p p r o x i m a t e l y $43 b i l l i o n i n 1972 c o n s t a n t d o l l a r s , compared w i t h t h e 1968 t o t a l o f a p p r o x i m a t e l y $52 b i l l i o n i n 1972 c o n s t a n t d o l l a r s ) . There were t w e l v e t r a n s a c t i o n s d u r i n g 1981 v a l u e d a t more t h a n $1 b i l l i o n - Grim r e f e r s t o t h e s e a s "mega-deals." t o t h e $82.6 b i l l i o n t o t a l . Together t h e y c o n t r i b u t e d $38.4 b i l l i o n These t r a n s a c t i o n s i n c l u d e d t h e f o l l o w i n g w i d e l y publicized d e a l s : . 1. t h e $8 b i l l i o n c a s h and s t o c k a c q u i s i t i o n o f Conoco, Inc b y t h e Du Pont Co., one of t h e l a r g e s t c o r p o r a t e t a k e o v e r s i n r e c e n t U.S. history; 2. t h e $4.3 b i l l i o n p u r c h a s e of T e x a s g u l f , I n c . by S o c i e t e N a t i o n a l e Elf Aquitaine of France; 3. t h e t a k e o v e r o f S t . J o e M i n e r a l s Corp. b y F l u o r Corp. f o r $2.7 b i l l i o n i n c a s h and s t o c k ; 4. t h e $2 b i l l i o n c a s h a c q u i s i t i o n o f Kennecott Corp. by S t a n d a r d O i l Co. of Ohio; and 5. t h e $1.8 b i l l i o n merger between N a b i s c o , I n c / . and / Standard Brands, Inc . But Grim a l s o r e p o r t s t h a t "while mammoth t a k e o v e r s r e a c h e d r e c o r d b r e a k i n g l e v e l s , a c q u i s i t i o n s of s m a l l p r i v a t e l y h e l d companies remain t h e foc a l p o i n t " o f m e r g e r s and a c q u i s i t i o n (MA) activity. Of t h e 2,395 t r a n s a c t i o n s 221 P r e s s R e l e a s e , "W.T. G r i m & Co. Announces Record Year i n Mergers," W.T. Grinnu & Co., Chicago, I l l i n o i s , J a n u a r y 2 , 1982. tabulated for 1981, 1,332 or 56 percent involved the sale of a closely held firm. This figure actually represents an increase from 52 percent in 1980. The second most active segment of MSA activity involved divestitures. According to Grimm, the sale of divisions, subsidiaries, or product lines in 1981 accounted for 830 transactions or 35 percent of all acquisition activity. 231 Data compiled by the Federal Trade Commission ( F T C ) are not as current as the Grimm data, nor are they comparable. Most recent FTC data are preliminary for 1979, and they are only for publicly held manufacturing and mining companies with an acquisition value of $10 million or more. Thus, they do not include ser- vice companies, which have been important participants in MCA activity. (By com- parison, Grimm data are current and include all merger transactions with no restriction as to value or industry.) Nevertheless, the FTC data permit de- tailed historical comparisons between the current and last merger periods. The following tables show: - conglomerate mergers predominate in both periods (See Table 1); there were fewer acquisitions in 1979 than in 1968, but the average current dollar value per acquisition was greater in 1979 (See Table 2 and Chart 1); - when adjusting merger activity to take inflation into account, both the 1979 total value of assets and the average size of the acquisition remain smaller in constant dollars than during the peak of the prior merger wave, but the recent trend toward "mega-deals" has probably increased the average size of acquisitions since 1979 (see Table 2); - when adjusting merger activity to account for growth in assets for the manufacturing and mining sector as a whole, data in 1979 show that merger and acquisition assets accounted for a smaller percentage of the total assets of all manufacturing and mining companies than in 1968 (See Table 3). 23/ According to G r i m , "persistent high interest rates and dwindling cash flows have led to an increase in both divestitures and sales of private concerns. Divestitures permit large corporations to redirect assets into the most productive areas of their business. Sales of private concerns are increasingly motivated by a desire for liquidity on the part of selling stockholders." See release, "Merger Upturn Persists: Third Quarter Up 25X." W.T. G r i m & Co., Chicago, Illinois, October 21, 1981. TABLE 1 Distribution of Assets Acquired in Large a/ Mining and Manufacturing Mergers by Type For Selected Years 1948-1979 (percentages) b/ Horizontal 38.8 36.6 27.3 13.3 11.4 Vertical 23.8 11.5 20.1 23.8 8.9 Conglomerate 37.5 51.9 52.6 62.9 79.7 37.5 45.7 33.5 37.8 49.9 Product extension Market extension NA 2.7 5.0 8.0 8.7 Other NA 3.6 14.2 17.1 21.2 Horizontal 4.2 19.4 18.8 30.7 28.5 2.3 Vertical 7.2 7.7 15.9 15.1 7.3 88.6 72.9 65.3 68.2 56.4 90.4 39.0 31.7 13.3 22.6 28.0 35.9 5.9 3.1 15.3 7.6 .O .O 43.6 38.1 36.7 38.0 28.4 54.2 Conglomerate Product Extension Market Extension Other 1.1 Source: Federal Trade Commission. a/ Acquired firms with assets of $10 million or more for which data are publi~lyavailable. b/ Percentages may not sum to 100 percent because of rounding. c/ Figures for 1979 are preliminary. Note: It is possible that in any one year a small number of acquisitions of companies with large asset values could distort the data, however, the general trends observed are probably reasonably accurate. TABLE 2 L a r g e A c q u i s i t i o n s i n M a n u f a c t u r i n g and M i n i n g , By Y e a r , 1960-1979 Year Number o f Acquisitions (1) Assets (in millions of current dollars) (2) Assets (in millions of constant 1972 d o l l a r s ) (3) Average Size of Acquisition (in millions of current dollars) (4) S o u r c e : B u r e a u o f Economics, F e d e r a l T r a d e Commission. c a l c u l a t e d by CRS. -a / -b / Average S i z e of Acquisition ( i n constant 1972 d o l l a r s ) t5 Columns 3-5 A c q u i r e d f i r m s w i t h a s s e t s o f $10 m i l l i o n o r m o r e . F i g u r e s f o r 1979 a r e p r e l i m i n a r y . N o t e : Not i n c l u d e d i n above t a b u l a t i o n a r e c o m p a n i e s f o r which d a t a a r e n o t p u b l i c l y a v a i l a b l e . The d a t a a r e o n l y f o r l a r g e m i n i n g and m a n u f a c t u r i n g c o m p a n i e s and t h e r e f o r e d o n o t i n c l u d e s e r v i c e i n d u s t r i e s , which h a v e been q u i t e a c t i v e i n m e r g e r s and a c q u i s i t i o n s . The W.T. rim d a t a , on t h e o t h e r h a n d , c o v e r a l l t y p e s o f m e r g e r s and a c q u i s i t i o n s and a r e more c u r r e n t t h a n t h e FTC d a t a . The Grim d a t a show a d r a m a t i c i n c r e a s e i n t h e a v e r a g e s i z e o f a c q u i s i t i o n s s i n c e 1979, p r i m a r i l y b e c a u s e o f t h e i n c r e a s e i n "mega-deals." I n 1981 t h e r e w e r e 12 s u c h d e a l s o f o v e r $1 b i l l i o n e a c h ( e q u i v a l e n t t o $530 m i l l i o n i n 1972 d o l l a r s ) , compared w i t h o n l y 4 such t r a n s a c t i o n s i n 1980. CHART 1 LARGE* MANUFACTURING AND MINING FIRMS ACQUIRED 194801979 2oop-- UMBER OF FIRMS ACQUl ($ Billions) 'Firms with assets of $10 million or more. SOURCE: Buteou of Economics, Federal Trade Commission. TABLE 3 T o t a l . A s s e t s o f A l l Large M a n u f a c t u r i n g and Mining Companies Acquired a s a P e r c e n t a g e o f T o t a l A s s e t s o f A l l M a n u f a c t u r i n g and Mining C o r p o r a t i o n s , 1960-1979 A l l Manufacturing and Mining ~ o r ~ o r a t i o na s/ Total Assets ($ Millions) Year Large b/ Manuf a c t u r y n g and Mining ~ c ~ u i s i t i o n s Total Assets ($ Millions) Percentage a / F i g u r e s f o r Manufacturing and Mining C o r p o r a t e A s s e t s have been revisTd t o r e f l e c t t h e use of F i r s t Q u a r t e r Q u a r t e r l y F i n a n c i a l Reports. b/ - Acquired f i r m s w i t h a s s e t s o f $10 m i l l i o n o r more. c/ - F i g u r e s f o r 1979 a r e p r e l i m i n a r y . S o u r c e : C o r p o r a t e Manufacturing A s s e t s o b t a i n e d from Q u a r t e r l y F i n a n c i a l R e p o r t s . T o t a l s f o r Mining d e r i v e d from IRS S t a t i s t i c s o f Income f o r 1966 t h r o u g h 1974, and from Q u a r t e r l y F i n a n c i a l R e p o r t s t h e r e a f t e r . Bureau o f Economics, F e d e r a l Trade Commission. There a r e o t h e r d i f f e r e n c e s between t h e c u r r e n t p e r i o d o f i n c r e a s e d merger a c t i v i t y and t h e p r e c e d i n g one. I n t h e l a t e 1 9 6 0 s , r i s i n g s t o c k p r i c e s , which many a n a l y s t s r e g a r d e d a s " i n f l a t e d , " p r e c i p i t a t e d t h e p u r c h a s i n g o f companies i n exchange f o r s t o c k and c o n v e r t i b l e d e b e n t u r e s w i t h s u c h s p e c u l a t i v e e n t h u s i a s m t h a t t h e s e s t o c k s and d e b e n t u r e s were e u p h e m i s t i c a l l y r e f e r r e d t o r e s p e c t i v e l y a s "Chinese t r a d i n g stcanps" and " C a s t r o C o n v e r t i b l e s ." 241 By c o m p a r i s o n , i n t h e c u r r e n t wave o f merger and t a k e o v e r a c t i v i t y , a s i g n i f i c a n t l y g r e a t e r prop o r t i o n o f t h e d e a l s a r e f o r c a s h , whereby s t o c k i s p u r c h a s e d b y t h e b i d d e r on a - t e n d e r o f f e r b a s i s . 251 T h i s e n a b l e s t h e h o s t i l e o f f e r o r t o make h i s o f f e r q u i c k l y and d i r e c t l y t o t h e t a r g e t ' s s h a r e h o l d e r s r a t h e r t h a n h a v i n g t o g e t a p p r o v a l from t h e company's board o f d i r e c t o r s , which would have t o p u t t h e matter t o a shareholder vote. While t h e a c c o u n t i n g d e v i c e s which r e p o r t e d l y b o o s t e d merger a c t i v i t i e s i n t h e l a t e 1960s have l a r g e l y been r e v i s e d , some a c c o u n t i n g i n c e n t i v e s r e m a i n . There i s s t i l l a p o t e n t i a l " b o o t s t r a p " e f f e c t on e a r n i n g s p e r s h a r e when m e r g e r s o c c u r , a l t h o u g h t h i s may be l e s s i m p o r t a n t i n an a t m o s p h e r e where an i n c r e a s i n g number of i n s t i t u t i o n a l i n v e s t o r s p a r t i c i p a t e i n t h e m a r k e t and have t h e capaci t y t o analyze t h i s information. Some i n c e n t i v e t o buy a t l e a s t a p a r t i a l i n - t e r e s t i n a n o t h e r company, however, cames from t h e e q u i t y a c c o u n t i n g method, whereby a company owning 20 p e r c e n t o f a n o t h e r c a n i n c l u d e a p r o r a t a s h a r e of t h e l a t t e r ' s e a r n i n g s i n i t s own p r o f i t s t a t e m e n t . 24/ - P h a l o n , op. c i t . , p. 66. 25/ According t o W.T. Grim, f o r t h e f i r s t n i n e months o f 1981, among t h e d e a l s f o r which payment d a t a a r e d i s c l o s e d , c a s h a c q u i s i t i o n s comprised 4 2 % , exchange o f s t o c k 35%, and c o m b i n a t i o n s o f c a s h / s t o c k a n d / o r d e b t 22%. Data f o r 1968 show t h a t , a t t h e h e i g h t o f t h e l a s t c o n g l o m e r a t e merger wave, 29% o f t h e d e a l s were f o r c a s h , 62% were f o r s t o c k , and 9% w e r e f o r a c o m b i n a t i o n of cash and s e c u r i t i e s . 4. C u r r e n t M o t i v a t i o n s t o Merge It a p p e a r s t h a t t h e m a j o r impetus f o r t a k e o v e r a c t i v i t y now comes from a s e r i e s o f e v e n t s r e l a t e d t o h i g h i n f l a t i o n and h i g h i n t e r e s t r a t e s . First, i n f l a t i o n h a s t e n d e d t o make d e p r e c i a t e d a s s e t v a l u e s , a s s e t f o r t h on t h e books o f c o r p o r a t i o n s , less t h a n t h e i r f a i r m a r k e t o r r e p l a c e m e n t v a l u e s . Absence o f r o b u s t growth i n t h e s t o c k market f r e q u e n t l y means t h a t t h e m a r k e t p r i c e p e r s h a r e i s l e s s t h a n t h e i n t r i n s i c v a l u e o f t h e a s s e t s and even l e s s t h a n t h e i r d e p r e c i a t e d book v a l u e . For t h e S t a n d a r d and P o o r ' s 400 i n d u s t r i a l s , t h e aver- a g e r a t i o o f m a r k e t t o book v a l u e was r o u g h l y 2 i n 1969; i t h i t a h i g h i n - 1972 o f 2 . 3 and t h e n d e c l i n e d t o 1 . 1 i n 1974. 261 The a v e r a g e r a t i o f o r 1980 was s t i l l o n l y 1 . 2 . During t h e mid 1970s weakness i n t h e U.S. d o l l a r r e l a t i v e t o f o r e i g n c u r r e n c i e s s u c h a s t h e Deutschmark and t h e Swiss f r a n c made f o r e i g n p u r c h a s e o f U.S. s e c u r i t i e s , and t h e r e f o r e f o r e i g n t a k e o v e r s o f U.S. more a t t r a c t i v e . While h i g h e r U.S. companies, r e l a t i v e l y i n t e r e s t r a t e s have s i n c e somewhat moderated t h i s t r e n d , h i g h i n f l a t i o n r a t e s have b r o u g h t c o r p o r a t e r e l u c t a n c e t o r i s k new v e n t u r e s and a p r e f e r e n c e f o r p u r c h a s i n g ongoing b u s i n e s s e s o r proved reserves. With t h e c u r r e n t s o a r i n g i n f l a t i o n and h i g h c o s t o f b u i l d i n g new f a c i l i t i e s , t h e f i n a l c o m p l e t i o n c o s t i s n o t known... Because o f t h e current situation--i.e., t h e h i g h y i e l d from bonds and t h e d o u b l e t a x on dividends--common s t o c k s a r e s e l l i n g a t much l e s s t h a n t h e i r t r u e v a l u e , sometimes even l e s s t h a n t h e i r book v a l u e . T h e r e f o r e , i t i s g e n e r a l l y more a t t r a c t i v e t o a c q u i r e a g o i n g b u s i n e s s t h a n t o a t t e m p t t o b u i l d a d d i t i o n a l c a p a c i t y . 271 - 26/ Comments by Joseph H. P e r e l l a a t t h e 1979 American Bar A s s o c i a t i o n Urge t o Merge--Where Has It Come From and Where Is It ~ n n u a l ~ e e t i n ~The . Going? The B u s i n e s s Lawyer, A p r i l , 1980. p. 1419-1421. ( T h i s m e e t i n g and p u b l i c a t i o n h e r e i n a f t e r c i t e d a s ABA ~ e e t i n g . ) 271 - Comments by Thomas M. Evans, ABA M e e t i n g , op. c i t ., p . 1424-1425. T h i s s i t u a t i o n was e s p e c i a l l y e v i d e n t i n Mobil O i l ' s q u e s t f o r Marathon Oil. The Wall S t r e e t J o u r n a l r e p o r t e d comments from two Wall S t r e e t a n a l y s t s : A t a k e o v e r of Marat.hon would be s i m p l y ''a v e r y good p u r c h a s e " f o r Mobil.. M a r a t h o n ' s s h a r e s r e c e n t l y had t r a d e d a t s u c h low l e v e l s r e l a t i v e t o t h e i r underlying value t h a t a takeover " i s an opportunity.. The c o s t o f f i n d i n g o i l i s $12 t o $15 a b a r r e l . By b u y i n g Marathon a t $85 a s h a r e , Mobil c a n buy i t a t a b o u t $ 3 t o $3.50 p e r b a r r e l . 281 . ... ." - T h i s i s n o t t o s u g g e s t t h e t o t a l a b s e n c e o f more t r a d i t i o n a l m o t i v a t i o n s t o merge o r a c q u i r e , s u c h a s : -a d e s i r e t o a c h i e v e a l a r g e enough s i z e t o r e a l i z e an economical s c a l e of production and/or d i s t r i b u t i o n ; -a d e s i r e t o d i v e r s i f y t o r e d u c e t h e r i s k s o f b u s i n e s s ; -a d e s i r e t o u t i l i z e c e r t a i n t a x b e n e f i t s which may be a v a i l a b l e w i t h m e r g e r s or corporate reorganizations; -a d e s i r e t o overcome c r i t i c a l l a c k s i n o n e ' s own company by a c q u i r i n g t h e n e c e s s a r y complementary r e s o u r c e s , p a t e n t s , o r f a c t o r s of production; -a d e s i r e t o a c h i e v e s u f f i c i e n t s i z e t o have e f f i c i e n t a c c e s s t o c a p i t a l markets or inexpensive advertising; -a d e s i r e on t h e p a r t of managers t o i n c r e a s e t h e i r domain and t h e i r profits; -a d e s i r e t o respond t o s h r i n k i n g o p p o r t u n i t i e s f o r growth a n d / o r p r o f i t i n o n e ' s own i n d u s t r y b e c a u s e o f s h r i n k i n g demand o r e x c e s s i v e c o m p e t i t i o n . 291 - I n d e e d , t h e v a r i e t y o f t y p e s of m e r g e r s r e p o r t e d by t h e FTC and Grim undoubtedly i n d i c a t e d i v e r s i t y of purpose. But what d i f f e r e n t i a t e s t h e p r e s e n t merger wave from p r i o r waves i s a s e t o f m a r k e t c o n d i t i o n s which have encouraged l a r g e and e s t a b l i s h e d companies t o engage i n an u n p r e c e d e n t e d number o f h o s t i l e acquisitions. G r i m d a t a i n d i c a t e t h a t t e n d e r o f f e r s f o r p u b l i c 1y t r a d e d 281 B l u s t e i n , P a u l . M o b i l ' s Bid f o r Marathon R e f l e c t s L e s s o n s from ~ o n o c T 0 ffe r , Urge t o Gain R e s e r v e s . Wall S t r e e t J o u r n a l , November 4 , 1981. 291 - See S t e i n e r , op. c i t . , p. 30 e t s e q . companies in 1981 rose 42% to 75 from 53 a year earlier. accompanied by a rise in takeover battles. This increase was Among the 75 offers attempted during 1981, 28 or 37% were contested by the subject company's management, compared with 12 or 23% in 1980. This reflects the highest number of hostile tender offers that Grimm's research department has ever recorded. Of the 28 target companies resisting takeover attempts, G r i m notes that 15 were able to ward off their hostile suitors. But not all 15 remained independent- 9 were taken over by "white knights." The period can best be summed up by the following statement by a prominent merger and acquisitions specialist at First Boston, a leading investment firm: ... if you start with the premise that capital generally travels to areas of highest return where the smallest amount of attendant risk exists, and put that in the context of the figures [regarding the market price to book value ratios and the relative value of the dollar] perhaps you can better understand the explosion in cash merger and acquisition activity since 1974. a tremendous gap developed and still exists between the stock market value for 100 shares of stock and the underlying commercial value of an enterprise. ...y ou have the stock market down and lots of bargains around. The accountants passed rules making pooling more difficult, but no one really cares about pooling any more, with stocks selling way below book. Analysts used to be very nervous about goodwill, but that was pretty much reevaluated, and people began to care less about goodwill if they were paying more than book for stocks. When cash built up in the coffers of your so-called blue chip companies, they looked around and noticed that there was a Williams Act written that said if you want to make a takeover bid, this is how to do it. ... ... So you had the large, well-established, so-called AAA buyers looking not for the tun-around situations, but for quality, wellmanaged target companies. Therefore, [in] the last five years, you saw companies like Cargill, Clba-Geigy, International Nickel, Mobil Oil, Schlumberger, and Standard of Indiana launch unsolicited 30/ takeover efforts. In the current hostile atmosphere, few companies faced with an unsolicited tender offer survive as independent companies 301 - z/ even though companies are Perella, op. cit., p. 1420. 31/ The survival rate for domestic companies faced with a takeover via a tenderffer is small, but it is even smaller when foreign companies make tender offers for U.S. companies. See Winch, Corporate Mergers, op. cit., p. 14. employing a variety of defensive tactics to thwart raiders. Often the only possibility is to secure the protection of a "white knight," a company willing to purchase the target on terms arguably more favorable to it and usually with a provision to retain existing management. Yet, characteristic of this merger wave, shareholders may benefit greatly from premiums paid which are well above market price. 321 But the spectacle of large Fortune 500 companies attacking each other, counterattacking and maneuvering as if engaged in war games has raised public policy questions which go beyond the traditional antitrust and economic concentration questions raised in prior merger periods. In a somewhat skewed notion of the survival of the fittest, it is the wellmanaged firms which are frequently the targets. =/ At a time of concern over the competitive position and the rate of investment of U.S. industry, some cash-rich firms are moving to acquire in order to avoid being acquired. Questions of "fairness" arise at least as often as the traditional questions of whether a merger or acquisition will impede competition. When the tactics are so hostile, fairness-to munity-is management, shareholders, labor, pension fund recipients, the comnot easily defined but seems to be at the crux of the public policy debate. 321 J.A. Morgan & Co., an Oak Brook, Illinois, member consulting firm, reporcd that the average price paid for profitable manufacturing companies increased to 13.9 times their earnings for the 12-month period ending in the 3rd quarter of 1981. This compares with a 13.7 price-earnings ratio paid in the second quarter of 1981 and a 10.3 ratio in the 1980 third quarter. (To illustrate the magnitude of the premium, the PIE for the Dow Jones Industrials was 7.2 on December 4, 1981.) Buyers were willing to pay the highest premiums ever above net worth. The median premium was 100% more than net worth, up from 40% in the preceding quarter and 50% in this year's first quarter. Wall Street Journal, October 21, 1981. 331 - Perella, op. cit., p. 1420. CRS-27 11. THE TAKEOVER PROCESS: OFFENSIVE TACTICS A. S t r u c t u r i n g t h e Deal A s e r i e s o f i n n o v a t i v e t r a n s a c t i o n s h a s b e e n used i n r e c e n t y e a r s t o acq u i r e c o n t r o l o f p u b l i c companies. Some examples a r e : ... E d p e r ' s a c q u i s i t i o n o f 25 p e r c e n t o f t h e s t o c k o f B r a s c a n on t h e f l o o r o f t h e American S t o c k Exchange f o r t h e s o l i c i t a t i o n o f between 30 and 5 0 i n s t i t u t i o n a l h o l d e r s o f t h e s t o c k . The s e c o n d , and e v e n more c o n t r o v e r s i a l , was S u n ' s m i d n i g h t r a i d , p u r s u a n t t o which t h e y a c q u i r e d 35 p e r c e n t o f t h e s t o c k o f B e c t o n , D i c k i n s o n , T h i r d was t h e h i g h l y u n u s u a l o f f e r r e c e n t l y made by J . P . Fuqua t o a c q u i r e c o n t r o l of t h e Hoover Company.. . . h e made an o f f e r o n l y t o members o f t h e Hoover f a m i l y , who were s p r e a d t h r o u g h o u t t h e c o u n t r y and c o n t r o l l e d a p p r o x i m a t e l y 42 p e r c e n t o f t h e Hoover s t o c k . 3 4 1 - While t a k e o v e r s may be p u r s u e d by a l i m i t l e s s v a r i e t y o f t e c h n i q u e s , t h i s s e c t i o n e x p l o r e s some o f t h e b a s i c and well-known o f f e n s i v e t a c t i c s used by a h o s t i l e o f f e r o r ( s o m e t i m e s p e j o r a t i v e l y known a s a " r a i d e r " ) to acquire control of a s u b j e c t o r " t a r g e t " company t h r o u g h an u n s o l i c i t e d t e n d e r o f f e r . Any t a k e - o v e r s i t u a t i o n i s d y n a m i c , w i t h many moving p a r t s , i n c l u d i n g a c t i o n s b y : - t h e o f f e r o r ' s management and i t s i n v e s t m e n t b a n k i n g , l e g a l , b a n k , and public relations advisors; t h e s u b j e c t ' s management, w i t h i t s b a t t e r y o f i n v e s t m e n t b a n k i n g , l e g a l , b a n k , and p u b l i c r e l a t i o n s a d v i s o r s ; t h e i n v e s t m e n t community, i n c l u d i n g i n s t i t u t i o n a l i n v e s t o r s , t h e d i r e c t o r s o f s t o c k e x c h a n g e s on which i n v o l v e d s e c u r i t i e s a r e t r a d e d , t h e a r b i t r a g e u r s , and t h e s h a r e h o l d e r s of t h e o f f e r o r and s u b j e c t companies ; 341 - Comments by Edward F. G r e e n e , ABA M e e t i n g , o p . c i t . p. 1443-1444. CRS -2 8 - t h e r e g u l a t o r y a u t h o r i t i e s , i n c l u d i n g t h o s e a t t h e SEC, t h e FTC, t h e J u s t i c e Department, t h e F e d e r a l Reserve Board, t h e Committee on F o r e i g n I n v e s t m e n t i n t h e United S t a t e s , and o t h e r r e g u l a t o r y agencies, a s appropriate; - s/ t h e F e d e r a l and S t a t e c o u r t s ; t h e Congress and S t a t e and l o c a l l e g i s l a t o r s ; and o t h e r i n t e r e s t e d p a r t i e s , such a s l a b o r u n i o n s and p e n s i o n fund r e p r e s e n t a t i v e s , a s w e l l a s p u b l i c i n t e r e s t g r o u p s such a s consumer g r o u p s . While t h e r e i s no " t y p i c a l " takeover--each t a c t i c s o r t h e e v o l u t i o n o f a new method--the i n s t a n c e may evoke a change i n following s e c t i o n s provide t h e mechanics o f a s i m p l i f i e d t a k e o v e r example, n o t i n g t h e r o l e s o f t h e s e d i f f e r e n t par t i e s . 1. The O f f e r o r C o n s i d e r s a Range of I s s u e s A company's management may form t h e i d e a t o i n i t i a t e a t a k e o v e r o f a n o t h e r company from a v a r i e t y o f s o u r c e s , i n c l u d i n g i t s i n v e s t m e n t b a n k e r , p e r s o n a l f r i e n d s o f management, i t s l e g a l c o u n s e l , o r t h e i n t e r n a l c o r p o r a t e r e s e a r c h 35/ T h i s r e p o r t d e a l s w i t h j u s r i s d i c t i o n e x e r c i s e d by t h e SEC, FTC, and ~ u s t i Department z over a l l mergers g e n e r a l l y , but i t does not cover individIt s h o u l d be noted t h a t a d d i t i o n a l u a l agency o v e r s i g h t i n t h e merger a r e a . s p e c i a l i z e d s c r u t i n y i s r e q u i r e d by c e r t a i n a g e n c i e s f o r p a r t i c u l a r i n d u s t r i e s : e . g . , t h e Nuclear R e g u l a t o r y Commission must approve a c q u i s i t i o n s o f companies i n t h e e n e r g y f i e l d ; t h e F e d e r a l Energy R e g u l a t o r y Commission must a p p r o v e comb i n a t i o n s o f i n t e r s t a t e e l e c t r i c and g a s u t i l i t i e s ; and t h e F e d e r a l Communicat i o n s Commission must a p p r o v e a c q u i s i t i o n s i n t h e communications f i e l d . The Committee on F o r e i g n Investment i n t h e United S t a t e s (CFIUS), an i n t e r - a g e n c y body e s t a b l i s h e d by t h e e x e c u t i v e branch and l e d by t h e T r e a s u r y Department, i s charged w i t h g u a r d i n g a g a i n s t f o r e i g n i n v e s t m e n t s which a r e n o t i n t h e national interest. I t s o v e r s i g h t powers a r e l i m i t e d , however, as e v i d e n c e d by t h e f a c t t h a t i t s J u l y 1981 r e q u e s t t o t h e French government t o d e l a y t h e ac; , q u i s i t i o n o f an American f i r m exas as gulf) by a state-owned French f i r m ( ~ o c i e t e N a t i o n a l e E l f A q u i t a i n e ) was i g n o r e d . e f f o r t s o f i t s own in-house financial advisory s t a f f . The d e a l i s r e s e a r c h e d and s t r u c t u r e d t o t a k e i n t o c o n s i d e r a t i o n s u c h m a t t e r s a s : - t h e t a x and a c c o u n t i n g e f f e c t s o f v a r i o u s means o f e f f e c t i n g t h e combination ; - t h e b e s t s t r a t e g y f o r accomplishing t h e takeover ( e . g . n e g o t i a t e d a c q u i s i t i o n , u n s o l i c i t e d t e n d e r o f f e r , q u a n t i t y o f s t o c k needed t o a s s u r e c o n t r o l , t e r m s o f t h e d e a l needed t o e n s u r e t h a t t h e a r b i t r a g e u r s w i l l provide l i q u i d i t y f o r t h e d e a l ) ; - t h e a p p r o p r i a t e instruments t o use i n t h e d e a l ( e . g . , s t o c k , c a s h , d e b t , o r some c o m b i n a t i o n o f t h e s e ) ; - t h e c o s t o f t h e merger i n t e r m s o f i n v e s t m e n t a d v i s o r y , l e g a l , and public relations fees; - tender for t h e premium n e c e s s a r y t o e n s u r e t h a t t h e t e n d e r o f f e r g o a l i s met ( e . g . , t h a t i n v e s t o r s s u c h a s s h a r e h o l d e r s and a r b i t r a g e u r s w i l l enter i n t o the deal); - t h e r i s k and f i n a n c i a l i m p l i c a t i o n s o f a b i d d i n g war w i t h a r i v a l ; - t h e methods o f m e e t i n g t h e f i n a n c i a l r e q u i r e m e n t s f o r t h e d e a l ( e . g . , from i n t e r n a l l y g e n e r a t e d f u n d s from bank l o a n s o r from newly issued s e c u r i t i e s ) ; - t h e o p p o r t u n i t y c o s t o f making t h e a c q u i s i t i o n a s opposed t o u s i n g t h e f u n d s f o r a l t e r n a t i v e i n v e s t m e n t p u r p o s e s ; and t h e l e g a l r a m i f i c a t i o n s of t h e proposed d e a l ( e . g . , t h e r i s k of v i o l a t i n g a n t i t r u s t o r SEC o r S t a t e d i s c l o s u r e l a w s ) . 2. The S p e c i a l R o l e o f A r b i t r a g e u r s Among t h e c o n s i d e r a t i o n s a f f e c t i n g t h e s e d i v e r s e p a r t i e s , some m e n t i o n 361 whose p a r t i c i p a t i o n s h o u l d b e made o f t h e r o l e o f r i s k a r b i t r a g e u r s , - 361 "Risk" a r b i t r a g e d i f f e r s from t h e more c l a s s i c " r i s k l e s s " a r b i t r a g e i n t h a t t h e l a t t e r i n v o l v e s t h e p u r c h a s e o f a s e c u r i t y and t h e s i m u l t a n e o u s o r n e a r l y s i m u l t a n e o u s s a l e o f an e q u i v a l e n t o r r e l a t e d s e c u r i t y a t a s l i g h t l y higher price. See d e f i n i t i o n s i n w e l l e s , C h r i s . Inside the Arbitrage Game. I n s t i t u t i o n a l I n v e s t o r , August 1981. p . 41-57. c a n a f f e c t t h e outcome o f a proposed t a k e o v e r d e a l ; d e s c r i b i n g t h e i r r o l e a l s o a f f o r d s i n s i g h t i n t o the o v e r a l l s t r a t e g y of t h e d e a l . I n i t s most s i m p l e form, r i s k a r b i t r a g e i n v o l v e s t h e o u t r i g h t p u r c h a s e o f s e c u r i t i e s i n a company t h a t i s t h e s u b j e c t o f a planned r e o r g a n i z a t i o n , most commonly a m e r g e r , exA r e l a t i v e l y s m a l l g r o u p of change o f f e r , c a s h t e n d e r o f f e r , o r l i q u i d a t i o n . h i g h l y p r o f e s s i o n a l s p e c i a l i s t s c a l l e d t h e " p r o f e s s i o n a l a r b i t r a g e u r s " dominates t h i s f i e l d , a l t h o u g h an i n c r e a s i n g number o f "amateur a r b i t r a g e u r s , " made up o f t h e i n v e s t i n g p u b l i c and r e t a i l s t o c k b r o k e r s , h a s j o i n e d i n t h e s p h e r e o f merg e r s p e c u l a t i o n s u r r o u n d i n g " d e a l s t o c k s , " which a r e t h e s u b j e c t o f announced o r anticipated takeovers. According t o t h e I n s t i t u t i o n a l I n v e s t o r , i n t h e r e l a - t i v e l y s m a l l number o f b i l l i o n - d o l l a r d e a l s , t h e a r b i t r a g e u r s ' r o l e may b e m i n o r , but i n t h e much more common $100 m i l l i o n t o $500 m i l l i o n d e a l s , e s p e c i a l l y t h o s e i n v o l v i n g r i v a l b i d d e r s , a r b i t r a g e u r s ( a r b s ) o f t e n come t o c o n t r o l 30 t o 4 0 p e r c e n t o f t h e s t o c k . Once a s t o c k becomes a d e a l s t o c k , s a y s one mba (merger and a c q u i s i t i o n ) c h i e f , t h e r e g u l a r i n s t i t u t i o n s g e t out of t h e s t o c k and t h e a r b i t r a g e community t a k e s t h e i r p l a c e . The a r b s t h e n s e t t h e m a r k e t . So you have t o c a t e r t o t h e i r t a s t e s . 371 - The o f f e r o r must gauge what "premium1'--the d i f f e r e n c e between t h e m a r k e t p r i c e of t h e s h a r e s i n a company i t w i s h e s t o a c q u i r e and t h e merger o f f e r i n g price--is n e c e s s a r y t o m o t i v a t e a s u f f i c i e n t number o f i n v e s t o r s , i n c l u d i n g a r - bitrageurs, t o tender t h e i r shares t o the offeror. tender offer , A f t e r an announcement o f a t h e a r b i t r a g e u r s may buy s t o c k i n t h e s u b j e c t company, d e p e n d i n g on t h e i r a s s e s s m e n t o f t h e v a l u e of t h e d e a l , which i s based on a c o m b i n a t i o n o f t h e p o t e n t i a l premium i f t h e d e a l i s consunrmanted and t h e r i s k t h a t t h e d e a l w i l l f a l l through. A l s o , g e n e r a l l y s p e a k i n g , t h e more a r b i t r a g e u r s t h e r e a r e i n t h e d e a l , t h e more l i k e l i h o o d of s u c e s s s , s i n c e t h e y a r e much more l i k e l y t o t e n d e r 371 - W e l l e s , op. c i t . , p. 51. t h e i r s h a r e s t h a n c e r t a i n c l a s s e s o f i n v e s t o r s s u c h a s management and employee g r o u p s t h a t may own c o n s i d e r a b l e b l o c k s o f s t o c k . The v a l u e o f t h e i r p a r t i c i p a - t i o n stems from t h e f a c t t h a t , u n l e s s t h e t a r g e t e d amount o f s h a r e s needed t o gain control is a c t u a l l y tendered, t h e deal w i l l collapse. The a r b i t r a g e u r s ' m o t i v a t i o n s may be summed up: The p r o f i t s i n r i s k a r b i t r a g e , o f c o u r s e , d e r i v e from t h e d i f f e r e n t i a l o r s p r e a d between t h e p r i c e o f t h e s t o c k f o l l o w i n g t h e announcement o f a r e o r g a n i z a t i o n and t h e v a l u e u l t i m a t e 1 y r e a l i z e d b y s h a r e h o l d e r s when t h e t r a n s a c t i o n i s c o m p l e t e d . The r i s k i n r i s k a r b i t r a g e d e r i v e s from t h e p o s s i b i l i t y t h a t t h e t r a n s a c t i o n w i l l n o t b e completed. Between t h e announcement and t h e c o m p l e t i o n of a d e a l , t h e s t o c k w i l l t e n d t o t r a d e somewhere between i t s pre-announcement p r i c e and t h e e s t i m a t e d v a l u e of t h e deal t o the shareholders. I f the deal i s terminated, the s t o c k w i l l u s u a l l y d r o p p r e c i p i t o u s l y t o pre-announcement l e v e l s [ e m p h a s i s t h e i r s ] . 381 - - Thus, s t r u c t u r i n g t h e d e a l so a s t o be a t t r a c t i v e t o t h e a r b i t r a g e u r s , e s p e c i a l l y t h e p r o f e s s i o n a l a r b i t r a g e u r s , c a n be i m p o r t a n t . The a r b i t r a g e u r s v a l u e more h i g h l y d e a l s i n which t h e r e i s l i k e l i h o o d t h a t a l l t h e s h a r e s t h e y p u r c h a s e w i l l be a b l e t o be t e n d e r e d , a l t h o u g h some d e a l s a r e , f o r o t h e r f i n a n c i a l r e a s o n s , s t r u c t u r e d so a s t o put a c e i l i n g on t h e number o f s h a r e s an o f f e r e r w i l l exchange. p l e , U.S. In t h i s c a s e , tendered shares a r e p r o r a t e d . o or exam- S t e e l made a t e n d e r o f f e r f o r 30 m i l l i o n s h a r e s o r 51 p e r c e n t o f M a r a t h o n ' s s h a r e s . N i n e t y p e r c e n t o f M a r a t h o n ' s s h a r e s were t e n d e r e d , s o f o r each share tendered, t h e shareholder received 51/90ths, o r t h e value of approximately 56 s h a r e s f o r each 100 t e n d e r e d . ) When a n o f f e r o r o f f e r s t e r m s o t h e r t h a n c a s h , such a s c o n v e r t i b l e p r e f e r r e d s t o c k o r b o n d s , t h e a r b i t r a g e u r s w i l l v a l u e t h e deal differently. T h e i r r o l e i n i n f l u e n c i n g t h e s t r u c t u r e and t h e s u c c e s s o r f a i l u r e of a d e a l should be n o t e d . 381 W e l l e s , - op. c i t . , p. 42. 3. The O f f e r o r Buys a n I n i t i a l Block of t h e S u b j e c t ' s S t o c k Assuming t h a t t h e o f f e r o r d e c i d e s c o n d i t i o n s a r e f a v o r a b l e f o r g o i n g f o r ward w i t h an a c q u i s i t i o n , h e may b e g i n t h e m u l t i - s t e p p r o c e s s a l r e a d y r e f e r r e d to: t h e o f f e r o r f i r s t buys a b l o c k of s t o c k , t h e n makes a t e n d e r o f f e r and f i n a l l y f o l l o w s up w i t h a n e g o t i a t e d a c q u i s i t i o n t o "mop up1' t h e d e a l . Of c o u r s e , t h e o f f e r o r may s k i p t h e f i r s t s t a g e and go d i r e c t l y t o t h e t e n d e r o f f e r s t a g e , b u t s i n c e t h e o f f e r o r a l m o s t always w a n t s 100 p e r c e n t o f t h e t a r g e t , which i s v i r t u a l l y i m p o s s i b l e t o o b t a i n t h r o u g h a t e n d e r o f f e r , a mop-up d e a l i s generally required. A company c o n t e m p l a t i n g a t a k e o v e r may f i r s t buy a b l o c k of - s t o c k f o r a number of r e a s o n s , i n c l u d i n g : 391 ( 1 ) t o u t i l i z e e q u i t y a c c o u n t i n g , which e n a b l e s a company p u r c h a s i n g 20 p e r c e n t o f a n o t h e r company's s t o c k t o i n c l u d e i n i t s e a r n i n g s a p r o - r a t a s h a r e o f t h e l a t t e r ' s e a r n i n g s ( a l t h o u g h p u r c h a s e of 5 p e r c e n t o r more r e q u i r e s an SEC b e n e f i c i a l o w n e r s h i p 13D f i l i n g o r , i f a t e n d e r o f f e r i s t h e i n t e n t , an SEC t e n d e r o f f e r 14D-1 f i l i n g ; see following section for d e t a i l s ) ; ( 2 ) t o g a i n a f o o t h o l d , p o s s i b l y even a s e a t on t h e board o f d i r e c t o r s , and t h u s a c h i e v e more s t a n d i n g i n n e g o t i a t i n g w i t h t h e s u b j e c t ' s management a b o u t an a c q u i s i t i o n ; ( 3 ) t o t e s t t h e market t o g e t a f e e l f o r t h e a p p r o p r i a t e o f f e r i n g p r i c e ; ( 4 ) t o p r o v i d e " n e g a t i v e c o n t r o l ," whereby, a s a l a r g e s t o c k h o l d e r , t h e p o t e n t i a l o f f e r o r could a t t e m p t t o b l o c k management from employing a v a r i e t y o f d e f e n s i v e "shark-repellent" t a c t i c s such a s : - i s s u i n g more s h a r e s t o d i l u t e t h e p o t e n t i a l o f f e r o r ' s h o l d i n g s ; - merging w i t h a n o t h e r company r e f e r r e d t o a s a " w h i t e k n i g h t " ; buying a company which w i l l p r e s e n t t h e p o t e n t i a l o f f e r o r w i t h a n t i t r u s t c o n f l i c t s , e t c . ( ~ o t e :d e f e n s i v e t a c t i c s w i l l be d i s c u s s e d f u r t h e r i n a s u b s e q u e n t s e c t i o n ) ; and - ( 5 ) t o p r o v i d e some i n s u r a n c e a g a i n s t l o s s e s i n t h e e v e n t t h a t t h e p o t e n t i a l o f f e r o r d o e s make a t e n d e r o f f e r b u t t h a t t h e s u b j e c t goes t o a r i v a l higher bidder ( i n t h i s c a s e , t h e o f f e r o r ' s s t o c k w i l l be t e n d e r e d a t a p r o f i t ) . 39/ - See P h a l o n , op. c i t . , p. 33, 7 8 , 92. B. Mergers and A c q u i s i t i o n s : S e c u r i t i e s R e g u l a t i o n s 1. SEC J u r i s d i c t i o n Over a n I n i t i a l P u r c h a s e o f a Block o f S t o c k S e c t i o n 1 3 ( d ) o f t h e s e c u r i t i e s and Exchange Act o f 1934, a s amended by t h e W i l l i a m s Act o f 1968, r e q u i r e s t h a t a S c h e d u l e 13D form be f i l e d w i t h t h e SEC, w i t h t h e s u b j e c t o r t a r g e t company, and w i t h e a c h exchange on which t h e s u b j e c t ' s s e c u r i t i e s a r e t r a d e d , w i t h i n 10 d a y s a f t e r any p e r s o n o r g r o u p acq u i r e s " b e n e f i c i a l ownership" of 5 p e r c e n t o r more o f a c l a s s o f r e g i s t e r e d - e q u i t y s e c u r i t i e s . 401 The Schedule 13D must d i s c l o s e , among o t h e r t h i n g s , t h e s o u r c e o f f u n d s f o r t h e a c q u i r e d s e c u r i t i e s , t h e p u r p o s e o f t h e a c q u i s i t i o n , and t h e purchaser's f u t u r e plans with respect t o c o n t r o l of t h e s u b j e c t o r t a r g e t . I f t h e p u r c h a s e s a r e t o s t r e n g t h e n t h e a c q u i r o r ' s p o s i t i o n i n a n t i c i p a t i o n of merger n e g o t i a t i o n s , i t must b e d i s c l o s e d t h a t a p o s s i b l e m e r g e r w i l l b e considered. I f t h e p u r p o s e o f t h e p u r c h a s e i s t o f r u s t r a t e a t a k e o v e r by a t h i r d - p a r t y , d i s c l o s u r e o f t h a t f a c t must a l s o b e made. 411 S e c t i o n 1 3 ( d ) o f t h e Williams Act h a s been c r i t i c i z e d on t h e g r o u n d s t h a t some companies have made l a r g e a d d i t i o n a l a c c u m u l a t i o n s o f t h e s u b j e c t ' s s t o c k d u r i n g t h e 10-day "window" p e r i o d p r i o r t o f i l i n g t h e r e q u i r e d S c h e d u l e 13D., and have t h u s i n c r e a s e d t h e i r l e v e r a g e o v e r t h e s u b j e c t company d e s p i t e SEC f i l i n g r e q u i r e m e n t s , which a r e i n t e n d e d t o d i s c l o s e such a c t i o n s . 401 - E a r l y i n 1980, SEC Requirements a r e o u t l i n e d i n K a t c h e r , o p . c i t . , p. 4-7 e t s e q . 4 1 / See K a t c h e r f o r b e n e f i c i a l o w n e r s h i p f i l i n g r e q u i r e m e n t s f o r i n s t i t u t i o n a r i n v e s t o r s and members o f t h e s e c u r i t i e s p r o f e s s i o n such a s b r o k e r - d e a l e r s and r i s k a r b i t r a g e u r s who t a k e p o s i t i o n s i n a s t o c k w i t h no i n t e n t i o n o f g a i n i n g c o n t r o l . C e r t a i n o f t h e s e ( a s w e l l a s b e n e f i c i a l owners who had a c q u i r e d n o t more t h a n 2 p e r c e n t o f a c l a s s o f s e c u r i t i e s w i t h i n a 12-month p e r i o d ) may f i l e a Schedule 1 3 G which i s an a b b r e v i a t e d S c h e d u l e 13D. Op. c i t . , p . 4-10, e t s e q . Commissioner Harold W i l l i a m s proposed amendments t o t h e W i l l i a m s Act t o c o r r e c t t h e s e perceived abuses. 421 These amendments, which have n e v e r been en- a c t e d , would, among o t h e r t h i n g s , " c l o s e t h e 10-day window p e r i o d by r e q u i r i n g t h a t s h a r e h o l d e r s owning 5 p e r c e n t o f a company make p u b l i c announcement w i t h i n 1 b u s i n e s s d a y a f t e r r e a c h i n g t h e 5 p e r c e n t l e v e l , f i l e a S c h e d u l e 13D w i t h i n 5 b u s i n e s s d a y s , and r e f r a i n from making f u r t h e r p u r c h a s e s u n t i l 2 b u s i n e s s days a f t e r t h e f i l i n g i s made." 431 Opponents o f t h e proposed amendments a r g u e t h a t d e l a y s i n a b i l i t y t o p u r c h a s e s e c u r i t i e s and more cumbersome r e p o r t i n g r e q u i r e ments w i l l i n t e r f e r e w i t h smooth f u n c t i o n i n g o f t h e s e c u r i t i e s m a r k e t s . I n t h e f a s t - m o v i n g merger p r o c e s s , t h e t i m i n g f o r amending S c h e d u l e 13D may be i m p o r t a n t . Amendments a r e r e q u i r e d t o b e made "promptly" s p e c i f i e d ) i f any " m a t e r i a l " (no time i n t e r v a l change o c c u r s i n t h e f a c t s s e t f o r t h i n t h e Schedule a n d / o r i f c h a n g e s o c c u r i n b e n e f i c i a l o w n e r s h i p e q u a l t o one p e r c e n t o r more o f the class. Proposed amendments would have r e q u i r e d t h e d i s c l o s u r e t o be f i l e d w i t h i n 5 b u s i n e s s d a y s o f t h e s e changes and would have r e q u i r e d p u r c h a s e r s t o r e f r a i n from making a d d i t i o n a l p u r c h a s e s u n t i l two b u s i n e s s days a f t e r f i l i n g t h e amendment. 2. The O f f e r o r Makes a Tender O f f e r and T r i g g e r s A d d i t i o n a l SEC O v e r s i g h t The n e x t s t e p i n t h e t a k e o v e r p r o c e s s o c c u r s when a p o t e n t i a l o f f e r o r f i n a l i z e s h i s p l a n s t o make a t a k e o v e r b i d . The f o l l o w i n g d i s c u s s i o n assumes 42/ I n r e s p o n s e t o a r e q u e s t from members o f t h e S e n a t e Banking Committee SEC ~ G i s s i o n e rHarold W i l l i a m s t r a n s m i t t e d a l e t t e r on F e b r u a r y 1 5 , 1980, and s h o r t l y t h e r e a f t e r s e n t a d r a f t o f a proposed b i l l t o amend t h e W i l l i a m s A c t . Both t h e l e t t e r and t h e proposed b i l l were r e p r i n t e d i n S e c u r i t i e s Reg. & L . Rep. (BNA) Spec. Supp. 2 , F e b r u a r y 1 7 , 1980, and Spec. Supp. 20, F e b r u a r y 27, 1980. See F o g e l s o n , James H . , Joanne R. Wenig and B r i a n P. Friedman. Changing t h e Takeover Game: The S e c u r i t i e s and Exchange Commission's Proposed Amendments t o t h e W i l l i a m s Act. Harvard J o u r n a l on L e g i s l a t i o n , Vol. 1 7 , W i n t e r 1980. ( H e r e i n a f t e r c i t e d a s Fogelson e t a 1 .) p. 410. 43/ - K a t c h e r , op. c i t . , p. 4-9. See a l s o F o g e l s o n , e t a l . he h a s c h o s e n t o f o l l o w up h i s i n i t i a l p u r c h a s e w i t h an u n s o l i c i a t e d t e n d e r o f f e r f o r a l l o r a c o n t r o l l i n g portion of t h e s u b j e c t ' s s e c u r i t i e s . The W i l l i a m s Act r e g u l a t e s t a k e o v e r b i d s i n f o u r ways; i t : ( 1 ) r e q u i r e s d i s c l o s u r e t h r o u g h s t a t e m e n t s f i l e d w i t h t h e SEC and circulated to investors; ( 2 ) p r e s c r i b e s s u b s t a n t i v e r e q u i r e m e n t s a s t o t h e form and c o n t e n t o f offers ; ( 3 ) p l a c e s c o n t r o l s o v e r recommendations a s t o t e n d e r o f f e r s ; and ( 4 ) c o n t a i n s a broad a n t i f r a u d p r o v i s i o n . %/ Tender o f f e r r u l e s have been r e v i s e d a number o f t i m e s . Current r u l e s which became e f f e c t i v e J a n u a r y 7 , 1980, a r e grouped i n t o two c a t e g o r i e s , R e g u l a t i o n s 14D and 14E. Both r e g u l a t i o n s a p p l y t o t e n d e r o f f e r s f o r any c l a s s o f e q u i t y s e c u r i t y i s s u e d by a r e g i s t e r e d p u b l i c company. I f the t e n d e r o f f e r o r s e e k s s e c u r i t i e s o t h e r t h a n t h a t o f a r e g i s t e r e d company, o n l y R e g u l a t i o n 14E a p p l i e s . B r i e f l y , t h e s e a r e t h e main p r o v i s i o n s : %/ R e g u l a t i o n 14-D Rule 14d-3 r e q u i r e s t h e b i d d e r t o f i l e w i t h t h e SEC and d i s s e m i n a t e t o t h e s u b j e c t company, any o t h e r b i d d e r , and any n a t i o n a l s e c u r i t i e s exchange o r t h e N a t i o n a l A s s o c i a t i o n o f S e c u r i t i e s D e a l e r s , a Tender O f f e r S t a t e m e n t on S c h e d u l e 14D-1 f i v e d a y s a f t e r t h e commencement d a t e of t h e o f f e r . T h i s 14D-1 f i l i n g r e q u i r e s much more i n f o r m a t i o n t h a n was r e q u i r e d by S c h e d u l e 13D ( u s e d t o r e p o r t b e n e f i c i a l o w n e r s h i p of 5 p e r c e n t o f a c l a s s o f s e c u r i t i e s ) . I t e m s on S c h e d u l e 14D-1 c a l l f o r d i s c l o s u r e o f t h e b i d d e r ' s f i n a n c i a l s t a t e m e n t s and any a r r a n g e m e n t s between t h e b i d d e r and t h e t a r g e t company and t h e i r o f f i c e r s and d i r e c t o r s , and t h e a p p l i c a b i l i t y o f t h e a n t i t r u s t laws and m a r g i n requirements. These must be d i s c l o s e d i f t h e y a r e m a t e r i a l t o a d e c i s i o n b y a s e c u r i t y h o l d e r whether t o s e l l , t e n d e r o r h o l d s e c u r i t i e s b e i n g s o u g h t i n t h e t e n d e r o f f e r . A l s o , i n f o r m a t i o n such a s l o a n a g r e e m e n t s t o f i n a n c e t h e t e n d e r o f f e r must b e p r o v i d e d . 441 Wander, H e r b e r t S. The E f f e c t o f t h e S e c u r i t i e s Laws on V a r i o u s ~ c ~ u i x t i oMethods, n P a r t 2, ALI-ABA Course M a t e r i a l s J o u r n a l , Vol. 5 , F e b r u a r y 1981. p. 86. 45/ The f o l l o w i n g d e s c r i p t i o n o f R e g u l a t i o n s 14D and 14E i s l a r g e l y e x c e r F e d from Wander, op. c i t . , p. 87-90, b u t i n c l u d e s r e f e r e n c e s t o K a t c h e r op. c i t . , as w e l l . R u l e 14d-2 d e f i n e s t h e commencement d a t e f o r t h e t e n d e r o f f e r , a key c o n c e p t under t h e new r u l e s . An o f f e r i s commenced b y p r e s s r e l e a s e , newspaper a d v e r t i s e m e n t o r o t h e r p u b l i c s t a t e m e n t made by t h e b i d d e r o r on h i s b e h a l f which ( i ) i d e n t i f i e s t h e b i d d e r and t h e s u b j e c t company and ( i i ) s t a t e s t h e amount and c l a s s o f s e c u r i t i e s b e i n g sought i n t h e t e n d e r o f f e r and t h e p r i c e o r r a n g e of p r i c e s b e i n g o f f e r e d . But no t e n d e r o f f e r w i l l be deemed t o have commenced i f , w i t h i n f i v e b u s i n e s s d a y s , t h e b i d d e r i s s u e s an announcement t h a t i t i s n o t continuing with t h e o f f e r . Rule 14d-1 d e a l s w i t h t h e scope o f t h e r e g u l a t i o n o f t e n d e r o f f e r s and p r o v i d e s a d e f i n i t i o n a l framework t o c l a r i f y t e r m s . Rule 14d-9 s t a t e s t h a t no s o l i c i t a t i o n t o s e c u r i t y h o l d e r s may b e made by any p e r s o n o t h e r t h a n t h e b i d d e r s p e c i f i e d i n t h e r u l e w i t h r e s p e c t t o a t e n d e r o f f e r u n l e s s t h a t p e r s o n f i l e s w i t h t h e SEC a Tender O f f e r S o l i c i tation-Recomnendation S t a t e m e n t on Schedule 14D-9 on t h e d a t e s u c h s o l i c i t a t i o n is f i r s t sent t o security holders. Minimum i n f o r m a t i o n r e q u i r e m e n t s a r e s t i p u l a t e d by t h i s r u l e and d i s c l o s u r e r e q u i r e m e n t s a r e c o v e r e d by Rule 14d-6. R e g u l a t i o n 14E Rule 14e-1 r e q u i r e s any t e n d e r o f f e r t o remain open f o r a minimum of 20 b u s i n e s s d a y s from t h e d a t e i t i s f i r s t p u b l i s h e d o r s e n t t o s e c u r i t y h o l d e r s . A l s o , t h e o f f e r must remain open a t l e a s t t e n days f o l l o w i n g n o t i c e o f an i n c r e a s e i n e i t h e r t h e o f f e r e d c o n s i d e r a t i o n o r t h e d e a l e r ' s s o l i c i t i n g f e e . The c o n s i d e r a t i o n f o r t h e t e n d e r e d s e c u r i t i e s must be p a i d o r t h e s e c u r i t i e s r e t u r n e d "promptly" a f t e r t h e t e r m i n a t i o n o r withdrawal of t h e o f f e r . Rule 14e-2 i n t e r r e l a t e s w i t h Rule 14d-9 and r e q u i r e s t h e t a r g e t company t o p u b l i s h o r send n o t i c e o f i t s p o s i t i o n c o n c e r n i n g t h e o f f e r t o s e c u r i t y h o l d e r s w i t h i n t e n days o f t h e o f f e r ' s commencement. T h i s p o s i t i o n s h o u l d t a k e one o f s e v e r a l forms: a recommendation t o a c c e p t o r r e j e c t t h e b i d d e r ' s o f f e r ; a s t a t e m e n t t h a t t h e t a r g e t company i s exp r e s s i n g no o p i n i o n and i s r e m a i n i n g n e u t r a l toward t h e b i d d e r ' s o f f e r ; o r a s t a t e m e n t t h a t t h e t a r g e t company i s u n a b l e t o t a k e a p o s i t i o n w i t h respect t o the bidder's offer. When t h e W i l l i a m s Act was p a s s e d , Congress d e c l i n e d t o d e f i n e t h e term "tender o f f e r ." Many have argued t h a t t h e dynamic n a t u r e o f t e n d e r o f f e r s and t h e need f o r t h e SEC t o i n t e r p r e t t h e W i l l i a m s Act i n a f l e x i b l e manner p r e clude p r e c i s e d e f i n i t i o n . I n terms o f c o n v e n t i o n a l u s a g e , o n e commentator n o t e s t h a t a t e n d e r o f f e r may be c o n s i d e r e d t o be ''a p u b l i c l y made i n v i t a t i o n addressed t o a l l shareholders o f a c o r p o r a t i o n t o tender t h e i r s h a r e s f o r s a l e - a t a s p e c i f i e d price." 46/ But, given t h e i n n o v a t i v e n a t u r e o f t h e s e c u r i t i e s i n d u s t r y , w i t h i t s wide v a r i e t y o f open market and p r i v a t e p u r c h a s e methods t o a c q u i r e s e c u r i t i e s ( w i t h o r w i t h o u t p u b l i c announcements), t h e r e would have t o be c o n s i d e r a b l e a m b i g u i t y c o n c e r n i n g when a t r a n s a c t i o n i s a t e n d e r o f f e r . C u r r e n t l y , a c o m b i n a t i o n o f j u d i c i a l p r e c e d e n t and SEC r u l e m a k i n g p r o d u c e s an evolving d e f i n i t i o n of a tender o f f e r . The F e b r u a r y 1980 proposed amendments t o t h e W i l l i a m s Act a l s o i n c l u d e d a d e f i n i t i o n o f " t e n d e r o f f e r " t h a t would make t h e f o r m a l t e n d e r o f f e r p r o v i s i o n s of t h e W i l l i a m s Act g e n e r a l l y a p p l i c a b l e t o a c q u i s i t i o n s o f t e n p e r c e n t o r more o f a company's e q u i t y s e c u r i t i e s and t o most a c q u i s i t i o n s by p e r s o n s , i n c l u d i n g o f f i c e r s and d i r e c t o r s , who have p r e v i o u s l y a c q u i r e d a 10 p e r c e n t p o r t i o n . proposed d e f i n i t i o n o f t e n d e r o f f e r would i n v o l v e a t w o - t i e r a p p r o a c h and an o f f e r would c o n s t i t u t e a t e n d e r o f f e r i f i t were t o meet t h e t e s t i n e i t h e r - t i e r : 47/ ( 1 ) Under t h e f i r s t t i e r , t h e t e r m " t e n d e r o f f e r " would c o n s i s t o f : -one o r more o f f e r s t o p u r c h a s e , o r s o l i c i t a t i o n s o f o f f e r s t o s e l l , s e c u r i t i e s of a s i n g l e c l a s s - d u r i n g any 45-day p e r i o d - d i r e c t e d t o more t h a n t e n p e r s o n s and s e e k i n g t h e a c q u i s i t i o n o f more t h a n f i v e p e r c e n t of t h e c l a s s o f s e c u r i t i e s . ( 2 ) Under t h e second t i e r , o n e o r more o f f e r s t o p u r c h a s e , o r s o l i c i t a t i o n s of o f f e r s t o s e l l , s e c u r i t i e s of a s i n g l e c l a s s would be a t e n d e r o f f e r i f : -the o f f e r s o r t h e s o l i c i t a t i o n s a r e disseminated i n a widespread manner ; - t h e p r i c e o f f e r e d r e p r e s e n t s a premium i n e x c e s s o f t h e g r e a t e r of 5 p e r c e n t o r $2 above t h e c u r r e n t m a r k e t p r i c e o f t h e sec u r i t i e s b e i n g s o u g h t ; and - t h e o f f e r s do n o t p r o v i d e f o r a m e a n i n g f u l o p p o r t u n i t y t o n e g o t i a t e t h e p r i c e and terms--thus t r u l y n e g o t i a t e d p u r c h a s e s o f s e c u r i t i e s would n o t b e r e g u l a t e d a s a t e n d e r o f f e r under t h e second t i e r . 46/ 47/ - S e e d i s c u s s i o n i n Fogelson e t a l . , E x c e r p t e d from Wander, o p . c i t ., p. p. 4 2 9 , n o t e 101. 91. The Debate i n Congress on t h e s e proposed amendments was v i g o r o u s , p r o p o n e n t s a r g u i n g f o r t h e need t o c l a r i f y t h e d e f i n i t i o n t o p r e v e n t a b u s e s and o p p o n e n t s a r g u i n g t h a t o t h e r a b u s e s would r e s u l t from an approach which a l l e g e d l y r e moves f l e x i b i l i t y from t h e SEC. While c o n s i d e r a t i o n o f t h e m e r i t s o f t h e v a r - i o u s arguments f o r and a g a i n s t t h e s e proposed amendments i s beyond t h e scope o f t h e p r e s e n t r e p o r t , t h e p r o p o s a l s a r e a i r e d t o p r o v i d e a s e n s e o f t h e comp l e x i t y and c o n t r o v e r s y s u r r o u n d i n g c u r r e n t SEC m o n i t o r i n g of t h e merger and takeover process. 3. A Tender O f f e r May Be S u b j e c t t o S t a t e Takeover Laws and t o S t a t e C o u r t Review and I s S u b j e c t t o F e d e r a l C o u r t Review The t r a d e j o u r n a l Mergers and A c q u i s i t i o n s r e p o r t e d t h a t , a s of mid- - 1981, 37 s t a t e s had e n a c t e d t e n d e r o f f e r laws. 481 Some S t a t e s t a t u t e s d e f i n e a " t e n d e r o f f e r " a s any o f f e r f o r more t h a n a s p e c i f i e d p e r c e n t a g e ( u s u a l l y f i v e p e r c e n t b u t sometimes a s much a s t w e n t y p e r c e n t ) o f any c l a s s o f e q u i t y securities. 491 The t y p i c a l S t a t e s t a t u t e d o e s n o t a p p l y t o " f r i e n d l y " m e r g e r s o r t a k e o v e r s , r e q u i r e s n o t i c e o f a t a k e o v e r b i d p r i o r t o i t s commencement, and r e q u i r e s p r o r a t a p u r c h a s e s , which may d i f f e r from t h e amounts s e t f o r t h by t h e SEC. 501 There i s a s e r i o u s l e g a l q u e s t i o n whether t h e s e S t a t e s t a t u t e s a r e preempted by F e d e r a l law. he F e b r u a r y 1980 proposed amendments t o t h e W i l - l i a m s Act would have r e s o l v e d t h i s q u e s t i o n by making e x p l i c i t F e d e r a l preempt i o n of S t a t e t a k e o v e r l a w s . ) 481 Bowers, Thomas L. Tender O f f e r s : A Guide f o r t h e 1980s. and ~ q u i s i t i o n s , Summer 1981. p. 28. 491 501 - K a t c h e r , op. c i t . , p. 4-91. Wander, o p . c i t . , p. 93-94. Mergers S t a t e t a k e o v e r laws p l a y a r o l e i n t h e merger p r o c e s s , a l t h o u g h r e c e n t l y most t e n d e r o f f e r c h a l l e n g e s have t a k e n t h e r o u t e o f s e e k i n g a F e d e r a l c o u r t injunction. B u t , s i n c e t h e w a i t i n g p e r i o d s between f i l i n g and commencement o f an o f f e r a r e f r e q u e n t l y l o n g e r a t t h e S t a t e l e v e l , t h i s may g i v e t h e s u b j e c t t i m e , i f n o t t o a v o i d a t a k e o v e r , a t l e a s t t o f i n d a "white k n i g h t ." Wander o f f e r s t h e f o l l o w i n g comnent on S t a t e laws: "because t h e s e laws t e n d t o f a v o r management and work a g a i n s t t h e p a r t y making t h e t e n d e r o f f e r , t h e y p r o v i d e t h e most e f f e c t i v e d e f e n s i v e t a c t i c s a v a i l a b l e t o management ." 51/ Bowers n o t e s t h a t , " a l t h o u g h packaged a s i n v e s t o r p r o t e c t i o n s t a t u t e s , many s t a t e laws - preempted t h e s h a r e h o l d e r p r o t e c t i o n p r o v i s i o n s o f t h e W i l l i a m s Act." 52/ The i n t e r r e l a t i o n s h i p between F e d e r a l and S t a t e c o u r t j u r i s d i c t i o n i s o u t l i n e d i n Chart 2 . F e d e r a l c o u r t s r e v i e w d e t e r m i n a t i o n s b y t h e SEC and h a v e de- voted considerable a t t e n t i o n t o defining tender o f f e r s . They may e n j o i n t h e a c t i v i t y o f t e n d e r o f f e r o r s o r s u b j e c t s which h a v e v i o l a t e d F e d e r a l and S t a t e tender o f f e r s t a t u t e s . F e d e r a l c o u r t s a l s o judge w h e t h e r S t a t e t e n d e r o f f e r law i s c o n s t i t u t i o n a l , a p p l y i n g t h e Commerce C l a u s e and t h e Supremacy C l a u s e o f t h e United S t a t e s C o n s t i t u t i o n . Of p a r t i c u l a r c o n c e r n i s whether t h e S t a t e laws o b s t r u c t i n t e r s t a t e commerce and w h e t h e r t h e y c o n f l i c t w i t h F e d e r a l t e n d e r o f f e r law. S e v e r a l S t a t e s t a t u t e s , i n c l u d i n g t h o s e o f I l l i n o i s , New J e r s e y , and North - C a r o l i n a , have been h e l d u n c o n s t i t u t i o n a l on one o r b o t h o f t h e s e g r o u n d s . 531 52/ - Bowers, o p . c i t . , p. 28. 531 Bowers, op. c i t . , p. 29. A c a s e c u r r e n t l y pending i n t h e Supreme ~ o u r t 7 ~ i Corp. t e v . Dixon was d e c i d e d i n t h e 7 t h C i r c u i t C o u r t o f A p p e a l s , and t h e Supreme Court n o t e d j u r i s d i c t i o n i n Edgar v . M i t e Corp. on May 4, 1981) may d e t e r m i n e t h e c o n s t i t u t i o n a l i t y o f S t a t e t a k e o v e r l a w s . Sources of Law Affecting Tender Offers Interprets federal and state tender offer laws Promulgates rules to supplemen! and enforce the Federal Tender Offer Ac! Determines constitutionality of state tenaer offer law Receives federal tender offer filings Determmes whether bidders or targets have vlolated state or federal tender offer law or anhtrust law Determines whether bidders or targets have vlolated the federal tender offer act Determines whether target directors have breached their fiduaary duty to protect shareholder interests Revlews SEC detemunatlons Has authority to stop potentially anticompetitlve acquisitions Enacts tender offer law (Wiharns Act) Enacts adrmnlstrative and regulatory statutes affecting tender offers Must approve acqulsitions of compurues in industries 11 regulates Creates adnunistratwe and regulatory agencies to enforce above law -- Must approve acquisitions o! compunies in industries it regulates Interprets state tender offer act Determines constitutionality of state tender offer act Determines whether bidders or targets have vlolated the state tender offer a a or other administrative or regulatory acts Determines whether target directors have breached their fiduciary duty to protect shareholder interests Revlews determinations made by the state securities commissioner Enacts tender offer law which endows the state securities commissioner urlth power to enforce the law Promulgates rules and regulatiqns to supplement and enforce the state tender offer act Enacts regulatory statutes affecting tender offers Receives all tender offer filings Enacts genera: incorporation law including director responsibilities Determines whether bidders or targets have wolated the state act Source: Mergers and Acquisitions, Vol. 16, Summer 1981. p . 30. S t a t e c o u r t s c o n s i d e r a s e t o f i s s u e s s i m i l i a r t o t h o s e c o n s i d e r e d by Federal c o u r t s : L i k e t h e f e d e r a l c o u r t s , which i n t e r p r e t t h e W i l l i a m s A c t , c o u r t s i n a g i v e n s t a t e system i n t e r p r e t t h e i r s t a t e ' s t e n d e r o f f e r a c t and determine i t s c o n s i t u t i o n a l i t y . In r e l a t i o n t o congressional rulings, t h e y d e t e r m i n e whether t e n d e r o f f e r o r s o r t a r g e t s have v i o l a t e d state t e n d e r o f f e r s t a t u t e s o r any a d m i n i s t r a t i v e o r r e g u l a t o r y a c t s which t h e s t a t u t e s have y i e l d e d t h e s t a t e c o u r t s ( a l s o ) review d e t e r m i n a t i o n s made by t h e s t a t e s e c u r i t i e s conrmissions .... . z/ An e x t r e m e l y i m p o r t a n t q u e s t i o n i n c o u r t a c t i o n s c o n c e r n i n g proposed t a k e o v e r s i s t h e d e t e r m i n a t i o n o f whether t a r g e t company d i r e c t o r s h a v e f i d u c i a r y d u t i e s t o t h e t a r g e t company s h a r e h o l d e r s and whether s u c h d u t i e s , i f a n y , have been b r e a c h e d . Such f i d u c i a r y r e s p o n s i b i l i t y s u i t s a r e common, b u t few a r e suc- c e s s f u l , s i n c e t h e c o u r t s a r e r e l u c t a n t t o second-guess t h e b u s i n e s s judgment o f t h e t a r g e t ' s d i r e c t o r s , unless they a c t "egregiously contrary" t o t h e share- - h o l d e r s ' b e s t i n t e r e s t s . 55/ ( A p p l i c a t i o n of S t a t e law t o uphold t h e b u s i n e s s judgment of management t o r e j e c t a t a k e o v e r b i d w i l l be d i s c u s s e d i n t h e Def e n s i v e T a c t i c s S e c t i o n below. ) C. Mergers and A c q u i s i t i o n s : F e d e r a l R e s e r v e O v e r s i g h t 1. Marein Reauirements S e c t i o n 7 of t h e S e c u r i t i e s Exchange Act o f 1934 a u t h o r i z e s t h e Board o f Governors o f t h e F e d e r a l Reserve System ( t h e F e d ) t o r e g u l a t e m a r g i n r e q u i r e ment t e r m s under which c r e d i t can be extended when s e c u r i t i e s a r e used a s c o l - - l a t e r a l f o r a l o a n i n c o n n e c t i o n w i t h f i n a n c i n g an a c q u i s i t i o n . 5 6 / 54/ 55/ - The Fed Bowers, op. c i t . , p. 29. Bowers, op. c i t . , p. 31. 56/ For a more comprehensive t r e a t m e n t o f t h i s s u b j e c t , s e e U.S. L i b r a r y The Role o f S e c u r e d Bank C r e d i t o f ~ o s r e s s . C o n g r e s s i o n a l Research S e r v i c e . i n C o r p o r a t e A c q u i s i t i o n s . Report No. 81-186 E , by Kevin F. Winch. Washington, 1981. ( H e r e i n a f t e r c i t e d a s Winch, Secured Bank C r e d i t . ) has issued a series of regulations which apply to tender offer loans including: - establishes margin requirements which restrict (1) Regulation U the amount of bank credit which may be used for the purpose of purchasing or carrying "margin securities," (defined to include, among other things, stock registered on a national securities exchange and over-the-counter securities) where securities are used as collateral stock. - (2) Regulation T prohibits broker-dealers from extending credit or arranging for credit extension in violation of the margin requirements established by the Fed. (3) Regulation G - (4) Regulation X - governs margin rules for lending by persons other than broker-dealers and banks. prohibits, among other things, the borrowing of money which is lent in violation of the Fed's margin rules and thus governs borrowers who obtain securities credit, as opposed to lenders, as in regulations U, T and G. Margin requirements have ranged from 25 to 100 percent but have been set at 50 percent since January 3, 1974. This means that banks and broker dealers may not extend or arrange credit for the purpose of purchasing securities in excess of 50 percent of the value of such securities. Margin provisions serve several functions: Historically, their primary function has been to protect the nation's economy by preventing the excessive use of credit resources for securities speculation, rather than for the purposes of commerce, industry and agriculture. Their secondary historical purpose has been to provide one means of preventing instability in the securities markets. Such instability can occur when margin requirements are inadequate, because securities held as collateral for margin loans must be sold when they decrease in value and when customers are unwilling or unable to provide additional collateral. Such forced sales can accelerate the decline of securities prices. Third, margin requirements provide a measure of investor protection by preventing the extension of credit beyond what is reasonable for investors to carry. 571 The need for regulation of margin requirements in the area of corporate acquisitions may be regarded as similiar to that more traditionally applicable to the retail investor. Like individuals, corporate entities can also 571 U.S. Congress. House. Uniform Margin Requirements. Report No. 97-25x 97th Congress, 1st Session. Washington, U.S. Govt Print. Off, 1981. p. 2. . overextend themselves, especially in an atmosphere where tender offers can create an inflated price for the stock of a target company. Rumors of takeover can promote sharp market fluctuations, which margin requirements may temper. But, perhaps most important, the corporate takeover can involve diversion of credit to the stock markets of far greater magnitude than the financing of - individual speculation. 581 For any stock-secured bank loan, including the few used in tender offers, the Fed requires the filing of a statement of purpose of the loan; thus such - loans are commonly referred to as "purpose credit" or "purpose loans." 591 While charges that an offeror failed to make adequate disclosure in connection with these loans may be used as a defensive tactic, this has rarely, if ever, been a successful defense. 2. Credit Policies and Foreign Investors Substantial public attention has recently been focused on credit policies associated with acquisitions of U.S. corporations by foreign investors, especially because a larger proportion of takeovers of domestic companies by foreign companies involves bank financing than domestic takeovers by domestic c o w panies. 601 In this connection, the discrepancy between margin requirements applicable to U.S. persons and to foreign investors spurred congressional inquiry in 1981 by the Subcommittee on Teleconnnunications, Consumer Protection, and Finance of the U.S. House Energy and Commerce Committee. New 581 Lipton, Martin. Some Recent Innovations to Avoid the Margin Regulations. Law Review, Vol. 46, March 1971. p. 13. Y GUniversity ~ 591 - Winch, Secured Bank Credit, op. cit. 601 - Winch, Secured Bank Credit, op. cit . p. 11. p. 11-12. The Subcommittee found that foreign investors enjoy an advantage over U. S. persons in the takeover process. U.S. persons, whether they receive margin credit from domestic or foreign sources, are subject to the Fed's margin requirements, but foreign purchasers of U.S. securities, using foreign credit sources, are not. H.R. 4145, passed by the U.S. House of Representatives on December 16, 1981, amends the Securities Exchange Act of 1934 to provide uniform margin requirements in transactions involving the acquisition of certain U.S. corporations by non-United States persons where such acquisition is financed by non-United States lenders. A companion Senate bill, S. 1436, has been marked up in committee but has not, at this writing, been further acted upon. D. Mergers and Acquisitions: FTC and Justice Department Oversight 1. The FTC and the Justice Department Will Scrutinize the Proposed Merger for Possible Antitrust Violations The initial antitrust law, the Sherman Act of 1890, prohibits existing firms from entering into a contract, combination, or conspiracy in restraint of trade (Section 1) and makes it illegal to monopolize, attempt to monopolize, or combine or conspire to monopolize trade (Section 2). But the primary antimerger statute is Section 7 of the Clayton Act of 1914, which is directed against any acquisition which may have an anticompetitive effect. Section 7, as amended by the Celler-Kefauver Act of 1950, makes it illegal to acquire the stock or the assets of any corporation where the effect of that acquisition may be substantially to lessen competition, or to tend to create a monopoly in any line of commerce in any section of the country. The Clayton Act was further amended in 1980 to cover non-corporate acquisitions and to cover companies "affecting" but not necessarily "engaged in" interstate commerce. Two agencies, the Federal Trade Commission (FTC) and the Department of Justice, have concurrent jurisdiction to enforce Section 7 of the Clayton Act and, under the Hart-ScottRodino Act, which added Section 7A to the Clayton Act, large mergers and acqui- - sitions require filing with both the FTC and the Justice Department. 61/ Antitrust attorney Ira Millstein describes the principal merger and acquisition antitrust issues as those concerning the definitions of the relevant product and geographic markets and whether the effect of the merger or acquisition may be substantially to lessen competition in those defined markets. 62/ 2. Merger Guidelines The Justice Department has issued guidelines and the FTC has issued 63/ to indicate their enforcement policies in the merger area. rules - The Jus- tice Department's 1968 merger guidelines set forth standards which the Department has employed in determining whether or not to challenge in the courts a merger or acquisition under Section 7 of the Clayton Act, as well as more general expressions of its enforcement policy. The Guidelines are currently being revised so that, according to William Baxter, Assistant Attorney General, Antitrust Division, they more accurately reflect market realities, The revised guidelines are expected to be available by spring of 1982 and, until such time 61/ After a filing is made, an informal FTC and Justice Department liason commi'iTee meets to decide which agency will take jurisdiction over the transaction. Prior jurisdiction over a company or industry does not necessarily indicate whether it will be the FTC or Justice which will exercise jurisdiction in a new matter. 62/ Prepared statement by Ira M. Millstein, CRS Merger Tactics and ~ u b l i r ~ o l iSeminar, c~ October 21, 1981. p. 3. 63/ The FTC's rules are embodied in special industry guidelines issued in 19z-1968 (some of which have since been repealed), which are applicable to a limited number of industries: food distribution, cement, grocery products, manufacturing, textile mill products and dairy. von Kalinowski, op. cit., 174-3. as they are available, participants in merger/takeover transactions have been advised to utilize the 1968 guidelines. Eut it should be emphasized that these guidelines are merely intended to acquaint interested parties with the policies and methods of the Department of Justice generally, and should not be solely relied on to predict the Department's response to a particular merger or acquisition. Millstein notes that factors not considered in the guidelines may lead the Department to challenge a merger which appears on its face to fall within the range of permitted mergers. Furthermore, compliance with the guidelines does not constitute a defense to a Department of Justice, FTC, or private challenge under Section 7 of the Clayton Act. 64/ The Guidelines focus principally on the structure of the market and are intended to identify those mergers that "alter market structure in ways likely now or eventually to encourage or permit non-competitive conduct." The concept of market structure is key, since, according to the Guidelines: the conduct of the individual firms in a market tends to be controlled by the structure of that market, e.g., by those market conditions which are fairly permanent or subject only to slow change (such as, principally the number of substantial firms selling in the market, the relative sizes of their respective market shares, and the substantiality of barriers to the entry of new firms into the market). The current guideline standards vary according to whether the proposed merger is classified as horizontal, vertical, or conglomerate. They rely on four- firm-concentration-ratios (the sum of the market shares of the four largest firms in the industry) and on the market shares of the acquired and acquiring 64/ For a detailed discussion of private Section 7 actions, see American Bar goc cia ti on Section of Antitrust Law, "The Private Enforcement of Section 7 of the Clayton Act, 1977.'' firms to evaluate the likely anticompetitive effects of horizontal mergers and acquisitions. Certain exceptions exist for firms considered to be ''failing." 651 (1) Horizontal acquisitions. structure criteria: The Guidelines focus primarily on market a. In highly concentrated markets (the four largest firms occupy over 7 5 % of the market, as defined by an appropriate measure such as sales or shipments for a manufacturing company or deposits for a bank), a merger would ordinarily be challenged if it involved the following percentage shares of the market: Acquiring Firm 4% 10% 15% or more Acquired Firm 4% or more 2 % or more 1 % or more b. In less highly concentrated markets (the four largest firms occupy less than 7 5 % of the market), a merger would ordinarily be challenged if it involved the following market shares: Acquiring Firm 5% 10% 15% 20% 2 5 % or more Acquired Firm 5% or more 4% or more 3% or more 2 % or more 1 % or more c. In a market with a trend towards concentration (the aggregate market share of any grouping of the largest firns in the market from the two largest to the eight largest has increased by approximately 7 % or more of the market over a specified and representative period of time), a merger would be challenged if any of the eight largest companies in the market wished to merge with any firm occupying 2% or more of the market. Acquiring Firm any of the eight largest Acquired Firm 2% or more 6 5 / To fall within the perameters of the failing company doctrine and to make s p r i m a facie case that a company is a "failing company," it must show, at least, that ( 1 ) it is facing business failure and its prospects of reorganization are dim or nonexistent, and that ( 2 ) it has no other reasonable alternatives less detrimental to competition; e.g., it must show that there are no other available purchasers with whom a merger would have had a less anticompetitive effect. See U. S. Library of Congress. Congressional Research Service. A Legal Overview of the Antitrust Aspects of Mergers. Report No. 78-247 A, by Janice Rubin. Washington, 1 9 7 8 . d. In cases where there are no specific market share standards, a merger would ordinarily be challenged in the following circumstances: 1. acquisition of a competitor which is a particularly "disturbing," "disruptive," or "otherwise unusually competitive factor" in the market; and 2. merger involving a substantial firm and a firm which, despite an insubstantial market share, possesses an unusual competitive potential or has an asset such as a patent that confers an unusual competitive advantage. 661 The Guidelines focus on three criteria: (a) the market share of the supplier firm; (b) the market share of the -buyer firm; and (c) conditions of entry in the buyer firm's market. ( 2 ) Vertical Acquisitions. The types of vertical mergers likely to be challenged are those where a significant adverse competitive effect is considered probable in either of the two markets when measured by the following standards : a. Adverse effect in the market of the supplying partner is assumed where: 1. the supplying partner to the merger accounts for approximately 10% or more of the sales in its market, and 2. a merging firm that purchases the products of the supplying partner accounts for approximately 6% percent of the purchases in that market, unless it clearly appears that there are no significant barriers to entry into the business of the merging (i.e., purchasing) firm. b. Adverse effect in the market of the purchasing partner is assumed where : 1. the supplying partner to the merger accounts for approximately 20% or more of the sales in its market, and 2. a merging party uses what the other supplies and accounts for approximately 10% or more of the sales in the market in which it sells, and 3. the product sold by the supplying partner and its competitors is either a complex one in which innovative changes have been made or is a scarce raw material, and 4. the product sold by the supplying partner is a significant feature of the end-product manufactured by the consuming partner and its competitors. 6 6 1 Vertical acquisitions such as those which occur when the firms are in a buyer-supplier position; forward vertical integration occurs when a firm purchases a buyer and backward vertical integration occurs when a firm purchases a supplier. c. Adverse effect is assumed in the following non-market share cases: 1. if a customer or supplier is acquired by a major firm in an industry with a significant trend toward vertical integration, if such a combination would raise barriers to entry, and if it does not promise to cut the costs of product ion, or 2 . if a customer or a supplier is acquired for the purpose of barring competitors from the market or otherwise putting them at a disadvantage. (3) Conglomerate Acquisitions. The Guidelines vary according to the type of conglomerate acquisition. a. Mergers involving potential entrants (deemed to have the technological and financial resources and economic incentive to enter a market) will ordinarily be challenged if the proposed merger is one between one of the most likely entrants into the market and 1. any firm with approximately 25% or more of the market; 2 . one of the two largest firms in a market in which the shares of the two largest firms amount to approximately 50% or more; 3. one of the four largest firms in a market in which the shares of the eight largest firms amount to approximately 75% or more, provided the merging firm's share of the market amounts to approximately 10% or more; or 4. one of the eight largest firms in a market in which the shares of these firms amount to approximately 75% or more, provided the merging firm's share of the market is not insubstantial and there are no more than one or two likely entrants into the market, or the merging firm is a rapidly growing firm. b. The Guidelines state that mergers may be challenged on the grounds that they create a danger of reciprocal buying, 671 6 7 1 Mergers creating danger of reciprocal buying (favoring one's customers when &king purchases of a product which is sold by the customer) will ordinarily be challenged if 15% or more of the total purchases in a market in which one of the merging firms sells is accounted for by firms which also make substantial sales in markets where the other merging firm is both a substantial buyer and a more substantial buyer than all or most of the competitors of the selling firm. That the merger will result in economies is not considered to be a valid defense to an otherwise unlawful merger that creates the danger of reciprocal buying. t h a t t h e y e n t r e n c h m a r k e t power o r r a i s e b a r r i e r s t o e n t r y , 681 o r t h a t t h e y a f f e c t a g g r e g a t e c o n c e n t r a t i o n . 69/ A s a p r a c t z a l m a t t e r , however, M i l l s t e i n n o t e s t h a t t h e s e t G o r i e s have r a r e l y , i f e v e r , b e e n r e l i e d upon t o c h a l l e n g e a m e r g e r o r a c q i s i t i o n . ( 4 ) J o i n t V e n t u r e s . N e i t h e r t h e Department o f J u s t i c e n o r t h e FTC h a s promulgated g u i d e l i n e s r e l a t i n g t o j o i n t v e n t u r e s . The c o u r t s h a v e i n d i c a t e d t h a t t h e j o i n t c r e a t i o n by two o r more c o r p o r a t i o n s o f a t h i r d c o r p o r a t i o n may evoke s e r i o u s problems u n d e r S e c t i o n 7 70/ o f t h e C l a y t o n a c t i n e i t h e r of t h e f o l l o w i n g s i t u a t i o n s : a . two o f t h e j o i n t v e n t u r e r s would have e n t e r e d t h e m a r k e t a l o n e b u t f o r t h e j o i n t v e n t u r e , o r o n e would have e n t e r e d and a n o t h e r was and would have remained a s u b s t a n t i a l p o t e n t i a l c o m p e t i t o r ; t h e i n d u s t r y i s a n o l i g o p o l y s u c h t h a t a few companies occupy most o f t h e m a r k e t ; and t h e j o i n t v e n t u r e r s , o r a t l e a s t two o f them a r e i n d u s t r y l e a d e r s i n o t h e r m a r k e t s ; o r 6 8 / Mergers t h a t e n t r e n c h market power o r r a i s e b a r r i e r s t o e n t r y w i l l o r d i n a r i l y b e i n v e s t i g a t e d where t h e p o s s i b i l i t y o f a n t i c o m p e t i t i v e c o n s e q u e n c e s e x i s t s , e s p e c i a l l y where a n a c q u i s i t i o n o f a l e a d i n g f i r m i n a r e l a t i v e l y conc e n t r a t e d o r r a p i d l y c o n c e n t r a t i n g m a r k e t may s e r v e t o e n t r e n c h o r i n c r e a s e t h e m a r k e t power o f t h a t f i r m o r r a i s e b a r r i e r s t o e n t r y i n t h a t m a r k e t . Examples are: 1 . a m e r g e r which p r o d u c e s a v e r y l a r g e d i s p a r i t y i n a b s o l u t e s i z e between t h e merged f i r m and t h e l a r g e s t remaining f i r m s i n t h e r e l e v a n t markets; 2. a merger o f f i r m s p r o d u c i n g r e l a t e d p r o d u c t s which may i n d u c e p u r c h a s e r s , c o n c e r n e d a b o u t t h e merged f i n n ' s p o s s i b l e u s e o f l e v e r a g e , t o buy p r o d u c t s o f t h e merged f i r m r a t h e r t h a n t h o s e o f c o m p e t i t o r s ; and 3. a m e r g e r which may enhance t h e a b i l i t y o f t h e merged f i r m t o i n c r e a s e product d i f f e r e n t i a t i o n i n t h e r e l e v a n t market. 6 9 / Mergers t h a t a f f e c t a g g r e g a t e c o n c e n t r a t i o n . I n 1 9 6 9 , t h e Department o f ~ u z i c eannounced t h a t i t m i g h t " v e r y w e l l " o r "would p r o b a b l y " b r i n g a c t i o n s a g a i n s t t h e s e t y p e s o f m e r g e r s , a l t h o u g h no s i g n i f i c a n t c a s e h a s been b r o u g h t u n d e r t h e s e g u i d e l i n e s . The G u i d e l i n e s a f f e c t : 1. a n y c o n g l o m e r a t e merger among t h e t o p 200 m a n u f a c t u r i n g f i r m s o r f i r m s o f comparable s i z e i n o t h e r i n d u s t r i e s , and 2. a n y c o n g l o m e r a t e merger by o n e o f t h e t o p 200 m a n u f a c t u r i n g f i r m s of any l e a d i n g producer i n any concentrated industry. 70/ - von K a l i n o w s k i , op. c i t . , 574.05 b. t h e j o i n t v e n t u r e r s have t h e power t o t r a n s f e r s u b s t a n t i a l market power t o t h e j o i n t v e n t u r e . The j o i n t v e n t u r e r s may have such power i f t o g e t h e r t h e y account f o r a s u b s t a n t i a l p o r t i o n of t h e market o u t l e t f o r companies i n t h e b u s i n e s s of t h e j o i n t v e n t u r e , o r i f t h e y c o n t r o l a s u b s t a n t i a l s u p p l y of t h e raw m a t e r i a l needed by companies i n t h e b u s i n e s s of t h e j o i n t venture. 3. Premerger N o t i f i c a t i o n Is Required Under t h e p r o v i s i o n s of T i t l e I1 of t h e P ( t h e Hart-Scott-Rodino Act), c/p a r t i e s , t r u s t Improvemen .t of 1976 i n c l u d i n g f o r e i g n i n t e r e s t s , involved i n a t r a n s a c t i o n such a s a merger, a c q u i s i t i o n , o r even a j o i n t v e n t u r e , must f i l e a premerger n o t i f i c a t i o n form w i t h t h e F e d e r a l Trade Commission and t h e A n t i t r u s t D i v i s i o n of t h e J u s t i c e Department. of c e r t a i n s i z e s a r e covered. Only t r a n s a c t i o n s among companies (The b a s i c c r i t e r i a a r e t h a t one company must have $100 m i l l i o n i n t o t a l a s s e t s o r a n n u a l n e t s a l e s and t h e o t h e r company must have $10 m i l l i o n i n t o t a l a s s e t s o r a n n u a l n e t s a l e s , and t h e t r a n s a c t i o n must i n v o l v e $15 m i l l i o n o r more i n s t o c k o r a s s e t s o r 15% o r more of t h e o u t s t a n d ing voting stock.) The f i l i n g s b e f o r e t h e FTC and J u s t i c e a r e i n t e n d e d t o e l i c i t s p e c i f i c i n f o r m a t i o n from t h e p a r t i e s t o a t r a n s a c t i o n r e l a t i n g t o t h e t r a n s a c t i o n , i n c l u d i n g t h e purchase p r i c e , each company's s o u r c e of r e v e n u e s , and o t h e r f i n a n c i a l and marketing i n f o r m a t i o n . The timing f o r review of t h e a n t i t r u s t i m p l i c a t i o n s of a merger i s i n many c a s e s c r i t i c a l t o t h e d e a l , s i n c e d e l a y may g i v e t h e s u b j e c t company i n c r e a s e d o p p o r t u n i t y t o f i n d a "white knight." S u b s t a n t i a l i n v e s t i g a t i o n by t h e FTC o r t h e J u s t i c e Department may r e s u l t i n a r b i t r a g e u r s p u l l i n g o u t of t h e d e a l , reducing 71/ M i l l s t e i n n o t e s t h a t t h e premerger n o t i f i c a t i o n scheme i s c r e a t e d by t h e h r t - ~ c o t t - ~ o d i n oA n t i t r u s t Improvements Act of 1976, amending S e c t i o n 7 of t h e Clayton Act by adding S e c t i o n 7A, 1 5 U.S.C. ยง18A, and by t h e FTC Rules and R e g u l a t i o n s promulgated p u r s u a n t t o S e c t i o n 7A(d) of t h e Act and found i n 16 CFR P a r t s 801, 802 and 803. the likelihood the offeror will attain the requisite number of tendered shares, thus causing the deal to collapse. This happened when the Justice Department announced in the summer of 1981 that it wanted more information about Mobil's proposed acquisition of Conoco. Also, early in 1982, the FTC blocked, at least temporarily, Mobil Oil's proposed acquisition of 15 to 25 percent of U.S. Steel's common stock, a purchase considered by many analysts to be an attempt to use U.S. Steel shares as a wedge to pry loose all or part of Marathon Oil's assets which are being purchased by U.S. Steel. (Mobil had lost its bid for Marathon in the courts on anritrust grounds.) Once the basic information concerning the transaction is submitted, the Government has thirty days to study a proposed merger transaction (fifteen days for a cash tender offer--see footnote 72) and the transaction cannot be closed during this time period. Millstein describes the procedure as it relates to a merger transaction : If the Government feels that the transaction does not raise significant antitrust problems, the thirty day waiting period will pass and the parties can consummate the transaction. On the other hand, if the Government is suspicious that the transaction does raise antitrust problems, it will, within the thirty day period, request additional information from the parties. As a result of a request for additional information, the transaction cannot be consummated until twenty days after the date on which the parties fulfill the Government's request for additional information. Moreover, the parties can consummate the transaction only if the Government takes no successful steps in that second twenty day period to challenge the acquisition--such as by seeking a preliminary injunction. Thus, in effect, before most mergers or acquisitions can be transacted, the Government will have at least fifty days--the initial thirty day waiting period plus the twenty day waiting period after a request for additional information is fulfilled--to study the transaction. It is during this period that the Administration's enforcement policies come into play. z/ 7 2 1 Millstein, op. cit., p. 4-5. The initial waiting period for a cash tender offer is 15 days; a request for additional information to the offeror extends the period for 10 days subsequent to compliance with the request. The offeree must comply with such a request in a "reasonable" period of time, but cannot extend the waiting period (and thereby delay the tender offer) by delaying its response to the request. Does t h e Reagan A d m i n i s t r a t i o n P r o p o s e t o Change A n t i t r u s t Enforcement R e l a t i n g t o Mergers and A c q u i s i t i o n s ? Eecause o f t h e d e l i c a t e t i m i n g i n v o l v e d i n m e r g e r and a c q u i s i t i o n a c t i v i t y , t h e Government's a b i l i t y t o d e l a y a d e a l c a n h a v e a v i t a l l y i m p o r t a n t d e t e r r e n t e f f e c t and c a n a c t u a l l y s u b s t i t u t e f o r a more l e n g t h y m o n i t o r i n g e f f o r t i n v o l v ing litigation. T h e r e i s c o n s i d e r a b l e c o n t r o v e r s y , however, a b o u t how v i g o r o u s l y t h e c u r r e n t a d m i n i s t r a t i o n i s m o n i t o r i n g a n t i t r u s t a c t i v i t i e s i n g e n e r a l and t h e a n t i t r u s t a s p e c t s o f m e r g e r and a c q u i s i t i o n a c t i v i t y i n p a r t i c u l a r . The r e c e n t proposed s e t t l e m e n t o f t h e American Telephone & T e l e g r a p h Company s u i t , t h e d i s m i s s a l o f t h e l e n g t h y I E M s u i t , and o t h e r a c t i o n s by t h e c u r r e n t a d m i n i s t r a t i o n have prompted commentators t o s a y t h a t t h e s e d e v e l o p m e n t s mark a r a d i c a l r e l a x a t i o n o f a n t i t r u s t enforcement. While comments a b o u t how a n t i t r u s t p o l i c y i n g e n e r a l i s c h a n g i n g a r e beyond t h e s c o p e o f t h i s r e p o r t , some b r i e f comments on p o s s i b l e changes i n a n t i t r u s t p o l i c y a s i t r e l a t e s t o mergers a r e r e l e v a n t . Some c o n t e n d t h a t t h e FTC's and J u s t i c e D e p a r t m e n t ' s c u r r e n t e n f o r c e m e n t a c t i o n s w i t h r e s p e c t t o m e r g e r s d o e s n o t a p p e a r t o b e a d r a m a t i c d e p a r t u r e from past policies, a t l e a s t so far. z/Thus, i n 1981, t h e J u s t i c e Department e f - f e c t i v e l y b l o c k e d t h e Mobil-Conoco merger by r e q u e s t i n g a d d i t i o n a l i n f o r m a t i o n a b o u t t h e d e a l , t h e J u s t i c e Department announced i t would o p p o s e o n a n t i t r u s t g r o u n d s a m e r g e r i n t h e b e e r i n d u s t r y between J o s . S c h l i t z Prewing and G. Heileman Erewing, and t h e FTC announced i t would a s k t h e c o u r t t o b a r LTV from b u y i n g Grumman (LTV l a t e r backed o u t of t h e d e a l ) . I n December 1981, t h e FTC announced o p p o s i t i o n t o Mobil O i l ' s t a k e o v e r o f Marathon O i l and i n J a n u a r y 1982 t h e FTC d e l a y e d H o b i l ' s p u r c h a s e o f a l a r g e b l o c k of U.S. S t e e l s t o c k , presumably s i n c e Mobil was a t t e m p t i n g t o a c q u i r e i n d i r e c t l y some of Marathon O i l ' s a s s e t s . a c t i o n s d o i n d i c a t e some c o n t i n u a t i o n o f p r i o r e n f o r c e m e n t t r e n d s . 73/ - M i l l s t e i n , o p . c i t . p . 5-7. These On the other hand, the FTC has been criticized as giving the appearance of assisting in the Mobil-Marathon deal by detailing terms--Congressmen John Dingell and Albert Gore Jr. have charged that the FTC thus provided a "blueprintw--under which Mobil could sell certain downstream operations to Amerada Hess to avoid antitrust problems and gain approval. It is not unusual, how- ever, for parties to a merger to meet with FTC staff (or, for that matter, with Justice staff) and to arrive at informal agreements leading to a stipulation-which could conceivably incorporate such actions as a hold separate order. But the FTCfs method of disclosing its terms, by unilaterally issuing terms of approval, was unusual and did give the appearance of unprecedented assistance. The Wall Street Journal reported that Tyler Baker, special assistant to Antitrust Division chief William Baxter, briefed a conference of attorneys in November 1981 on proposed changes in the Justice Department's merger guidelines. Baker is quoted as saying: "There is a high degree of consistency in merger enforcement...there won't be a great deviation from the past at all, once the new guidelines are published." 741 Among the changes alluded to was the possible replacement of indicators of market share. Existing guidelines define a market as varying more or less in concentration depending on how many companies command what portion of sales; various percentages of market share are then used to provide one indicator of permissible mergers. A measure called the - Herfindahl index 751 is expected to replace existing guidelines to determine 74/ Lawyers See Planned Merger Guidelines of U.S. as Little Softened from the Past. Wall Street Journal, November 16, 1981. 75/ The Herfindahl index was named for Orris C. Herfindahl's 1950 work on concezration in the U.S. steel industry. Apparently there is some dispute as to the author of the index since Albert 0. Hirschman claims to be the originator bv virtue of his havinn first computed the index for a large number of countries ii his 1945 book ~ationalPower and the Structure of ~oreignTrade. (See Hirschman, Albert 0. The Paternity of an Index. American Economic Review. (continued) permissible mergers at varying levels of market concentration. Millstein argues that use of the index indicates the Administration still intends to scrutinize market share numbers and the index method will not yield dramatically different results from use of the guidelines. 761 Furthermore, since Baxter (continued) October 1964, p. 761-2.) In any event, the so-called Herfindahl Index expresses market concentration as the sum of the squares of the market share percentage of each firm in the relevant industry. Thus, the index for an industry with four equal-size competitors is 2,500 (25'+ 25'+ 251+ 25L). If one of these firms were to control 70% of the market andleach of the other three only lo%, the index would be 5,200 (702+ loz+ lo2+ 10 ) As the examples demonstrate, the Herfindahl index not only measures the extent of concentration within an industry, but also reflects the distribution of market share among the major firms of the industry. Since many economists believe that an industry which is both concentrated and dominated by one or two very large firms is less competitive than one which is merely concentrated, the Herfindahl index is thought to be a superior indicator of market competitiveness than the four-firm-concentrationratio more commonly employed. Thus, while in the two examples above the Herfindahl index ranges from 2,500 to 5,200, the four-firm-concentration-ratio test would not distinguish among them at all, since in each instance the fourfirm-concentration-ratio is 100%. According to the Justice Department, mergers or acquisitions in an industry with a Herfindahl index of more than 1,600 would very likely be challenged, if the merger or acquisition raised the index by 50 to 75 points. Mergers that raised the index by at least 100 points would typically be challenged, where the industry's index was between 1,000 and 1,600. And mergers in industries with an index of below 1,000 would usually not be challenged. A change in the Herfindahl index is equal to twice the product of the market shares of the firms involved. For example, if one firm with a market share of 10% proposed to acquire another firm with market share of 5%, this would raise the index by 100 points, and the acquisition would typically be challenged. (Discussion of Herfindahl index excerpted from a January 25, 1982, memorandum sent by Ira M. Mills tein to CRS. ) . 761 According to calculations made by Millstein, the proposed Herfindahl indexstandards are more lax for industries with several large competitors. But in industries dominated by one or two large firms but with relatively low four-firm-concentration-ratios, the proposed standards are actually stricter. For example, in an industry with firms having market shares of 40%, lo%, and 3%, and numerous smaller firms, a merger between the firms with 10% and 3% market shares would not be subject to challenge under the existing standards but would be under the proposed standards. Even where the proposed guidelines are less strict, the change from the existing standards is moderate. For example, in an industry with a four-firm-concentration-ratio of between 50% and 75%, under the existing standards a firm with a market share of 10% may acquire a firm with a market share of less than 4%. Under the proposed Herfindahl index standard, it could acquire a firm with a market share of less than 5%. (January 25, 1982, memorandum, op. cit.) has indicated he will not permit a failing company defense, he may be tougher than his predecessors on this issue. In the area of conglomerate mergers, where numerical guidelines are not established, Eaxter has stated that, in general, he does not believe conglomerate mergers pose an antitrust problem. Millstein notes that while prior administrations had from time to time challenged conglomerate mergers under Section 7 of the Clayton Pct, the Government has recently lost lost virtually every case, and the Supreme Court has seriously circumscribed the potential competition theories that underlie these cases. Thus, it is argued, no dramatic change in enforcement in the merger area has thus far occurred. z/ On the other hand, public statements made by Administration officials have not inspired confidence in a strict enforcement policy. For example, press ac- counts report statements by Antitrust Chief Eaxter (he doesn't believe that "conglomerate mergers, or mergers generally, have increased economic concentration to dangerous levels"), Attorney General William French Smith (the Government "must recognize that bigness in business does not necessarily mean badness"), and FTC Chairman James Miller (the Commission's past enforcement of antitrust laws barring price discrimination were "misdirected" and he has, "strong reservations" about certain long-standing FTC requirements and about the role of the FTC itself). 781 Thus far, however, the only significant evi- dence of relaxation of merger policy has been the FTC's issuance of the "blueprint" for the Mobil-Marathon merger. Most other major merger policies to 77/ Millstein, Prepared Statement, op. cit., p. 9. Washington Post, August 23, 781 See Antitrust: More Boom Than Bust. 1 98 1; a n d FTC Chief Miller Questions Agency Role in Consumer Protection, Antitrust Areas. Wall Street Journal, October 27, 1981. See also Big Shift in Antitrust Policy. Dun's Review, Vol. 118, August 1981. p. 38-40; and Eaxter American Lawyer, at Antitrust: Can the Professor Succeed on Erains Alone? Vol. 3, July 1981. p. 25, 28-31. date support the Millstein thesis that formal enforcement in this area is not changing very much. Finally, the courts, the ultimate forum for resolving questions concerning the antitrust implications of proposed mergers, seem to be supporting a reasonably strict interpretation of antitrust laws, as illustrated by the recent series of rulings on Mobil's attempt to take over Marathon Oil. Thus, on November 30, 1981, Federal Judge John Manos in Cleveland issued a preliminary injunction barring Mobil's acquisition of Marathon, holding there was a substantial likelihood that Mobil's proposed takeover would be found to violate antitrust law, especially because of overlaps in gasoline marketing and refining in the Midwest (Marathon Oil Company v. Mobil Corp., No. 81-2193). The injunction was upheld on December 23rd by the U.S. Court of Appeals for the Sixth Circuit. (Nos. 81-3704, 81-3713). Finally, early in January 1982, Chief Justice Warren Burger of the U.S. Supreme Court denied Mobil's emergency application to enjoin U.S. Steel's takeover of Marathon pending an appeal to the full court of the Sixth Circuit's ruling that Mobil could not acquire Marathon. Mobil had based its appeal partially on the ground that Judge Manos had refused to reconsider his original ruling in light of Mobil's subsequent proposal to sell Marathon's U.S. marketing and refining assets to Amerada Hess. 111. A. THE TAKEOVER PROCESS: DEFENSIVE TACTICS The R e s ~ o n s i b i l i t i e sof Management Management of a company which i s t h e o b j e c t o f a h o s t i l e t a k e o v e r a t t e m p t , o r which b e l i e v e s i t s e l f t o b e v u l n e r a b l e t o s u c h a n a t t a c k , may engage i n c e r t a i n d e f e n s i v e t a c t i c s t o t h w a r t what i t c o n s i d e r s t o b e an u n d e s i r a b l e " r a i d . " I n a wide v a r i e t y o f i n s t a n c e s , management may e v a l u a t e t h e b i d and r e j e c t i t under what h a s come t o b e known a s t h e b u s i n e s s judgment r u l e . For example, i n P a n t e r v . M a r s h a l l F i e l d & Co. ( d e c i d e d i n 1 9 8 0 ) , s t o c k h o l d e r a c t i o n s were b r o u g h t , a t t a c k i n g t h e board of d i r e c t o r ' s r e j e c t i o n o f a t a k e o v e r p r o p o s a l and t h e d e f e n s i v e m e a s u r e s (which i n c l u d e d a l a w s u i t and an a c q u i s i t i o n program) t a k e n by t h e board t o f o r e c l o s e t h e t a k o v e r . The c o u r t h e l d t h a t t h e b u s i n e s s judgment r u l e g o v e r n s t h e c o n s i d e r a t i o n o f a t a k e o v e r b i d by t h e board o f d i r e c t o r s of a t a r g e t ; where t h e d i r e c t o r s r e a c h t h e i r d e c i s i o n a f t e r f u l l cons i d e r a t i o n of a l l o f t h e i n t e r e s t s a f f e c t e d by t h e p r o p o s a l and a f t e r r e c e i v i n g a n t i t r u s t and s e c u r i t i e s law a d v i c e from o u t s i d e c o u n s e l , t h e y c a n n o t b e h e l d - t o have breached t h e i r f i d u c i a r y d u t i e s . 791 On t h e o t h e r h a n d , a board may r e j e c t a b i d n o t on t h e m e r i t s o f t h a t b i d , b u t r a t h e r t o r e t a i n c o n t r o l o v e r t h e company and t o keep management i n o f f i c e . C o u r t s have h e l d t h a t , under t h e p r i m a r y , defensive t a c t i c s are improper i f t h e y a r e f o r t h e primary p u r p o s e o f k e e p i n g management i n o f f i c e . I n a d d i t i o n , c e r t a i n o t h e r t a c t i c s used by management d u r i n g t h e t a k e o v e r proc e s s may be c h a l l e n g e d i n t h e c o u r t s . a g a i n s t U.S. S t e e l , t h e U.S. F o r example, i n a r u l i n g i n J a n u a r y 1982 Court of Appeals f o r t h e S i x t h C i r c u i t i n Cincin- n a t i h e l d i l l e g a l c e r t a i n agreements d e s i g n e d t o " l o c k up" t h e f r i e n d l y merger 791 L i p t o n , M a r t i n . Takeover Bids i n t h e T a r g e t ' s Boardroom; an Update ~ f t e r a n eYear. B u s i n e s s Lawyer, v . 36, 1981. p. 1018. between U.S. S t e e l and Marathon. The a g r e e m e n t s gave U.S. ("poisoned w e l l o p t i o n s " ) from Marathon: o n e g r a n t e d U.S. S t e e l two o p t i o n s Steel the right to buy M a r a t h o n ' s i n t e r e s t i n t h e Y a t e s o i l f i e l d i n Texas f o r 2.8 b i l l i o n d o l l a r s r e g a r d l e s s o f whether U.S. S t e e l won Marathon; t h e o t h e r g r a n t e d U.S. Steel the r i g h t t o buy 10 m i l l i o n new Marathon compon s h a r e s , about 17 p e r c e n t o f t h e t o t a l o u t s t a n d i n g f o r 90 d o l l a r s a s h a r e . The c o u r t might have q u e s t i o n e d whether t h e g r a n t i n g o f s u c h o p t i o n s b r e a c h e d t h e f i d u c i a r y d u t y of Marathon d i r e c t o r s t o t h e i r s h a r e h o l d e r s b u t r e f r a i n e d from d o i n g s o . I n s t e a d , t h e c o u r t a t t a c k e d t h e a g r e e m e n t s on t h e g r o u n d s t h a t t h e y c o n s t i t u t e d " m a n i p u l a t i v e " b e h a v i o r under t h e s e c u r i t i e s laws. The c o u r t r e a s o n e d t h a t , by r e n d e r i n g t h e Y a t e s f i e l d s u n a v a i l a b l e t o o t h e r companies and i n c r e a s i n g t h e number of s h a r e s o t h e r companies would have t o o b t a i n t o g e t c o n t r o l , t h e agreements e f f e c t i v e l y c r e a t e d an a r t i f i c a l c e i l i n g on t h e p r i c e of Marathon s h a r e s , t h e 125 d o l l a r p e r s h a r e p r i c e t h a t U.S. offered public shareholders. Steel The "poisoned w e l l o p t i o n s ," a c c o r d i n g t o t h e c o u r t , not o n l y a r t i f i c i a l l y a f f e c t , but f o r a l l p r a c t i c a l purposes completely - b l o c k , c o m p e t i t i v e b i d d i n g f o r Marathon s h a r e s . 801 While commentators view t h e c o u r t ' s r u l i n g a s a s e t b a c k f o r c e r t a i n b i d d i n g t a c t i c s , t h e c r e a t i v i t y w i t h which o f f e n s i v e and d e f e n s i v e t a c t i c s have r e c e n t l y e v o l v e d i n t h e dynamic merger p r o c e s s almost c e r t a i n l y i n s u r e s t h a t i f t h e s e l o c k up agreements a r e no l o n g e r u s e f u l , some o t h e r t a c t i c w i l l r e p l a c e them and t h e c o u r t s w i l l have t o r u l e on how t h e d e f e n s e ' s new v a r i a t i o n meshes w i t h t h e f i d u c i a r y r e s p o n s i b i l i t y o f management i n e v a l u a t i n g t a k e o v e r bids. 80/ Court R u l i n g s on U . S . S t e e l and Mobil May Change Merger Game, Slow O i l ~ x e o v e r s ,Wall S t r e e t J o u r n a l , J a n u a r y 7 , 1982. E v a l u a t i n g a Takeover Bid When a company makes an u n s o l i c i t e d t e n d e r o f f e r f o r a n o t h e r , d e s p i t e t h e me r e s t r i c t i o n s r e l a t i n g t o SEC, FTC a~ n dJ u s t i c e Department m e r g e r o v e r s i g h t d e t a i l e d a b o v e , t h e a c t i o n can t a k e p l a c e r a p i d l y - m u c h negoitated acquisition. more r a p i d l y t h a n f o r a The s u b j e c t ' s board o f d i r e c t o r s may have l i t t l e time t o study t h e ramifications of t h e d e a l ; indeed, t h a t i s part of t h e offensive strategy. A l s o , a c e r t a i n momentum may be b u i l t up b e c a u s e , o n c e a t e n d e r o f f e r i s announced, s h a r e h o l d e r s may f e e l compelled t o t e n d e r t h e i r s h a r e s , o r e l s e f a c e t h e p r o s p e c t o f becoming m i n o r i t y s h a r e h o l d e r s i n a company c o n t r o l l e d by t h e offeror--in t h i s e v e n t t h e y may b e " f r o z e n o u t " and l o g e b o t h l i q u i d i t y and value. A s u b j e c t company may view t h e d e a l from a v a r i e t y o f p e r s p e c t i v e s and i t may s e e k t o r e s o l v e a t l e a s t t h e f o l l o w i n g q u e s t i o n s : - What - w i l l c o n t r o l by a n o t h e r company mean t o management? they l o s e t h e i r jobs? Will I s t h e o f f e r i n g p r i c e f a i r ? I s t h e r e a n o t h e r company--a " w h i t e knight1'--which would o f f e r more o r b e a more c o m p a t a b l e match i n o t h e r r e s p e c t s ? - What i s t h e q u a l i t y of t h e o f f e r o r ' s s e c u r i t i e s i f an exchange Are a l l s h a r e h o l d e r s p r o v i d e d f o r e q u a l l y by t h e t e r m s o f t h e o f f e r ? i s involved? - Is t h e t i m i n g r i g h t o r would c o n d i t i o n s b e more f a v o r a b l e t o v a r i o u s i n t e r e s t e d p a r t i e s such a s management and s h a r e h o l d e r s a t another time? - What - What w i l l a change i n c o n t r o l mean t o employees, s u p p l i e r s , c u s t o m e r s , and o t h e r c o n s t i t u e n c i e s o f t h e company s u c h a s t h e community i n which t h e s u b j e c t company i s l o c a t e d ? i s t h e r i s k t h a t t h e d e a l w i l l n o t b e consumated? Are t h e r e p o t e n t i a l a n t i t r u s t problems? Are o t h e r r e g u l a t o r y a p p r o v a l s r e q u i r e d ? Has t h e o f f e r o r f a i l e d t o make material disclosures? C. S t r u c t u r i n g a D e f e n s e i n Advance o f a Takeover The N a t i o n a l A s s o c i a t i o n o f A c c o u n t a n t s c o n d u c t e d a s u r v e y , p u b l i s h e d i n t h e s p r i n g o f 1980, o f c o r p o r a t e d e f e n s e s t r a t e g i e s among 177 o f t h e 1 , 0 0 0 l a r g e s t i n d u s t r i a l companies. The s u r v e y i n d i c a t e d t h a t 40 p e r c e n t o f t h e com- panies consider themselves t o be vulnerable t o a takeover. The p r i n c i p a l r e a - s o n t h e y g a v e f o r t h e i r v u l n e r a b i l i t y i s t h e low p r i c e - e a r n i n g s r a t i o of t h e i r stock; o t h e r major f a c t o r s t h a t c o n t r i b u t e t o t h e i r perceptions o f v u l n e r a b i l i t y a r e u n d e r v a l u e d o r h i d d e n a s s e t s , a book v a l u e h i g h e r t h a n t h e m a r k e t p r i c e o f t h e i r s t o c k , h i g h b o r r o w i n g c a p a c i t y , and above a v e r a g e r e t u r n on n e t - w o r t h . 811 The q u e s t i o n n a i r e used i n t h i s s u r v e y p r o v i d e s i n s i g h t i n t o some of / t h e major t y p e s o f d e f e n s e s t r a t e g i e s . 1. E l e m e n t s i n t h e O v e r a l l S t r a t e g y These p r i m a r i l y i n v o l v e amassing a team of d e f e n s e e x p e r t s and making some c h a n g e s i n t h e company's image and d e a l i n g s w i t h i t s employees, i t s m a j o r s h a r e h o l d e r s , and t h e p u b l i c a t l a r g e . According t o t h e s u r v e y , a c t i o n s - might i n c l u d e : 8 2 / -establishing a permanent in-house d e f e n s e commit t e e - a r r a n g i n g f o r a s p e c i a l i z e d law f i r m on s t a n d b y r e t a i n e r ( i n d e e d , h i r i n g on r e t a i n e r from among t h e r e l a t i v e l y few t o p l e g a l s p e c i a l i s t s would mean t h i s l e g a l t a l e n t won't be used a g a i n s t t h e company) - a r r a n g i n g f o r a proxy s o l i c i t a t i o n f i r m on s t a n d b y r e t a i n e r ( s h o u l d management wish t o wage a proxy b a t t l e f o r i t s own s h a r e s t o p r e v e n t t o o many s h a r e s from f a l l i n g i n t o t h e hands o f t h e o f f e r o r ) 8 1 / T a k e o v e r s : A Survey of C o r p o r a t e Defense S t r a t e g i e s , Mergers and ~ G u i s i t i o n s ,S p r i n g 1980, p. 21. 821 The f o l l o w i n g a c t i o n s ( b u t n o t t h e p a r e n t h e t i c a l commentary on t h G e a c t i o n s ) a r e e x c e r p t e d from t h e N a t i o n a l A s s o c i a t i o n o f A c c o u n t a n t s Survey, i b i d . -arranging with an investment banker to be available for emergency action (an investment banker can assist in evaluating the deal, or in finding a "white knight") -maintaining a list of all larger stockholders to be contacted by telephone immediately after a tender offer (to assist management in keeping a substantial portion of the stock from being tendered or from being sold to arbitrageurs who would undoubtedly tender) -preparing in advance statements asking shareholders not to act until management has had time to evaluate the offer -preparing in advance a text stating why the company would be more successful operating independently rather than as a unit of a larger corporation -arranging with an outside public relations consultant to be available for emergency action (public relations specialists can be invaluable in stirring up public reaction against a takeover, including possible legislative action to block the takeover) -arranging for a variety of schedules for placing advertisements in the media and establishing a media list for distribution of news releases -establishing or intensifying an investor relations program to strengthen loyalty of existing stockholders and gain additional support for its stock -establishing or intensifying employees' stock purchase plan to create more support for the company and to create more insider holdings -establishing a system for tracking stock transfer records to detect any suspect new share ownership which might signal an attack. 2. Shark-Repellent Tactics and Porcupine Amendments These can involve a series of changes in the company's capitalization or changes in charter and bylaw provisions to make a takeover attempt more difficult. Briefly they may include: =/ 83/ See National Association of Accountants Survey, op. cit.; and Lipton, ~ a r t i z Takeover Bids in the Target's Boardroom, The Business Lawyer, v. 35, November 197 9. changes i n c a p i t a l i z a t i o n -arranging f o r placement o f common s t o c k i n f r i e n d l y h a n d s - m a k i n g new o f f e r i n g s o f c o n v e r t i b l e o r o t h e r e q u i t y i s s u e s t h a t d i s p e r s e v o t i n g power o r p l a c e more v o t i n g power i n f r i e n d l y hands -buying t h e company's own s t o c k on t h e open m a r k e t t o r e d u c e p u b l i c ownership -changing dividend p o l i c y t o encourage shareholder l o y a l t y - i n s t i t u t i n g a dividend reipvestment plan. b. c h a r t e r amendments - i n c o r p o r a t i n g i n a n o t h e r s t a t e where t h e t a k e o v e r laws a r e more s t r i n g e n t - r e o r g a n i z i n g t h e e l e c t i o n o r c o m p o s i t i o n o f t h e board of d i r e c t o r s ( t h i s m i g h t i n v o l v e amendments t o i n c r e a s e t h e number o f board members and s t a g g e r t h e i r t e r m s i n o r d e r t o d i l u t e t h e v o t e o f a new member o f t h e board p l a c e d t h e r e by t h e o f f e r o r which h a s purchased a s u b s t a n t i a l b l o c k o f t h e s u b j e c t company's s t o c k ) - r e o r g a n i z i n g t h e company's v o t i n g p r o c e d u r e s (which might i n c l u d e r e q u i r i n g more t h a n a m a j o r i t y v o t e by t h e b o a r d o r by s h a r e h o l d e r s t o a p p r o v e any b u s i n e s s c o m b i n a t i o n ) - i n s t i t u t i n g compensation p r o v i s i o n s f o r s h a r e h o l d e r s who do n o t t e n d e r t h e i r s t o c k t o a r a i d e r ( a company's board m i g h t v o t e an amendment g i v i n g s h a r e h o l d e r s who do n o t t e n d e r s h a r e s d u r i n g an o f f e r t h e r i g h t t o submit them f o r redemption a t t h e o f f e r p r i c e o r t h e h i g h e s t market p r i c e d u r i n g t h e p r e v i o u s 18 months) -implementing r e t i r e m e n t and s e v e r e n c e pay t e r m s f o r management o r o t h e r employment c o m p e n s a t i o n t e r m s which might d i s c o u r a g e a takeover - d e v i s i n g s t a t e m e n t s t h a t t h e board of d i r e c t o r s h a s a company p o l i c y n o t t o engage i n m e r g e r d i s c u s s i o n s o r t h a t t h e board i s r e q u i r e d t o c o n s i d e r t h e i n t e r e s t s o f employees, c u s t o m e r s , s u p p l i e r s and o t h e r s when c o n s i d e r i n g a merger o r t a k e o v e r b i d ( t h e s e may have o n l y minimal e f f e c t , b u t may b e u s e f u l when t h e c o u r t s a p p l y t h e b u s i n e s s judgment r u l e t o the board's rejection of the bid). D. S t r u c t u r i n g a Defense Once t h e Tender O f f e r h a s been Made Assuming a board of d i r e c t o r s i s faced w i t h a h o s t i l e u n s o l i c i t e d t e n d e r o f f e r , i t may engage i n a n m b e r o f a c t i o n s t o fend o f f t h e a t t a c k . State c o u r t s have been q u i t e l i b e r a l i n a p p r o v i n g d e f e n s i v e a c t i o n s under t h e busi n e s s judgment r u l e , u n l e s s i t c a n b e shown t h a t t h e p r i m a r y p u r p o s e f o r t h e d e f e n s i v e a c t i o n i s t o keep management i n power. The l a t t e r i s g e n e r a l l y d i f f i - c u l t t o p r o v e , s i n c e c o u r t s have h e l d t h a t t h e premium p r i c e a l o n e d o e s n o t c o n s t i t u t e t h e s o l e d e t e r m i n a t i o n o f whether t h e b i d s h o u l d be a c c e p t e d and t h e s u b j e c t company w i l l have a b a t t e r y o f i n v e s t m e n t a d v i s o r s , e x p e r t s t o e v a l u a t e i t s w o r t h , and perhaps even a committee o f i n d e p e n d e n t d i r e c t o r s who w i l l t e s t i f y about t h e shortcomings o f t h e d e a l . The c o u r t s g e n e r a l l y have been e x t r e m e l y r e l u c t a n t t o second-guess t h e " b u s i n e s s judgment" s e n s e o f mana g e r s who r u n l a r g e c o r p o r a t i o n s . The r e c e n t r u l i n g a g a i n s t t h e U.S. Steel lock-up agreements" may c a u s e merger s t r a t e g i s t s t o r e t h i n k t h e i r t a c t i c s , 11 b u t i t i s n o t l i k e l y t h a t t h i s r u l i n g w i l l s u b s t a n t i a l l y r e v e r s e a widespread t r e n d of employing complex d e f e n s i v e a c t i o n s . s e n s e o f t h e r a n g e of p o s s i b i l i t i e s - a n d t i o n s a s s i t u a t i o n s change. The f o l l o w i n g a c t i o n s p r o v i d e a t h e r e i n e v i t a b l y w i l l be more v a r i a - A s u b j e c t company may t r y t o defend i t s e l f by: - f i n d i n g a "white k n i g h t " t o buy i t on t e r m s more f a v o r a b l e e i t h e r w i t h r e s p e c t t o t h e premium o r w i t h r e s p e c t t o management a r r a n g e m e n t s s u c h a s an agreement t o a l l o w t h e t h e company t o o p e r a t e autonomous 1y and w i t h c u r r e n t management - a c q u i r i n g a n o t h e r company which would c r e a t e an a n t i t r u s t o r r e g u l a t o r y problem f o r t h e o f f e r o r -making a " s t a n d s t i l l agreement" w i t h a " b i g b r o t h e r " who buys a s u b s t a n t i a l b l o c k o f t h e s u b j e c t company's s t o c k t o make i t h a r d e r f o r t h e o f f e r o r t o g a i n a m a j o r i t y of t h e s h a r e s i n t h e tender o f f e r - p u r c h a s i n g a t a premium s h a r e s t h e o f f e r o r h a s a c q u i r e d p r i o r t o making t h e t e n d e r o f f e r -purchasing a t t h e going market p r i c e t h e company's own s h a r e s i n t h e market t o t i e up enough s h a r e s t o reduce t h e p o s s i b i l i t y t h a t t h e o f f e r o r w i l l g a i n c o n t r o l (because of t h e premium g e n e r a l l y o f f e r e d , t h e s t o c k would, however, be a t a p r i c e h i g h e r t h a n b e f o r e t h e t e n d e r o f f e r was announced, and i f t h e o f f e r o r i s d e f e a t e d , t h e s t o c k may s i n k t o t h e pre-tender o f f e r l e v e l ) - i n s t i t u t i n g a s u i t a g a i n s t t h e o f f e r o r on t h e grounds t h a t a d e q u a t e d i s c l o s u r e was n o t made under t h e s e c u r i t i e s laws. - e n t e r i n g i n t o long-term employment c o n t r a c t s w i t h e x i s t i n g management t o make t h e t a r g e t company l e s s d e s i r a b l e - s e l l i n g key a s s e t s o r d i v i s i o n s p e r c e i v e d t o be t h o s e a s p e c t s of t h e t a r g e t company most wanted by t h e o f f e r o r . Merger t a c t i c s a r e c l e a r l y i n n o v a t i v e and s t i l l evolving. new d e f e n s i v e t a c t i c - - t h e ' ' r o y a l t y trust1'--is An i n t e r e s t i n g a p p a r e n t l y under c o n s i d e r a t i o n by some o i l companies worried a b o u t Marathon O i l ' s kind of v u l n e r a b i l i t y t o t a k e o v e r . Although t a x q u e s t i o n s concerning t h i s t a c t i c a r e a s y e t u n r e s o l v e d , 841 the method i n v o l v e s s p i n n i n g o f f d i r e c t l y t o s h a r e h o l d e r s a company's o i l and g a s reserves. The s h a r e h o l d e r s become d i r e c t owners o f t h e o i l flows and t h e y r e - c e i v e monthly d i s t r i b u t i o n s of t h e p r o d u c t i o n p r o f i t s . A t t h e same t i m e , t h e company s h r i n k s i t s r e s e r v e b a s e , l e s s e n i n g t h e r i s k of t a k e o v e r . New discov- e r i e s t h e n have g r e a t e r impact and some a n a l y s t s c l a i m t h a t t h e combined e f f e c t of t h e v a l u e of t h e common s t o c k and t h e r o y a l t y t r u s t can be a n improvement o v e r t h e common s t o c k a l o n e . On t h e o t h e r hand, management may r e j e c t t h e i d e a on t h e grounds t h a t s p i n n i n g o f f r e s e r v e s would d e p l e t e c a s h f l o w and reduce t h e company's a b i l i t y t o develop p r o p e r t i e s . Eut f o r a company whose r e s e r v e s 841 The Wall S t r e e t J o u r n a l r e p o r t s t h a t t h e u n c e r t a i n t a x s t a t u s of t h e r o y a l t y t r u s t h a s made companies wary. Mesa, Southland, and Houston O i l a l l s e t up t r u s t s between l a t e 1979 and t h e end of 1980, and have been w a i t i n g f o r a d e f i n i t i v e r u l i n g from t h e I n t e r n a l Revenue S e r v i c e on whether t h e t r u s t s ' monthly d i s t r i b u t i o n s a r e s u b j e c t t o t a x a t i o n o n l y on t h e i n d i v i d u a l l e v e l , o r whether, l i k e d i v i d e n d s , t h e y w i l l be taxed on b o t h t h e c o r p o r a t e and i n d i v i d u a l l e v e l s . See Thurow, Roger. Royalty T r u s t s Seen a s P o s s i b l e Defense f o r O i l Firms Worried About Takeovers. Wall S t r e e t J o u r n a l , November 24, 1981. a r e g e n e r a t i n g mure c a s h t h a n c a n be used i n c u r r e n t o p e r a t i o n s , some a n a l y s t s contend t h e r o y a l t y t r u s t i s p r e f e r a b l e t o r i s k i n g a t a k e o v e r o r s p e n d i n g t h a t c a s h on i n v e s t m e n t s o u t s i d e t h e e n e r g y f i e l d . The e v o l u t i o n a r y p r o c e s s o f mer- g e r t a c t i c s t h u s p r o c e e d s , a l t h o u g h t h e r e t u r n t o t h e t r u s t , from whence a n t i t r u s t p o l i c y emanated, d o e s a p p e a r t o b e a n i r o n i c development. IV. THE BOTTOM LINE: WHOSE INTERESTS ARE AT STAKE? Those making p u b l i c p o l i c y c o n c e r n i n g m e r g e r s and a c q u i s i t i o n s must cont e n d w i t h a v a r i e t y o f competing i n t e r e s t s i n c l u d i n g t h o s e r e p r e s e n t e d by: - management which may wish t o r e t a i n c o n t r o l o v e r t h e company e i t h e r t o e x e r c i s e p r u d e n t b u s i n e s s judgment o r m e r e l y t o preserve t h e i r jobs; - - s h a r e h o l d e r s who may want t o t e n d e r t h e i r s h a r e s a t t h e h i g h e r premium p r i c e an o f f e r o r w i l l b i d ; s h a r e h o l d e r s who a r e " f r o z e n o u t " by v i r t u e o f n o t t e n d e r i n g o r by v i r t u e of a l i m i t e d tender o f f e r f o r o n l y a p o r t i o n of t h e s h a r e s who f i n d t h e m s e l v e s w i t h a m i n o r i t y i n t e r e s t , l e s s t h a n f a i r v a l u e , and l i t t l e l i q u i d i t y f o r t h e i r s h a r e s ; employees who may v i e w a change o f management a s e i t h e r a p o s i t i v e o r n e g a t i v e development ( f r e q u e n t l y employees w i l l oppose a t a k e o v e r i f t h e y b e l i e v e a more d i s t a n t c e n t r a l c o r porate headquarters w i l l be l e s s responsive t o t h e i r needs); - t h e community i n which t h e company under t h r e a t o f t a k e o v e r i s l o c a t e d which may f e a r p l a n t c l o s i n g s and r e l a t e d l o s s o f income t o t h e l o c a l economy; and - t h e p u b l i c a t l a r g e which m i g h t be a f f e c t e d by: ( a ) p o s s i b l e changes i n t h e economics of p r o d u c i n g goods and i s p o s s i b l e t h a t t h e e n t r e n c h e d management services-it i s l e s s e f f i c i e n t t h a n t h e new management would be and t h a t t h e a c q u i s i t i o n w i l l produce p r o d u c t i o n economies ; o r ( b ) p o s s i b l e changes i n c o n c e n t r a t i o n o f c o r p o r a t e power which may have long-run n e g a t i v e i m p l i c a t i o n s f o r compet i t i o n and t h e p r i c e and a v a i l a b i l i t y o f goods and s e r v i c e s i n t h e economy. A t t o r n e y M a r t i n L i p t o n , who h a s deve oped d e f e n s e s t r a t e g i e s f o r numerous f i r m s , a r g u e s t h a t management h a s a r i g h t t o oppose a t a k e o v e r i t deems n o t i n i t s p r o p e r i n t e r e s t and t h a t a v o i d a n c e o f t a k e o v e r a t t e m p t s w i l l r e s u l t i n , among o t h e r t h i n g s , a s t a b l e long-run environment f o r f i r m s t o d e v e l o p . This i n s u l a t i o n from t a k e o v e r a t t e m p t s w i l l f r e e managers from h a v i n g t o worry about m e e t i n g s h o r t - r u n p r o f i t g o a l s and about h a v i n g a c q u i r e d r e s e r v e s o r c a s h which make i t a t a r g e t . S h a r e h o l d e r r e p r e s e n t a t i v e Melvyn W e i s s , on t h e o t h e r h a n d , a r g u e s t h a t management s h o u l d n o t b e e n t i t l e d t o i n t e r f e r e w i t h t h e r e l a t i o n s h i p between a t h i r d p a r t y who w a n t s t o make an o f f e r and t h e s h a r e h o l d e r s t o whom t h e o f f e r i s d i r e c t e d , o r t o p r e v e n t a s h a r e h o l d e r from e a r n i n g a premium r e t u r n on h i s i n v e s t m e n t ; i n h i s v i e w , management i s i n v a r i a b l y i n t e r e s t e d i n k e e p i n g c o n t r o l o f t h e company and r e t a i n i n g employment and t h e p e r q u i s i t e s o f t h e c o r porate o f f i c e . Weiss a l s o a r g u e s t h a t management's r o l e s h o u l d be l i m i t e d t o s u p p l y i n g i n f o r m a t i o n t o t h e s h a r e h o l d e r s t o a s s i s t them i n making an informed d e c i s i o n a s t o whether o r not t o accept t h e t h i r d p a r t y ' s o f f e r . Furthermore, Weiss a r g u e s t h a t , i f management's u s e o f d e f e n s i v e t a c t i c s d o e s n o t a l l o w t a k e o v e r s t o o c c u r a s p a r t o f t h e normal f u n c t i o n i n g of t h e m a r k e t , t h e n i n e f f i c i e n t management may remain i n p l a c e d e s p i t e t h e f a c t t h a t s h a r e h o l d e r s and t h e company i n g e n e r a l might b e b e t t e r o f f w i t h new management. But L i p t o n c o n t e n d s t h a t s h a r e h o l d e r s a r e g e n e r a l l y b e t t e r o f f i f t h e y do n o t t e n d e r t o an o f f e r o r and t h e t a k e o v e r d o e s n o t go t h r o u g h , s i n c e c a s e s h e has studied i n d i c a t e t h a t t h e a p p r e c i a t i o n i n stock p r i c e a f t e r a takeover i s b l o c k e d i s a t l e a s t a s g r e a t a s t h e premium o f f e r i n g p r i c e . Weiss d i s p u t e s t h i s s i n c e t h e premium i s f r e q u e n t l y s u b s t a n t i a l and t h e r e a r e f i n a n c i a l benef i t s a s s o c i a t e d w i t h h a v i n g t h e u s e o f t h e premium p r i c e f u n d s . L i p t o n a r g u e s t h a t c o n s i d e r i n g o n l y t h e premium p r i c e b e n e f i t t o s h a r e h o l d e r s i g n o r e s t h e f a c t t h a t s h a r e h o l d e r s w i t h l e g i t i m a t e long-term i n t e r e s t s i n t h e company may g i v e way t o a r b i t r a g e u r s i n t e r e s t e d o n l y i n making a k i l l i n g and not i n t h e long-run good of t h e company. Weiss c o u n t e r s t h a t management i s not n e c e s s a r i l y a f r i e n d l y "big brother'' t o shareholders, t h a t t h e s e c u r i t i e s m a r k e t i s s t i l l a f r e e m a r k e t , and t h a t p a r t o f owning s h a r e s i n p u b l i c compan i e s c a r r i e s w i t h i t t h e r i g h t t o s e l l t o t h o s e who wish t o buy. Weiss a l s o p o i n t s o u t t h a t a dichotomy f r e q u e n t l y e x i s t s between management's o p i n i o n o f t h e v a l u e o f a company when f a c e d w i t h a t e n d e r o f f e r and when t r y i n g t o t a k e a company p r i v a t e . Thus, management may a t t e m p t t o b l o c k a t e n d e r o f f e r from a third party as being inadequate when their jobs and positions of power are at stake, but the same management may attempt to take a company private by "freezing" or "squeezing" out the minority shareholders at prices well below what the third party might have used as the basis for the tender offer. Lipton endorses the current practice whereby courts rely on investment advisors and the findings of a board independent of management to approve the business judgment of management to reject a tender offer. But Weiss says this independence is not possible since it is the incumbent board which chooses the parties to evaluate the offer. Yet Lipton believes that there are so many reasons beyond premium price why a board may properly reject an offer that management should be given wide discretion. Furthermore, it is Lipton's position that management can and should employ a wide variety of permissible techniques at its disposal to fend off an offeror's attack. Weiss argues that some of these techniques result in an unwarranted shift of power from shareholders to management. For example, Weiss points out that, during the LTV bid for Grumman, Grumman's management replaced the pension fund managers and ordered the new managers to buy substantial amounts of Grumman stock to thwart the LTV tender offer. 851 Yet, by buying this stock, which had risen in price from the pre-tender offer price, management was willing to pay more for the stock than it would be worth if its efforts were successful and the takeover were blocked-in could fall to the prior levels. which case the price Thus management was seen to be using its of- fice to the possible detriment of the shareholders and the former employees who are pension fund holders. Grumman Pension Plan Buys More Stock in 851 See also Carley, William M. ~ f f o r F t oBlock LTV, Which Plans Suit. Wall Street Journal, October 13, 1981; and Carley, William M. Grulmnan, by Acquiring Its Own Shares, Seems to Be Gaining in Bid to Block LTV. Wall Street Journal, October 14, 1981. A l s o , d e p e n d i n g on how t h e d e a l i s s t r u c t u r e d , a s u b s t a n t i a l g r o u p of s h a r e h o l d e r s may be p o o r l y t r e a t e d i n t h e "mop-up" egement o f a company g a i n i n g c o n t r o l . p a r t o f t h e d e a l by t h e man- For example, i n t h e U.S. S t e e l tender o f f e r f o r Marathon, t h e o f f e r was f o r 51 p e r c e n t o f M a r a t h o n ' s s h a r e s a t 125 d o l l a r s per share. But t h e r e m a i n i n g 49 p e r c e n t , comprised o f t h o s e who e i t h e r d i d n o t t e n d e r o r t h o s e who t e n d e r e d b u t were g i v e n a p r o r a t a v a l u e , a r e o f f e r e d U.S. S t e e l d e b e n t u r e s v a l u e d a t l e s s t h a n 80 d o l l a r s p e r s h a r e . The in- t e r e s t s o f t h i s c l a s s o f m i n o r i t y s h a r e h o l d e r s (which c o u l d on o c c a s i o n i n c l u d e employees r e f u s i n g t o t e n d e r ) who a r e " f r o z e n o u t " i s t h e s u b j e c t o f some p o l i c y concern i n t h e takeover process. The r o l e and i n t e r e s t s o f v a r i o u s b r a n c h e s o f t h e Government s h o u l d a l s o be noted i n t h e merger p r o c e s s . For example, t h e F e d e r a l government may have c o n s i d e r a b l e l a t i t u d e t o a f f e c t t h e c o u r s e o f merger and a c q u i s i t i o n a c t i v i t y even b e f o r e t h e i s s u e s r e a c h t h e c o u r t s . I n f o r m a l d i s c u s s i o n s between FTC and J u s t i c e Department a t t o r n e y s may r e s u l t i n r e s t r u c t u r i n g a merger o r b r e a k i n g o f f a d e a l even b e f o r e a premerger n o t i f i c a t i o n i s f i l e d . The t i m i n g i n merger d e a l s i s f r e q u e n t l y such t h a t r e q u e s t s f o r a d d i t i o n a l i n f o r m a t i o n by t h e FTC and J u s t i c e Department c a n e f f e c t i v e l y k i l l a d e a l , a s o c c u r r e d i n t h e MobilConoco proposed m e r g e r . On t h e o t h e r h a n d , some commentators contend t h a t c e r - t a i n r e g u l a t o r y a g e n c i e s have f a c i l i t a t e d h o s t i l e t a k e o v e r s by n o t e n f o r c i n g s t a t u t o r y r e q u i r e m e n t s f o r p r i o r a p p r o v a l of changes i n c o n t r o l ( t h i s was a l l e g e d when t h e C i v i l A e r o n a u t i c s Board approved v o t i n g t r u s t s i n t h e Continen- - t a l A i r and Western A i r c a s e s ) . 86/ A c t i o n s a t t h e S t a t e l e v e l can a l s o a f f e c t t h e merger p r o c e s s . An impor- t a n t q u e s t i o n o f whether F e d e r a l o r S t a t e law s h o u l d g o v e r n t e n d e r o f f e r s 86/ W r i t t e n communication from a t t o r n e y M a r t i n L i p t o n t o CRS, ~ a n u a r y1982. i s c u r r e n t l y under review by t h e Supreme Court. t h a t S t a t e law--which Meanwhile, Weiss h a s argued i s f r e q u e n t l y more f a v o r a b l e t o t h e d e f e n s i v e t a c t i c s of management a t t e m p t i n g t o thwart a takeover-should minant of t e n d e r o f f e r outcomes. n o t be t h e b i n d i n g d e t e r - The r a t i o n a l e i s t h a t s h a r e h o l d e r s a s w e l l a s g e n e r a l c o r p o r a t e a c t i v i t i e s a r e o f t e n d i s p e r s e d throughout t h e c o u n t r y , y e t a company may c h a r t e r i t s e l f i n a S t a t e w i t h laws g i v i n g management more d i s c r e t i o n a t t h e expense o f t h e r i g h t s o f a n a t i o n a l c l a s s of s h a r e h o l d e r s . And where are t h e i n t e r e s t s of t h e p u b l i c a t l a r g e i n t h i s d e b a t e ? To t h e e x t e n t t h a t s t r u g g l e s between management, s h a r e h o l d e r s , and employees produce a Darwinian dynamic which l e a d s t o e f f i c i e n c y i n t h e p r o d u c t i o n of goods and s e r v i c e s , t h e p u b l i c w i l l be b e t t e r o f f . On t h e o t h e r hand, i f takeover a c t i - v i t y crowds o u t h e a l t h y c o m p e t i t i o n i n t h e economy, t h e p u b l i c w i l l s u f f e r . The s t r u g g l e i s g r e a t a s i t r e l a t e s not o n l y t o c o n c e n t r a t i o n of power throughout t h e economy but a l s o t o c o n c e n t r a t i o n of power w i t h i n t h e f i r m , s i n c e management, s h a r e h o l d e r s , and employees have v a r y i n g i n t e r e s t s a t s t a k e . Devising p u b l i c p o l i c y s t r a t e g i e s and t a c t i c s t o a c h i e v e e q u i t y and e f f i c i e n c y among a l l t h e p a r t i e s i s a s complex and dynamic a s t h e takeover p r o c e s s i t s e l f . RELATED CRS PUELICATIONS U.S. Congress. Joint Economic Committee. Antitrust law and administration: a survey of current issues, by Julius W. Allen. Washington, U.S. Govt. Print. Off., 1976. At head of title: 94th Congress, 2d session. "Serial no. 77-976" U.S. Library of Congress. Congressional Research Service. Completed and pending acquisitions involving large U.S. oil companies: March 1, 1981 August 5, 1981, by Eernard A. Gelb. [Washington] 1981. (Typed report) ----- Corporate mergers: selected references, 1980-1981, by Kurt Beske. [Washington] 1982. (Bibliography L0067) ----- Corporate mergers in 1981, by Kevin F. Winch. (Typed report) [Washington] 1982. ----- Corporate mergers through tender offers: measurement and public policy considerations, by Kevin F. Winch. [Washington] 1981. (Report no. 81-260 E) ----- The economic rationale for antitrust legislation pertaining to mergers and acquisitions, by Gwenell Eass. [Washington] 1980. (~eportno. 80-81 E) ----- ----- A legal overview of the antitrust aspects of mergers, by Janice Rubin. [Washington] 1978. (Report no. 78-247 A) Mergers and acquisitions by twenty major petroleum companies: January 1977 through March 1981, by Eernard A. Gelb and Mark Jickling. [Washington] 1981. (Typed report) ----- The role of secured bank credit in corporate acquisitions, by Kevin F. Winch. [Washington] 1981. (Report no. 81-186 E) ----- Selected mergers and acquisitions in the natural resources industry, 1981: case histories and financial profiles, by Jeffrey P. Erown. [Washington] 1981. (Report no. 81-205 E)