Mergers, Acquisitions, and Corporate Restructurings

PATRICK A. GAUGHAN is President of Economatrix Research Associates, an economic and financial consulting firm. The firm specializes in the application of economics and finance to litigated matters. Dr. Gaughan also provides various consulting services in the field of mergers and acquisitions and valuation. Dr. Gaughan is also a Professor at the University of International Business and Economics in Beijing, China.

Preface xi

Part I: Background

Chapter 1: Introduction 3

Recent M&A Trends 3

Terminology 11

Valuing a Transaction 13

Types of Mergers 13

Merger Consideration 14

Merger Professionals 15

Merger Arbitrage 18

Leveraged Buyouts and the Private Equity Market 19

Corporate Restructuring 20

Merger Negotiations 21

Deal Structure: Asset versus Entity Deals 24

Merger Agreement 28

Merger Approval Procedures 29

Deal Closing 31

Short-Form Merger 31

Freezeouts and the Treatment of Minority Shareholders 32

Appraisal Arbitrage 33

Reverse Mergers 34

Chapter 2: History of Mergers 41

Merger Waves 41

First Wave, 1897–1904 43

Second Wave, 1916–1929 48

The 1940s 49

Third Wave, 1965–1969 49

Trendsetting Mergers of the 1970s 54

Fourth Wave, 1984–1989 59

Fifth Wave, 1992–2001 64

Sixth Wave, 2004–2007 68

Chapter 3: Legal Framework 71

Laws Governing Mergers, Acquisitions, and Tender Offers 72

Other U.S. Takeover Rules 85

Takeovers and International Securities Laws 86

U.S. State Corporation Laws and Legal Principles 96

State Antitakeover Laws 99

Regulation of Insider Trading 108

Antitrust Laws 110

Measuring Concentration and Defining Market Share 117

Example of the HH Index 118

European Competition Policy 121

Research Note: Event Studies Methodology 124

M&A Research: Event Studies 124

Chapter 4: Merger Strategy 127

Growth 127

Synergy 136

Operating Synergy 138

Diversification 146

Focus Hypothesis 151

Possible Explanation for the Diversification Discount 152

Do Diversified or Focused Firms Do Better Acquisitions? 156

Other Economic Motives 157

Hubris Hypothesis of Takeovers 168

Do Managerial Agendas Drive M&A? 171

Other Motives 176

Part II: Hostile Takeovers

Chapter 5: Antitakeover Measures 183

Management Entrenchment Hypothesis versus Stockholder Interests Hypothesis 184

Rights of Targets’ Boards to Resist: United States Compared to the Rest of the World 185

Preventative Antitakeover Measures 186

Poison Pills 187

Corporate Charter Amendments 199

Changing the State of Incorporation 210

Active Antitakeover Defenses 211

Information Content of Takeover Resistance 234

Chapter 6: Takeover Tactics 237

Preliminary Takeover Steps 238

Tender Offers 245

Advantages of Tender Offers over Open Market Purchases 260

Proxy Fights 267

Chapter 7: Hedge Funds as Activist Investors 279

Macroeconomic Foundations of the Growth of Activist Funds 281

Leading Activist Hedge Funds and Institutional Investors 282

Hedge Funds as Acquirers 288

Hedge Fund Activism and Firm Performance 292

Buyout Premiums: Activist Hedge Funds versus Private Equity Firms 294

Part III: Going-Private Transactions and Leveraged Buyouts

Chapter 8: Leveraged Buyouts 305

Terminology 305

Historical Trends in LBOs 306

Management Buyouts 314

Conflicts of Interest in Management Buyouts 318

U.S. Courts’ Position on Leveraged Buyout Conflicts 319

Financing for Leveraged Buyouts 328

Returns to Stockholders from LBOs 336

Returns to Stockholders from Divisional Buyouts 337

Empirical Research on Wealth Transfer Effects 342

Protection for Creditors 343

Intra-Industry Effects of Buyouts 344

Chapter 9: The Private Equity Market 345

History of the Private Equity and LBO Business 345

Private Equity Market 346

Computing Private Equity Internal Rates of Return 360

Characteristics of Private Equity Returns 361

Replicating Private Equity Investing 365

Board Interlocks and Likelihood of Targets to Receive Private Equity Bids 366

Secondary Market for Private Equity Investments 366

Chapter 10: High-Yield Financing and the Leveraged Loan Market 369

History of the Junk Bond Market 369

Leveraged Loan Market 380

Stapled Financing 383

Part IV: Corporate Restructuring

Chapter 11: Corporate Restructuring 389

Divestitures 392

Divestiture and Spinoff Process 403

Managerial Ownership and Sell-Off Gains 408

Activists and Sell-Offs 408

Shareholder Wealth Effects of Spinoffs: U.S. versus Europe 417

Equity Carve-Outs 424

Voluntary Liquidations or Bust-Ups 430

Tracking Stocks 431

Master Limited Partnerships and Sell-Offs 433

Chapter 12: Restructuring in Bankruptcy 437

Types of Business Failure 438

Causes of Business Failure 439

Bankruptcy Trends 444

U.S. Bankruptcy Laws 448

Reorganization versus Liquidation 449

Reorganization Process 450

Benefits of the Chapter 11 Process for the Debtor 457

Prepackaged Bankruptcy 461

Workouts 465

Corporate Control and Default 470

Liquidation 471

Investing in the Securities of Distressed Companies 472

Chapter 13: Corporate Governance 477

Structure of Corporations and Their Governance 477

CEO Severance Payments 494

Managerial Compensation, Mergers, and Takeovers 494

CEO Compensation and Power 495

Golden Parachutes 499

Compensation Characteristics of Boards That are More Likely to Keep Agency Costs in Check 501

Role of the Board of Directors 502

Antitakeover Measures and Board Characteristics 512

Disciplinary Takeovers, Company Performance, CEOs, and Boards 515

Merger Strategy and Corporate Governance 516

CEO Compensation and M&A Programs 516

Do Boards Reward CEOs for Initiating Acquisitions and Mergers? 516

CEO Compensation and Diversification Strategies 517

Agency Costs and Diversification Strategies 518

Interests of Directors and M&As 519

Managerial Compensation and Firm Size 520

Corporate Control Decisions and Their Shareholder Wealth Effects 521

Does Better Corporate Governance Increase Firm Value? 522

Corporate Governance and Competition 523

Executive Compensation and Postacquisition Performance 524

Mergers of Equals and Corporate Governance 525

Chapter 14: Joint Ventures and Strategic Alliances 535

Contractual Agreements 535

Comparing Strategic Alliances and Joint Ventures with Mergers and Acquisitions 536

Joint Ventures 536

Strategic Alliances 542

Chapter 15: Valuation 551

Valuation Methods: Science or Art? 553

Managing Value as an Antitakeover Defense 553

Benchmarks of Value 554

How the Market Determines Discount Rates 566

Valuation of the Target’s Equity 579

Marketability of the Stock 579

Takeovers and Control Premiums 583

Valuation of Stock-for-Stock Exchanges 588

Shareholder Wealth Effects and Methods of Payment 589

Exchange Ratio 595

Fixed Number of Shares versus Fixed Value 602

Merger Negotiations and Stock Offers: Halliburton versus Baker Hughes 603

International Takeovers and Stock-for-Stock Transactions 603

Desirable Financial Characteristics of Targets 604

Chapter 16: Tax Issues in M&A 613

Financial Accounting for M&As 614

Taxable versus Tax-Free Transactions 614

Tax Consequences of a Stock-for-Stock Exchange 617

Asset Basis Step-Up 618

Changes in the Tax Laws 619

Role of Taxes in the Merger Decision 620

Role of Taxes in the Choice of Sell-Off Method 622

Organizational Form and M&A Premiums 622

Capital Structure and Propensity to Engage in Acquisitions 623

Taxes as a Source of Value in Management Buyouts 624

Miscellaneous Tax Issues 625

Glossary 631

Index 643