FTC Staff Comment to the Hon. Steven H. Amick Concerning Delaware H.B. 396 to Restrict the Ability of Acquirers to Engage in Business Combinations with Target Corporations

UNITED 51 ATES OF AMERICA
FEDERAL TRADE COMMISSION
WASHINGTON, D.C. 20~80
CDMMiSSiON AUTHnRIZED
yggcJtJ/J5
January 	15, 	1988
'-The 	Honorable 	St.even 	H. 	Amick
House 	of 	Representatives
·Legislative 	Hall
.Dover, 	Delaware 	19901
Dear ~r. 	Amick:
The 	staff 	of 	the 	Federal 	Trade 	Co~r.ission is 	pleased 	to 	re-
spond 	to 	your 	letter 	of 	invitation 	of 	January 	7, 	1988, 	to 	comment
on 	House 	Bill 	No. 	336. 	~/ 	The 	bill 	incorporates 	the 	recommenda-
tion 	of 	the 	Delaware 	Bar Association 	to 	amend 	Delaware's 	General
Corporation 	Law 	by 	adding 	a 	"business 	combination" 	provision 	as
section 	203. 	The 	proposed 	legislation, 	if 	enacted, 	would 	re-
strict 	the 	ability 	of 	acquirers 	to 	engage 	in 	business 	combina-
tio~s with 	target 	corporations 	for 	three 	years 	after 	acquiring
ten 	percent 	of 	the 	target 	firms' 	shares.
We 	believe 	that 	enactment 	of 	proposed 	section 	203 	is 	likely
to 	deter 	takeovers 	that 	benefit 	stockholders, 	employees, 	consum-
ers, 	and 	~he economy 	as 	a 	whole. 	If 	the 	legislature 	nevertheless
decides 	to 	enact 	proposed 	section 	203, 	we 	urge 	it 	to 	consider
making 	that 	provision 	applicable 	solely 	to 	corporations 	that 	af-
firmatively 	elect 	to 	be 	covered 	by 	it 	throug~ amendmer.~s to 	the~r
certificates 	of 	incorporation. 	An 	affirmative 	"optin£ 	in" 	provi-
sion 	would 	enable 	the 	~tockholders of 	each 	corporation 	to 	dete~
mine 	whether 	restraints 	on 	the 	transfer 	of 	corporate 	control 	are
in 	the 	interests 	of 	the 	corpcration.
:ntere;t 	and 	Experience 	Qf 	the 	Federal 	Trade 	CQmmission
The 	Federal 	Trade 	Commission 	is 	charged 	by 	statute 	with 	pre-
venting 	unfair 	methQd~ of 	competition 	and 	unfair 	or 	deceptive
practices 	in 	cr 	affecting 	commerce. 	15 	U.S.C. 	S 	45. 	Pursuant. 	to
this 	mandate, 	the 	Commission 	seeks 	to 	identify 	and 	urge 	the 	re-
moval 	of 	restrictions 	that 	impede 	competitiQn 	or 	increase 	costs
wit.~out Qffering 	counte~ailing benefits 	to 	consumers. 	Our 	ef-
fc:..'t.s 	have 	included 	pro....·iding 	comments 	to 	federal, 	state, 	and
local 	legislatures 	and 	administrative 	agencies 	on 	mat.ters 	tha~
raise 	issues 	of 	competiti.Jn 	or 	consumer 	protection 	policy.
~/ 	These 	comments 	represent 	the 	vie~s Qf 	the 	Federal 	Trade 	Com-
mission's 	Burea~s of 	Competition, 	Consumer 	Protection, 	and 	Eco-
nomics, 	and 	do 	not 	necessarily 	represent 	the 	views 	of 	the 	CO~T.is
sion 	itself 	Qr 	any 	individual 	CQmmissioner. 	The 	Commission 	has
voted, 	however, 	with 	Comrr.issioner 	Eailey 	dissenting, 	to 	aut.horize
us 	to 	suj~it these 	commer.t.£ 	for 	your 	consideration. 	Co~~issio~er
Cel\'ar:i 	did 	no- 	perticipat.e 	in 	the 	Commission's 	vote.

The 	Honorable 	Steven H. 	Amick
Page 	2
The 	Commission 	has 	substantial 	experience 	in 	the 	area 	of
mergers 	and 	acquisitions. 	The 	Commission 	enforces: section 	7 	of
the 	Clayton 	Act, 	15 	U.S.C. 	S 	18, 	which 	prohibits 	~cqUisitions of
corporate 	assets 	or 	securities 	that 	may 	substantially 	lessen 	Com-
petition 	or 	tend 	to 	create 	a 	monopoly. 	Under 	the 	Hart-Scott-
'Rodino 	Antitrust 	lmprovemer.ts 	Act 	of 	1976, 	15 	U.S.C. 	S 	18a, 	the
Commission 	reviews 	proposed 	acquisitions 	of 	corporate 	securities,
including 	tender 	offers, 	to 	determine 	whether 	they 	violate 	the
antitrust 	laws.
The 	Commission's 	staff 	has 	addressed 	issues 	related 	to 	the
market 	for 	corporate 	control 	through 	scholarly 	studies 	and 	com-
ments 	to 	state 	governments. 	Earlier 	this 	year, 	the 	Commission's
Burea~ of 	Economics 	published 	a 	study 	on 	the 	effects 	of 	takeover
legislation 	enacted 	by 	New 	York 	in 	1985. 	1/ 	In 	the 	past 	two
years, 	the 	Commission's 	staff 	provided 	comments 	on 	corporate 	con-
trol 	legislation 	to 	the 	governor 	of 	New 	Yor}~ 	and 	to 	the 	New 	Jer-
sey 	legislature.
Effect 	of 	Takeovers 	on 	Economic 	~elfare
The' corporate 	takeover 	is 	a 	mechanism 	for 	transferring 	con-
trol 	of 	corporate 	assets. 	The 	transfer 	of 	corporate 	control 	can
serve 	a 	number 	of 	desirable 	economic 	functions, 	such 	as 	facili-
tating 	the 	redeployment 	of 	corporate 	assets 	to 	more 	efficient
uses 	and 	improving 	corporate 	management. 	Although 	not 	every
takeover 	ultimately 	produces 	such 	benefits, 	we 	believe 	that 	take-
overs 	in 	the 	aggregate 	are 	likely 	to 	enhance 	economic 	efficiency
and 	be~lefit stockholders, 	err.ployees, 	and 	consumers. 	As 	discussed
in 	fur~her detail 	below, 	although 	some 	critics 	have 	questioned
the 	benefits 	of 	takeovers, 	the 	criticism 	appears 	to 	lack 	empiri-
cal 	support.
Studies 	suggest 	tr,at 	management-opposed 	corpora~e acquisi-
tions 	are 	most 	comrno~ly carried 	out 	when 	outside 	bidders 	have 	an
opportunity 	to 	improve 	the 	performance 	and 	thereby 	increase 	the
value 	of 	target 	corporations. 	1/ 	Such 	bidders 	pay 	substantial
1/ 	L. 	Schumann, 	S~atQ Rec~latio~ of 	Takeovers 	and 	SharQholder
~~a}th: 	The 	Effec~s of 	~e~ York's 	lSE5 	Takeover 	Sta~utQs 	(Federal
Trade 	Corr~ission, Bureau 	of 	Economics, 	1987).
1/ 	See 	Eradley, 	Desai 	& Kim, 	The 	Rationale 	Behind 	Interfi~
Tender 	O:fers: 	Infor~a:ion or 	Synerm·, 	11 	J. 	Fin. 	Econ. 	183
(1523); 	Gilson, 	A Struc:ural 	ApDroach 	to 	Corporations: 	The 	C=se
A05inst 	Defensive 	~actics in 	Tender 	Offers, 	33 	Stan. 	L. 	Rev. 	619
(1961); 	Easterbrook 	& Fischel, 	The 	Pro?er 	Role 	of 	a 	Taroet's 	~c~-
(cont~nuec.. ,)

The 	Honorable 	Steven H. 	Amick
page 	3
premiums 	over 	the 	market 	value 	of 	the 	shares 	of 	target 	corpora-
tions 	because 	they 	believe 	that 	the 	corporations 	will 	be 	worth
more 	under 	their 	control. 	l/
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, 	bid-
_ ders 	may 	be 	able 	to 	improve 	efficiency 	by 	combining 	firms 	with
co~plementary strengths, 	integrating 	production 	or 	distribution
channels, 	eliminating 	duplicative 	functions, 	or 	facilitating
mutually 	beneficial 	techr,ology 	transfers. 	Takeovers 	may 	also
permit 	firms 	to 	shift 	co~porate 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 	stockholders, 	employees, 	and 	the 	economy 	as 	a
whole, 	as 	well 	as 	the 	successful 	bidder. 	Stcckholders, 	many 	of
whom 	are 	employee 	pension 	funds, 	benefit 	in 	two 	ways. 	First, 	be-
cause 	bidders 	for 	corporate 	control 	offer 	substantial 	premiurr.s
over 	the 	pre-offer 	market 	price 	of 	corporate 	shares, 	t~rget com-
pany 	stockholders 	enjoy 	rapid 	appreciation 	of 	the 	value 	of 	their
shares. 	Second, 	the 	threat 	of 	takeovers 	may 	motivate 	incumbent
corporate 	managers 	to 	improve 	corporate 	performance. 	EmFloyees
benefit 	from 	enhanced 	corporate 	efficiency 	and 	the 	accompanying
gains 	in 	corporate 	competitiveness. 	i/ 	The 	entire 	economy 	can
benefit 	both 	fro~ the 	transfer 	of 	corporate 	control 	to 	more 	e:-
ficient 	management 	and 	from 	the 	incentives 	that 	takecvers 	create
for 	improved 	managerial 	performance.
Numerous 	scholarly 	studies 	have 	concluded 	that 	takeovers, 	on
average, 	lead 	to 	an 	increase 	in 	the 	stock 	market's 	valuation 	c:
both 	the 	acquired 	and 	the 	acquiring 	firms. 	2/ 	According 	to 	a 	re-
1/( ... continuec)
aoement 	in 	Responding 	to 	a 	Tender 	Offer, 	94 	Harv. 	L. 	Rev. 	1161
(1981).
1/ 	There 	is 	evidence 	that 	share 	prices 	of 	most 	target 	companies
significantly 	underperform 	the 	market 	in 	the 	pre-~::er periot.
See 	Gilson, 	scpra 	note 	2, 	at 	8:2-53, 	and 	so~rces cited 	there~n.
i/ 	Profitable 	firms 	provide 	the 	best 	opportunities 	for 	wage
growth, 	new 	employment, 	and 	the 	fulfillment 	of 	pension 	and 	other
contractual 	obligations 	to 	workers.
~/ 	These 	studies 	measure 	the 	stock 	market 	performance 	cf 	t:;e
companies 	involved 	during 	short 	periods 	of 	time 	surrounding 	take-
over 	tids. 	hlthough 	these 	studies 	may 	be 	viewed 	as 	offering 	a
"snapshot." 	vie·...· 	of 	t.he 	stock 	market's 	valuation 	of 	takeo,'e:::-s, 	a:-:::
(con:inuec ... )

The 	Honorable 	Steven H. 	Amick
Page 	4
cent 	study, 	share 	prices 	of 	acquired 	firms 	increase by 	an 	average
of 	53.4 	percent. 	Q/ 	Different 	studies 	repor~ tha~ the 	share
prices 	of 	acquiring 	firms 	increase 	by 	smaller 	amounts, 	ranging
from 	approxima~ely 2 	percent 	to 	approximately 	7 	percent. 	2/
These 	studies 	suggest 	that 	the 	market 	values 	both 	the 	acquiring
company 	and 	the 	target 	company 	more 	highly 	than 	in 	the 	absence 	of
a 	takeover. 	~/ 	In 	the 	aggregate, 	tckeovers 	enhance 	the 	welfare
of 	stockholders 	of 	both 	acquiring 	and 	target 	companies.
A substantial 	body 	of 	economic 	and 	legal 	literature 	supports
the 	view 	that 	the 	increases 	in 	the 	stock 	market's 	valua~ion of
firms 	follo~ing a 	takeover 	represent 	efficiency 	gains 	-- 	and 	the
creation 	of 	new 	wealth 	-- 	attributable 	solely 	to 	the 	ta}:eover. 	2/
Because 	participants 	in 	the 	stock 	market 	act 	on 	the 	basis 	of 	em-
pirical 	observations, 	the 	stock 	market 	is 	unlikely 	to 	have 	sys-
tematically 	revalued 	upward 	the 	prices 	of 	equity 	securities 	in-
volved 	in 	takeovers 	unless 	prior 	takeovers, 	on 	average, 	produced
such 	gains. 	A smaller 	group 	of 	studies 	quarrels 	with 	these 	con-
clusions, 	but 	many 	of 	these 	s~udies contain 	methodological 	er-
;;./ ( ... cont.inued)
thus 	as 	only 	indirect 	measures 	of 	long-te=rn 	performance, 	econo~ic
scholars 	largely 	agree 	that 	the 	increases 	in 	company 	valuations
repor"ted 	by 	these 	st.udies 	represent 	efficiency 	gains. 	See 	note
9, 	infra, 	and 	accompanying 	text.
Q/ 	Securities 	and 	Exchange 	Co~~ission, Office 	of 	the 	Chie: 	Sco-
nomist, 	The 	Economics 	of 	Anv-or-hll, 	Partial, 	and 	Two-Tier 	~enc~r
Offers, 	Table 	4A 	(1985).
2/ 	Those 	findings 	are 	summarized 	in 	Jensen 	& Ruback, 	~he ~2r}:e~
for 	Corpora~e Con~rol: The 	Scientific 	Evidence, 	11 	J. 	Fin. 	Econ.
5, 	11 	(Table 	3), 	16-22 	(1983). 	See 	also 	Jarrell 	& Bradley, 	~he
Economic 	Effects 	of 	Federal 	and 	St.ate 	Regulatic~s of 	Cash 	Tenjer
O:fers, 	23 	J. 	Law 	Econ. 	371, 	393-95 	(1980); 	Counc~l of 	Economic
Advisers, 	Economic 	Report 	of 	the 	President 	197 	(1985).
~/ 	Similarly, 	share 	prices 	of 	both 	bidd~ng and 	target 	firms
usually 	decline 	af~er unsuccessful 	takeover 	bids 	to 	belo~ the
pre-offer 	level. 	Bradley, 	Desai 	& Kim, 	supra 	note 	2, 	at 	1ES-2C~;
Jensen 	& Ruback, 	sU2ra 	note 	i, 	at 	E.
~I 	The 	economic 	and 	legal 	literature 	discussing 	the 	benefits 	0:
takeovers 	is 	vast.. 	See, 	g.g., 	Econo~ic Report. 	of 	the 	President,
SUDra 	note 	7, 	a~ 	187-216; 	Jensen 	& Ruback, 	supra 	note 	6; 	Erac-
ley, 	Desai 	& Kim, 	supra 	not.e 	2; 	Gilson, 	supra 	note 	2; 	Easterbroc~
& Fischel, 	sucra 	note 	2; 	Easterbrook 	& Jarrell, 	Do 	Tarcet~ 	SenE-
fit 	from 	Defeatina 	Tenjer 	Offers, 	59 	N.Y.U.L. 	Rev. 	~;7 	(lSE~);
Pound, 	Lenn 	& Jarrell, 	~~e Takeovers 	Ho~ti:e to 	Eccno~ic Pe~:c~
rna~ce?, 	Regulation, 	Sept.-Oct. 	1986, 	25.

The 	Honorable 	Steven 	H. 	Amick
Page 	5
rors. 	lQ/ 	A major 	scholarly 	study 	that 	took 	issue 	with 	the 	con-
clusions 	of 	the 	stock 	market 	studies, 	relying 	insteaa 	on 	account-
ing 	data, 	concluded 	that 	takeovers 	neither 	improved 	nor 	degraded
'-the 	performance 	of 	the 	target 	firms. 	11/
Accordingly, 	no 	scholarly 	consensus 	on 	the 	economic 	effec~s
'of 	takeovers 	supports 	changes 	in 	the 	law 	to 	make 	management-o~
.posed 	takeovers 	more 	costly 	and 	difficult. 	On 	the 	contrary, 	the
preponderance 	of 	schola~ly opinion 	on 	the 	subject 	supports 	the
conclusion 	that 	management-opposed 	takeovers 	produce 	economic
benefits. 	New 	restrictions 	on 	takeovers 	are 	likely 	to 	underrr,ine
.l.Q.! 	For 	example, 	\oIeidenbaum 	& Vogt, 	TaKeovers 	and 	StoC'}:holde!'~:
~inner~ and 	Lose~s, 	19 	Cal. 	Y.grnt. 	Rev. 	157 	(1987), 	incorrectly
relied 	on 	evidence 	concerning 	negotiated 	mergers 	to 	conclude 	that
management-opposed 	takeovers 	reduce 	efficiency. 	When 	the 	evi-
dence 	of 	management-opposed 	takeovers 	reviewed 	by 	the 	authors 	is
examined 	separately, 	it 	supports 	the 	conclusion 	that 	takecvers
enhance 	efficiency. 	Similarly, 	Lipton, 	Takeover 	Bids 	in 	the 	~a!'
cet's 	BC2~droom, 	35 	Bus. 	Law. 	101 	(1979), 	offered 	evidence 	p~~
porting 	to 	show 	t~at stockholders 	benefited 	from 	management 	re-
sistance 	that 	resulted 	in 	the 	defeat 	of 	takeover 	bids. 	Linton'S
evidence 	showed 	that 	the 	share 	prices 	of 	some 	firms 	that 	had 	de-
feated 	takeover 	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 	sa~e
period. 	More 	systematic 	studies, 	whic~ examine 	abnormal 	returns
on 	shares 	of 	takeover 	targets 	compared 	to 	overall 	marKet 	trenjs,
show 	that 	stockholders 	incur 	significant 	losses 	from 	the 	defeat
of 	takeover 	bids. 	See 	oenerally 	Easterbrook 	& Jarrell, 	s~pra
note 	9, 	at 	262-64.
'll! 	D. 	Ravenscraft 	& F. 	Scherer, 	1".eroe~s, Sell-Offs, 	and 	EC:O:"l':-
rr:ic 	Effic:ency 	101-03 	(1967). 	The 	authors 	used 	accounting 	d2~a
to 	measure 	economic 	rates 	of 	return. 	This 	me~hodology is 	con-
troversial 	because 	profits 	revealed 	by 	such 	data 	are 	subject 	to
wide 	variations 	resulting 	from 	the 	use 	of 	divergent 	accounting
conventions 	by 	different 	firms. 	See 	oenerallv 	Benston, 	The 	vcli-
cit" 	of 	~rofits-Structure Studies 	wit~ Particular 	Reference 	~~
the 	F~C's Line 	of 	B~siness Data, 	75 	hID. 	Econ. 	Rev. 	37 	(lSES);
Fisher 	& ~cGowan, 	On 	the 	~isuse of 	~ccountino Rate~ cf 	R~~~rn to
Infer 	!':cnopoly 	Profits, 	73 	J...m. 	rcon. 	Rev. 	62 	(1983). 	In 	ac:ic:..-
tion, 	be:ause 	of 	cons~raints on 	the 	availability 	of 	data, 	t~e
study 	focuses 	largely 	on 	conglo~erate merge~s. 	See 	Ravensc=a:~ &
Scherer, 	surra 	note 	11, 	at 	22. 	As 	the 	au~hors observe, 	ho...·e·;er,
the 	incidence 	of 	horizontal 	merge~ ac~:"vi~y has 	increased 	marxec-
ly 	in 	t~~s decade, 	and 	"[t)he 	shift 	toward 	large 	horizon~al ~er
g~rs 	is 	mo!'e 	d:"fficult 	to 	evalua~e solely 	on 	the 	basis 	of 	o~r =E-
search." 	Ie:, 	a~ 	219.

The 	Honorable 	Steven 	H. 	Amick
Page 	6
economic 	efficiency 	by 	impeding 	the 	flo~ of 	corporate 	assets 	to
value-maximizing 	uses 	and 	by 	entrenching 	inefficient 	managers.
hsserted 	Disadvantaoes 	of 	Takeover 	Activity
Several 	purpcrted 	disadvantages 	of 	takeover 	activity 	are
often 	cited 	to 	justify 	restraining 	corporate 	acqui£itions. 	Al-
though 	these 	disadvantages 	have 	not 	been 	sub£tantia~ed throuah
empirical 	research, 	they 	are 	of:en 	cited 	by 	incumbent 	manacers
and 	other 	takeover 	critics 	in 	testimony 	before 	Congressional
commi ttees 	and 	in 	articles 	in 	the 	general 	press. 	In 	the 	abser.ce
of 	persuasive 	evidence 	substantiating 	these 	asserted 	disadvan-
tages, 	these 	claims 	do 	net 	support 	the 	enactment 	of 	curbs 	on
takeover 	activity.
Some 	takeover 	critics 	claim 	that 	acquirers 	often 	take 	over
well-managed 	corporations, 	oust 	good 	manageme~t, anc 	red~ce cor-
porate 	efficiency 	by 	installing 	less 	capable 	management 	teams.
This, 	indeed, 	may 	happen 	in 	some 	cases. 	Corporate 	acguirers,
like 	all 	other 	businesspersons, 	may 	nake 	mistakes. 	This 	poss~~i
lity, 	however, 	does 	not 	justify 	controls 	on 	takeover 	activity 	a~y
more 	than 	the 	pOSSibility 	of 	poor 	investments 	in 	plant 	or 	eguip-
ment 	justifies 	government 	controls 	on 	investment 	decisio~s mc~~
by 	corporate 	managers. 	In 	a 	market 	economy, 	investment 	decis~ons
generally 	are 	best 	left 	to 	investors, 	who 	stand 	to 	pro:it 	fro~
correct 	decisions 	and 	lose 	from 	poor 	ones. 	The 	critical 	fact 	is
that 	takeover 	activity, 	in 	the 	aggregate, 	ap?:ars 	to 	benefit
society. 	Eecause 	the 	benefits 	of 	takeover~ outweigh 	their 	costs,
restricting 	takeovers 	in 	the 	hope 	of 	preventing 	un~ise invest-
ments 	is 	likely 	to 	harm 	societal 	welfare.
It 	also 	has 	been 	argued 	that 	management-opposed 	takeovers
result 	disproportionately 	in 	facility 	closings 	and 	lay-effs,
which 	irr.pose 	great 	social 	costs 	on 	individuals 	and 	corr~ur.ities in
which 	plants 	are 	located. 	But 	factual 	support 	for 	the 	position
that 	takeovers 	in 	fact 	lead 	to 	plant 	closings 	and 	lay-cffs 	that
would 	no:. 	hev€' 	Dcc-..:rred 	ot.her....·ise 	is, 	at 	best, 	scanty. 	1.1./ 	hr.)'
12/ 	C:oc 	Jer.sen 	orr-\'OO\Te~c::;' 1:"0'1.,-, 	0 	ane' 	C:cl'e"''''e 	1..:'a ..... ' 	Bne: 	';;Q\'	...:.-. 	~ 	.. 	,'- C # • _ 	_ _. 	.. 	_ ,~ ... 	..... 	,-,;J '- 	, 	r.. 	_ v .. 	10.0. _" 	J , _ 	..
Nov.-Le~. 	lSS~, 	at 	114 	i 	cf. 	~~ericcn Er.terprise 	Ins~itu~e, :~~
nCC::;-'e: 	l~~e-~'n~ 	Co~~~""a~e 	~-l·p-'\'e .... e: 	jl 	(lCBS) 	(c'-'ng 	~'nc"~~	r 	_c __ 	.... ~ --- &...,J 	_t:--.FL 	.... 	.-ct._--, 	__ 	~ 	... 	_L.... 	~- 	... ,,'":!
the:' 	"very 	fe ....· 	jobs 	were 	af fected" 	by 	6,000 	corporate 	acq~isi
tions 	in 	19705). 	The 	AFL-CIO 	estimates 	that 	a 	total 	of 	60,000
jobs 	of 	members 	of 	its 	affilie:ed 	unions 	have 	been 	lost 	as 	a 	"~e
sul t 	of 	cor-porate 	rest.ru::turing" 	in 	recent 	years. 	Ho~":i:e ';c. ':.::'-
O\'e:-=" 	Hearings 	oefore 	the 	Ser,ate 	Co~itt.ee on 	Ban}:i.ng, 	Ho'.:s.:.r.;,
-n~ 	U ~-n 	~&f-,~e: 	100·h 	CO""'" 	1e:- 	See:e: 	262 	(lOR-I) 	(e:·-·e~=r-	c· 	....,c .. 	r._ .. c 	, 	'- 	;''':''' 	_... 	_-..J. 	.,...... 	_ .... c:~ 	•. _ .. -
cf 	Thor.,as 	F.. 	Dc;,ahue) 	(hereinafter 	"H:c~incs on 	HC'~:.ile ';c~:c
(c.)r.:.in~e:: ... )

The 	Honorable 	Steven 	H. 	Amick
Page 	7
closings 	or 	lay-offs 	that 	are 	necessary 	to 	achieve 	greater 	ef-
ficiency 	likely 	would 	have 	been 	carried 	out 	by 	the 	target's 	man-
~gement in 	any 	event 	if 	the 	firm 	were 	to 	remain 	competitive.
··~oreover, most 	economic 	changes 	that 	increase 	efficiency 	-- 	and
thereby 	increase 	aggregate 	societal 	wealth 	-- 	create 	dislocatio~s
that 	reduce 	the 	welfare 	of 	some 	individuals. 	11/ 	This 	is 	true 	of
. virtually 	every 	major 	technological 	advance, 	which 	renders 	ear-
lier 	technologies 	obsolete 	and 	may 	harm 	firms 	and 	individuals
dependent 	on 	the 	earlier 	technologies.
It 	has 	been 	asserted 	that 	the 	financing 	of 	corporate 	acqui-
sitions 	through 	high 	yield 	(or 	"junk") 	bonds 	saddles 	acquiring
firms 	with 	"excessive" 	debt. 	Some 	critics 	argue 	that 	the 	as-
sertedly 	high 	debt 	burden 	assumed 	by 	corporate 	acquirers 	will
lead 	persons 	who 	gain 	control 	of 	a 	target 	firm, 	among 	other
things, 	to 	close 	productive 	plants, 	terminate 	expenditures 	for
activities 	that 	lead 	to 	long-term 	benefits, 	such 	as 	research 	and
development 	operations, 	and 	"loot" 	corporate 	cash 	accounts 	a~d
other 	assets 	of 	the 	firm. 	Although 	the 	focus 	of 	the 	criticism
has 	been 	acquirers' 	use 	of 	high 	yield 	bonds 	to 	fiD3nce 	takeovers,
relatively 	little 	takeover 	financing 	is 	made 	through 	high 	yield
bonds. 	In 	the 	first 	nine 	months 	of 	1986, 	a 	year 	of 	significant
takeover 	activity, 	high 	yield 	bonds 	represented 	only 	7.6 	percent
cf 	tender 	offer 	financing. 	Iii
12/( ... continued)
overs"). 	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 	wou~d
have 	been 	abolished 	in 	any 	event 	to 	improve 	the 	competitiveness
of 	the 	affected 	companies. 	To 	put 	the 	figure 	in 	perspective, 	a
total 	of 	5.1 	million 	workers 	lost 	their 	jobs 	because 	of 	plant
closings 	or 	efficiency 	measures 	in 	the 	years 	1979-1983. 	Bure~u
c: 	Labor 	Statistics, 	~onthlv Labor 	Review 	(June 	1985).
III 	It 	would 	~eeffi preferable 	for 	government 	to 	respond 	to 	these
inevitable 	economic 	dislocations 	by 	initiating 	effective 	remedial
measures 	to 	assist 	displaced 	individuals 	rather 	than 	severely 	rE-
stricting 	economic 	activity 	t~at benefits 	society.
14/ 	E. 	Sherman 	& R. 	Schrager, 	Junk 	Bonds 	ar.d 	Tender 	C::er
Finane-inc 	18 	(1987), 	re:>ri:-.:.ed 	iI, 	Hearincs 	on 	Hostile 	~c}:eo\'ers,
supra 	note 	13, 	at 	627. 	To 	put 	the 	point 	in 	perspective, 	in 	1525,
only 	600 	U.S. 	companies 	qualified 	for 	investment 	gracs 	ratin;s,
w~ile 19,000 	additional 	companies 	with 	assets 	of 	more 	than 	$25
millior. 	did 	not 	qualify. 	Imcect 	of 	Corporate 	Takeovers, 	~ea~ir.ss
Eefore 	the 	Senate 	Committee 	on 	Banking, 	Housing, 	and 	Urban 	h:-
fairs, 	99th 	Cong., 	1st 	Sess. 	695 	(1985) 	(statement 	of 	Freder':c}:
Joseph). 	~ar.y of 	these 	corporations 	use 	high 	yield 	bonds 	t: 	:.:-
(co:-.:..:nue: ... )

The 	Honorable 	Steven 	H. 	Amick
Page 	B
It 	is 	highly 	improbable, 	moreover, 	that 	corporate 	acquirers
would 	undertake 	obligations 	they 	believe 	likely 	tq 	render 	an 	ac-
quired 	company 	unprofitable, 	because 	deing 	so 	likely 	would 	defeat
the 	very 	purpose 	of 	their 	investment. 	It 	is 	not 	in 	the 	interest
of 	acquirers 	to 	shut 	down 	profitable 	operations 	or 	eliminate
". beneficial 	research 	and 	development 	efforts 	for 	the 	purpose 	of
satisfying 	debt 	obligations. 	Divestiture 	of 	ccrporate 	assets 	or
reduction 	in 	research 	and 	development 	efforts 	for 	the 	sake 	of
satisfying 	debts, 	rather 	than 	for 	business 	reasons, 	will 	rob 	the
divesting 	firm 	of 	a 	source 	of 	future 	earnings 	to 	satisfy 	fut~re
debt 	obligations. 	1.2/ 	l-:oreover, 	the 	sopr.isticated 	institutior.al
investors 	who 	buy 	high 	yield 	bonds, 	which 	include 	pension 	funes,
insurance 	companies, 	m°.;tual 	funds, 	end 	other 	financial 	insti tu-
tions, 	are 	unlikely 	to 	lend 	money 	for 	tak80vers 	unless 	they 	ex-
pect 	them 	to 	be 	profitat:e.
.Finally, 	it 	is 	argued 	tha~ takeovers 	force 	corporate 	ma~-
agers 	tc 	focus 	on 	short 	term 	profits 	and 	forego 	long 	te~ 	invest-
ments. 	The 	evidence 	shows, 	hOwever, 	that 	foregoing 	long 	te~
investment 	makes 	companies 	more, 	not 	les s, 	....'U 1 nerable 	to 	tcd:e-
overs. 	Takeover 	targets 	tene 	to 	have 	below-average 	research 	a~c
development 	budgets, 	sho~ing a 	lesser 	commitment 	to 	long 	ter~
investme·nts 	than 	the 	average 	firm. 	li../
ll/ ( ... continued)
nance 	growth 	because 	debt 	securities 	offer 	them 	ffiQre 	flexibili~y
than 	bank 	loans 	or 	term 	loans 	by 	ins~re~ce companies, 	which 	~ntil
recently 	had 	been 	their 	only 	available 	avenue 	for 	dett 	fin~:.cing.
Thus, 	in 	1985, 	firms 	issued 	a 	total 	of 	S15 	billion 	in 	high 	yiele
bonds. 	Sherman 	& Schrager, 	supra, 	at~. 	During 	the 	same 	year,
the 	total 	value 	of 	debt 	securities 	issued 	to 	finance 	tender 	of-
fers, 	including 	investment 	grade 	securities, 	~as 	S~.3 billie".
Id. 	at 	17.
15/ 	Of 	course, 	acquirers 	may 	sell 	portions 	of 	acquired 	fi~s
because 	they 	do 	not 	fit 	into 	the 	firms' 	business 	plans, 	and 	will
shut 	do~n inefficient 	facilities, 	including 	inefficient 	research
a~d 	development 	operations, 	because 	they 	are 	un;rofitable 	in 	the
lone 	run. 	B~t 	this 	is 	precisely 	the 	sort 	of 	redeplo)~ent 0: 	cor-
porate 	assets 	to 	more 	efficie~t uses 	that 	results 	in 	bene:its 	to
society.
12/ 	This 	proposition 	is 	supported 	by 	a 	recent 	empirical 	study 	of
th~ 	investment 	patt~=ns of 	takeover 	taroets. 	The 	st~dy, 	~h:ch
ex?mined 	all 	21i 	ta}:eover 	targets 	that 	~ere acquired 	beLwEen 	1~SO
and 	198~, 	found 	thaL 	~akeovEr taree~s had 	below 	average 	rat:cs 	c:
(i) 	research 	and 	development 	expenditures 	to 	total 	expene:L~res
cDC 	(ii) 	ca~iLal investment 	LO 	earnings. 	Securities 	ane 	Ex=~=~;e
(cont: inUEC ... )

The 	Honorable 	Steven 	H. 	Amick
Page 	9
Effect 	of 	~Busines~ Combination" 	Re!~rictions
Proposed 	section 	203 	governs 	"business 	combinations" 	bet..... een
"interested 	stockholders" 	and 	takeover 	target 	firms. 	Section
.203(c)(5) 	defines 	"interested 	stockholders" 	as 	owners 	of 	15 	per-
cent 	or 	more 	of 	the 	voting 	shares 	i~ 	Delaware 	corporations. 	Un-
"der 	the 	proposed 	legislation, 	such 	stockholders 	would 	be 	prohi-
bited 	from 	merging 	with 	or 	conducting 	other 	fpecified 	business
activities 	with 	target 	corporations 	for 	three 	years 	after 	becom-
ing 	interested 	stockholders, 	unless 	the 	business 	combination 	or
the 	purchase 	of 	shares 	was 	approved 	by 	the 	target 	corpora~ion's
board 	of 	directors 	before 	the 	aco~irer became 	an 	interested
stockholder. 	12/ 	~
The 	proposed 	legisl~tion is 	likely 	to 	d~ter takeovers 	whose
profitability 	depends 	on 	the 	ability 	of 	the 	acquirer 	to 	merge
with 	the 	target 	corporation. 	The 	successful 	bidder 	for 	corporate
control 	commonly 	seeks 	to 	consolidate 	the 	target 	into 	its 	opera-
tions 	by 	means 	of 	a 	merger. 	~/ 	A three-year 	merger 	prohibition
is 	likely 	to 	require 	many 	acquirers 	to 	mai~tain ine~ficien~ for~s
of 	business 	organization 	and 	would 	thus 	undercut 	their 	ability 	~o
improve 	the 	efficiency 	of 	target 	corporations. 	This, 	in 	turn,
may 	deter 	some 	takeover 	bids 	that 	would 	benefit 	the 	economy.
The 	bill 	would 	also 	prohibit 	~he sale 	or 	other 	o~spositicn
of 	substantial 	target 	company 	assets, 	"except 	proportionately 	as
a 	stockholder 	of 	the 	corporatiorl," 	to 	or 	with 	interested 	st.ock-
holders 	for 	a 	period 	of 	t.hree 	years 	aft.er 	the 	stoc}:holder 	became
~/( ... cont.inued)
Commission, 	Office 	of 	the 	Chief 	Economist, 	Instit~tioT',cl C'·...·rler-
shiD, 	Tender 	O:fers, 	and 	Lona-Term 	:nvestment 	6-10 	(1~E:).
17/ 	Pro:?osed 	section 	203 \ a) 	also 	exempt.sany 	stocj:holder 	who
acquires 	at 	least 	E5 	percent 	of 	the 	corporation'S 	shares 	"upon
consumma~ion of 	the 	transactio~" in 	which 	it 	becomes 	an 	in~er
ested 	stockholder, 	or 	whe, 	after 	becomino 	arl 	i~terested sto=k-
holder, 	o::Jtains 	approYal 	for 	the 	business 	corr':':ir.ation 	by 	the
board 	of 	directors 	and 	secures 	the 	a~thorization therefor 	ty 	the
vot.e 	of 	t ..... o-thirds 	of 	the 	outstanding 	shares 	of 	remaining 	s~ock
holders.
ill 	See 	P 	Gilson, 	'!'he 	La..,.. 	ar;d 	Fine.nce 	of 	CO::-Dorat..e 	""cc:..::s':':':'=-::~
854 	(1956).

The 	Honorable 	Steven 	H.Amick
Page 	10
an 	interested 	stockholder. 	~/ 	Many 	corporate 	acquisitions 	are
financed 	through 	debt 	securities 	that 	may 	be 	partially 	retired
through 	the 	sale 	or 	other 	disposition 	of 	acquired ~ssets. 	Sec-
tion 	203(c)(3)(ii) 	of 	the 	proposed 	legislation 	would 	prohibit
pledging 	or 	otherwise 	transferring 	substantial 	assets 	to 	or 	~i~h
interested 	stockholders. 	~/ 	This 	prohibition 'Would 	increase
the 	cost 	of 	financing, 	and 	in 	many 	cases 	may 	deter, 	takeovers 	de-
signed 	to 	redeploy 	assets 	to 	more 	efficient 	uses.
The 	proposed 	legislation 	'Would 	restrict 	the 	freedom 	of
stockholders 	to 	control 	and 	dispose 	of 	their 	property 	~ithou~
government 	scrutiny. 	O~ners of 	assets 	should 	be 	free 	to 	se:l
property 	~ithout having 	the 	state 	examine 	the 	merits 	of 	the
transac~ion, absent 	a 	compelling 	justification. 	When 	stockhold-
e~s 	determine, 	for 	whateve~ reason, 	to 	transfer 	control 	of 	c
corporation, 	the 	state 	should 	not 	frustrate 	their 	will 	and 	re-
quire 	them 	to 	retain 	managers 	they 	~ish to 	displace.
Empirical 	Evidence 	on 	Effect 	of 	Anti-Takeover 	Le£islaticn
Two 	recent 	empi~ical studies 	concerning 	the 	effect 	of 	an~i
takeover 	legislation 	have 	concluded 	that 	anti-takeover 	la~s 	hc~m
stockholders 	and 	undermine 	economic 	efficiency. 	A recent 	em~i
rical 	study 	by 	the 	Commission's 	Bureau 	of 	Economics 	of 	a 	New 	Yc~k
statute 	21/ 	similar 	to 	section 	203 	analyzed 	the 	extent 	of 	the
economic 	harffi 	caused 	by 	restrictions 	on 	"business 	combina-
tions." 	III 	The 	stucy 	found 	that 	the 	announcement 	by 	Ne ....· 	Yo:-}:' s
gove~nor 	of 	the 	proposed 	legislation 	that 	ultimately 	became 	the
19/ 	The 	phrase 	"except 	propo~tionately as 	a 	stockholder 	of 	the
corporation" 	did 	not 	a~?ear in 	an 	earlier 	ve~sion of 	the 	legisla-
tion 	circulated 	for 	corr~ent by 	the 	Delaware 	Bar 	Association 	an=
was 	added 	by 	the 	Association 	in 	a 	later 	draft. 	As 	we 	understand
the 	modification, 	the 	acquired 	corporation 	would 	be 	free 	to 	dis-
pose 	of 	substantial 	assets 	after 	an 	interested 	stockholder 	gai~s
control 	so 	long 	as 	the 	gains 	of 	the 	transaction 	are 	distributed
proportionately 	to 	all 	stockholders. 	Although 	we 	welcome 	this
modification, 	for 	th~ 	reasons 	set 	forth 	in 	the 	text 	be:o~ we
th:nk 	that 	eli~inating the 	prohibition 	altogether 	~ould be 	p:-e-
ferable.
lQ/ 	~ith ~he exception 	of 	the 	adGitional 	phrase 	exe~~ting asse~
transfers 	made 	"proportionately 	as 	a 	stockholder 	of 	the 	corp8ra-
tion," 	the 	prohibition 	in 	section 	203(c)(3)(ii) 	is 	virtually
identical 	to 	that 	set 	forth 	in 	section 	912(a)(S)(B) 	of 	the 	~e~
Y~rk Business 	Co~pora:ion La~, 	which 	has 	been 	interFrete~ to 	~~~
hibit 	the 	transf~~ of 	assets 	~hose value 	exceeds 	the 	perce~~a~E
of 	tetal 	cerpora~e a~sets set 	for~h therein.
2~.' 	Ne ....· York 	Bus. 	Corp. 	La,", 	§ 	S12.

The 	Honorable 	Steven 	H. 	Amick
Page 	11
New 	York 	law 	resulted 	in.a 	statistically 	significant 	decline 	in
the 	average 	value 	of 	shares 	of 	New 	York 	corporations. 	The 	de-
cline 	was 	equal 	to 	approximately 	one 	percent 	of 	the 	value 	of 	the
shares, 	or 	S1.2 	billion. 	111 	As 	the 	study 	noted 	in 	conclusio~:
[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 	sharehold-
ers. 	[In 	addition, 	the 	statute) 	may 	promote
the 	inefficient 	management 	of 	society's 	assets 	by
lessening 	the 	ability 	of 	capital 	markets 	to 	effi-
ciently 	reallocate 	assets. 	Consequently, 	the 	real
cost 	of 	the 	goods 	and 	services 	produced 	by 	the
firms 	affected 	by 	[thE 	statute] 	may 	increase, 	in-
juring 	consumers 	cs 	well 	as 	shareholders. 	Iii
Another 	study, 	conducted 	by 	the 	Office 	of 	the 	Chief 	Econo-
mist 	of 	the 	Sec~rities and 	Exchange 	Commission, 	also 	concludes
that 	anti-takeover 	legislation 	is 	harmful 	to 	the 	interests 	0:
stockholders. 	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 	stockholders 	in
assessing 	takeover 	bids. 	£21 	The 	SEC 	study 	found 	that 	the 	en-
actment 	of 	the 	Ohio 	la~ caused 	an 	immediate 	two 	percent 	decline
in 	the 	eq~ity value 	of 	corporations 	insulated 	from 	takeovers 	ty
the 	Ohio 	la.....
Consi~eration 	of 	an 	"Optino-In" 	~echanism
If 	the 	le;isla:ure 	decides 	to 	enact 	proposed 	section 	2C3 	in
some 	form 	despite 	the 	concerns 	discussed 	above, 	we 	re~Jest 	tha~
you 	consider 	modifying 	the 	bill 	to 	make 	it 	inapplicable 	to 	ccrpo-
rations 	that 	do 	not 	affirmatively 	elect 	to 	be 	covered 	by 	its 	pro-
visions 	through 	amendments 	to 	their 	certificates 	of 	incorpora-
tion. 	In 	its 	pres~nt forr." 	proposed 	section 	203 	applies 	to 	all
corporations 	that 	do 	not 	"Opt 	out." 	To 	the 	extent 	that 	prcposed
sectic~ 203 	is 	motivated 	by 	a 	concern 	for 	stockholders, 	its 	p~r
pose 	.... ould 	be 	be~ter served 	by 	a 	requirement 	t:-.at 	stockholders
.., 3 I
~I
lil
~~. 	at 	41, 	46-~7.
J~. 	a-: 	47.
25/ 	Securi:ies 	and 	Exchange 	Comrr.~ssion, Office 	of 	the 	Ch~e:
Econo~is~, Sha~eh~lder ~eclth E::ects 	of 	Ohio 	Lecislot:c~ ~::~~:
ins 	~ci:'?cve~s (198i). 	The 	Ohio 	la.... 	is 	codified 	in 	Ohio 	Roe'.', 	:::':2
hnn. 	§ 	liOl.01 	et 	se:;. 	(Page 	1986 	SUp?).

The 	Honorable 	Steven 	H. 	Amick
Page 	12
approve 	a 	decision 	to 	opt 	into 	the 	proposed 	legislation. 	We-re-
commend 	that 	a 	corporation's 	decision 	to 	opt 	into 	the 	statutory
scheme 	be 	made 	solely 	through 	a 	stockholder 	vote 	ame.nding 	the
certificate 	of 	incorporation.
If 	the 	ltgislature 	decides 	to 	retain 	the 	proposed 	opting-out
mechanism, 	we 	recommend 	that 	it 	consider 	giving 	immediate 	effect
to 	stockholder 	d~terminations to 	opt out 	of 	the 	legislation.
Under 	proposed 	section 	203(b)(3), 	an 	amendment 	to 	a 	corpora~iGn's
certificate 	of 	incorporation 	expressly 	elec~ing not 	to 	be 	govern-
ed 	by 	the 	legislation 	does 	not 	become 	effective 	:or 	twelve
months. 	Such 	amendment, 	moreover, 	is 	made 	inapplicable 	to 	busi-
ness 	combinatio:.s 	with 	any 	person 	who 	became 	an 	ir.terested 	stock-
holder 	at 	the 	time 	of 	or 	prior 	to 	the 	amendment. 	This 	is 	a 	seri-
ous 	restraint 	on 	the 	freedom 	of 	stockholders 	to 	control 	the 	cor-
porations 	they 	own. 	The 	inclusion 	of 	an 	opting-out 	provision
embodies 	an 	implicit 	recognition 	that 	the 	proposed 	legislatic~
may 	be 	harmful 	to 	the 	interests 	of 	stockholders. 	hn 	ineffectual
opting-out 	provision, 	however, 	does 	little 	to 	amelicrate 	t.:'a~
harm.
Conclusion
The 	case 	has 	not 	been 	made 	to 	date 	that 	proposed 	section 	203
is 	a 	necessary 	or 	desirable 	response 	to 	corporate 	takeover 	act.i-
vity. 	On 	the 	~hole, we 	believe 	that 	vigorous 	takeover 	ac~ivi~y
enhances 	economic 	efficiency 	and 	thus 	benefit.s 	consumers, 	work-
ers, 	and 	stockholders. 	~e 	are 	troubled 	that 	proposed 	sect.io~ 203
would 	impede 	many 	of 	the 	beneficial 	conseque~ces of 	takeover~
without 	offering 	counter\-ailing 	benefits. 	~e 	urge 	you 	to 	con-
sider 	whether 	the 	proposed 	legislat.ion 	would 	und~ly int.erfere
with 	the 	market 	for 	corporate 	control 	to 	the 	detriment 	o~ 	the
national 	economy.
Sincere':"y,
9/hr~C§~.c~....--._r-
Jeffrey 	I. 	Zuckerman
Director