Hostile Takeovers, Corporate Law, and the Theory of the Firm
| DOI | http://doi.org/10.1111/1467-6478.00040 |
| Date | 01 March 1997 |
| Published date | 01 March 1997 |
| Author | Simon Deakin,Giles Slinger |
INTRODUCTION
The legal treatment of hostile takeovers1is a central issue in the contem-
porary debate on corporate governance. In the 1980s, hostile takeovers came
to be regarded a mechanism both for raising shareholder value and for
enhancing the efficiency of the corporate system as a whole. Two main effects
were imputed to hostile bids. First, the threat of an unwelcome bid served
to improve the performance of incumbent managers and to align their
interests more completely with those of shareholders. Secondly, hostile bids,
even where they were not successful, tended to induce corporate restruc-
turings which in turn freed up productive resources to be reallocated to more
efficient uses elsewhere in the economy. In order to realize these ends, the
fostering of an active market for corporate control was seen as one of the
principal goals of company law.
More recently, this view has been challenged by the ‘stakeholder’ model
which sees hostile takeovers as occasions for the redistribution, rather than
the generation, of wealth. The gains made by shareholders are said to accrue
not from greater efficiency in the management of assets, but from income
transfers made at the expense of the long-term employees, suppliers, and
customers of the firm. The threat of such expropriation undermines co-
operation within the productive process and thereby threatens long-run compet-
itiveness. Views of this kind informed the adoption of ‘stakeholder’ or
‘constituency statutes’ in many United States jurisdictions in the late 1980s
and early 1990s but, as yet, have had little impact on the British debate.
The legal framework of corporate law – broadly conceived to include not
just company law but also elements of labour law, commercial law, and the
law of taxation – is more immediately concerned with the definition of the
property rights and income streams of those with interests in or against the
business enterprise, than with considerations of economic efficiency. Economic
© Blackwell Publishers Ltd 1997, 108 Cowley Road, Oxford OX4 1JF, UK and 238 Main Street, Cambridge, MA 02142, USA
*ESRC Centre for Business Research, Department of Applied Economics,
University of Cambridge, Sidgwick Avenue, Cambridge CB3 9DE, England
124
JOURNAL OF LAW AND SOCIETY
VOLUME 24, NUMBER 1, MARCH 1997
ISSN: 0263–323X, pp. 124–51
Hostile Takeovers, Corporate Law, and the Theory of the Firm
SIMON DEAKIN*AND GILES SLINGER*
The support of the Economic and Social Research Council (ESRC) is gratefully acknowledged.
The work on which this paper is based formed part of the Corporate Governance Programme
of the ESRC Centre for Business Research.
125
© Blackwell Publishers Ltd 1997
arguments may nevertheless provide a powerful justification for, or critique
of, corporate law systems. The argument that it is the purpose of a given
branch of the law to defend the interests or rights of one group as opposed
to another can, in the end, only take us so far. It is of limited assistance,
for example, in determining when shareholders’ interests should be qualified
by those of, for example, employees or creditors. In practice, shareholders’
property rights are rarely unqualified; they depend on the state of company
law and corporate governance within particular national systems, and they
vary considerably according to differences in company structure, conceptions
of directors’ duties, and the specific regulation of takeover activity. It is
largely because there is no one ‘natural’ model of shareholder rights that
attention has focused on the implications of different systems for economic
efficiency.
It is in the context of this debate that the present paper makes an
assessment of the competing economic theories of the corporation, with
particular reference to the regulation of takeovers. We firstly contrast the
contractarian model to a loosely-related group of theories (including the
‘stakeholder’, evolutionary, and competence-based models) which maintain
that the essence of the firm as a productive entity cannot be fully captured
by a contractual analysis. Next we examine how far legal conceptions of the
corporation and, more specifically, of the takeover process, offer support
for the different economic models. The focus here is on the United Kingdom
takeover code and related aspects of company law, the broad features of
which are contrasted to those of the United States and German systems.
This is followed by an evaluation of the available empirical evidence (which
is mainly north American) on the efficiency effects of takeovers. The
concluding section considers the relevance of economic theory for the design
of corporate law and corporate governance.
ECONOMIC THEORIES OF THE CORPORATION
1. The contract model
The notion of the corporation as a ‘nexus of contracts’ is a development
from Coase’s initial insight into the firm as a means of economizing on
transaction costs.2However, where Coase saw the firm as ‘superseding’ the
price mechanism, suggesting that the firm was an alternative to the market
as a mode of economic co-ordination, the line of thought initiated by Jensen
and Meckling has maintained that:
it makes little or no sense to try to distinguish those things which are ‘inside’ the firm
(or any other organization) from those which are ‘outside’ of it. There is in a very real
sense only a multitude of complex relationships (i.e., contracts) between the legal fiction
(the firm) and the owners of labor, material and capital inputs and the consumers of
output.3
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