The EU Takeover Bids Directive 2004/25/EC has been in force since 2006. The introduction of an EU level takeover directive was controversial and the difficulty of getting agreement from all Member States led to a number of opt-outs being included within the terms of the directive. In particular, Article 12 of the Directive gives Member States the right to opt out of the Board Neutrality Rule (Art 9) and the Breakthrough Rule (Art 11). In accordance with the terms of the Directive, it was reviewed after 5 years. An Assessment Report was carried out, on behalf of the Commission, by Marccus Partners, in cooperation with the Centre for European Policy Studies. They found that the Directive had been transposed in all of the Sample Countries they considered (22 Member States) and that no substantial compliance issues had emerged. They found that, as of 2012, 19 Member States applied the Board Neutrality Rule (ie had not opted out of Article 9), but that only one (Estonia) applied the Breakthrough Rule in full. As a result of this Assessment Report, the Commission has stated that the regime created by the Directive appears to be working satisfactorily, and significant changes to the Directive are not in contemplation. Specifically, no changes to the opt-out arrangements are envisaged.
This needs to be re-thought, however. There are strong arguments in favour of making the Board Neutrality Rule mandatory.
First, the target shareholders and not the target directors are the preferable group to take the control shift decision. The target directors are in a severe conflict of interest, being biased either in favour of a successful bid (if they are part of the MBO team, for example) or against it (where they fear for their jobs). It is sometimes suggested that there may be benefits to the shareholders if the target directors are given a role in the decision, as they do in Delaware, where the bid can’t succeed without the consent of the target directors, who determine whether the shareholders will have the opportunity to decide whether to accept the offer. A benefit to shareholders is sometimes said to flow from the fact that shareholders are likely to obtain a higher premium where the directors control the sale process. One reason for this is the perceived informational advantage which target directors may have, but this can be dealt with, to a large extent, by requiring information to be passed to the target shareholders by the directors (a requirement of the Takeover Bids Directive) and by independent third parties (something which is not harmonised across the EU but which does occur in some Member States, see eg rule 3.1 of the UK Takeover Code). A second reason is that if the bidder deals with the target board this can alleviate the collective action problem which target shareholders face. It is certainly true that target shareholders are at risk of “divide and conquer” strategies by bidders, but this is something that takeover regulation can deal with effectively, via strategies such as the equality principle, the mandatory bid rule, squeeze out and sell out rights etc.
The argument that giving the target directors a role in the control shift decision can be good for shareholders is therefore difficult to accept. In support of this, empirical work conducted by John Coates did not detect a difference in bid premia as between the Delaware model (in which the target directors take a decision making role) and the UK model (in which they do not). It is sometimes suggested that changes in recent years in the constitution of the shareholder body may lend weight to the view that target directors should be involved in the decision making. In particular, it is noted that often by the time that the offer is made the shareholder body is formed of a large number of short term shareholders (such as hedge funds) who, it is said, are not in a good position to determine whether the company is better off in the hands of the bidder. These concerns regarding short termism arose in the UK post-Cadbury/Kraft and have also come to the fore in other Member States, but they are not entirely convincing. Of course the shareholders who purchase shares in the immediate pre-bid period are likely to want the bid to succeed, and are therefore likely to tender their shares. However, they bought them from supposedly longer term shareholders who decided to sell rather than wait for the bid to succeed (or to bear the risk that the bid would fail). In effect, these longer term shareholders have themselves already made a pro-bid choice by selling their shares to the incoming shareholders. Further, it may be said that if this is an issue then this problem should be dealt with within the shareholder body and not by introducing a role for the (necessarily conflicted) target directors.
Alternatively, it is sometimes suggested that the Delaware model provides the directors with the opportunity to determine whether the takeover is in the best interests of the company as a whole, including stakeholder interests separate to those of the shareholders. However, this model will have value in practice if the directors use their position only to defeat opportunistic bids, and not merely to entrench their own position, ie where the employees’ interests align with those of managers.
A further argument in favour of a mandatory Board Neutrality Rule can be made on the basis of the importance of a functioning market for corporate control for corporate governance in the EU (see eg this paper by Hopt). Takeovers can operate as an effective form of corporate governance, since a drop in share price caused by lazy or self-seeking managers can allow the bidder to come in and deal directly with the target shareholders, sidelining the directors, and can facilitate a control shift that gets rid of those underperforming or self-interested managers. On this analysis, limiting the number of takeovers is problematic, especially if this is as a result of boards acting to entrench themselves. This suggests that limiting the defensive measures regarding takeovers could be beneficial for the competitiveness of the EU market.
Finally, where opt-outs occur, they are often being used in a protectionist way by Member States, a point noted in the Commission’s Paper (2012) responding to the Assessment Report.
Consequently, opt-outs of the Board Neutrality Rule by Member States should not be possible. This remains a politically sensitive topic, however, and many of the difficult issues which led to the opt-outs in the first place are still in place. The possibility of legislative change at the present time is small. For this reason, a number of compromise solutions have been proposed, the most attractive being the idea that the Board Neutrality Rule should be the default position, and the opt-out decision should be given to companies rather than Member States, ie this would be for the general meeting of shareholders to determine (an argument raised by a number of authors, see eg Enriques (2009) and Davies, Schuster and Ghelcke (2010)). This suggestion falls short of a mandatory application of the Board Neutrality Rule, but has the benefit of avoiding protectionism by Member States while still protecting shareholders.
If we are serious about shareholder protection within the EU, it is time to rethink the optionality of the Board Neutrality Rule.
Jennifer Payne is Professor of Corporate Finance Law at the University of Oxford.