Institutional Shareholders, Private Equity, and Antitakeover Protection at the IPO Stage

Abstract

Institutional investors have been slow to respond to the widespread presence of takeover defenses in the charters of firms whose shares they hold through private equity funds, and their response to date has been tepid compared to their efforts in the proxy context. Institutions' hesitancy may reflect a rational unwillingness among private equity funds, as well as the institutions' own investment staff, to require portfolio companies to go public with takeover-friendly charters. This article develops a hypothesis to explain the common presence of defenses in the charters of firms that go public with private equity investment and the half-hearted response of institutional investors to this situation. Under this hypothesis - based on private equity funds' need to maintain a reputation for dealing well with successful managers of portfolio companies - it is privately rational but socially inefficient for private equity funds to have their portfolio companies adopt takeover defenses. The implication of the hypothesis is that institutional investors may face at least as difficult a challenge in ridding IPO charters of takeover defenses as they face in urging managers of already-public firms to eliminate defenses from their charters.