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Professor Henry G. Manne of the Washington University Law School put forth the theory of the market for corporate control in 1965. According to him, the market for corporate control has a role of mitigating problems of agency, which is caused by separation of ownership and control in corporations.
This essay will give a brief account of theory of the market for corporate control. This theory promotes accountability, action and efficiency of managers of corporation and governance in order to meet the sole aim of ensuring the interests of the shareholders. However, a corporation is influenced by varied factors. This essay will determine whether or not the theory of the market for corporate control considers all the other interests affected by takeovers. This essay will conclude with a summary of the findings.
The market for corporate control is the mechanism for managerial mechanism in order to promote accountability of managerial interests and align them with corporate interests. It performs a disciplinary function in addition to the other corporate governance regulatory mechanism. The market for corporate control as the disciplinary mechanism can address the role of the board of directors to undermine any disciplinary functions. It can resolve promote accountability serious performance failures by correcting them and may deter certain opportunistic behaviour. It enables redistributing wealth to the shareholders of the acquiring firms.
Behaviour of a corporation is influenced by multiple factors, including legal system, regulatory framework, and market competition amongst other things. These factors defined what corporate control is. Such control involves an active control of the capital of the corporation, which includes all assets, including human resource, physical assets of the IP information of the corporation. Corporate control represents the right to determine how corporate resources will be managed.
The market for corporate control, also termed takeover market, addresses resolve promote accountability serious performance failures governance of corporation in the area of incentivising directors for the best interest of the shareholders, generating highest value of the resources and transfer of control in a corporation from one party to another. The theory of market for corporate control, thus, deals with how the market for corporate control facilitates the transfer between parties of control of management of the corporate assets. However, whether or not this theory considers all relevant range of interests that may be impacted or affected by takeovers is the question that will be addressed in this essay.
According to the theory of market for corporate control, the firms should comply with the aim of maximising value, which otherwise would reduce the value of the firm and become the target of takeovers. In case of takeover, frequent changes to the board of directors and managers may occur. The potential impact of this kind of external pressure enables the firm to bring down costs incurred by separation of ownership and control. This view is possible when the stock market price reflects the action and efficiency of the firm’s managers and that the managers lack abilities or their actions deviate from the single aim, which enable a takeover. Market of corporate control exists when takeovers through the buying and selling of shares. This means there are fair rules.
Corporate takeovers are importance aspects of the market for corporate control. There are a range of interests that are involved in a takeover. They affect many groups. Employees may lose jobs. Bondholders may suffer in case the rate of the bond gets lowered. Local communities may lose their economic base. Various defences against takeover bids may be put up by the by the management, including poison pills, greenmail and golden parachutes. Considering all the varied elements, is the market for corporate control able to consider all the relevant interests involved in a takeover? Will it be able to address the interests in situation involving hostile takeover, where important decisions are not taking place in the common market?
The market for corporate control is also regarded as the inefficient management hypothesis in the area of takeovers. This theory presents the threat of takeover that has the potential of reducing agency problem. It stimulates agents to make decisions aligned with the interest of the principals. It provides the acquiring firm the opportunity to restructure an underperforming target.
The aspects of this theory may be subject to two tests. Eichholtz and Kok explored this area by assessing how the market for corporate control functioned in respect to property companies. Firstly, it was tested by measuring target performance before takeover announcement by using stock returns or using operating performance measures. Secondly, it was tested by assessing performance of target and bidder at the time of or after announcement of the takeover bid. Eichholtz and Kok found that first test did not show whether the hypothesis holds. The second test found that wealth effects to acquiring firm were documented negative. These findings did not conform to the purpose of the market for corporate control. The first result shows that there is no link between the target performance before takeover announcement and disciplinary function of the market for corporate control, as mentioned earlier. The second result shows that the performances of the acquiring and target firms do not have any link with the wealth effects to acquiring firm. The absence of the linkage may create doubt on the significance of the market for corporate control.
Walsh and Ellwood also found similar result. They explored the roles of mergers and acquisitions in disciplining of inefficient managers. They considered the relationship between a firm’s history and subsequent top management turnover. They sampled target companies, parent companies and a group of companies that were not involved in merger and acquisition. The result found that the turnover of the management was higher than the ‘normal’ in prior 2 years after a merger or acquisition. They did not find any link between this management turnover and the performance of the previous target company. It was found that the first‐year turnover rates of the target company were associated with relatively poor performance of the parent company and the second‐year turnover rates were associated with relatively good performance of the parent company.
Managers are not the only determinants
As pointed out earlier, the theory of market for corporate control is subject to two conditions, which is the market price reflecting the action and efficiency of manager and occurrence of takeover due to lack of managers’ abilities or their deviation from the single aim of shareholders’ interests. These two conditions are subject to the arguments that they do not consider many other elements that are not related to the managers. Managers are not the only determinants of a company’s value. Even if they were, their actions could not be observed by the market. No information symmetry could be found between them and the market. This reduces the dependency between share price and actions of the managers. Thus, the lack of action, abilities or efficiency of manager cannot be the only cause for takeovers.
The “thumbing rides” principle is one of the elements that are not related to the action or efficiencies of the managers. This principle can affect the efficiency of the market for corporate control. Small shareholders may not consider the ownership of corporate control, but pay focus attention to the share price fluctuations. They end up holding their share considering that acquisition would increase the share price. While doing so, it would increase the cost of acquisition. This would reduce the chances of success of acquisition and hence affect the efficiency of market for corporate control.
The views expressed in the above paragraphs represent an absence of linkage between market price of the shares and the action and efficiency of manager or between takeover and lack of managers’ abilities. What it means is that the market for corporate control must consider other elements, such as ownership structure or the factors that shape shares’ price. It can go beyond just focusing on the managers’ role and shareholding interests.
It could be observed that the market for corporate control is met with opposite corporate tactics that could defy its governance. Corporate managers have a strong influence on the board of directors. They may present strong opposition against takeover bids. Hence, the board may take anti-takeover provisions, such as poison pills, dual-class stock and such other mechanism to protect the corporation. Managers can impair the firm by mismanaging or extracting exorbitant rents, which may pose difficulty against the market place that would replace such managers. One such example where the market for corporate control may not be able to give a response is when the exiting CEOs employ tactics, including employment contract, accelerated provisions, change-of-control provisions, and such enablements, which give them huge separation pay. In such case where takeover bids are created at a premium, which may be 15% or more, of the target’s stock market valuation, the question of disciplinary motive is difficult to infer.
It is also observed that the market for corporate control does not seem to work effectively in the events of hostile takeover and leveraged buyout. As such, criticism arises in regard to the consequences for corporate profitability and productivity and the welfare of the employees. The market for corporate control may not play the role it was supposed to. It may allow reallocation of productive assets as going concerns to the highest bidder. It may allow transferring the asset to highest value use if the bidder uses their own money or acts on behalf of the shareholders of the highest bidding firm. It may allow the managers of the firm to serve their own interests rather than that of the shareholders. Thus, the market for corporate control becomes a means for the managers to acquire companies by using other’s money and to discipline or displace themselves.
Similar to the observation made in section 3.2 above. The market for corporate control must also consider the company laws and regulation that allow corporate managers to exercise strong influence on the board of directors in the form of the arrangements under the anti-takeover provisions. The absence of such consideration or the inability of the market for corporate control to address such arrangement also creates a doubt on the necessity or significance of the market for corporate control.
The market for corporate control has left the managers with considerable autonomy. It exposes the managers and directors to vulnerability of control test. They may act against the interests of the shareholders. However, if necessary arrangements are in order, for example arrangement in terms of compensation, the operation of the market for corporate control can impose penalty of such managers. An alternative perspective is that such arrangements are viewed as a narrow view that is purely economic based. There are other social and psychological factors, such as loyalty or collegiality that influence directors. Abusive or outrageous arrangements may impose greater costs on executives than what the market produces. However, directors and managers may care about the social and professional groups view them. They may prefer to avoid criticism from social and professional groups who opinion they value. Thus, even if there are insufficient economic incentives provided by the market for corporate control, the fear of criticism or disapproval would discourage managers and directors from outrageous arrangements.
The presence of influence of social and psychological groups on the behaviours of the managers and directors could be treated as an alternative option against the market for corporate control that could address the autonomy of managers. As such, this also creates the doubt on the necessity or significance of the market for corporate control. The market for corporate control must consider this aspect as well. So, sufficiency of the economic incentives is not enough. Social and psychological factors must also be considered.
The market for corporate control may affect internal control mechanisms. It may influence internal and external innovation. The market for corporate control leaves the firm to emphasise on financial controls and focus less on strategic controls. This would lead to less internal innovation. As a result, the form would seek external innovation in order to gain short-term benefits. This is one of the major criticisms. It is also relevant with public companies where market for corporate control may cause managers and boards to focus on short-term performance of share price instead of long-term projects. However, this criticism may not be appropriate as share prices is a representation of the current value of future return. It is a measure of the long run. For example, if a major pharmaceutical corporation cuts its R&D budget to zero, there would be a rise in earnings, but a fall in share price. In the event of a takeover, since the acquiring firm is for a long haul, the expenditures on R&D might not fall after a takeover. This observation is similar to that under section 3.2. There may arise an urgency situation to conform to market for corporate control that influences the managers to focus on firms’ short term performance.
The issue seems to lie with the fact that the firm’ failure to effect necessary framework of rules and procedures so that the markets for corporate control functions in an efficient and transparent manner. The firms have the discretion in regard to such framework. This issue is recognised by OECD. OECD provides that rules and procedures governing the framework must be clearly articulated and disclosed in order that investors understand available rights and recourse. There must be transparent prices and fair conditions of transaction to protect rights of shareholders. The managers and boards must not use any anti-takeover to escape accountability. OECD pointed out existence of violation of fiduciary duties by the boards where they used means to protect themselves at the cost of the shareholders. One example could be that of overvalued equity. The manager and boards overestimate the capabilities and benefits or misrepresentation of assets that leave the acquiring firm with loss of shareholding value.
The market for corporate control requires the managers and boards to not deviate from the aim of protecting the interests of the shareholders and basic value of the company. However, it is sometimes found to over-focus on the shareholders. Lesser attention is provided on other elements of a public corporation, including workers and local communities. The reason may lie in the lack of provisions in antitakeover laws that provide for protection of these elements. Protection offered by the laws might create high level inefficiencies when they reduce quantity and quality of monitoring management of the corporation. The laws may also not support the elements as they may entrench target-company management. Further, there is no contract that gives these elements a say or negotiating power in any takeover decision.
This essay has found that an active market for corporate control is important for ensuring accountability of managers and boards and for protecting interest of shareholders and fair redistribution of wealth. This essay finds that a corporation behaves under influence of multiple factors, including managers’ abilities, management arrangements, share price, performance, and other elements.
This essay has explored the efficiency of the market for corporate control by assessing relationship between performance of the concerned firms and share price or their relationship with the theory of market for corporate control. While doing so, it finds that the market for corporate control may not be an essential ingredient of regulating company’s behaviour or any financial or economic development of the company. As shown in this essay, the necessity or significance of the market for corporate control is in doubt considering the alleged absence of link between the disciplinary function of the market for corporate control and concerned firms’ performance or economic incentives to managers. The market for corporate control must consider all these elements to produce its desired disciplinary functions.
Moreover, the presence of social and psychological factors or different forms of arrangements under the anti-takeover provisions makes it difficult to infer the disciplinary function of the theory in question. There arrangements appear to be an effective institutional arrangements and if there are no coordinated market systems, the theory of market for corporate control may become just a standard of disciplinary function that could be easily overcome.
The findings of the essay, thus, recommends that the market for corporate control must consider all these discussed elements and go beyond just emphasising on shareholders’ interests and managers’ role. As suggested in this essay, until and unless there are standard regulation codes that effectively address all elements and associated issues, more economic and social costs would incur driven by takeover bids that may be hostile. The eventual result in case of failure to consider the elements would be harming growth and developing of corporation and the financial and economic system.
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