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In America, Pfizer would struggle to launch a hostile takeover

21 May 2014

The Pfizer takeover debate has been framed as a dispute between politicians, who claim to speak for the public interest, and shareholders, who own companies. Some have even claimed that it’s a dispute between free enterprise and state control, but the dispute is not between politicians and shareholders, it’s between two kinds of shareholder: those with a long-term commitment to customers and those focused only on immediate gain.

In Pfizer’s homeland it is far more difficult to launch a hostile takeover. The aim of America’s laws is to encourage the exercise of personal responsibility in business and commerce. Despite her reputation as the heartland of ruthless corporate capitalism, America’s company law entrenches personal responsibility far more effectively than ours. In particular, it provides companies with protections against hostile takeovers so that people with a long-term commitment to business ideals can pursue them without disruption by corporate raiders.

Adam Smith was among the first to voice criticism of short termism. He severely criticised ‘projectors’ who wasted money on foolish projects in the hope of acquiring sudden wealth and preferred to encourage a steady desire to better our condition. Some companies, he thought, broke the link between ‘judicious industry and profit’.

The takeover debate has been framed as a dispute between AstraZeneca, which wants to focus over years, even decades, on developing cures for disease, and Pfizer, which wants to escape corporation tax and keep its share price buoyant to preserve ‘shareholder value’.

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It is important not to confuse support for a market economy itself with support for the particular legal institutions that have come down to us. Some types of corporation are more consistent with  the exercise of personal responsibility than others. Defenders of free enterprise argue that shareholders have stronger  motives than politicians to invest wisely, but their claim assumes that the company is managed by people who will bear the responsibility of failure and consequently avoid reckless risks. Shareholders, when compared with government officials, are assumed to have an incentive to be better informed and judge risk more carefully, but often shareholders have only a flimsy connection with the company. The average length of a shareholding is a few weeks, and often shares are held for only a few seconds. Most trading involves no commitment to the company at all, let alone an understanding of the business.

No one doubts the commitment of America to a market economy and that is perhaps why its company law (which varies from state to state) allows companies  a variety of devices to make corporations more closely resemble an individual with a strong sense of personal responsibility.

For example, when some private companies decide to go public they issue A and B shares, with one class typically having ten times more votes than the other. This allows founders, executives or other large stakeholders who are the custodians of the ideals of the company to prevent hostile takeovers by companies who may be asset strippers or monopolists intent on buying and then closing down their rivals. There is no standard terminology for these share classes – sometimes B shares have more votes than A shares and sometimes it’s the other way round. When Google went public in 2004, it issued a second class of shares to ensure that the firm’s founders could keep control. Class B shares had 10 votes, while ordinary A shares had just one. In most cases, enhanced voting shares are not publicly traded. Ford also has two share classes to allow the Ford family to control 40 per cent of the votes with only about 4 per cent of the total equity. Berkshire Hathaway, led by Warren Buffett, also has shares with different voting power.

Companies can also use ‘poison pill’ strategies to discourage hostile takeovers. A ‘flip-in’ allows existing shareholders to buy more shares at a discount when a bidder reaches a trigger point, such as owning 20 per cent of the shares. By purchasing more shares at below the market price the long-standing shareholders are rewarded for their loyalty and simultaneously dilute the shares held by the acquirer.

Companies often register in states that frown on takeovers, which explains why tiny Delaware is a popular choice. Its courts have supported ‘poison pill’ defences so long as boards act in good faith and in keeping with their fiduciary duties. The top court commented in one leading case that some shareholders were arbitrageurs who would have taken the offer price regardless of the long term value of the company. Because they had no genuine commitment to the company, the court refused to support their ambitions.

The Pfizer bid is a reminder that we urgently need to question the legal forms that private property can take. Criticising Pfizer is not anti-business and does not reveal hostility to free enterprise. On the contrary, replacing the anonymous, ‘ownerless’ corporation with a legal structure closer to real private property is the best way to uphold a market economy. It will entrench commitment to human improvement and discourage financial manipulation.

David G. Green is Director of Civitas and author of The Demise of the Free State

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  • Makroon

    Very good blog-post.
    The European chemical industry used to be dominated by the three German “illegitimate daughters” of I G Farben, and ICI. The City of London and it’s army of parasitic and self-interested consultants, lawyers and “investment” bankers forced ICI to demerge to “release value”.
    The chemical component was soon taken over by the (much smaller) AKZO-Nobel, the pharma business merged with Astra.
    The German “chemical conglomerates” sailed serenely on.
    Now that a predator company with a CEO who bears a striking resemblance to Fred Goodwin has taken a shine to Astra-Zeneca’s “pipeline”, those same city interests can’t wait to sell.
    I hold some funds managed by Schroder which have performed poorly, I suppose that management are keen to boost bonuses with a “quick kill”. I shall exit these funds ASAP.
    Ironic that in the same month as the attempted coup on AZ, GE, perhaps the most grotesque and ridiculous conglomerate in the world, is busy trying to buy Alsthom.
    So, where are the birds of prey swooping to break-up and “release value” from GE ?
    I am old enough to remember Harold Geneen and ITT, and the break-up of that company after the old man’s death. These days, US companies are “strategic assets” and jealously protected.
    UK entrepreneurs are always blamed by politicians for “exiting too early” or being too impatient to build large companies, but the truth is that any promising growth company is handed on a plate to the highest bidder by the City parasites.

    • ClausewitzTheMunificent

      They are not “illegitimate daughters”, they were founding members of the IG Farben conglomerate, later disassembled. The reason that they dominate is because the Germans launched and dominated the Second Industrial Revolution in Chemical and Electrical Engineering.

    • perdix

      City parasites….. nuff said!

  • El_Sid

    The trouble is that it’s a short step from a separate class of shares “to protect the company from short-termism” to a separate class of shares that enables the company to be run as a private fiefdom. It’s no coincidence that dual-class shares are so common in the oligarch capitalism of Russia and China – and that they’re pretty common in the Canadian markets, who haven’t got the best reputation. Despite a few high-profile examples, they’re actually pretty rare in New York and it’s a Good Thing that they’re discouraged in the UK – voting power should reflect economic interest. If someone’s only owning a share for a few seconds, then they won’t be voting at the AGM, so long-term holders effectively have more than their fair share of voting power.

    The popularity of Delaware is less to do with poison pills and everything to do with its low taxes and negligible disclosure requirements. Even the Cayman Islands have been complaining about the lack of regulation in Delaware!

    If you’re serious about reconnecting economic interest with companies, try campaigning against the regulations that effectively force UK private investors to hold shares via nominee accounts. These divorce people from a close relationship with the company, for instance they lose the automatic right to annual reports etc and you will typically need a letter of representation (at a cost of £30 or so from the broker holding the nominee) just to attend the AGM and vote.

  • BigAl

    It is worth remembering that over the last 3-5 years, AZ have taken over many small companies and taken their assets for themselves. Also, AZ are closing their Alderley Edge site and moving to a new one near Cambridge with thousands of job losses plus a significant impact on the local economy. AZ have used the Labour playbook of good take-overs and site closures (AZ) and bad takeovers and site closures (Pfizer) with the support of the media.

    I am no supporter of the Pfizer takeover for AZ but let us look at the facts through 20/20 lenses.

  • SimonToo

    “The average length of a shareholding is a few weeks, and often shares are held for only a few seconds. ” That may be so, but the great majority of shares are held long term. The frequency with which packets of shares move between short-term investors will produce a great number of changes in shareholdings, whereas the shares held long-term generate no such transactions. It would be wrong to assume, though, that the churning of a few shares is representative of the stability of the holding of most of the shares

    One of the general rights of a shareholder is a share in the control of the company. Structuring the equity of the company to restrict the voting rights of some shareholders or to create poison pills is all too often symptomatic of a sclerotic company blinkered by the ideas of its has-been founders. It might not have been when the structure was created or the pill put in place, but time then passes yet the structure remains unchanged.

    It is usually wise to look askance at protectionism, no matter how benevolently expressed. Like an egg, even though it might start out fresh it quickly goes off.

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