DealLawyers.com Blog

The following was posted by Professor John Coates of Harvard Law School in Harvard’s “Corporate Governance Blog” (based on Prof. Coates’ working paper, “The Powerful and Pervasive Effects of Ownership on M&A“):

Mergers and acquisition (M&A) practices vary – indeed, practitioner lore is that every deal is unique. But M&A deals have much in common. M&A contracts, techniques, and outcomes vary systematically. While practitioners exploit such patterns, few have been reported, analyzed, or considered in academic research, and not all practitioners fully reflect these patterns in their practices. In a recent working paper, available here, I show that ownership dispersion is a first-order determinant of M&A practices. Firms with dispersed ownership are more salient, and tend to be larger, but dispersion varies significantly even at large US businesses, and affects M&A deal size, duration, techniques, contract terms, and outcomes.

Privately held firms are an important part of the US economy, as is private target M&A. Most US business corporations had 100 or fewer owners, and those firms generated 20+% of corporate receipts in 2006. Of businesses with more than $250 million in assets, only 18% were C corporations with 500+ shareholders. Even at public companies, dispersion varies significantly. A few have millions of record owners, and 500+ have 15,000+ shareholders. But 500+ “public” companies have fewer than 50 record shareholders, and over a third have fewer than 300 record holders. These companies are the reverse of firms that have “gone dark” – they could deregister with the SEC, but instead voluntarily choose to “remain lit” and file regular reports.

M&A practices thus can and do diverge based on variation in ownership. Dispersion creates transaction costs and heterogeneous beliefs and preferences that have straightforward effects on M&A deal size, techniques, and some contract terms. But dispersion also has less intuitive, indirect, and important effects as mediated through laws that among other things compensate for agency costs and collective action problems. Each key body of law for M&A – contract law, corporate law, securities law, and antitrust law – is shaped in practice by ownership of target firms.

These effects are tested with comprehensive M&A data from 2007 and 2008, and a new detailed hand-coded matched sample of 120 recent public and private target M&A contracts. Among other things, simple comparisons and regression analyses show:

– Size, frequency and volume. Public target bids are ten times larger than private target bids, but much less common. The overall result – aggregate deal volume – is roughly the same order for the two kinds of targets.

– Cross-border and diversifying bids. Public target bids much more commonly are diversifying (i.e., bidder and target in different industries) and cross borders, even among similarly sized bids.

– Bid duration and completion. Private target bids typically involve simultaneous signing/closings, which are rare (but do sometimes occur) in public target bids. Public target bids with deferred closings take twice as long to close, even above Hart-Scott-Rodino thresholds and controlling for bid size. Partly as a result, announced public target bids are withdrawn 10+ times more often.

– Deal structure. Public target bids are almost always either one-step mergers or multi-step bids that include a tender offer. Private target bids are most commonly negotiated stock purchases, but also commonly are one-step mergers or asset purchases.

– Bid consideration. While both types of bids use a variety of types of consideration overall, bidders for private targets much more commonly offer mixed consideration and debt consideration (i.e., seller financing).

– Risk-and profit-sharing contracts. Private target bid contracts much more commonly use earn-outs, indemnification, price adjustments, escrows, and holdbacks, all of which are rare (but are sometimes used) in public target bids.

– Fiduciary outs and deal protection. Public target bid contracts much more frequently address the target board’s fiduciary duties, including through fiduciary outs, and much more frequently include deal protection clauses – but private target bids do sometimes include these provisions. When included, termination fees are actually higher in private target bids (as a percentage of the bid size, and controlling for bid size).

– Dispute resolution and remedies. Private target contracts more frequently choose arbitration, both for price adjustment clauses and for the contract as a whole, whereas public target contracts more frequently choose Delaware courts and more frequently provide for specific performance.

Appreciation of how pervasive and powerful the effects of ownership are on M&A should improve contracting and has implications for investment bankers, boards, courts, and researchers in choosing comparable transactions for valuation, benchmarking, doctrinal analogies, drafting models, teaching M&A in business and law schools, and econometric modeling of M&A.