Paying to lose control


A ‘person’ who owns more than 19.9% of a publically listed firm can only increase their stake by making a takeover bid to all shareholders, or alternatively, by ‘creeping’ forward in ownership by 3% per six months.  So, to get from 19.9% to say 37.9% would take 3 years if maximum use were made of the creep provisions in the Corporations Act.  The Act actually uses the word “creep”.

There has been a lot of hand wringing about this by journalists lately.  Apparently they are worried that Gina Rhinehart will slowly but surely take control of Fairfax Media using the creep provisions.  Adding more weight to the argument that the creep provisions should be eliminated, or curtailed, is the call by Australian Securities and Investments Commission boss Greg Medcraft for changes.  The arguments put forward for ending or curtailing the creep provisions are very weak.  First, it is argued that Australia has creep provisions and some other countries do not — so what?  Second, it is argued that with the creep provisions in place a ‘person’ (as the Act says) could acquire control of the firm without paying a premium to the other shareholders  —  again, so what?  Third, — there is no third point in the argument.

It is not obvious that small shareholders are worse off when a single party takes a large controlling stake.  When the shareholder base is atomised then no single investor has a strong enough incentive to properly monitor the management of the firm.  If a large stakeholder emerges, which does have a strong enough incentive to monitor, that may make the shares of the other shareholders more valuable.  It may even be optimal for small shareholders to pay one party to take a controlling stake (if that party commits to hold the stake), by all small shareholders selling some of their shares at a discount.  

There is a premium for control.  It is an empirical fact that when a firm has A and B class shares that are only separated by the B class shares having no voting rights, then the A class shares sell at a small premium.  It is hard to determine what the premium represents.  It mostly seems to be a premium for a seat at the table in negotiations.  But that does not mean that there is anything wrong with the existing takeover laws.  People, such as Greg Medcraft, and members of the press, who state that a premium must be paid for control, should explain what they mean.  It is not at all obvious that any premium is due.  What is obvious is that making takeovers more difficult entrenches bad management teams, which is to the determent of small shareholders.

The moral hazard problem in public firms is large.  Management teams will not act in the interests of shareholders unless they are either closely monitored by  a large stakeholder or management’s incentives are aligned with shareholders by giving them stock options.  If you don’t want high executive pay with large stock options, but you do want to block the acquisition of large stakes in the firms, which allows for monitoring, then it seems to me that you probably don’t understand the nature of the moral hazard problem that arises from the separation of ownership and control in public corporations.


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