The Mandatory Bid Rule: Efficient, After All?
| Published date | 01 May 2013 |
| DOI | http://doi.org/10.1111/1468-2230.12023 |
| Date | 01 May 2013 |
The Mandatory Bid Rule: Efficient, After All?
Edmund-Philipp Schuster*
The mandatory bid rule has its origins in the UK and now applies throughout the EU and in
many other jurisdictions. Under a mandatory bid, an acquirer of a controlling stake in a listed
company has to offer to the remaining shareholders a buy-out of their minority stakes at a price
equal to the consideration received by the incumbent controller. While the rule warrants that no
value-destroying control transfers take place, it is often criticised for preventing value-increasing
transactions. This paper challenges some of the claims made by critics of mandatory bids.
Highlighting the effects of synergy gains in private sale-of-control transactions, it is shown that
mandatory bids prevent inefficient control transfers, where minority shareholder protection rules
provide inadequate protection. Furthermore, mandatory bids help facilitate transfers to the most
efficient bidders in multi-bidder settings. The mandatory bid is justifiable, on economic grounds,
in wider circumstances than is commonly assumed by law and economics scholars.
INTRODUCTION
Corporate takeovers can create value, primarily by replacing inefficient man-
agement and by realising synergies.1In widely-dispersed companies, control
over a company can be obtained through a takeover bid addressed to all target
shareholders, by making use of statutory mergers or schemes of arrangement,2or,
in limited circumstances, through market purchases.3
Where a company is controlled by a single shareholder,4potential acquirers
will typically first have to negotiate with this blockholder when seeking control
over the company, as the success of the transaction will ultimately depend on this
blockholder’s willingness to sell.5
*Lecturer in Law, London School of Economics and Political Science. I would like to thank John
Armour, Paul Davies, Peter Doralt, Leonardo Felli, Carsten Gerner-Beuerle, Tom Kirchmaier, Roland
Kirstein, Jonathan Rickford, Alan Schwartz, Martin Winner and two anonymous referees for very
helpful comments and suggestions.
1 See eg R. Romano, ‘A Guide to Takeovers: Theory, Evidence and Regulation’ (1992) 9 Yale
Journal of Regulation 119; J. C. Coffee Jr, ‘Regulating the Market for Corporate Control: A Critical
Assessment of the Tender Offer’s Role in Corporate Governance’ (1984) 84 Columbia Law Review
1145; P. Davies, E. Schuster and E. van de Walle de Ghelcke, ‘The Takeover Directive as a
Protectionist Tool?’ in U. Bernitz and W-G. Ringe (eds), Company Law and Economic Protectionism
(Oxford: OUP, 2010) 117–120.
2 These require a combination of board and shareholder approval in most jurisdictions. See
E. Rock, P. Davies, H. Kanda and R. Kraakman, ‘Fundamental Changes’ in R. Kraakman and
others (eds), The Anatomy of Corporate Law (Oxford: OUP, 2nd ed, 2009) 197–198.
3 P. L. Davies and K. J. Hopt, ‘Control Transactions’ in Kraakman and others (eds), ibid, 226.
4 Or, likewise, a coordinated group of shareholders, exercising joint control.
5 There are, of course, situations where an acquisition can be facilitated against the will of the
incumbent controller, ie where the blockholder controls enough voting rights to dominate the
shareholders’ meetings (de facto-control), without holding the majority of the voting rights (de
jure-control). Differences between de facto and de jure-control mainly arise due to passivity and lack
of coordination of minority shareholders; see Davies et al, n 1 above, 122.
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© 2013 The Author. The Modern Law Review © 2013 The Modern Law Review Limited. (2013) 76(3) MLR 529–563
Published by Blackwell Publishing, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA
The rationales for, as well as problems associated with, such ‘private control
sales’ differ in many respects from those arising in takeovers of widely-held
companies. With ownership and control not (fully) separated, the corporate
governance function of the market for corporate control plays a far smaller
role, as blockholders already have sufficient incentives to monitor manage-
ment.6Furthermore, when deciding about selling his shares, the blockholder
is neither conflicted in the same way as a non-owner manager,7nor as
constrained by collective action problems as shareholders of a Berle-Means
company.8
At the same time, a separate set of problems arises in private sale-of-control
transactions. While in widely-held companies the majority of a relatively
homogenous shareholder body decides on the merits of a transaction, this
procedure is substituted by the blockholder’s private evaluation of the offer in
companies with concentrated ownership. The blockholder’s economic position
can (and often will) differ substantially from the mere aggregate of a correspond-
ing number of non-controlling shareholders; this can have a decisive influence
on the outcome of the control contest.
There are two fundamentally different approaches in regulating private sale-
of-control transactions. First, they can be treated like most other sales of private
property, with the seller keeping all of the consideration paid by the acquirer.
Alternatively, the law may impose a sharing requirement, forcing the parties to
let outside shareholders participate in the bargain (ie the premium). The former
approach is sometimes referred to as ‘market rule’, emphasising its deregulatory
nature; it is the concept normally applied in sale-of-control transactions in the
US. The ‘sharing rule’, on the other hand, is most relevant in the form of the
so-called mandatory bid rule (MBR). It is the rule applicable to listed companies
throughout the EEA since the adoption of the Takeover Directive; it is also
applied in many other jurisdictions.9
The classical assessment of the MBR, particularly the assessment by law and
economics scholars, is rather negative. The main point of criticism is that the
MBR prevents some desirable transactions, and thus creates inefficiency costs
6 For a more detailed analysis see Davies et al, ibid, 122; see also C. G. Holderness, ‘A Survey of
Blockholders and Corporate Control’ (2003) Economic Policy Review 51, 54–55.
7 See eg F. H. Easterbrook and D. R. Fischel, ‘The Proper Role of a Target’s Management in
Responding to a Tender Offer’ (1981) 94 Harvard Law Review 1161; J. C. Coffee Jr, ‘Market
Failure and the Economic Case for a Mandatory Disclosure System’ (1984) 70 Virginia Law Review
717; and J. Armour and D. A. Skeel, ‘Who Writes the Rules for Hostile Takeovers, and Why?
– The Peculiar Divergence of US and UK Takeover Regulation’ (2007) 95 Georgetown Law
Journal 1727, regarding problems linked to managerial discretion.
8 ie a company with widely dispersed, uncoordinated shareholders; see A. A. Berle and G. C.
Means, The Modern Corporation and Private Property (New York: Harcourt, Brace & World, [1932]
1968); for collective action and free-rider problems see, eg, S. J. Grossman and O. D. Hart,
‘Takeover Bids, The Free-Rider Problem, and the Theory of the Corporation’ (1980) 11 Bell
Journal of Economics 42; L. A. Bebchuk, ‘The Pressure to Tender: An Analysis and a Proposed
Remedy’ (1987) 12 Delaware Journal of Corporate Law 911.
9 Including Australia, Hong Kong, Russia, Singapore, South Africa, Switzerland and, with some
variations, in Canada and Japan.
The Mandatory Bid Rule
© 2013 The Author. The Modern Law Review © 2013 The Modern Law Review Limited.
530 (2013) 76(3) MLR 529–563
which are unlikely to be off-set by the rule’s (undisputed) advantages over the
deregulatory approach in certain situations.10
This article re-evaluates the efficiency of the MBR. It is argued here that the
MBR offers advantages that are often ignored in the efficiency assessment of this
legal strategy. The analysis involves substituting the question whether or not a
transaction is efficient with the question how efficient the transaction with the
winning bidder is, as compared to other potential outcomes. It will be shown
that, in auction-like control sales, a US-type market rule often creates suboptimal
results, as it fails to facilitate control-taking by the most value-creating bidder.
Not taking this effect into account leads to systematic overestimation of the
inefficiency costs of the MBR.
It will further be shown that these advantages exist irrespective of the level of
investor protection offered in a particular jurisdiction. Private benefits of control,
typically associated with illegal conduct by the majority shareholder, insufficient
investor protection laws and inadequate enforcement, are the main drivers for
differences in the two rules’ performances. It will be shown that synergies play
an important role in analysing the optimality of the two rules, and, consequently,
that the MBR fulfils a role beyond minority shareholder protection – one that
cannot easily be substituted by other legal strategies.
The second section will give an overview of the regulatory solutions in the
EU and the US. The third section will examine the efficiency implications of
both rules in one-bidder scenarios. In the fourth section, the two rules will be
compared in multiple-bidder scenarios, identifying additional advantages of the
MBR; section five concludes with a summary of the findings.
PRIVATE SALES OF CORPORATE CONTROL IN THE EU AND
THE US
The mandatory bid rule
The MBR’s history goes back to 1972, when it was inserted into the City Code
– then a purely self-regulatory body of ‘soft law’11 – by the UK Takeover Panel,12
and it has remained virtually unquestioned ever since.13
10 See, eg, F. H. Easterbrook and D. R. Fischel, ‘Corporate Control Transactions’ (1982) 91 Yale
Law Journal 698; L. A. Bebchuk, ‘Efficient and Inefficient Sales of Corporate Control’ (1994) 109
Quarterly Journal of Economics 957; see also S. M. Sepe, ‘Private Sale of Corporate Control: Why
the European Mandatory Bid Rule is Inefficient’ at ssrn.com/abstract=1086321 (last visited 27
January 2013), for an overview of the literature.
11 With the implementation of the Takeover Directive, the City Code has been put on a statutory
footing, which, however, did not substantially change the ‘soft law’ approach; see eg P. L. Davies,
Gower & Davies’ Principles of Modern Company Law (London: Sweet & Maxwell, 8th ed, 2008)
28–34.
12 See Takeover Panel, Announcement by the City Working Party 1972/2, at http://www.
thetakeoverpanel.org.uk/wp-content/uploads/2008/12/1972-02.pdf (last visited 27 January
2013).
13 N. Jennings, ‘Mandatory Bids Revisited’ (2005) 5 Journal of Corporate Law Studies 37, 38.
Edmund-Philipp Schuster
© 2013 The Author. The Modern Law Review © 2013 The Modern Law Review Limited. 531
(2013) 76(3) MLR 529–563
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