12 August 2010

Proposed takeover regulations - bad idea

I have a long piece in the Economic Times today on why the takeover regulations as proposed by an advisory committee of SEBI are a bad idea for investors. Here are excerpts of the piece:

"The first problem with the regulation is that it increases the tender offer trigger from 15% to 25%. The argument made is that the corporate scenario has changed since the existing regulations were enacted in 1997. The committee ignores the recent mandate of the finance ministry to companies to have a minimum float of 25% that will dramatically reduce promoter shareholding over the next three years. If promoter shareholding reduces, public shareholding increases, thus making shareholding more fragmented. In other words, if you could control a company with 15% in 1997, you could do so with, say, 10% or 12% going forward. That is an argument for reducing the 15% threshold, not for increasing it. The report’s argument about de facto control at 25% is contrary to an annexure to the report that shows more companies are controlled with less than 15% than between 15% and 25%. Bad for shareholders.

The second issue is with respect to raising the minimum tender offer from 20% of voting capital to 100% of public shareholding . This is based on the mythological assumption that all shareholders must get an exit if there is substantial acquisition of shares or control. In fact, the move raises the costs of acquisitions by a factor of several times for an acquirer, making the possibility of a tender offer itself remote. If there is no tender offer, shareholder get no exit option. Again, the evidence attached to the report itself states that over the past four years, over 85% of all offers occurred at the 20% level that is currently the minimum requirement. The recommendation would jeopardise 85% of the market for control. Clearly, an import of the provision from some capital-rich western countries is inappropriate given both capital scarcity as well as restrictions on leverage for acquisition financing imposed by the RBI. The 100% offer, therefore, means that foreign players with easy access to debt and capital will find it easier to acquire Indian companies. Bad for shareholders , great for promoters.

Thirdly, the report seeks to allow creeping acquisition, i.e., small purchases of 5% in a year, only to promoters. It does this by allowing creeping acquisition to only those holding above 25%. While a similar rule exists today at the 15% level, moving the threshold to 25% ensures it protects promoters. The report continues the imperfect rule of mandating a tender offer on crossing 25% (15% today). This means that you can acquire 5% shares a bit below or above the threshold number, but acquiring even one share that would result in crossing 25% (or 15%) would trigger the regulations. This isn’t logical or fair. The rationale of allowing creeping acquisition is that so long as you are acquiring shares slowly, and given that shareholders know about this through disclosures, shareholders can exit in the secondary market. Disallowing creeping acquisition below 25% is, therefore, unwarranted and discriminates against nonpromoter shareholders. Great for promoters , bad for acquirers.


Overall, on balance of the good, the bad and the ugly, there appears no compelling reason to sink one-and-a-half decades of law and jurisprudence. It should be remembered that a mistake will be costly. A poor market for control doesn’t just mean reduced takeover activity, it means promoters will be less efficient as they don’t have to care about the threat of takeover in case of poor management of the company. Bad for corporate governance, good for inefficiency. It would be better to clean up the obvious mistakes of the existing regulations and let the big picture of the current regulations remain. Never ask a barber if you need a haircut, never ask a committee if change is better.

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