Let investors in acquiring firms have a say

The minority shareholders of the target firm enjoy favourable exit options while their counterparts do not

As mergers go, there couldn’t have been a more perfect ‘made in corporate heaven’ match than the one between multinationals Monsanto and Bayer that has recently been announced.

The former is primarily known for its genetically modified seeds (Bt Cotton) business while the latter is into crop protection chemicals. In other words, the combined entity would be telling the farming community that if their seeds don’t kill germs, their pesticides surely will.

In Bayer’s case, it also has the added advantage of being in the pharmaceuticals business as well. So then, that would take the concept of hedging against business risks altogether to a new and higher level.

Look at it this way. If the output of genetically modified seeds and plants doused in weed-killing chemicals can harm a consumer in any way, they have the capacity to complete the loop by coming up with the perfect medicine for his quick recovery back to health.

Yet for all the obvious advantages, the merger hasn’t quite stirred the market with the Monsanto stock nowhere near the bid price that Bayer is offering. So, why aren’t investors queuing up to buy the Monsanto stock at current prices and pocket the difference? For that matter, why hasn’t the Bayer stock reacted positively if there are synergies to be had from such a combination?

The only plausible explanation could be that perhaps the market doesn’t think that the two companies are quite up to jumping through the many regulatory hurdles that lie in their paths.

As such it may well end up as a non-event. Which is just as well. Synergy gains from mergers are more often in the minds of managers behind the merger than in the real world.

A recent New York Times report quoted a Standard & Poor’s research study to say that companies making acquisitions underperform not only their competitors but also the broader market as well. The S&P research team offers many explanations — some accounting and others strategic.

The accounting explanation is that acquisitions are financed by debt which carries interest costs and savings in costs (synergy gains) are often over-estimated. The amortisation of one-time costs and write-offs add to the problem of profits that are already stressed. From a strategic perspective, acquisitions happen when markets are at their peaks and an inflexion point downwards may just be around the corner. Also, acquisitions feed off a frenzy of growth in asset size of the acquiring firm. This implies that companies are already growing too fast for their own good and acquisition only compounds their woes.

Exit option, at a cost

If acquisitions are more often than not ‘value-destructive’ as literature suggests, minority shareholders have a right to subject the management to a higher degree of due-diligence than what the market can impose. Conventional wisdom has it that minority shareholders always have the option of exiting the stock through a secondary market operation. But this is far from satisfactory. If the market has already given a thumbs-down to the acquisition, it responds by marking the stock price down, sooner than the minority shareholder can exit from the stock. In other words, from a minority shareholder perspective, the ‘exit’ option comes at a cost, namely, a potential loss of investment value.

On the other hand, restraining the management outright, merely because there is a possibility that the acquisition may backfire, is also not an ideal solution. A balance has to be struck between managerial freedom to execute a strategic vision of its choice and minority shareholder aspirations to preserving investment value. The issue acquires added significance because in all cases of corporate acquisitions/business divestitures, minority shareholders of target firms are relatively better placed.

The Board of Directors of target firms are enjoined by law to advise the shareholders as to whether the terms of the acquisition are in the best interests of company. The shareholder has the advantage of exercising an exit option through the ‘open offer’ route that the acquirer company offers. While acquisitions can be a win-win for shareholders of both companies, there is a possibility that it can well be a zero-sum game with gains for one set of shareholders offset by losses to the other.

In fairness, therefore, minority shareholders of the acquiring firm who remain unpersuaded by the synergy gains should have the privilege of a management sponsored buyout similar to that enjoyed by minority shareholders of the target firm.

If the management is so convinced that a buyout is in the interests of the company perhaps they can put a little more money where their mouths are. No doubt, it makes the process of acquiring companies and sustaining a vibrant market for takeovers and acquisitions just that bit more expensive.

A clause for ‘open offers’

But much the same argument was trotted out when the ‘open offer’ requirement in favour of minority shareholders of target firms was first proposed. It was argued that such a requirement would kill the market for ‘corporate control’.

But subsequent events clearly demonstrated that these fears were vastly exaggerated with acquisitions and takeovers continuing to be a facet of corporate India.

It is time to push the envelope of a healthier corporate governance a little further by incorporating a clause for ‘open offers’ for minority shareholders of acquiring firms at a price that is at least not lower than the average price in the market before an acquisition announcement is made.

(This article was published on September 25, 2016)

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