To understand whether any regulatory regime encourages or discourages certain market practices, one must work backward, beginning with an understanding of the core tenets of a theory such as the Corporate Control Theory, from which principles can be derived. These principles, in turn, inform policymakers on how to regulate and influence market practices.
The Market for Corporate Control theory, introduced by Henry Manne in 1965, emerged during a period when US legislators sought to tighten regulations on activities deemed detrimental to the economy, such as vertical mergers and predatory competition. These actions were condemned under the principles derived from antitrust laws. Even mergers between successful and failing companies faced strong opposition, with courts rejecting arguments that a merger could revive a failing entity, viewing it as anti-competitive.
At its core, the Corporate Control Theory posits that when one entity takes over corporate control of another, the resulting entity must create value. This value creation hinges on the belief that there’s a strong correlation between management efficiency and a company’s share price. Inefficiently managed companies tend to have lower share prices, providing an opportunity for a predator company to take control, improve efficiency, and realize the true value of the company’s shares.
Manne outlines three methods of corporate control: proxy fights, direct share purchases, and mergers. Proxy fights, while allowing outsiders to advocate for shareholder interests, are deemed less suitable for transferring corporate control due to their expense and regulatory constraints. Direct share purchases suffer from limitations such as involving only a subset of shareholders and potential inequality in transaction terms. Mergers, requiring management approval, are seen as preferable as they ensure equality among shareholders and involve all stakeholders in the decision-making process.
Michael Jensen expanded on Manne’s theory with the Agency Theory, emphasizing that managers act as agents of shareholders and must efficiently manage the company to maintain share prices. Inefficient management leads to decreased share prices, inviting takeovers to rectify the situation.
In theory, the market for corporate control enhances social welfare by incentivizing efficient management and ensuring shareholder value. However, this solution is viable only when managerial inefficiencies are the primary issue and not due to external factors. Empirical evidence suggests that hostile takeovers often result in replacing inefficient management, leading to increased shareholder value. However, long-term studies are inconclusive due to measurement challenges.
For the theory of corporate control to succeed, the costs of inefficiency and agency problems must outweigh the transaction costs of turnover. Additionally, factors such as liquidity in the stock market, efficiency in capital markets, and manageable resistance from target management are crucial.
While factors like gaining intellectual property rights may also drive takeovers, they ultimately align with the principles of the corporate control theory, aiming to maximize social welfare by extracting more value from assets.
In conclusion, regulatory regimes based on the corporate control theory generally encourage takeover transactions, but efficiency gains post-takeover are a prerequisite. This principle is reflected in acquisition laws worldwide, lending authority to the theory.
Overall, understanding the nuances of the theory of market for corporate control provides insight into the regulatory landscape and its implications for market practices.
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