In September 2011, significant changes were made to the UK’s takeover rules. These changes were seen as a response to the initially hostile takeover of Cadbury by the US acquirer, Kraft, but the British Private Equity and Venture Capital Association (BVCA) was among those who argued (following a member survey) that they would have an inhibiting effect on all “take private” activity – and would particularly disadvantage financial bidders. Recent academic research would appear to bear out at least the first part of that claim.
The 2011 reforms to the UK’s Takeover Code were controversial at the time, and the most noteworthy change was the prohibition (with limited exceptions) of inducement, break or termination fees, and other forms of “deal protection”. Until 2011, it had been common for bidders for public companies (including private equity funds) to agree with the target board that, if a rival bid emerged after it had made its offer, a fee (of up to 1% of the bid value) would be paid to the unsuccessful bidder. Such a payment was intended to induce a bidder to come forward and, to some degree, cover its costs in making a public bid.
Bidding for public companies is a risky business, and the loss of this key protection was thought likely to inhibit deal activity. Financial bidders might rely more heavily on this protection than strategic acquirers – because they won’t have synergies to bolster the price they can pay and, once a company is “in play”, other bidders are quite likely to emerge. Since private equity firms have to weigh up the costs and benefits of pursuing a public target instead of a private one, they may feel that the risk is too great without any form of deal protection from the putative target.
The first academic research into the effect of the 2011 changes seems to confirm that deal volumes were significantly affected by these reforms, with a fall of 50% relative to a control group – estimated to equate to a drop in deal values from deterred bids of $17.5 billion (£13.5 billion or €15.3 billion) per quarter.
Of course, an absolute fall in deal volumes would be easy to measure but would not prove that the 2011 reforms were responsible. However, the researchers look at volumes in relative, rather than absolute, terms – and conclude that UK takeovers fell in comparison to those on a wide range of markets, many of which would have been subject to similar market conditions.
On the other hand, it might be expected that target shareholders would get some corresponding benefits from the changes; for example, once a company is “in play”, competing bidders might be more willing to come forward, and to pay more, knowing that the assets of the target will not be depleted by the break fee if they succeed. However, the researchers find no evidence of any such effect: there was no discernible increase in competing bids, or in deal premiums, after the reforms.
This research does not indicate that private equity bidders were more inhibited by the reforms than their strategic counterparts – rather, it suggests that the effect was substantially the same – nor does it untangle the impact of the prohibition on break fees from the effects of the other changes made to the Takeover Code at the same time. Those changes included a 28-day “put up or shut up” period (with extensions generally only possible with management backing), early identification of prospective bidders, and additional financing disclosure requirements. However, the more general claim – that the package of changes reduced the number of deals – seems clearly established.
The political climate at the time of these reforms may suggest that a reduction in takeover activity was indeed their objective and, if so, this research suggests that the reforms achieved their goal. But these academic researchers take a different view: they argue that deal protections are socially desirable, facilitating the flow of resources to their most valuable use, and they suggest that the lesson from the UK reforms is that they should not be copied elsewhere.
For further information, see The Effect of Prohibiting Deal Protection in M&A: Evidence from the United Kingdom, Fernan Restrepo and Guhan Subramaniam, Journal of Law and Economics (forthcoming), available at http://dx.doi.org/10.2139/ssrn.2820434.