Shareholder Protection, Compulsory Acquisition and the Efficiency of the Takeover Process

Abstract

This paper examines public good problems connected with takeovers. Two broad categories of exclusion device-oppression of minority interests and compulsory acquisition of shares-are evaluated. It is argued that inability to control the level of oppression with any precision renders the first method unsatisfactory from the policy viewpoint, but that strong protection of minorities coupled with compulsory acquisition rights for the acquiror can straightforwardly generate an efficient solution to the public good problems. It is shown that, in the U.K., company law and the City Code on Takeovers and Mergers combine to produce an approximation to this efficient solution. against managements which are performing poorly in the eyes of the capital market and, since the work of Marris [1964], this incentive mechanism has come to play a prominent role in the economic analysis of company behaviour. The usual argument is that, as the market value of a particular company falls relative to the level that it is generally believed could be obtained by other managers following different policies, the firm becomes increasingly vulnerable to a takeover by a raider attracted by the prospect of the capital gains that would ensue following managerial changes. In turn, the threat to the incumbent managers acts as a deterrent to behaviour which runs counter to shareholders' interests. The effectiveness of the workings of the takeover mechanism is therefore of some importance for the efficient utilisation and allocation of resources. Potential obstacles to the smooth functioning of the takeover process have, however, been recognised for quite some time. As long ago as 1926 the Greene Committee on Company Law Reform identified cases where a takeover had been inhibited by the actions of small minorities of shareholders. Much more recently Grossman and Hart [1980] have formalised some of the earlier points in a way that clearly highlights one of the major difficulties: that freeriding strategies on the part of shareholders in firms with dispersed share ownership can prevent successful bids. The argument is that shareholders of the target company, believing their own actions have a trivially small effect on