FTC Staff Comment to the Hon. Vincent J. Funo Concerning Pennsylvania S.B. 1310 to Regulate Hostile Takeovers of Certain Companies

52G-A Atrium Office Plaza
668 Euclid Avenue
Cleveland, Ohio 44114
(216) 522-4210
Facsimile: 522-7239
Marlc D. Kindt
Regional Director
UNITED STATES OF AMERICA
FEDERAL TRADE COMMISSION
CLEVELAND REGIONAL OFFICE
COMMISSION AUTHORIZED
February 23, 1990
The Honorable Vincent 1. Furno
Senate of Pennsylvania
Senate Post Office
The State Capitol
Harrisburg, Pennsylvania 	17120-0030
Dear Sena tor Fumo:
The staff of the Federal Trade Commission is pleased to respond to your
letter requesting comments on Senate Bill 1310.1 The bill, if enacted, would amend
Title 15 of the Pennsylvania Consolidated Statutes governing corporations and
unincorporated associations to regulate "hostile" takeovers of certain companies
incorporated in Pennsylvania. 	Specifically, the bill would prohibit bidders for
corporate control from voting "control shares" unless a majority of shareholders,
including incumbent management, has voted to authorize the exercise of that
right. 	The proposed legislation would also prohibit potential and actual corporate
acquirers from retaining any increase in value of corporate securities sold within
18 months of attaining "controlling person or group" status, and require the
payment of severance compensation to employees terminated within two years of
a successful acquisition.
We believe that enactment of the proposed legislation is likely to deter
takeovers that may increase economic welfare. 	Further, the proposed legislation's
disgorgement provisions would appear to impede shareholders' legitimate rights to
control the assets they own. 	If the legislature nevertheless decides to enact the
bill, we suggest that it consider making subchapter G and subchapter H of the
1 	These comments are the views of the staff of the Cleveland Regional Office
and the Bureau of Economics of the Federal Trade Commission. 	They are not
necessarily the views of the Commission or any individual Commissioner.

The Honorable Vincent J. Furno
February 23, 1990 	Page 2.
legislation applicable solely to corporations that affirmatively elect to be covered
by them through amendments to their articles of incorporation. 	An affirmative
"opting in" provision would enable the shareholders of each corporation to
determine whether such restraints on the transfer of corporate control are in the
interests of the corporation.
I. 	INTEREST AND EXPERIENCE OF THE STAFF
OF THE FEDERAL TRADE COMMISSION.
The Federal Trade Commission ("FTC") is charged by statute with
preventing unfair methods of competition and unfair or deceptive acts or
practices in or affecting commerce. 	15 U.S.C § 45. 	Pursuant to this mandate, the
staff of the FTC seeks to identify restrictions that impede competition or increase
costs without offering countervailing benefits to consumers. 	Our efforts have
included providing comments to federal, state, and local legislatures and
administrative agencies on matters that raise issues of competition or consumer
protection policy.
The staff of the FTC has substantial experience in the area of mergers and
acquisitions. 	The FTC enforces Section 7 of the Clayton Act, 15 U.S.C § 18, which
prohibits acquisitions of corporate assets or securities that may substantially lessen
competition or tend to create a monopoly. 	Under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, 15 U.S.C § 18a, the FTC reviews proposed acquisitions
of corporate assets or securities, including tender offers, to determine whether
they violate the antitrust laws.
The FTC's staff has addressed issues related to the market for corporate
control through scholarly studies and comments to state governments. 	The FTC's
Bureau of Economics has published a study on the effects of takeover legislation
enacted by New York in 1985. 2 In the past three years, the FTC's staff has
provided comments on the corporate control legislation of several states?
2 	L. SCHUMANN, STATE REGULATION OF TAKEOVERS AND SHAREHOLDER WEALTH: 	THE
EFFEcr5 OF NEW YORK'S 1985 TAKEOVER STATUTES (Federal Trade Commission, Bureau
of Economics, 1987).
3 	E.g., Letter to Hon. Lois Pines, Massachusetts State Senate, June 23, 1989;
Letter to Hon. Steven D. Wolens, Texas House of Representatives, May 10, 1989;
Letter to Hon. Barbara Flynn Currie, Illinois House of Representatives, May 4,
1989.

The Honorable Vincent J. Fumo
February 23, 1990
n. 	EFFECT OF TAKEOVERS ON ECONOMIC WELFARE.
Page 3.
The corporate takeover is a mechanism for transferring control of corporate
assets. 	The transfer of corporate control can serve a number of economic
functions, such as facilitating the redeployment of corporate assets to more
efficient uses and improving corporate management. 	Although not every
takeover ultimately produces such benefits, we believe that takeovers in the
aggregate are likely to enhance economic efficiency.
Some studies suggest that management-opposed corporate acquisitions are
most commonly carried out when outside bidders have an opportunity to improve
the performance and thereby increase the value of target corporations. 4 Such
bidders pay substantial premiums over the pre-offer market price of the shares of
target corporations because they believe that the corporations will be worth more
under their control. 5
There are a number of sources for the potential gain in an acquired firm's
performance. 	In some cases, bidders are able to improve the management of the
target firm. 	In other cases, bidders may be able to combine firms with
complementary strengths, integrating production or distribution channels,
eliminating duplicative functions, or facilitating mutually beneficial technology
transfers. 	Takeovers may also permit firms to shift corporate assets to more
efficient uses by selling or changing the use of underperforming facilities.
The transfer of corporate control in such circumstances is likely to benefit
shareholders, employees, and the economy as a whole, as well as the successful
bidder. 	Shareholders benefit in two ways. 	First, because bidders for corporate
control offer substantial premiums over the pre-offer market price of corporate
shares, target company shareholders enjoy rapid appreciation of the value of their
shares. 	Second, the threat of takeovers may motivate incumbent corporate
managers to improve corporate performance. 	Employees benefit from enhanced
4 	See Bradley, Desai & Kim, The Rationale Behind Interfirm Tender Offers:
Information or Synergy, 11 1. FIN. EcoN. 183 (1983); Gilson, A Structural Approach to
Corporations: 	The Case Against Defensive Tactics in Tender Offers, 33 STAN. L REv. 819
(1981); Easterbrook & Fischel, The Proper Role of a Target's Management in Responding
to a Tender Offer, 94 HARv. L. REV. 1161 (1981).
5 	There is evidence that share prices of most target companies significantly
under perform the market in the pre-offer period. 	See Gilson, supra note 4, at
852-53, and sources cited herein.

The Honorable Vincent 1. Furno
February 23, 1990 	Page 4.
corporate efficiency and the accompanying gains in corporate competitiveness.6
The economy can benefit both from the transfer of corporate control to more
efficient management and from the incentives that takeovers create for improved
managerial performance.
Numerous scholarly studies have concluded that takeovers, on average, lead
to an increase in the stock market's valuation of both the acquired and the
acquiring firms. 	For example, the Office of the Chief Economist of the SEC
found that share prices of acquired firms increase by an average of 53.4 percent?
Similarly, share prices of some acquiring firms have increased, albeit by smaller
amounts. 	Various studies of share prices of acquiring firms have reported
increases that ranged from 2 percent to approximately 7 percent in the fast,8
although other studies have found no gains for acquirers in this decade. 	Even if
the acquiring company's shares experience no gains, these studies suggest that the
6 	Profitable firms provide the best opportunities for wage growth, new
employment, and the fulfillment of pension and other contractual obligations to
workers.
7 	OFFICE OF THE CHIEF ECONOMIST, SECURITIES AND EXCHANGE COMMISSION, ECONOMICS OF
ANY-QR-ALL, PARTIAL, AND Two-TIER TENDER OFFERS Table 4A (1985).
8 	Those findings are summarized in Jensen & Ruback, The Market for
Corporate Control: 	The Scientific Evidence, 11 J. FIN. EcoN. 5, 11 (Table 3), 16-22 (1983).
See also Jarrell & Bradley, The Economic Effects of Federal and State Regulations of
Cash Tender Offers, 23 J. LAW EcoN. 371, 393-95 (1980); COUNCIL OF ECONOMIC ADVISERS,
ECONOMIC REPORT OF THE PRESIDENT 197 (1985).
9 	See Jarrell, Brickley & Netter, The Market for Corporate Control: 	The Empirical
Evidence Since 1980, 2 J. ECON. PERSP. 49 (1988). 	A recent study of acquiring firms in
78 management resisted takeovers between 1976 and 1981 concluded that those
firms lost 42 percent of the value of their stock prices over the three years
following their acquisitions. 	Magenheim & Mueller, Are Acquiring-Firm Shareholders
Better Off After An Acquisition?, in KNIGHTS, RAIDERS, AND TARGETS 171 (J. Coffee, L.
Lowenstein & S. Rose-Ackerman ed. 1988). 	That study has been criticized for using
methodology that significantly overstates the losses of the acquiring firms' value.
See Bradley & Jarrell, Comment, id. at 254. 	Bradley and Jarrell, using the data from
the Magenheim-Mueller study and a different methodology, concluded that the
acquiring firms' three year losses were actually statistically insignificant.
Moreover, they note that even when "acquiring firms suffer capital losses, the
gains to targets outweigh these losses, and the net effect is a significant increase
in the value of the combined assets." 	[d. at 256.

The Honorable Vincent J. Furno
February 23, 1990 	Page 5.
market values the combination of the acquirer and the target company more
highly than the individual firms absent a takeover.lO
These studies measure the stock market performance of the companies
involved during short periods of time surrounding takeover bids. 	They may be
viewed as offering the stock market's valuation of the long-term effects of
takeovers based on the information available at the time the takeover is
announced. 	These valuations may change over time as more information is
gained. 	Thus, these studies serve only as indirect estimates of long-term
performance. 	Economic scholars largely agree, however, that the increases in
company valuations reported by these studies represent efficiency gains. 	See note
11, infra. 	Of course, sharp fluctuations in market values, such as those experienced
in the October 1987 stock market, may require a cautious approach to long-term
conclusions.
A substantial body of economic and legal literature supports the view that
these increases in the stock market's valuation of firms following a takeover
represent efficiency gains, and the creation of new wealth, attributable solely to
the takeoverY 	Participants in the stock market are not likely to bid up the price
of equity securities involved in takeovers unless prior takeovers, on average,
produced such gains. 	Other studies quarrel with these conclusions, but many of
these studies contain methodological errors.u 	Some scholars have also questioned
10 Similarly, share prices of both bidding and target firms usually decline after
unsuccessful takeover bids to below the pre-offer level. 	Bradley, Desai & Kim,
supra note 4, at 189-204; Jensen & Ruback, supra note 8, at 8.
11 See, e.g., ECONOMIC REPORT OF THE PRESIDENT, supra note 8, at 187-216; Jensen &
Ruback, supra note 8; Jarrell, Brickley & Netter, supra note 9; Bradley, Desai &
Kim, supra note 4; Gilson, supra note 4; Easterbrook & Fischel, supra note 4;
Easterbrook & Jarrell, Do Targets Benefit from DefeaJing Tender Offers, 59 N.Y.U. L.
REV. 277 (1984); Pound, Lehn & Jarrell, Are Takeovers Hostile to Economic
Performance?, REGULATION, Sept.-Oct. 1986, 25.
U For example, Weidenbaum & Vogt, Takeovers and Stockholders: 	Winners and
Losers, 19 CAL. MGMT. REV. 157 (1987), incorrectly relied on evidence concerning
negotiated mergers to conclude that management-opposed takeovers reduce
efficiency. 	When the evidence of management-opposed takeovers reviewed by the
authors is examined separately, it supports the conclusion that takeovers enhance
efficiency. 	Similarly, Lipton, Takeover Bids in the Target's Boardroom, 35 Bus. LAW. 101
(1979), offered evidence purporting to show that stockholders benefited from
management resistance that resulted in the defeat of takeover bids. 	Lipton's
evidence showed that the share prices of some firms that had defeated takeover

The Honorable Vincent J. Furno
February 23, 1990 	Page 6.
the overall effects of mergers and unsolicited takeovers on economic efficiencyY
Another major scholarly study that relied on accounting data took issue with the
conclusions of the stock market studies and concluded that takeovers neither
improved nor degraded the performance of the target firms. 14
Using Census Bureau data on more than 18,000 individual plants,
Lichtenberg and Siegel recently analyzed the relationship between productivity
and changes in plant ownership.15 	Their study, which extended over a la-year
bids increased above the tender offer price a number of years later. 	His study did
not compare these share price movements to the overall market's movement
during the same period. 	More systematic studies, which examine abnormal returns
on shares of takeover targets compared to overall market trends, show that
stockholders incur significant losses from the defeat of takeover bids. 	See generally
Easterbrook & Jarrell, supra note 11, at 282-84.
13 See Ravenscraft & Scherer, The Long-Run Performance of Mergers and
Takeovers, in PUBLIC POLICY TOWARD CORPORATE TAKEOVERS 34 (M. Weidenbaum & K.
Chilton ed. 1988); Herman & Lowenstein, The Efficiency Effects of Hostile Takeovers,
in KNIGHTS, RAIDERS, AND TARGETS, supra note 9, at 211; Shleifer & Summers, Breach of
Trust in Hostile Takeovers, in CORPORATE TAKEOVERS: 	CAUSES AND CONSEQUENCES (A.
Auerbach ed. 1988).
14 D. RAVENSCRAFf & F. SCHERER, MERGERS, SELL-OFFS, AND ECONOMIC EFFICIENCY 101-03
(1987). 	The authors used accounting data to measure economic rates of return.
This methodology is controversial because profits revealed by such data are
subject to wide variations resulting from the use of divergent accounting
conventions by different firms. 	See generally Benston, The Validity of
Profits-Structure Studies with Particular Reference to the FTC's Line of Business Data, 75
AM. EcoN. REV. 37 (1985); Fisher & McGowan, On the Misuse of Accounting Rates of
Return to Infer Monopoly Profits, 73 AM. ECON. REV. 82 (1983). 	In addition, because of
constraints on the availability of data, the study focuses largely on conglomerate
mergers, and not management-opposed takeovers. 	See Ravenscraft & Scherer,
supra, at 22. 	As the authors observe, however, the incidence of horizontal merger
activity has increased markedly in this decade, and '1t]he shift toward large
horizontal mergers is more difficult to evaluate solely on the basis of our
research." 	I d. at 219.
15 Lichtenberg & Siegel, Productivity and Changes in Ownership of Manufacturing
Plants, in BROOKINGS PAPERS ON ECONOMIC AcrrvITY (1987). 	Since Lichtenberg and Siegel
study productivity changes directly, they avoid the controversy associated with
other studies that have utilized stock prices or accounting profits.

The Honorable Vincent J. Fumo
February 23, 1990
period, found that changes in corporate ownership were accompanied by
significant increases in productivity. 	They concluded:
Our findings concerning the determinants and effects of
plant turnover imply that ownership change plays an
important role in regeeming inefficient plants.... 	Our
evidence is consistent with the view that ownership
change or asset redeployment is an important mechanism
for correcting lapses from [efficient] producer behavior.
The gains realized by both target and acquiring
shareholders appear to be social gains, not merely private
ones. 16
Page 7.
Accordingly, no scholarly consensus on the economic effects of takeovers
supports changes in the law to make management-opposed takeovers more costly
and difficult. 	On the contrary, we believe that the preponderance of scholarly
opinion on the subject supports the conclusion that management-opposed
takeovers produce economic benefits, and that new restrictions on takeovers are
likely to undermine economic efficiency.
OJ. 	ASSERTED DISADVANTAGES OF TAKEOVER ACTIVITY.
Purported disadvantages of takeover activity are often asserted to justify
restraining corporate acquisitions. 	Although we know of no empirical research to
substantiate these disadvantages, they are often cited by incumbent managers and
other takeover critics in testimony before Congressional committees and in articles
in the general press. 	In the absence of persuasive substantiating evidence, these
claims do not support the enactment of curbs on takeover activity.
Some takeover critics claim, for example, that acquirers often take over
well-managed corporations, oust good management, and reduce corporate
efficiency by installing less capable management teams. 	This may happen in some
16 Id. at flj7. 	Lichtenberg and Siegel's empirical finding that ownership
changes tend to improve economic efficiency tends to refute the theoretical
conjecture of Shleifer and Summers, supra note 13, that the private gains from
takeovers in the form of higher stock prices may be more than offset by social
costs due to the breach of implicit contracts. 	A conclusion similar to Lichtenberg
and Siegel's was reached in a study that looked only at management buyouts. 	See
S. Kaplan, The Effects of Management Buyouts on Operations and Value (1989)
(accepted for publication 24 1. FIN. ECON.).

The Honorable Vincent 1. Fumo
February 23, 1990 	Page 8.
cases. 	Corporate acquirers, like all other businesspersons, may make mistakes.
This possibility, however, does not justify controls on takeover activity any more
than the possibility of poor investments in plant or equipment justifies
government controls on investment decisions made by corporate managers. 	In a
market economy, investment decisions generally are best left to investors, who
stand to profit from correct decisions and lose from poor ones. 	The critical fact is
that takeover activity, in the aggregate, has not been demonstrated to have
adverse effects and in fact appears to benefit society. 	Because the evidence
suggests that the benefits of takeovers outweigh their costs, restricting takeovers
in the hope of preventing unwise investments is likely to harm societal welfare.
It also has been argued that management-opposed takeovers result
disproportionately in facility closings and lay-offs, which impose great social costs
on individuals and communities in which plants are located. 	But factual support
for the position that takeovers lead to plant closings and lay-offs that would not
have occurred otherwise is, at best, scanty.17 	Indeed, it is difficult to assess
17 See Jensen, Takeovers: 	Folklore and Science, HARV. Bus. REV. Nov.-Dec. 1984, at
114; cf AMERICAN ENTERPRISE INSTITUTE, PROPOSALS AFFECTING CORPORATE TAKEOVERS 31
(1985) (citing finding that "very few jobs were affected" by 6,000 corporate
acquisitions in 1970's). 	See also Lichtenberg & Siegel, supra note 15, which
concluded that employment declines were more pronounced during the years
immediately preceding the ownership change than after the change. 	The authors
concluded that "our analysis indicates that changes in ownership are more likely to
stem employment reductions than trigger mass layoffs." 	Lichtenberg and Siegel,
supra note 15, at 665. 	More recent work by the same authors suggests that any
employment declines are more likely to occur in the central administrative office
than in production facilities. 	F. Lichtenberg & D. Siegel, The Effect of Takeovers
on the Employment and Wages of Central-Office and Other Personnel (National
Bureau of Economic Research Working Paper No. 2895, March 1989). 	The authors
conclude that "these findings are consistent with the view that reduction of
administrative overhead is an important motive for changes in ownership."
Id. at i. 	The AFL-CIO estimates that a total of 80,000 jobs of members of its
affiliated unions have been lost as a "result of corporate restructuring" in recent
years. 	Hostile Takeovers: Hearings Before the Senate Committee on Banking, Housing, and
Urban Affairs, 100th Cong., 1st Sess. 262 (1987) (statement of Thomas R. Donahue).
Even assuming that this estimate, for which the time frame is unspecified but
presumably spans a number of years, is correct, it is difficult to assess how many
of those jobs would have been abolished in any event to improve the
competitiveness of the affected companies. 	To put the figure in perspective, a
total of 51 million workers lost their jobs because of plant closings or efficiency
measures in the years 1979-83. 	BUREAU OF LABOR STATISTICS MONTHLY LABOR REVIEW
(June 1985).

The Honorable Vincent J. Fumo
February 23, 1990 	Page 9.
whether or not closings or lay-offs that occur after takeovers would have been
carried out bl the target's management in any event to keep the firm
competitive.1
Finally, it is argued that takeovers force corporate managers to focus on
short-term profits and forego long-term investments. 	The evidence shows,
however, that foregoing long-term investment makes companies more, not less,
vulnerable to takeovers. 	Takeover targets tend to have below-average research
and development budgets, showing a lesser commitment to long-term investments
than the average firm. 19 Further, recent studies refute the notion that firms that
have been recently acquired devote fewer resources to research and development
than firms that have not undergone an ownership change?O
IV. 	EMPIRICAL EVIDENCE ON EFFECTS OF ANTI-TAKEOVER LEGISLATION.
Four empirical studies concerning the effects of anti-takeover legislation
have concluded that anti-takeover laws harm shareholders and undermine
economic efficiency. 	A 1987 empirical study by the FTC's Bureau of Economics
analyzed the extent of the economic harm caused by a New York statute 21
18 It would seem preferable for government to respond to economic
dislocations by initiating effective remedial measures to assist displaced individuals
rather than severely restricting economic activity that benefits society. 	Such
measures may include, for example, programs to retrain workers displaced from
declining industries.
19 This proposition is supported by a recent empirical study of the investment
patterns of takeover targets. 	The study, which examined all 217 takeover targets
that were acquired between 1980 and 1984, found that takeover targets had below
average ratios of (i) research and development expenditures to total expenditures
and (ii) capital investment to earnings. 	OFFICE OF THE CHIEF ECONOMIST, SECURITIES AND
EXCHANGE COMMISSION, INSTITUTIONAL OWNERSHIP, TENDER OFFERS, AND LoNG-TERM
INVESTMENT 8-10 (1985).
20 See Hall, The Effect of Takeover Activity on Corporate Research and Development,
in CORPORATE TAKEOVERS: CAUSES AND CoNSEQUENCES, supra note 14; 	F. Lichtenberg & D.
Siegel, The Effects of Leveraged Buyouts on Productivity and Related Aspects of
Firm Behavior (June 1989Xunpublished manuscript).
21 N.Y. Bus. Corp. Law § 912.

The Honorable Vincent J. Furno
February 23, 1990 	Page 10.
restricting "business combinations.,,22 	The study found that the announcement by
New York's governor of the proposed legislation that ultimately became the New
York law resulted in a statistically significant decline in the average value of
shares of New York corporations. 	The decline was e~ual to approximately
one percent of the value of the shares, or $12 billion. 	As the study noted in
conclusion:
[D]espite the political rhetoric advocating the regulation
of takeovers on behalf of shareholders, the evidence ...
indicates that this very strong statute does not protect
shareholders; rather, the law protects managers at the
expense of shareholders.... [In addition, the statute] may
promote the inefficient management of society's assets
by lessening the ability of capital markets to efficiently
reallocate assets. 	Consequently, the real cost of the
goods and services produced by the firms affected by
[the statute] may increase, injuring consumers as well as
shareholders.2 4
Another study, conducted by the Office of the Chief Economist of the
Securities and Exchange Commission, also concludes that anti-takeover legislation
is harmful to the interests of shareholders. 	The study examined the effects of a
recent Ohio law that, among other things, authorized corporate directors to
consider the interests of persons other than the shareholders in assessing takeover
22 L. SCHUMANN, supra note 2. 	''Business combination" statutes restrict the ability
of acquiring firms to merge or engage in other specified business activity with
unsolicited takeover targets for a specified period of time following the
acquisition of target company shares.
23 Id. at 41, 46-47. 	Continuing research by the same author suggests that the
decline in the value of New York corporations caused by the enactment of the
legislation may have been significantly greater than reported in this study.
Measured over the entire 205-day course of the legislative process, the decline was
9.7 percent, net of market. 	Schumann, State Regulation of Takeovers and Shareholder
Wealth: 	The Case of New York's 1985 Takeover Statutes, 19 RAND J. ECON. 557 (Winter
1988).
24 L. SCHUMANN, supra note 2, at 47.

The Honorable Vincent J. Furno
February 23, 1990 	Page 11.
bids. 25 The SEC study found that enactment of the Ohio law caused an immediate
2 percent decline in the equity value of corporations insulated from takeovers. 	A
1987 study on the effects of Indiana's anti-takeover statute, which contains a
"control share" provision similar to that in the proposed legislation, found that the
enactment of Indiana's law caused a 42 to 61 percent decline in the value of
shares of Indiana corporations. 26 . Finally, a recent study examined the stock
market effects of all state anti-takeover laws introduced from 1982-87. 	The study
concluded that public announcement of state anti-takeover laws was associated
with an immediate 2.4 percent decrease in stock prices of firms incorporated in
those states?? 	.
v. 	EFFECTS OF RESTRICTIONS ON "CONTROL-8HARE ACQUISITIONS."
Subchapter G of the proposed legislation would regulate "control-share
acquisitions." 	A "control-share acquisition" is defined as the acquisition of voting
power over shares that, but for the subchapter's requirements, when added to the
acquiring person's voting power over other shares, would entitle the acquirer to
cast or direct the casting of votes within one of three ranges: 	one-fifth to
one-third, one-third to one-half, or 50 percent or more of all voting power. 2S
Section 2563(a) of proposed subchapter G provides that "control shares" do not
have voting rights unless voting rights are approved in two separate elections. 	In
one vote, the acquirer must secure the support of holders of a majority of the
corporation's shares; in the other it must gain the support of holders of a majority
of all "disinterested shares" of the corporation. 	'Disinterested shares" are those
25 OFFICE OF THE CHIEF ECONOMIST, SECURITIES AND EXCHANGE COMMISSION, SHAREHOLDER
WEALTH EFFECTS OF OHIO LEGISLATION AFFECTING TAKEOVERS (1987). 	The Ohio law is
codified in OHIO REV. CODE ANN. § 1701.01 et seq. (Page 1986 Supp.). 	Similar
provisions are found in 15 PA. CONST. STAT. §§ 511, 1721 (Purdon 1989), and proposed
amendments to those provisions contained in S.B. 1310.
26 J. Sidak & S. Woodward, Corporate Takeovers, The Commerce Clause, and
the Efficient Anonymity of Shareholders (March 1987) (unpublished manuscript).
The 42 percent decline represents a portfolio in which equal weight is given to all
Indiana firms. 	The 61 decline represents a value-weighted portfolio.
27 J. Karpoff & P. Maletesta, The Wealth Effects of Second Generation
Takeover Legislation (August 1989) (unpublished manuscript).
28 In practical terms, for most purposes of proposed subchapter G, the
acquisition of voting rights over shares that would give the acquirer more than 20
percent of the corporation's voting power are "control shares."

The Honorable Vincent J. Furno
February 23, 1990 	Page 12.
shares not owned by the acquiring person, the corporation's officers, or employee
stock plans in which employees do not have the right to determine whether plan
shares will be tendered in a tender or exchange offer. 	Shares owned by directors
who are not officers of the corporation qualify to vote as "disinterested shares,"
even though those directors are usually allied with incumbent management.
Under the provisions of Section 2564(a) of proposed subchapter G, an
acquirer of "control shares" may request a special shareholders meeting "for the
purpose of considering the voting rights to be accorded to the control shares." 	If
the request is accompanied by a written undertaking "to payor reimburse the
corporation for the expenses of a special meeting," the corporation must hold such
a meeting within 50 days of the request and undertaking. 	If no such request is
made, voting rights of control shares must be considered at the next annual or
special meeting of the corporation.
Proposed subchapter G, if enacted, would impose a number of restrictions
on the ability of potential acquirers to obtain control of target companies. 	First, a
potential acquirer who has purchased a majority of a corporation's voting shares
would not be assured of obtaining actual control of the firm. 	Rather, the acquirer
would be required to wager that the so-called "disinterested" shareholders will
agree to grant it the voting power that ordinarily passes with the ownership of
shares. 	In the event that the "disinterested" shareholders do not so agree, the
value of the acquired shares is likely to decline significantly. 	This restriction may
discourage many potential acquirers from even attempting takeover bids.
Moreover, the proposed legislation is likely to exact from acquirers a penalty that
increases directly with the size of their investment in the target firm; the larger
the acquirer's investment in a firm, the less likely it would be to gain control since
the remaining "disinterested" shares may be in the hands of entities friendly to
management, such as outside directors.
Second, although an acquirer may request a special shareholders meeting to
consider the voting rights to be accorded "control shares," the special meeting can
be delayed for as much as 50 days after it is requested. 	At a minimum, this
requirement will add three weeks to the 20-business-day minimum tender offer
period that bidders now face under federal law. 	See 17 C.F.R. § 240.14(eX1). 	During
that additional period, potential acquirers must bear a significant financial burden.
To avoid the risk of paying a premium price for what ultimately will be
nonvoting shares, bidders will have to extend the duration of tender offers to at
least the 50-day waiting period imposed by the statute. 	During that period, they
must bear the cost of capital for financing the acquisition, though they have no

The Honorable Vincent 1. Furno
February 23, 1990 	Page 13.
assurance that the acquisition will ultimately be made. 	By so increasin~ the costs
of acquisition efforts, the legislation is likely to reduce their frequency. 9
Third, the revocation of voting rights is not limited to shares purchased by
the acquirer. 	Voting rights are also denied to all shares which the acquirer may
vote by proxy or agreement. 	A potential corporate acquirer who has gained
substantial shareholder approval is denied the benefit of shareholder support that
may be critical to the success of the takeover attempt. 	The denial of voting rights
to shares pledged to a bidder for corporate control is likely to discourage takeover
attempts. 	Further, the provision seriously impairs the freedom of shareholders to
exercise ownership. rights in their corporations.
VL 	EFFECTS OF THE DISGORGEMENT PROVISIONS
OF THE PROPOSED LEGISLATION.
Subchapter H of the proposed legislation provides that any profit realized
by a "controlling person or group" from most sales of corporate securities acquired
up to 2 years before and sold within 18 months after acquiring controlling status
are recoverable by the corporation. 	The term "controlling person or group" is
defined in proposed Section 2573, and includes any person or group who has
acquired or offered to acquire 20 percent of all voting power, or who has publicly
disclosed directly or indirectly the intent to acquire such voting power. 	The
definition also encompasses any person or group who has publicly disclosed
directly or indirectly that control of the corporation may be sought by any other
means, such as a proxy contest, without regard to voting power held.
The stated purposes of subchapter H are to prohibit "greenmail," to promote
stable relationships among the parties involved in corporations and prevent the
erosion of public confidence in the future of corporations, and to prevent
29 Alternatively, bidders could make conditional tender offers, pursuant to
which acceptance of tendered shares is contingent on the subsequent approval of
voting rights for those shares. 	Because the 5O-day waiting period in the proposed
legislation exceeds the minimum offering period under federal law by three
weeks, however, incumbent management would gain an additional three week
period between the conditional acceptance and the shareholder vote in which to
adopt defensive measures to thwart the tender offer, such as the sale of corporate
assets to another firm. 	Under the "business judgement rule," such actions may be
insulated from judicial scrutiny. 	In addition, a conditional offer is less likely to be
successful than an unconditional one, since some shareholders will not wish to tie
up their shares for the period during which the voting right issue remains
unsettled.

The Honorable Vincent 1. Furno
February 23, 1990 	Page 14.
speculators from misappropriating corporate values or putting corporations "in
play" to reap short-term profits. 	In order to thwart a takeover attempt, incumbent
management may repurchase the potential acquirer's stock at a premium price, so-
called "greenmail." 	The payment of "greenmail" enables current management to
retain corporate control to the possible detriment of shareholders, who cannot
avail themselves of the offer to s~ll their shares at a premium and whose
investments may have increased in value to a greater extent if the takeover
attempt was successful. 	The proposed legislation does not, however, impose direct
curbs on the payment of "greenmail." 	Rather, the disgorgement provisions of
subchapter H deny sellers any profit realized on the disposition of stock acquired
up to 2 years before and sold within 18 months after a takeover attempt.
Subchapter H, if enacted, would deprive potential acquirers of any
increase in stock value, even though the activities of potential acquirers may have
caused or contributed to the stock's increased value. 	For instance, stock value
increases may be attributable to changes instituted by incumbent management to
frustrate the takeover attempt, or to a successful takeover by a third party that
values the firm even more highly than the first bidder for corporate control. 	By
requiring disgorgement of any profit realized on the sale of stock within 18
months of a takeover attempt, the proposed legislation is likely to discourage
legitimate bids for corporate control with the potential for enhanced economic
efficiency.
Subchapter H is particularly deleterious because it applies not only to
hostile tender offers, but also to any means of affecting control of a firm,
including proxy contests. 	Dissident shareholders who may wish to change current
management policies are confronted by the same disincentives as hostile bidders
under proposed subchapter H. 	If management were to "win" a proxy contest by
merely agreeing to adopt some or all of a dissident shareholder's program, the
losing dissident shareholder would be required to disgorge any profits realized
within 18 months on stock acquired up to 2 years prior to the proxy challenge.
Moreover, the proposed legislation requires disgorgement if shareholders
have as much as "publicly disclosed," directly or indirectly, that they may seek
control. 30 	It is possible that a shareholder could be liable for disgorgement if he
merely communicates dissatisfaction with management to other shareholders, since
30 The term "publicly disclosed or caused to be disclosed" is defined in
Section 2562 of the proposed legislation. 	The term includes any disclosure that
becomes public which is made with the expectation that it become public or which
is made to another who is not under an obligation to refrain from making the
disclosure public. 	When a disclosure "becomes public" is not addressed by the
definition.

The Honorable Vincent 1. Furno
February 23, 1990 	Page 15.
management could claim that such communication constituted an attempt to seek
the other shareholders' votes.
The ability to vote one's shares in order to affect the management of a firm
is a cornerstone of the corporate structure of business. 	The inclusion of proxy
contests within the disgorgemenf provisions of subchapter H may substantially
limit the ownership rights of shareholders, and undermines the proposed goal of
protecting the interests of shareholders.
VII. 	CONSIDERA nON OF AN "OPTING IN' MECHANISM.
If the legislature decides to enact the "control-share" acquisition restrictions
of proposed subchapter G and the disgorgement provisions of proposed
subchapter H despite the concerns discussed above, we suggest that the bill be
modified to make these provisions applicable only to corporations whose
shareholders affirmatively elect to be covered by them through amendments to
their articles of incorporation. 	In their present form, these provisions, if enacted,
would apply to all corporations that do not "opt out" by an amendment to their
bylaws or articles of incorporation?1 	To the extent that the proposed legislation is
motivated by a concern for shareholders, we think its purpose would be better
served by a requirement that shareholders approve a decision to opt into the
legislation. 	We recommend that a corporation's decision to opt into the statutory
scheme be made solely through a shareholder vote amending the articles of
incorpora tion. 32
If the legislature decides to retain the proposed "opting out" mechanism, we
suggest that decisions to opt out be implemented by a majority vote of all
shareholders. 	The proposed legislation would require an affirmative vote of 80
percent of all shares, unless the amendment has been approved by the board of
directors of the corporation. 	This requirement imposes a serious restraint on the
freedom of shareholders to control the corporations they own.
31 The "opt out" provisions are found in Sections 2561 and 2571 of S.B. 1310.
32 Corporate bylaws generally may be amended without the approval of the
shareholders. 	See 15 P A. CONS. STAT. § 1504 (Purdon 1989). 	Consequently, we believe
that the legislation should require decisions to opt in to be made in the form of
amendments to the articles of incorporation.

The Honorable Vincent J. Fumo
February 23, 1990
vm. 	CONCLUSION.
Page 16.
We believe that takeover activity most often enhances economic efficiency
and thus benefits consumers, workers and shareholders. 	We believe that Senate
Bill 1310 is likely to impede many of the potential beneficial consequences of
takeovers without offering countervailing benefits. 	In addition, some of the
provisions may significantly reduce the rights of shareholders (including those not
seeking control) to vote their shares and participate in the governance of the
corporations they own. 	The legislature, therefore, may wish to consider whether
this legislation unduly interferes with the market for corporate control to the
detriment of the economy and consumer welfare generally.
Sincerely,
/~~//Mark D. Kindt
Regional Director
Cleveland Regional Office