NCPA - National Center for Policy Analysis

Restoring Market Discipline: Hostile Takeovers

February 12, 2003

Financial scandals involving major U.S. companies such as Enron, Global Crossing and WorldCom have been used to support stricter regulation of American corporations and their accounting practices. However, some analysts say existing regulations severely limit a market mechanism that once effectively controlled greed: hostile takeovers.

In hostile takeovers, outside investor groups attempt to acquire a controlling interest in a corporation's publicly traded stock. If they succeed, they can fire the existing management.

The possibility of hostile takeovers discouraged excessive compensation, bonuses and stock options, as well as insider trading and cheating on financial statements. Such activities tend to reduce the value of the offending companies' shares, and new owners were able to profit by replacing the management and eliminating those practices.

  • However, the Williams Act of 1968 required these outside investors to notify the Securities and Exchange Commission of their intent to take over a corporation and made takeovers much more difficult to carry out.
  • In addition, state regulators authorized the easy use of so-called poison pills -- measures taken by corporate management to make takeovers prohibitively expensive -- and other practices that delay or prevent the take-over.
  • They also permit executives to exact large settlements for themselves before they lose their jobs.
  • During the late 1980s, after a rash of hostile take-overs and during a business downturn, new state regulations made the practice even more difficult.

Thus, observers note, anti-takeover regulations designed to protect shareholders inevitably end up serving the interest of existing companies, their executives, directors and unions.

Source: Herbert Gruel, "The Regulators versus Adam Smith," Fraser Forum, December 2002, Fraser Institute.


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