Corporate Governance, Minority Shareholders and Value Dynamics: the Italian Experience of Freeze-Outs

The objectives of this present work intend to interpret, taking the unique and strict perspective of the dynamic laws of company value, the solutions accepted in the studies of Grossman and Hart, of Yarrow and Amihud, Kahan, and Sundaram in the belief of being able to contribute to the fervent debate, also on an international level, on the conditions that influence the effectiveness of corporate control replacement and in general to the success of acquisitive operations aimed at creating value. The Grossman and Hart model identifies, in a nutshell, a hindrance to the efficient corporate control replacement in the individual conduct of the settled shareholder who do not participate to the tender offer, sensing that the unit value of the shares of the company post-acquisition will be higher than the takeover price. Such individual attitude when extended to the collective proclaims the failure of the control transfer. The proposed solution, according to which it would be sufficient to generate in the minority shareholder a different perception of the value of which it may have access (dilution mechanism), appears to be exceeded by the evolution of studies on the nature and extent of private control benefits. The minority shareholder is aware of the fact that:  he may never access the full strategic value of acquisition (v);  the price of the bidding (p) will be placed in an intermediate position between the economic value of the company for the minority shareholders (vs, similar to the fair market value of the minority shares) and the market price of the shares of the target in the period before the offer (q) on one hand, and the strategic value of acquisition (v), on the other. He will, however, tend to assess the magnitude of the dilution effect (i.e. dilution factor), based on a number of conditions hardly appreciable in a formal model, such as, for example, the management quality of the bidder, the past history of the buyer in the M&A operations, his ability to generate shareholder value, the quality of his strategic projects, the capacity to grow though external lines, that is without resorting to continuous social capital increases, etc. The solution of legalized dilution of proprietary rights of the minority shareholders in terms of value dynamics is therefore not only inelegant but also ineffective. The proposal of Yarrow to address the problem of minority opportunism in the context of freeze-out rights is certainly interesting on a practical level: the settled bidder who is aware that, in case of takeover success, will be forcibly removed from the corporate structure at the same amount of the offer, will tend to limit the scope of action of his arbitration. He may, at most, bet on the success or on the failure of the offer, but should he gain perception of the success of the takeover, he will not be able to take a decision with regard to the economic value of the post-takeover shares. Should the tender offer have success, such value in the said freeze-out rule, will necessarily coincide with the price at which the bidder will exercise the right to purchase, that is at a price that is coincident with the consideration of the previous bid. Yarrow’s solution is in fact the one adopted by the Directive 2004/25/EC and is currently being implemented in Legislative Decree 229/2007 which amends art. 111 of the TUIF. Setting a minimum price limit (lower bound), as suggested by Amihud, Kahan, and Sundaram, should also discourage low takeover bid prices, that is with lower considerations than the market value of the shares in the period before the offer. In these cases, the freeze-out will be exercised at the higher of the consideration of the tender offer and the market value of the shares before the bidding. The solution to create an automation able to let the strike price of the freeze-out coincide with the consideration of the previous tender offer requires some reflection on the underlying economic significance. More precisely, we want to investigate the relationship between the price of the mandatory tender offer and the fair market value of the residual shares. To do this, it is necessary to recall the mechanisms for determining the price of the takeover. In fact:  if the minimum price the mandatory tender offer is equal to the arithmetic average between the unit price of the securities that are part of the package purchased before the launch of the offer (Ppc) and the average unit price of the market in the twelve months preceding the launch of offer (Pm) (solution adopted by the previous formulation of Art. 106 of the TUIF), the exercise right to purchase at the corresponding value of the takeover bid means to recognize to the shareholders (pro-quota) that did not participate to the bidding at least half of the premium paid during the acquisition of the controlling package or of the relevant package, leaving them the same emoluments of the settled shareholders that have participated to the bid;  if the minimum mandatory tender offer is equal to the maximum price paid by the bidder for the same securities in the twelve months preceding the offer (POPA = max {Ppc‘ }), the recognition of the consideration for the tender offer to the minority shareholders holding the shares to be redeemed with the freeze-out has the effect of extending to them (of course, on a pro-rata basis) the entire extent of the premium paid to the holder of the control package and to the shareholders who have subscribed to the offer (solution adopted by the Directive 2004/25/EC and implemented in the new formulation of Art. 106 of the TUIF, from Legislative Decree 299/2007). The question of how to determine the freeze-out price should be addressed on two distinct levels. In terms of economic rationality and value dynamics, the extension of the control premium to the remaining shareholders, or even part of the synergistic indivisible benefits, components which are often implied in the takeover price, does not respond to any logic (Gurney, 1987; Copeland-Koller-Murrin, 1990; Zanda-Lacchini-Onesti, 2005). On the contrary, by arguing on the estimated fair market value of the shares subject to the freeze-out, it was noted that conditions do apply for the application of a minority discount. By addressing the issue on this ground, the sharing of the control premium components or of indivisible parts of the acquisition value with the remaining minorities ends up creating a treatment disparity between the settled shareholders, who have joined the bid, and those that did not. If in fact, the tender offer responds to the logic in which the leading bidder extends to the minority shareholders the extent of the premium paid to the former parent (logic also enhanced by the mechanism of the best price rule laid down by Directive 2004/25/EC) it seems clear that to deal, on an economic level, in the same manner with the participating shareholders and the shareholders on std-by or opportunistic, creates a substantially obvious disparity. In other words, participation to the control premium should be recognized only to shareholders who have accepted the offer and its terms. The freeze-out is evidently addressed to the shareholder who decides to wait, that is, to bet on the outcome of the bid or rather, on the failure to reach the threshold level in order for the bidder to exercise the freeze-out. In this circumstance, in fact, on one hand, the shareholder free-rider could, in the effective control acquisition, benefit from the share value increase resulting from a better management that the new parent company should be able to ensure. On the other hand, the shareholder who joined the tender bid would collect the offer amount, forgoing the possibility of accessing the benefits arising from the higher post-takeover value of the shares in his possession. It seems clear that the rule that raises the price of the freeze-out corresponding to the consideration of the takeover, waivers to assign a value to the bet made by the free-rider. These, in fact, will receive even in if the event the wager should not take place (that is, the assumption that the bidder reaches the threshold level to exercise the freeze-out) the very same treatment (pay-off) of the shareholder that has not made any wager in participating to the tender offer (in other words, it will be recognized during the freeze-out, the consideration of the offer). Yarrow’s solution sterilizes or attenuates the opportunistic behaviour of minorities as far as share price/value arbitration is concerned (price of the tender offer and share value post-takeover), but does not affect the bet on the event represented by the threshold achievement to exercise the freeze-out. To discourage this form of opportunism, it would be favourable to introduce a mechanism to determine the price of the freeze-out in a position to exclude free riders from participating in the control premium inherent in the takeover bid price, thus creating a substantial equal treatment of all settled shareholders. Shareholders who do not participate to the offer, would be recognized during the freeze-out, a value which would not be punitive (i.e. not detrimental to their legitimate property rights) represented by the fair market value of the shares in their possession. The delta existing between the price of tender offer and the (lower) fair market value of the minority shares would constitute the “price” (pricing) of the bet. One could argue that this type of solution would have the effect of increasing the pressure on the settled to sell, but as it has been widely noted such problem can be effectively confronted also through other instruments, such as the establishment of rules designed to encourage maximum transparency in the bidding process or the approval of appropriate powers of self protection for the shareholders or for the directors of the target company. Moreover, the establishment of the right to freeze-out, if wedged on a lower level than the one relative to the exercise of the freeze-out, could generate the effect of loosening the coalition to sell, without however prejudging the effectiveness of the plans designed to prevent the occurrence of opportunism behaviours. On a subjective level, however, the question of the mechanism for determining the price of the freeze-out could be addressed in other terms. In other words, the subjective profile of the target minority of the freeze-out should be clarified, it should be understood who the shareholders are that hold 5% (in the old formulation of the TUIF, 2%) of the capital that did not participate to the tender offer. It is clear that, if the conviction is rooted that these residual shareholders belong to the class of shareholder investors or disturbing shareholders, i.e. informed and updated subjects on the evolution of corporate events, familiar with the instruments to protect their patrimonial interests, the considerations made previously remains valid: they are considered aware free riders, informed betters, which must be attributed with a price combination, a different pay off from the settled shareholders who have decided to participate to the offer. But if the profile of the target shareholder of the freeze-out is that of many small investors which are defined as accidental, disinterested, not updated on the company events (known as “atomistic stakeholders”) or, as often happens, the “unintentional” shareholders, the issue of the strike price determination of the freeze-out may be addressed and resolved on a different level from value dynamic laws. In this perspective, the price of the freeze-out takes on an equitable valence, that is regardless of the logic of economic rationality and, therefore, the solution to recognize the price of the tender offer to these residual shareholders, uninformed and disinterested, may be considered acceptable.