Are Takeovers Efficient? The Market for Corporate Control and Employee Voice
Labour lawyers and corporate governance scholars in common law jurisdictions do not communicate very often or very well. Where labour law treats the ‘employer’ as a black box with considerable discretionary power over employees, against which employees
Doctrines in the United States and Canada’ (1992) 12 Northwestern Journal of International Law & Business 571, 589. See also Edward B. Rock and Michael L. Wachter, ‘Labor Law Successorship: A Corporate Law Approach’ (1993-94) 92 Michigan Law Review (Mich L Rev) 203.
3 Wolfgang Streeck, ‘Beneficial Constraints: On the Economic Limits of Rational Voluntarism’ in J. Rogers Hollingsworth and Robert Boyer (eds), Contemporary Capitalism: The Embeddedness of Institutions (CUP, 1997).
require protection, and with which they must bargain and contract, mainstream corporate governance opens up that black box to find a complex set of relations between shareholders and managers, but for the most part excludes employees from its analysis, assuming them to be fully protected by their employment contracts. Where labour law has traditionally concentrated on inequality of bargaining power and ‘social concerns’, the main normative concern of corporate governance is economic efficiency, which is assumed to follow from managers exclusively furthering the interests of shareholders. The name of the game is to prevent managers imposing ‘agency costs’ on their ‘principals’, the shareholders, these concepts being understood in economic rather than legal terms. In order to achieve this goal, conventional corporate governance theory advocates, among other things, the use of incentives to align the interests of management with those of shareholders, including linking their pay to the creation of shareholder value, as expressed in the share price or other, more qualitative metrics; and, more importantly for our purposes, the creation of a market for corporate control through the removal of legal and other barriers to hostile takeovers.
A market for corporate control exists where takeover bidders, normally legal entities, identify target companies which are underperforming in terms of creating value for their shareholders, and approach the target shareholders with an offer to purchase their shares. The approach may be indirect, via the company’s management, or direct to the shareholders, in which case the bid is termed ‘hostile’. It is hostile because the bidder does not seek the cooperation of the incumbent management, and will be very likely to remove the senior managers in the event that they are successful. The aim is to gain control of the general meeting of shareholders, which requires the bidder to acquire a majority of the voting shares. However, in the normal case, the bidder will want to acquire all the shares so that they can control the company without regard to the interests of any minority shareholders, and to enjoy the whole of any improvements in management. The acquisition of control is a first step to removing managers who are underperforming in terms of generating shareholder value, and, it is assumed, a more efficient allocation of control over the company’s assets.
Company law is broadly sympathetic to this type of activity. The common law, by means of the fiduciary duty of loyalty which directors owe to the company, restricts the directors’ ability to take measures intended to prevent the general meeting deciding on the takeover. This means that in most common law jurisdictions, with the possible exception of the US, the ‘gatekeeping’ function of directors, by which they might potentially exercise their discretion in favour of preserving jobs for employees by resisting a hostile bid which puts jobs at risk, is extremely weak. In the UK the pro-takeover approach of the City Code on Takeovers can be seen in its central provision, which truncates managerial discretion absolutely in the event of a bid, prohibiting directors of listed and other public companies from doing anything ‘which may result in any offer or bona fide possible offer being frustrated’. In a similar facilitative vein, statutory company law allows a bidder who acquires 90 per cent of a company’s shares to squeeze out the remaining shareholders. This right was introduced in the name of facilitating industrial consolidation, but now operates as a cornerstone of shareholder value corporate governance. Similarly Canadian securities law restricts directors’ defensive tactics, giving shareholders of the target company the right to have the decision put to them, whilst in Australia the policy of the Takeovers Panel is to ‘generally require that shareholders be able to determine the control and ownership of the company’, with frustrating action likely to be declared an ‘unacceptable circumstance’.
Taken together, these provisions establish a legal framework which allows a market for corporate control to operate. This favours shareholder primacy because this market disciplines managers who do not create sufficient value for shareholders, as expressed in the current share price. Where a target company’s share price is lower than it would be if its managers concentrated on enhancing shareholder returns, so the argument goes, a bidder can offer the target company’s existing shareholders a premium over the market price for their shares. Since most shareholders in listed companies have diversified portfolios, their interest in the companies in which they invest is purely financial, and they will be likely to accept any offer giving them a substantial short-term gain. Their wholesale acceptance will allow the bidder to acquire control of the 90 per cent necessary to squeeze out any stragglers who hold out against the bidder. Once the bidder has acquired control, it can remove the underperforming managers and replace them with nominees who are more committed to the cause of shareholder value. Given the assumption that previous managers were underperforming, the extra returns generated by the new managers will be more than sufficient to repay the premium paid to the existing shareholders, leaving the bidder with a good return on their investment. The generation of those extra returns becomes even more imperative where the takeover is leveraged, that is, funded by significant quantities of debt, which is then transferred onto the target company’s balance sheet. Improved returns are required to avoid defaulting on those debt obligations and wiping out the bidder’s equity stake in the target.
Takeovers are, of course, very expensive, with bidders needing to pay investment banks, law firms, and other intermediaries for advice and other services throughout the process. To conventional corporate governance theorists, the beauty of the market for corporate control is that the mere threat of hostile takeover is sufficient to encourage most managers to concentrate on generating immediate shareholder value through financial engineering techniques such as selling assets, increasing leverage, buying back shares and so on. Shareholder value can also be generated by cutting costs, so these same market forces also encourage managers to bargain hard with employees, outsource work wherever possible, casualize the work force, sell off non-core businesses and so on. It is these very patterns of management which are of concern to labour lawyers, who seek to influence them through collective bargaining between unions and management; however, they are also of concern to conventional corporate governance theorists, who praise them as resulting in the allocation of scarce resources to higher valued uses. This tension between labour law and corporate governance, compounded by disputes as to whether takeovers are purely a mechanism for redistributing wealth from workers to shareholders, lies at the heart of the efficiency debates which we address in this chapter.
There is increasing recognition that the market for corporate control results in a less than perfect alignment of management and shareholder interests. The reason for the imperfect alignment is that the share price, which is absolutely central to the market for corporate control, does not adequately reflect the interests of all shareholders. This is not the place to question the efficient markets hypothesis, which is fundamental to normative arguments about the desirability of hostile takeovers. However, the problem is also commonly framed as one of short-termism, which operates to the detriment of longer-term shareholders. Essentially, the ever-present threat of takeover puts managers under powerful pressure to take any action that they consider will be likely to raise the share price in the short term. In undertaking the financial engineering and cost-cutting strategies discussed earlier, corporate managers are behaving in a manner very similar to private equity firms. These are also the very strategies that activist hedge funds call for in the name of shareholder value in their direct communications with corporate managers. This is not to deny that these strategies result in the materialization of shareholder value in the short term in the form of share price increases and distributions of surplus assets. Rather, it is to emphasize that, in the longer term, they also create considerable social costs. High quality employment disappears from these shores, as does the spending capacity that accompanies it, while companies with fewer assets and more debt are less able to weather economic downturns.
In line with the focus of conventional corporate governance on shareholders, this dynamic is recognized as a potential source of prejudice to longer-term shareholders in UK-listed companies, such as UK-based pension funds and insurance companies. The policy prescription for dealing with short-termism driven by market imperatives is more active involvement of such long-term shareholders in corporate governance, coordinated through soft law in the form of the Stewardship Code, with the aim of articulating a longer-term perspective on corporate decision-making. Considerable reservations have been expressed about the viability of this mechanism, given that
UK-based institutional investors make up a declining proportion of the share registers of listed companies,15 but institutional investor activism remains the dominant prescription for correcting these apparent failures of the corporate governance system.16
Turning now to examine how these practices affect employees, it can be seen that they are potentially impacted twice: directly in the form of material reductions in the quality and quantity of their employment and increases in precariousness and uncertainty; and indirectly through damage to their pension funds in the event that a company in which they have invested fails because it has leveraged its balance sheet and divested its assets in the name of shareholder value, and so no longer has the equity buffer needed to resist a sustained economic downturn. Indeed, the spread of shareholder value may be undermining the long-term prospects of the corporate sector as a whole, something in which diversified pension funds have a clear interest. This indirect damage lies beyond the scope of this chapter, and it will suffice to note here that further research is needed on the extent to which this broader interest is taken into account and articulated by institutional investors such as pension funds in their dialogue with corporate man- agement.17 Here we focus on the direct damage to employees, and the extent to which mechanisms of voice might mitigate that harm.18
Where employees are organized, some of these restructuring options may be hindered by collective bargaining or by the threat of collective action. The role of collective
- 15 See Brian Cheffins, ‘The Stewardship Code’s Achilles Heel’ (2010) 73 MLR 985.
- 16 See The Kay Review of UK Equity Markets and Long-Term Decision Making, Final Report, July 2012 and the Government’s response to it, Ensuring Equity Markets Support Long-Term Growth, Department for Business Innovation and Skills, November 2012. Both the Kay Report and the earlier Myners Report on Institutional Investment in the UK (March 2001) called for greater clarity between asset holders and asset managers as regards mandates, performance assessment and policies towards activism, but the essential assumption is that short-termism can be corrected by market participants themselves through voluntary coordination of collective action, rather than by means of more prescriptive regulatory interventions.
- 17 Hawley and Williams argue that long-term institutional investors should be ‘concerned not only with the long-term performance of individual firms, but also with the performance of the economy as a whole’: see James Hawley and Andrew Williams, The Rise of Fiduciary Capitalism (University of Pennsylvania Press, 2000) 1. While this may be theoretically persuasive, it is far from clear that institutional investors are bringing such a macroeconomic perspective to bear on their investment activities, perhaps because of collective action or epistemological problems. Notably, the evidence from the build up to the financial crisis reveals wholesale complacency during the ‘good times’. For an argument that fiduciary duty should be interpreted as requiring institutional investors to consider wider measures of their beneficiaries’ well-being, and a discussion of Modern Portfolio Theory, which emphasizes individual investor rationality at the expense of public goods, as the main obstacle to this, see Steve Lydenberg, ‘Beyond Risk: Notes Towards a Responsible Investment Theory’ in James Hawley, Shyam Kamath, and Andrew Williams (eds), Corporate Governance Failures (University of Pennsylvania Press, 2011).
- 18 The extent of the harm to employees from the activities of takeover bidders has been clearly documented by Conyon et al. They conclude that ‘control changes do appear to be followed by substantial falls in labour demand, but no more so for hostile mergers than for friendly ones’, with the immediate negative impact on labour demand being about 7.5 per cent compared with the pre-merger level. However, they also find that hostile takeovers lead to an immediate fall in output of 17.9 per cent and in employment of 15 per cent, something they suggest should be attributed to the post-merger divestment of businesses that characterizes management after a hostile takeover. See Martin J. Conyon, Sourafel Girma, Steve Thompson, and Peter W. Wright, ‘Do Hostile Mergers Destroy Jobs?’ (2001) 45 Journal of Economic Behavior & Organization 427, 433, and 436. The evidence in relation to takeovers by private equity firms is more contested. Goergen et al. conclude that private equity acquisitions of corporate control result in a ‘significant decrease in employment in acquired firms’ without ‘any parallel or subsequent increase in firm productivity or profitability’: see Marc Goergen, Noel O’Sullivan, and Geoflf Wood, ‘Private Equity Takeovers and Employment in the UK: Some Empirical Evidence’ (2011) 19 Corporate Governance: An International Review 259. On the other hand,
bargaining may, broadly speaking, be facilitated by rights of information and consultation as well as the duty to bargain in good faith. However, failure to comply with what amount to no more than procedural safeguards will not invalidate the managers’ decision. Perhaps more importantly, following a hostile takeover, employees are likely to be dealing with newly appointed managers, who will be more focused than their predecessors on generating shareholder value, and will be unlikely to feel bound by their predecessors’ informal commitments in relation to industrial relations. Moreover, as we will show in the third section, although in the UK the right of employees to express their opinion on a takeover bid was strengthened in 2012, the value of this right depends primarily on shareholders taking account of employee interests. As we saw earlier, and despite the numerous failures identified by the Myners and Kay Reports, this might be conceivable if a large proportion of the company’s shares were held by long-term, UK-based institutional investors. However, as the share registers of UK companies become increasingly globalized, this becomes less likely as investors with global reach and limited jurisdictional commitments concentrate on benefits that accrue in direct, financial terms. Accordingly, we argue, employees have few, if any, meaningful rights to voice in the event of a takeover. For example, in the UK, in the event of a transfer of undertaking, employees have rights to information about the implications of the transfer, and must be consulted ‘with a view to seeking agreement’ in the event that the new employer ‘envisages . . . measures in relation to the employees’. It is significant that a transfer of control over a company by means of share purchase or takeover was excluded from the ambit of these information and consultation rights at the behest of the UK, with concerns expressed that it would interfere with share pricing on stock markets and discourage mergers. Such concerns do not arise in relation to the Information and Consultation of Employees Regulations 2004, which impose an obligation on the ‘employer’ to consult its employees in relation to, inter alia, ‘development of the undertaking’s activities’ and any ‘threat to employment’, because that obligation will only take effect after the takeover has been completed. In the US, although both labour law and corporate tests recognize that in principle acquiring control of a company by purchasing its shares does not in itself defeat a pre-existing collective bargaining agreement (CBA) or duty to bargain, the key consideration is whether ‘substantial continuity exists between the old firm’s and the surviving firm’s workers’. Applying the test of substantial continuity, a CBA and the duty to bargain remain prima facie binding
Amess and Wright conclude that companies acquired by private equity ‘do not have significantly different employment levels compared with a control sample of firms’. See Kevin Amess and Mike Wright, ‘Leveraged Buyouts, Private Equity and Jobs’ (2012) 38 Small Business Economics 419.
on a transferee following a share purchase, but significantly ‘the stock purchaser has no greater or lesser obligation to abide by the CBA than the old firm. In either situation, a change of circumstances, sometimes initiated by the employer, may render the CBA inapplicable' This gives flexibility to the purchaser to avoid a pre-existing duty to negotiate with workers by introducing fundamental restructuring of the corporation during the takeover.
This hands-off approach to institutions of voice during takeovers in itself serves to make takeovers more desirable from a shareholder value perspective than other forms of restructuring in which employees have voice rights. We argue that granting employees stronger voice rights in the corporate governance process itself, regardless of the means by which the change in the company's power structure is effected, would be an effective means of articulating and protecting employees' interests. In the next part we develop in more detail the argument that such voice rights can be justified on economic efficiency grounds.
-  Marleen O’Connor, ‘Labor’s Role in the American Corporate Governance Structure’ (2000) 22Comparative Labor Law and Policy Journal 97; Margaret Blair and Mark Roe (eds), Employees and CorporateGovernance (Brookings Institution Press, 1999).
-  Shleifer and Summers explain that ‘takeovers that transfer wealth from stakeholders to shareholdersmust be hostile’, with incumbent managers removed because they will not go along with this redistribution.See Andrei Shleifer and Lawrence H. Summers, ‘Breach of Trust in Hostile Takeovers’ in Alan Auerbach(ed.), Corporate Takeovers: Causes and Consequences (University of Chicago Press, 1988).
-  See for example, Hogg v Cramphorn Ltd  Ch 254;  3 All ER 420; Howard Smith Ltd v AmpolPetroleum Ltd  AC 821;  1 All ER 1126. For an overview of the common law approach totakeovers, see Andrew Johnston, ‘Takeover Regulation: Historical and Theoretical Perspectives on the CityCode’ (2007) 66 Cambridge Law Journal 422.
-  See UK Takeover Code, Introduction Paragraph 3 and Rule 21.1.
-  See Companies Act 2006, s. 979, originally introduced in 1926 on the recommendation of the GreeneCommittee on Company Law.
-  Robert Yalden, ‘Competing Theories of the Corporation and their Role in Canadian Business Law’ inAnita Anand and William Flanagan (eds), The Corporation in the 21st Century (Queen’s Annual BusinessLaw Symposium, 2003). Though it is now proposed to loosen this regulation to allow directors more time toconsider their response to hostile bids, this is unlikely to go as far as the US ‘just say no’ defence.
-  See Takeovers Panel, Guidance Note 12: Frustrating Action and Corporations Act 2001, s. 657A.
-  The beneficial properties of the market for corporate control were first eulogized by Manne: see HenryManne, ‘Mergers and the Market for Corporate Control’ (1965) 73 Journal of Political Economy 110.
-  Nor is this the place to discuss the argument that hostile takeovers frequently result in significant lossesfor shareholders in bidder companies: see for example Richard Roll, ‘The Hubris Hypothesis of CorporateTakeovers’ (1986) 59 Journal of Business 197.
-  See for example Lynn Stout, The Shareholder Value Myth (Berrett-Koehler, 2012) ch. 5.
-  See The UK Stewardship Code (Financial Reporting Council, September 2012).
-  For an illustration of this potential, as well as the limitations, see Charlotte Villiers, ‘The Rover Case (1)The Sale of Rover Cars by BmW—the Role of the Works Council’ (2000) 29 ILJ 386; John Armour and SimonDeakin, ‘The Rover Case (2)—Bargaining in the Shadow of TUPE’ (2000) 29 ILJ 395.
-  Council Directive 2001/23/EC of 12 March 2001 on the approximation of the laws of the MemberStates relating to the safeguarding of employees’ rights in the event of transfers of undertakings, businessesor parts of undertakings or businesses, OJ 2001 L82/16, Art. 7.
-  See Bob Hepple, ‘Workers’ Rights in Mergers and Takeovers: The EEC Proposals’ (1976) 5 ILJ 209.Fall-back information and consultation rights continue to apply under the Information and ConsultationRegulations 2004, SI 2004/3426.
-  See Regulation 20(1) of the Information and Consultation of Employees Regulations 2004, SI 2004/3426.
-  Rock and Wachter 219 (n 2).
-  Rock and Wachter 218 (n 2), discussing John Wiley & Sons, Inc. v Livingston 376 U.S. 543 (1964).
-  Schreiber (n 2). The situation under TUPE offers similar flexibility to the employer in relation to thepre-existing CBAs: Case C-426/11 Mark Alemo-Herron and Others v Parkwood Leisure Ltd  CJEU.