Tuesday 2 March 2010

Mandelson calls for tougher takeover tests

Peter Mandelson gave the Mansion House Speech for the second year in a row last night. The speech continues the Business Secretary's critical rethinking of New Labour's approach to political economy, reflected in the government's growth and industrial strategies.

Last night, this was extended through a significant call for rethinking the takeover rules, to throw "some extra grit" in the system, and for rules which incentivise the "stewardship" responsibilities of company directors. Mandelson argued that the Kraft takeover of Cadbury showed the need for reform of the current rules:

Nobody believes that poorly performing management should be protected. But the open secret of the last two decades is that mergers too often fail to create any long term value at all, except perhaps for the advisors and those who arbitrage the share price of a company in play.

A lot of M&A advisors must be sleeping badly in that knowledge. Or maybe not.

And it seems to me that given that a takeover can have huge implications for workforces and communities as well as investors, this is an area where good governance, and active and responsible shareholding, are absolutely critical. I do believe that there is a strong case for throwing some extra grit in the system.

This is true for us in particular because the UK has a very open market for corporate control, arguably the most open in the world. And it is in our interest to make sure that this openness is producing sound outcomes.

In the case of Cadbury and Kraft it is hard to ignore the fact that the fate of a company with a long history and many tens of thousands of employees was decided by people who had not owned the company a few weeks earlier, and probably had no intention of owning it a few weeks later.

Company Directors engaged in takeovers clearly have a legal duty to shareholders. For the Directors of the target this is often interpreted as meaning a duty to accept any price that exceeds their own assessment of the future valuation of the company.

However, the Companies Act sets out the duties of directors to consider the best outcome for a company in the long term, considering the interests of all the stakeholders – employees, suppliers, and its brands and capabilities. Getting a higher price in a takeover may not be perfect proxy for that.

These were the Business Secretary's specific proposals for reform of the takeover code.

I welcome last week’s decision of the Takeover Panel to consult on the provisions of the Takeover Code, following Roger Carr’s sensible suggestions reflecting his Cadbury/Kraft experience. I believe that there is a case for:

- Raising the voting threshold for securing a change of ownership to two thirds;

- Lowering the requirement for disclosure of share ownership during a bid from 1% to 0.5% so companies can see who is building up stakes on their register

- Giving bidders less time to “put up or shut up” so that the phoney takeover war ends more quickly and properly evidenced bids must be tabled.

- Requiring bidders to set out publicly how they intend to finance their bids not just on day one, but over the long term, and their plans for the acquired company, including details of how they intend to make cost savings; and;

- Requiring greater transparency on advisors’ fees and incentives.

I also think there is a case for requiring all companies making significant bids in this country to put their plans to their own shareholders for scrutiny. Kraft after all had to bend over backwards to avoid asking Warren Buffet for his binding opinion, although I think we all got his message.

None of these measures would necessarily have prevented Cadbury changing hands – that is not the point. They would have enabled the owners of both companies more actively to scrutinize the transaction, and better weigh the long term prospects for the merged company.

Mandelson said he was open to a debate about wider reform proposals, though expressed his caution about the TUC's call for a "public interest test" that a takeover is in the “long-term interest” of a company, as Adam Lent sets out on the TUC Touchstone blog.

Mandelson stressed that the focus should be on corporate stewardship and long-term ownership, not the fact of domestic or foreign ownership (though the TUC proposals do not seek to make distinctions on that basis.

Some people have gone further and suggested that we need a new form of public interest test to guard British companies against foreign acquisition. I am happy to have an open debate about this, but I think we need to be very cautious about this.

Britain benefits from inward investment and an open market for corporate control internationally. A political test for policing foreign ownership runs the risk of becoming protectionist, and protectionism is not in our interests.

We already have certain EU and UK rules that protect the public interest in a change of corporate control. A public interest test already applies to questions of competition, public security, media pluralism and - in the UK - financial stability.

These rules have evolved over time – most recently to absorb the concept of financial stability. They are not immutable, and as I said I am open to debate. But we must not get drawn into a narrow debate about foreign ownership, which is not the issue. More important is the need for reform to promote corporate stewardship and long term engagement and ownership amongst shareholders, boards and their directors.


Unknown said...

"we must not get drawn into a narrow debate about foreign ownership, which is not the issue"

Here Mandelson is right...

The issues are

1) investor-ownership and corporate structures which are geared towards profit-maximisation rather than mere profit-making

2) the exclusion of the general public and workforces from participation in decision-making in the economy.

Cantab83 said...

Well at least Mandelson is opening up the issue of takeovers for debate. However, his proposals for reform are insufficient because they fail to address the three main economic problems with corporate takeovers. I pointed most of this out a few months ago, but to re-cap, these are:

a) They result in lower corporate investment as companies are bullied or coerced into maximising short term profit in order to support their share price at the expense of future research, development and growth. Is it a coincidence that the UK with its liberal takeover rules is also the developed country with the lowest ratio of industrial R&D to GDP? I doubt it.

b) They are in principle anti-competitive, and therefore the enemy of the free market. How is it consistent for competition rules to on the one hand outlaw price-fixing between competing companies, and yet on the other hand to allow those same two companies to merge into a single entity with a single price structure? From the point of view of consumer choice the two scenarios are indistinguishable.

c) They generally increase the amount of debt within the economy as most takeovers are financed by new debt. This debt is then offset against profit to reduce tax, thereby reducing wealth redistribution and social provision.

Takeovers are a form of corporate cannabilism that allows companies to perpetuate an illusion of growth without creating real added value through endogenous growth. They reduce competition in the market and stifle innovation. In extremis they create quasi-monopolies and oligopolies. But perhaps most worryingly, they appear to have as much net benefit to the overall economy as a dog chasing its own tail. Too many takeovers are followed a few years later by de-mergers that end up recreating the very entities that pre-existed the original takeover. So who benefits from this continuous cycle of mergers and de-mergers other than company directors, advisors, consultants and corporate lawyers, many of whom appear to drive the whole process and receive bonuses and commissions as a result?

The fact is we need radical change. We need new rules because the current ones do not work. Too many recent anti-competitive cases have failed, some partly I suspect because the rules are too vague and arbitrary to be enforced effectively. The rules therefore need to be objective and absolute.

Cantab83 said...

In my comment above I outlined the problems. These are some possible solutions.

1) We need to outlaw ALL hostile takeovers.

2) We need to set fixed limits (say 10%) on market share for any merged company to maximise competition.

3) We should outlaw ALL mergers financed by debt. Companies should have to use cash or new shares. Moreover, there should be a time delay (of say 6 months or one year) before such shares were issued. So speculators would need to gamble on the long term share price of the merged company. Such mergers would be less attractive to speculators if there was no quick cash bonus on offer.

4) All mergers should require approval from over 75% of shareholders in each company, not just the takeover target.

5) Fundamentally, though, we need to look at rules of corporate governance. The argument that many proffer in favour of takeovers is that they are an essential tool that is required to keep management and boards of directors on top of their game. But isn't that what shareholders are supposed to do? If you need to take over a company in order to remove bad management, what does that imply about the effectiveness of corporate oversight and governance by shareholders? We clearly need to give more powers to long term shareholders, reduce the voting rights of short term speculators, reduce the power of CEOs on boards, and increase the power and independence of non-executive board members.

Finally it would be interesting to speculate on the relative attraction of the London Stock Exchange if a listing on it guaranteed a company increased protection from predators. Would more companies flock to the LSE, or de-list from it? I suspect the former, but would like to hear a reasoned argument for the opposite or latter scenario.

Sunder Katwala said...


Appreciate the detailed argument: how far do you feel the TUC's public interest test would capture the direction of travel you want?

And thanks for the link to the blog, which I have added to my googlereader and will follow.

Cantab83 said...


The problem with the TUC's public interest test is that, unless it is composed of a set of objective tests, it would be unworkable. For example, we have competition rules at the moment. Unfortunately their enforcement appears to be either arbitrary or haphazard. That often leaves them wide open to legal challenges.

The other problem is that any test cannot be discriminatory otherwise it risks contravening EU competition and single market rules, or UK law.

That said, there are a couple of public interest tests that the TUC could define objectively that would eradicate some of the problems I have outlined.

Test 1: No merger should be allowed if it increases the amount of net debt. Mergers should have to create added value to the economy not additional debt.

Test 2: No merger should be allowed between companies that compete in any sector of their business. This is essential to prevent a reduction in levels of competition in the market. Companies could get round this though, by de-merging the part of the takeover target that overlaps with their existing business.

The above rules should also apply to the sale of business units from one company to another.

Neither of these tests would, however, prevent large conglomerates from using spare cash to gobble up various industrial minnows that they can then asset-strip. Nor would they act as disincentives to speculators and other short term investors and stop them from buying into the takeover target and pushing the takeover through. The problem of speculators could be addressed by forcing them to become longer term investors.

Test 3 could be this. A takeover could only be funded by the issuing of preference or non-voting shares of some type that could not be traded for a year. After a year these would then convert to ordinary shares in the predator company at a rate predetermined at the time of the takeover. I think that this would act to discourage most short term investors. They would have to speculate on the new share price in 12 months time (no easy thing to do) and their money would be locked in for 12 months.

The only remaining issue is how we could guarantee a company legal protection from a hostile takeover (or even an agreed takeover that was against the UK national interest), if the three measures above all fail. This would probably require changes to the takeover rules of the LSE, and to the role of directors and shareholders under the Companies Act. We could bar the directors of the takeover target from being employed by the predator company, or from receiving any financial gain from the takeover. We also need to improve corporate governance by shareholders, not only to tackle takeovers, but also to address the issue of boardroom pay and bonuses.

As for Mandelson's argument that "Britain benefits from inward investment ...", sadly much of this investment is used to buy up our assets in order to solve our balance of payments problem.