To what extent has the emergence of a so-called 'market for corporate control' dealt with the problems surrounding corporate governance?

The emergence of a so-called ‘market for corporate control’ has been seen to contribute to the strategies for corporate governance employed in the Anglo-American model of company law, which essentially concerns itself with aligning the interests of shareholders with those of the managers of a company . Market theorists believe that the market for corporate control is the most effective way of disciplining the management of a company, or alternatively it is a back up control mechanism that comes into play when internal governance fails to reconcile the interests of shareholders and managers . The theory is that inefficient management will be reflected in low stock market valuation compared to similar companies that are run more effectively and consequently the company is likely to become the target of a takeover.

There are two ways in which the takeovers contribute to the corporate governance process –firstly if a takeover occurs, then it is likely that the inadequate management will be replaced by more effective managers. Secondly the threat of takeover itself encourages managers to act in the interest of shareholders to avoid their displacement .

However the effectiveness of the market for corporate control can be frustrated by defensive strategies on the part of the managers of a potential target company. Rather than the market for corporate control ensuring that management acts efficiently and maximises profits, it might be that it encourages managers to take action to make their company unattractive to any potential predator. Such actions will not necessarily benefit shareholders. An example of this might be a tactical absorption of other companies in order to increase the size of the potential target company or the initiation of an auction to increase the bid price. Managers could claim that these actions were in the interest of shareholders, while they were in fact defensive tactics to protect their position . Constraints on executives taking unreasonable defensive actions have consequently arisen as the market for corporate control has emerged, most notably in the form of the City Code on Takeovers and Mergers which prohibits action by the board of a target company designed to frustrate the bid unless such action is approved by the majority of shareholders .

But there are other imperfections in the market for corporate control which undermine its effectiveness as a corporate governance mechanism. Firstly there is the high financial cost of a takeover, namely underwriting, professional fees, advertising costs and the fact that the bidder will pay in excess of the market value for the shares , which acts as a disincentive to takeover. Another disincentive might arise through shareholders ‘freeriding’ –declining an offer for their shares in the belief that their decision will not impact on the takeover and that they will obtain post-merger gains , the result for the predator being high level acquisition costs and the majority of the benefit going to existing shareholders. Additionally there is the impetus on the board of the target company to engage in short-termism –the maximisation of short term performance at the expense of long term investment decisions , which typically results in the neglect of research, training and development . There are social costs too, such as the potential impact on employees, since the new owners do not take on the obligation to honour existing implicit contracts , for example when an employee works for a lower wage on the understanding that she will benefit from job security and long term employment. It is often the case that incoming management’s efficiency drive will involve reducing the workforce such that “(t)he market for control may be seen from this perspective, therefore, as having a negative side-effect in so far as it gives shareholders an opportunity to make unfair gains at the employees’ expense.”

Moreover local communities are often affected by the market for corporate control, since there is the tendency for the decision making processes to shift to the takeover parent company, likely to be situated in the South East.

Thus in terms of ensuring that managers run the company in the interest of shareholders, the market for corporate control might offer some assistance to resolving problems of corporate governance, even though it neglects other stakeholders such as employees and local communities. However while it is said that the market for corporate control is itself an investor protection mechanism, the fact that there is regulation of defensive tactics recognises that the market for corporate control does not guarantee the interests of shareholders . It is therefore apparent that the extent to which the market for corporate control deals with problems of corporate governance is limited and that it is merely a complementary device to be used alongside other internal corporate governance mechanisms .

Bibliography

Bradley C., “Corporate Control: Markets and Rules” in Wheeler S. (ed) A Reader on the Law of Business Enterprise (1994) OUP pp180-207.

Franks J. and Mayer C., “Governance as a Source of Managerial Discipline” http://www.dti.gov.uk/cld/franksreport.pdf Accessed 4/12/05.

O’Sullivan P., “Governance by Exit: An Analysis of the Market for Corporate Control” in Keasey K., Thomson S., & Wright M. (eds) Corporate Governance: Economic, Management, and Financial Issues (1997) OUP pp122-146.

Parkinson J., Corporate Power and Responsibility(1992) OUP.

Pettet B., Company Law (2005) Pearson.

Tridimas T., “Self-Regulation and Investor Protection in the United Kingdom: the Take-Over Panel and the Market for Corporate Control” Civil Justice Quarterly 10(Jan) pp24-43.

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