Hostile bids for corporate control became notorious in the 1980s, when corporate raiders would seize a company only to sell it off piece by piece. More recently, Wall Street has seen the rise of the so-called strategic takeover. The aim of such buyouts is to maximize the return on stockholders’ investment not by tearing a company apart but by lopping off fat, shedding unprofitable products, revitalizing marketing programs or using other tactics that supposedly "entrenched" management may be unwilling to take. At least, that’s the theory. In practice, the results are spotty. Supposedly savvy takeover artists have been known to leave companies in a financial shambles (Ronald Perelman and comic-book publisher Marvel, for instance, or Carl Icahn and TWA; both companies went bankrupt). Some tycoons, it seems, are better at engineering takeovers than running companies. But not every company has a Perelman or an Icahn sitting on its board, ready to discipline managers if they fail to deliver results. Rich blockholders are scarce, so they must concentrate their efforts on companies where their monitoring and restructuring services are needed. Indeed, if rich investors were commonplace, hostile takeovers would be rare, as a recent paper by the Wharton School’s
In "Blockholder Identity, Equity Ownership Structures, and Hostile Takeovers," Gorton and Kahl show why it is the rich investor and not the institutional investor who initiates takeover attempts. (Gorton and Kahl’s definition of "rich investor" includes not only individuals with large blocks of shares but also families with extensive holdings and hedge funds, which are controlled by a limited number of rich investors.)
One reason rich investors lead hostile takeovers is the tremendous advantage they have in terms of freedom to act. Institutional investors are run by professional managers who act as agents for the many interests controlling their funds. This limits their options and makes it virtually impossible for them to act quickly.
Gorton and Kahl show that skilled takeover artists such as Icahn, Perelman, Michael Price, Charles Bludhorn or Victor Posner are effective at winning takeover bids not because they have unlimited wealth but precisely because their wealth is finite. They must concentrate their capital where the payoff is likely to be greatest–that is, on firms that are faltering. Such companies need the rich investor’s monitoring and restructuring capabilities. Well-performing firms don’t.
Rich investors’ penchant for information-gathering tells them why a company’s financial performance is faltering and what needs to be done to turn the company around. This gives them considerable bargaining power with institutional investors in winning their support for a takeover. It also enables them to outperform institutional investors in terms of return on investment (ROI).
Despite much talk in the U.S. about institutional activism, institutional investors never initiate takeovers. Their historical ROI compared to rich investors shows that they are not as adept at investigating the firms in which they invest. Moreover, if institutional investors engaged in takeovers, they would soon be competing among themselves, driving up prices for stock and draining much if not all of the potential profit to be gained from a takeover.
Institutional investors tend to buy into a company early, when the entrepreneur leading the company seeks to raise money for a potentially profitable project. If the company subsequently falters in its financial performance, the rich investor may spring into action. He will buy large blocks of shares in an attempt to take over the firm. Once in command, he will restructure the company for greater profitability, perhaps selling off assets, divesting a business line or otherwise changing business strategy. If the restructuring is successful, the resulting gain in the firm’s value overcomes the cost of buying up large blocks of stock..
The institutional investor plays an important supporting role in all this. Clearly, it would not make sense for an institutional investor intentionally to invest large blocks of shares in troubled firms. When companies in which they have large blocks of shares do get in trouble, however, institutional investors serve the important function of supporting the rich investor in doing whatever he feels is needed, including a hostile takeover, to improve financial results.
Certainly, rich investors may do no better than an incumbent management in improving a company’s performance. But their ability to discipline corporate management makes them efficient corporate monitors. Institutional investors serve an important monitoring function, too. Their ability to sell blocks of shares to rich investors means they can grease the skids for an entrenched corporate management unwilling to do what is needed to make a company more profitable.
Gorton and Kahn also point out that hostile takeovers are not common to all capitalist economies. This is largely because outside the U.S. and the U.K., rich blockholders are not scarce. For example, in Germany, 85% of the largest companies have a single shareholder owning more than 25% of the voting shares. In Germany, not coincidentally, acquisitions by companies dominated by large blockholders get higher-than-average ROI than do companies without such investors.
Rich investors the world over, it seems, have ways of getting the most bang from their limited capital.
