Merges and takeovers in the corporate sector (main approaches to and challenges facing regulation in this area)

Publication date
Friday, 20.12.2002

A. Radygin

Voprosy Ekonomiki, N 12, December 2002


Since the late 19th century the US and some European economies periodically have seen ‘waves’ of mergers whose characteristic features were a notable scope and 15-20–year time intervals between them. At the time, between the late 19th through the early 20th centuries the stock market was emerging as a market for corporate control, for it provided resources for mass mergers and takeovers rather than ensured financing large-scale investment. Later, in the developed economies, buy-ups and sales of especially large stakes and operations on interception of control went beyond the frame of various exchanges, however, the first steps financial markets made in the transitional economies once again reminded of the above regularity.

Many economists and politicians view mergers and takeovers as one of key manifestations of market discipline: the competition on the market for corporate control can secure the transfer of a company to an economic agent capable of implementing a more efficient strategy of its development. However, the first ‘wave’ of mergers demonstrated that integration was carried out to ensure a more stable monopolistic position of the expanding firm. All this gave a rise to intense debates over the role mergers and takeovers play in the modern economy, and optimal forms of their regulation.

The present paper attempts to provide a general overview of specifics of Russia’s market for corporate control basing on the existing theoretical approaches, the domestic experience of empirical research, evaluation of problems in the effective law, and mechanisms that regulate mergers and takeovers.

Conflicting definitions

A notable discrepancy in defining mergers and takeovers is determined by a whole range of factors. First, such discrepancies are objectively pre-set by an elementary borrowing of the respective Anglo-American terminology that does not provide a unambiguous interpretation[1]. Secondly, numerous specific features derive both fr om the national business practices and differences between ‘academic’, ‘business’ and ‘legal’ interpretations. The absence of the terminological consistency is related to certain characteristic features of a national law[2]. For instance, in Russia once can fairly clearly see inconsistencies between types of reorganization legally stipulated in the Civil Code of RF and actual economic processes described by the term ‘merger’ or ‘takeover’.

Russian law interprets merger as a reorganization of legal entities under which, according to the respective transfer deed, the rights and liabilities of both parties are assigned to a newly established legal entity. Foreign practices can also interpret merger as an integration of several businesses that results in the survival of just one of them, while the other ones loose their independency and are no longer in existence. The Russian law describes this particular case as ‘accession’ [3] . For some authors the term ‘merger’ implies the whole spectrum of transactions related to mergers and takeovers [4] : a friendly takeover, ‘aggressive’ (hostile) takeover, acquisition of all or capital assets of a target company (without integration, i.e. in this particular case the target company is reduced to its mere ‘shell’ and cash resulted fr om the sale of its assets).

There also exists an opposite approach, when all the respective operations are united under the same term ‘merger’. According to E. Chirkova, traditionally, the literature on corporate finance identifies three types of mergers: voluntary mergers basing on negotiations with the management of a target company and a consequent buy-up (exchange) of shares; an aggressive takeover through tender offer on buying shares made directly to the company’s shareholders; getting control over its board without acquiring a control block in the equity through voting by proxy (proxy contest, proxy fights) [5] .

It is fairly often that in the literature broader concepts, such as ‘acquisition’ (in the economic context [6] ) or ‘ takeover’ (in the legal context, as stipulated in the Civil Code of RF), are used as synonyms to ‘takeover’. It is also defined as an acquisition by the company (that carries out the takeover) of a control block of an acquired company. Since fr om the formal perspective the companies proceed to remain legally independent entities, there is no merger of their organizational structures [7] . Takeover of a company can also be defined as a company getting control over another one, or managing it upon the acquisition (particularly through an exchange) of absolute or partial property rights for it.

The question of a strict definition of an ‘aggressive’ (‘tough’) takeover is still debated. For instance, W. Schwert cites five popular definitions of aggressive takeover that, strictly speaking, cannot be considered mutually exclusive [8] . Most often, aggressive takeover is understood as the situation when a buyer addresses to shareholders with his tender offer straight. Typically, such a scenario results from a deadlock in the buyer’s negotiations with the corporation’s executive management. In the early 80’s, in the US, at least half of takeovers can be characterized as friendly ones: the buy-up/sales terms and conditions were based upon a preliminary agreement between a corporation-buyer and its board on the one hand and the management of a company to be taken over (the target company) on the other. In some cases friendly takeovers can provide no preliminary negotiations.

As a business term, hostile takeover (capture) is understood as an attempt to acquire control over financial and economic operations or assets of a target company exercised vs. resistance on the part of the latter’s management or key stakeholders. Should the attacking company comply with all the requirements of regulatory bodies about making its actions known, the recognition of the hostile nature of the deal is likely to depend on the reaction of management and/or shareholders/stakeholders of the target company (which can be noted in Russian practices) [9] .

At this point, there should be noted yet another classification used in the literature: mergers in their traditional sense: the decision is made by management of the target company, while the corporate buyer gains control over 100% of shares; inter-firm tender offers (public tender    offers) – the decision is made by shareholders of the target company, while the corporate buyer acquires control over 51% of ordinary voting shares [10] .

In this paper, we proceed from the common definitions used in the corporate finance theory and the respective worldwide practices [11] . Merger is a transaction whose result is integration of two corporations into a single one, which is accompanied with a conversion of the merging companies’ shares and maintaining the owner structure. In another interpretation, merger is a synonym to friendly takeover, a contract between two companies’ groups of managers, terms and conditions of which are worked out in the course of negotiations. Takeover is a transaction that results in transferring property rights for a corporation; most frequently, takeovers are accompanied by a replacement of the acquired corporation’s management and changes in its financial and production policies. Under an ‘aggressive’ takeover, the buyer puts forward a public tender offer to the target corporation’s shareholders on a buy-out of a control block of ordinary voting shares, thus bypassing its management. In addition, acquisition of control over the board through voting by proxy, without acquiring a control share in the joint-stock capital can be noted as a special form of establishment of control.

Modern theoretical approaches

Market regulation of efficiency of economic operations (an insufficient efficiency of enterprises).  The list of conditions necessary for taking a firm out of crisis related to a relatively high level of production costs and/or sales usually comprises the change of its inefficient executives. It is assumed that it is mergers and takeovers that allow solution of these problems by the most radical means [12] . However, having intercepted the control, the firm must not necessarily ensure transition towards more efficient methods of production of all its goods. It is just the suspension of the projects characterized with a negative NPV that in some cases may result in a substantial rise of the market value of the firm. Such a kind of regulation is inevitably associated with huge costs - that is why some experts view mergers and takeovers (especially aggressive ones) just as ‘an ultimate instance’ with respect to implementation of market discipline, or discipline of last resort, that appears only after competitive labor market mechanisms collapse[13].

The list of sorts of this particular concept also implies theoretical models that relate such an inefficiency to manifestation of the ‘principal vs. agent’ conflict in the frame of a corporation, as well as the management’s policy aimed at maximizing free cash flow14 and/or the firm’s per share revenues. According to one of the versions of such a concept, the source of firms’ inefficiency lies with inertness of the ‘entrenched’ management as well as in the top executives’ feeble interest in increasing the firm’s market value. Usually, as an argument in this respect, one refers to a very indirect relation between market quotations of securities issued by the firm and material renumerations due to its top managers16, among others.

2)The ‘hubris theory’ has become widely known since the late ‘80s. The concept attributes an insufficient solidity of investment projects to an excessive inclination to risks and high ambitions (‘hubris’) of managers heading the corporation. The core of the problem is that in many cases an entrepreneur simply demonstrates his ‘hubris’ by assuming that he is a better appraiser of the firm’s potential value than the market17. The initiator of a takeover proceeds from the assumption that new owners would ensure a higher market value of the firm18.

Most often such a strategy is doomed to failure when a hypothesis on information efficiency of the financial market can be qualified as credible: in this case the stock and bonds issued by firm X that comprise all the information available on the firm.  It is only some absolutely unforeseen twist in the development of the situation that would be able to provide a buyer with a unique chance. However, the prerequisites that form the basis for the hypothesis on information efficiency of financial markets can hardly be considered absolutely realistic. Investors face various barriers to information flows, substantial transaction and information costs and other ‘imperfections’ of financial markets. As well, the situations of a ‘suppressed’ state of securities markets are well known: such a situation involves the effect of temporary market factors on q- Tobin coefficient  (the coefficient that characterizes correlation between the market value of securities issued by a company and the reproduction value of its actual assets) under which the latter plunges substantially. All this can create situations when the decision to buy the firm testifies to a shrewd computation rather than the investor’s ‘excessive’ hubris.

The criteria for empirical testing the ‘hubris’ concept do appear well defined. How one can effectively separate the ‘excessive ambition’ cases from regular mistakes in estimating prospects for restructuring? To what degree the dynamics of the company-buyer’s market value (according to the hubris theory, the quotation of its shares on the market should fall after the merger) mirrors just the ‘hubris’ rather than a regular zigzag of speculative operations on financial markets? The questions remain unanswered, that is why methods of empirical testing the noted hypothesis are not fairly clear, either.

3) Possibilities for an operational synergy. Most often, mergers and takeovers open possibilities for enjoying advantages related to horizontal or vertical integration of economic processes, and not only in the frame of the firm acquired. One of the most known theoretical hypotheses suggests that a company performs better under a high specialization of its assets20.  In such cases vertical integration can secure better coordination when mutually complementary highly specialized assets are used at different stages of the production process. As concerns horizontal integration, it allows to save conditionally permanent expenses and makes available economies of scale.

4) Financial synergies. In some cases a mere diversification of cash flows can ensure a beneficial effect: should cash flows in two companies be not closely correlated, given other conditions equal, their merger would help stabilize the joint company’s financial state. Under prerequisites usually used in standard theoretical models, the merger of companies that do not use ‘leverage’ (borrowed resources, gained, for instance, by means of bond-basing financing) can rarely ensure large financial benefits. An expansion of the firm’s borrowing-related transactions substantially changes the situation. Mergers help solidify the firm’s financial operations base, which in turn increases the firm’s credibility and allows it to pretend for the attraction of larger loans.

5) Slump on sectoral markets and diversification. Mergers and takeovers can constitute a convenient form of withdrawal of a part of capital out of sectors faced by production slump, especially under a long-term contraction in demand for their products. Moreover, in some cases diversification can open the way to more efficient use of mutually complementary resources and a more intense utilization of production capacities. Diversification often forms the starting point for a consequent ‘re-accentuation’ and restructuring of the firm’s whole economic strategy, particularly through placing emphasis on mastering the production of new goods and provision of new services.

6) Restructuring and reallocation of resources.  Restructuring of economic operations resulting from an interception of corporate control can be accompanied by a reallocation of resources between main participants in the corporation’s economic operations - that is, its owners, managers, and creditors, employees, etc. Usually it is associated, for instance, with liquidation of immediate effects of an inefficient management and can be accompanied by refusals of unprofitable contracts, exchanging earlier issued bonds requiring greater interest pay-offs for shares, dismissals of old and attraction of new employees under conditions being more beneficial for the company. Should such a reallocation be made in favor of shareholders, this would mean, at least, some restriction of monopolist practices on markets for production factors21, however, at the same time it can also be characterized by intensification of monopsyonist tendencies on the noted markets.

7) The role played by information, signaling and provision of liquidity. It is assumed that prices for shares do not contain comprehensive information of a target company. Accordingly, a tender offer can serve as the signal for increasing the company’s market value. The offer generates potential investors’ interest in the seemingly undervalued firm. Owning such a firm’s shares is often compared with owning a goldmine22. On the market for capital, the structure of financing investment itself can be considered a signal23. Thus a decision of company X to launch an additional bond issuance can be interpreted as a proof of its high solvency, which, in turn, can increase its attractiveness as an object of takeover.

One can also add to the noted concepts modern corporate governance theories. Material incentives driving stockholders to more or less active monitoring appear dependant on liquidity of the market for the respective shares24. The liquidity of stock itself encourages their owners to become more attentive to problems of a possible interception of the joint-stock control. For instance, in their model P. Bolton and E.-L von Thadden proceed from the existence of the following conflict: the more stable the control of the owners of a strategic block over the corporation is, the more keen they are to conduct a thorough monitoring of managerial decisions. At the same time, investors’ demand for liquid investment is met at the least degree. It is the company restructuring and the market for mergers and takeovers that form the group of main factors that allow to maintain the necessary liquidity of a stock market and to satisfy the respective demand on the part of investors25. This particular concept mirrors distinctively the emergence of mew markets in developed economies, on which both single firms as well as enterprises, economic subdivisions, departments, etc. form an object of trade26.

8) Separation of property from control and agency problems. Delegating powers to managers27 increases the role of decisions they make. At this point, along with an inefficient management, there also arises the possibility of biased priorities in the company’s development. Thus, following their financial considerations and reasons of prestige, top managers may implement the strategy of non-optimal (from the owner’s perspective) expansion of the company’s operational sphere. The modern theory proceeds from the assumption that with the assortment of products expanding, the role played by general management functions (organization and coordination of various production cycles, control over the expanded area of economic operations, etc.) grows substantially. While gaining an increasing role in the managerial sphere, top managers can initiate mergers and takeovers that do not lead to a rise in their company’s NPV.

An outspread of conglomerate mergers can give a rise to the whole 'chain' (cycle) of mergers and takeovers. Thus, in the course of mergers and takeovers initially vigorous ‘immeasurably arrogant’ managers have a number of companies affiliating to theirs. Consequently, the emerged ‘amorphous’ conglomerate gradually manifests its inefficiency, and sooner or later it turns into an object of consequent mergers and takeovers. Finally, a more successful entrepreneur manages to intercept the control and restructure the company through selling or ‘divesting’ its single business units. As a result, takeovers and mergers can result both from operations of top managers who pursue their own interests and the reaction of the market to the managers’ operations that lead to a lower inefficiency and an excessive ‘swelling’ of the firm due to conglomerate mergers28.

It was M. Jensen’s concept that became especially popular: in practice the core of the conflict between managers and stockholders is formed by movement of free cash flows and, more specifically, the amount of payment due to stockholders29. According to this hypothesis, top managers are keen to cut down the payments, thus keeping at their disposal as big proportion of free cash as possible. Managers’ attempts to impose their control over free cash flow should be most frequently found in the companies that try to get the major part of their capital out of ‘obsolete’ sectors. Should the agency costs caused by such decisions be especially huge, such firms inevitably turn into potential objects for mergers and takeovers. In some versions this concept can well be combined with an approach that suggests the top managers’ eagerness to build extensive ‘economic empires’ through conglomerate mergers.

9) Eagerness to strengthen monopolistic position of a firm.

The reallocation of resources that accompanied mergers and takeovers according to the aforementioned approaches, should clear away the way for competitive market forces’ effects. At the same time, as noted above, the emergence of opposite trends is also possible: that is, mergers and takeovers can be aimed at strengthening the firm’s monopolistic (oligopolistic) positions. More specifically, the firm’s strategy can suggest a takeover of a rival corporation.

The experiences of the first ‘waves’ of mergers and takeovers in the US provide a visible proof to rather a real nature of their interpretation as crucial means of elimination or restriction of competitive rivalry30. This undoubtedly is not associated only with the first ‘waves’ of mergers and takeovers, nor it concerns exclusively the US experiences. Thus, mergers in 12 manufacturing sectors in Western Germany over the 1960s led to quite a substantial rise in the level of production and capital concentration in the noted sectors31. It is not hard to assume that the scale of mergers and takeovers as well as the scope of horizontal integration in the US and Western European countries would have been far greater, had they not been limited by the antitrust law.

As far as a real life is concerned, the aforementioned theoretical merger and takeover patterns grouped according to different criteria can be interlaced in different ways. For instance, operational synergies can be combined with financial ones, while a tender purchase offer can form a signal that attracts attention of participants in market operations to opportunities that would allow to implement plans of olygopolistic coordination of actions, etc. 

Overall merger and takeover outcomes can be different, too. The processes often manifest effects of competitive forces (‘market discipline’), while at the same time, they can lead to restriction of competition and expansion of possibilities for an olygopolistic or monopolistic market regulation. In some cases economic integration processes pave the way to an efficient reorganization of the overall operations of the acquired corporation, while in other – give a rise to monstrous and ‘amorphous’ conglomerates facing numerous challenges, particularly in the management area.

Whereas both purely horizontal and many of vertical mergers fall under control of antirust regulation bodies, entrepreneurs are keen to identify the most flexible forms of reallocation of corporate control that would ensure an olygopolistic coordination of operations on product and financial markets. In the late 20th century, the cyclic nature of integration and isolation processes dynamics has become especially visible: once completed, many conglomerate mergers relatively shortly were followed by sales. Large corporations-conglomerates practiced various downsizing methods – sales, ‘divestitures’ and joint-stock ‘split-offs’. Mergers and takeovers of the 1980s saw prevalence of operations related to refusal by corporations that had practiced public issues of their status and transition to closed-end property forms.

An isolation of the respective segment (division) of a company (most often a daughter (dependent one) as a special legal entity is known as sell-off. In contrast to sale-offs,  ‘divestitures’ usually suggest a complete alienation of material assets, which, as a rule, are reassigned in exchange cash (or securities) to a trade partner represented by an already existing firm. Finally, ‘equity carve –outs’ is an intermediary form, when a carved-out division becomes a public corporation and launches a public offer of its stock on the primary market (it is also known as split-off IPO). This ensures conditions for emergence of outsiders in the list of shareholders issued by the carved-out company.

Between the late ‘70s through early ‘80s the US  economy witnessed  rather a broad outspread of such forms of economic operations restructuring as Leverage Buy-Out/LBO, management Buy-Out (MBO), Leveraged Cash-Out (LCO) with financing through issuing ‘junk bonds’ and mezzanine financing, return to the open-end corporation status and Reverse Leverage Buy-Out/RLBO. All the above suggests extremely strong fluctuations of the ratio between the company’s own and borrowed resources, etc. The evaluation of such forms that so far have not appeared characteristic of Russian economy and, more specifically, of their economic effects forms a special subject worth a special interest32

After a serious crisis in the area of mergers and takeovers between the 80’s and 90’s and shocks on the markets for low-quality bonds, there started a new ‘wave’ generated mostly by open-end corporations. The specificity of transactions of that particular wave was: 1) using new criteria of evaluation of managerial decisions and other payment methods that became more intimately associated with dynamics of market value and the firm (for instance, the so-called ‘Economic Value Added’ (EVA) system; 2) expansion of the sphere of monitoring of managers’ strategic actions conducted by more professional investors (given that in the 80’s institutional investors owned some 1/3 of all stock, by the late 90’s the proportion exceeded 1/2 , and, if trusted private individuals’ stock be added to this, the actual share will be even greater); 3) net stock issuing by the US financial corporations began to play a notable role; 4) the corporate executives’ motivations changed (according to some computations, between 1980 through 1998 top managers’ ‘sensitivity’ to changes in their corporations’ market value grew 10-fold)33; 5) there has been the further development of the tendency to specialization and/or the ‘focused’ nature of economic operations of highly-diversified companies.

As it was the case for the preceding ‘waves’ of mergers and takeovers, a reorganization of economic operations ensured conditions for a new allocation of resources. However, then the operations became increasingly focused on the use of new technologies, improving the data collection, processing and transmission means, and the firm’s prosperity under globalization of product and financial markets. Economic theory showed that the most of radical innovations are unlikely to emerge within a large corporation34. The trend to ‘disintegration’ of huge companies and separation of some of their divisions as independent research firms has intensified over the past decade. That contributed to further intensification of innovation processes.

The noted changes as well as the takeover protection system neatly built over the 80’s substantially mitigated incentives to an aggressive interception of shareholder control and the possibility for such an interception itself. The most of mergers and ‘split-offs’ were preceded by detailed negotiations between the acquiring corporation with the board and management of the target company. Once the negotiations failed, it was extremely rarely that there followed a tender offer put directly to owners of the company’s stock. As it was noted in the preceding ‘waves’, the mergers and takeovers of the 90’s were accompanied by intense speculations that have contributed to the intensification of shocks in the stock markets on the threshold of a new millennium. However, the scale of bankruptcies caused by failures to restructure economic operations remained far lesser than in the late 1980’s.

Mergers and takeovers in Russia: stages, specifics, and modern practices.

In the mid-90’s, takeovers, in their classical form, took place primarily in the sectors that did not require a high concentration of financial resources. The positive nature of the trend manifests itself primarily in, first, a certain regulation of the equity structure; and, second, in an increase of the overall effect throughout the sector: other enterprises also have to undertake restructuring measures, in order not to become an object for next takeover (or a takeover attempt).

The first (initial) stage- between the mid-90’s through the 1998 crisis- was characterized with single attempts to use classical takeover methods. Of course, if one also consider privatization deals as a separate specific method, the object for the analysis should become far broader. This particular instrument was used both as an independent mechanism and in the frame of expansionist strategies of the first FIGs (primarily informal ones established by banks).

If one considers public operations on the secondary market rather than a capture of control through various privatization mechanisms, the first – and single- experience of a hostile takeover in the country falls on the mid-90’s35. A well-known, though unsuccessful attempt of a public takeover operation was ‘Menatep’ banking group’s effort to capture ‘Krasny Oktyabr’ confectionery plant in summer 1995. Another well-known case was an acquisition of the control block of AO ‘Babayevsky’ confectionery plant by ‘Incombank’ holding. One can also note an open bidding tender on a stock sale announced by ‘Menatep’ bank on purchasing the 51% stake of ‘Pyatikranta’ paper and pulp plant from its several stockholders. There also were attempts to acquire control blocks through exchanges: thus, particularly, in summer 1997 ‘Ussuriysky Balsam’ acquired 59% of stock in ‘Vladivistok Vodka and Liqueur Plant’. As well, there was a well-known attempt of oil-producing company ‘Chernogorneft’ to have ‘Salomon Brothers’ develop an action plan to protect the company’s stockholders, had there occurred a change in the control of its mother structure – ‘Sidanco’.

At the time (and later) many largest banks (financial groups) and portfolio investment funds practiced takeovers of companies across the whole range of sectors. That was done both to meet their own needs and for the purpose of consequent sales to non-residents or strategic investors. Thus, starting from 1992 ‘Alfa-Bank’ and Alfa-Capital’ (the members of the group) have striken over 30 merger and takeover deals both for the group and its clients in such sectors as communication, chemicals, oil, glass, etc.36. Between 1997 to 1998 the food-processing sector has seen takeovers of regional breweries by ‘Baltica’ group, while various takeovers were noted in the pharmaceutical, tobacco sectors, and in the consumer goods production area.

The second stage (a post-crisis boom) falls on the period between mid-1999 through 2002. It was the period of the most visible effect of the specific reasons that had given rise the ‘wave’ of mergers and takeovers. It was the ongoing consolidation of equity that formed the main incentives for their intensification over the firs post-crisis years. Considering the specificity of the methods applied, some analysts even avoid using the term ‘mergers and takeovers’ and lim it themselves with a customary ‘property redistribution’ one. At that time, industrial groups’ expansion was combined with an intensification of the process of consolidation of assets.

At the time, the merger and acquisition process originally launched by the biggest oil companies was especially typical of the ferrous and non-ferrous metallurgy, chemicals, coal, food, pharmaceutical and forestry, and machine–engineering sectors. The transition to single share in oil companies can be viewed as a sort of merger.

The third stage (a re-organizational slump) was likely to start in 2002. There arose some slowdown of the existing groups’ expansion rate, the consolidation processes were coming to an end, and the transition to reorganization of groups and legal reorganization (primarily the legalization of amorphous holdings and groups) has become visible.

Overall, the process of structural changes in Russian companies (different types of reorganization in legal sense) developed rather intensively. According to the RF Ministry of Anti-monopoly Policy, in 1997 the number of various operations related to structural changes accounted for 500, 1998- some 9,000, 1999- a. 11,000, 2000 – 16,000, 2001- over 20,00037. No doubt, estimates of the scope of the merger and takeover processes in the country is dependent upon a particular methodological approach: thus, under the broadest approach many large-scale privatization deals can be considered friendly or hostile takeovers. Consequently, the significance of the process for the national corporate sector has been  extremely high through all 10 years (1992-2002) of its development.

If one considers the strictest and most traditional definitions in this respect, it becomes possible to name just the post-privatization period, single secondary transactions, and large companies. In this case alternative limitations appear objective (both for mergers and takeovers): the need in large amounts of cash (credits) that are available only for the largest companies (banks); the possibility to mobilize considerable stock packages for their further exchange; the absence of ‘legally clean’ objects for their takeover as a legacy of the privatization (possible breaches of the law, the non-registered first issue, a lapse of actions with respect to privatization deals, etc.).

So far mergers per se (friendly takeovers) of corporations in a strict sense (i.e. the participation of equal firms, a friendly and agreed upon deal between large companies without buying out stock from small shareholders, an exchange of shares or creation of a new company) have not formed a notable phenomenon, though this particular form does not require a highly developed capital market. Traditionally, this process becomes very active on the stage of economic growth and under the trend to soar of stock quotations. In Russian conditions, it happens more often that it is conceived as a possible anti-crisis mechanism, in the political context or as an institutional formalization of technological integration (renewal of old economic ties, fight over shares in the market, vertical integration).

Despite a whole range of limitations (the necessity of consolidation of large blocks, a strict and fixed property structure in a corporation, considerable financial resources), it is hostile takeovers (i.e. the market for corporate control itself) that have been most outspread in Russia. Over different time periods the activation of the market was associated primarily with expansion of the largest groups (holdings). Nonetheless, if one considers the whole spectrum of classical (generally accepted worldwide) and the country-specific takeover methods (for instance, bankruptcy), the volume of such operations has been quite great (especially post-crisis).

The identification of specifics of mergers and takeovers in Russia forms a separate subject that deserves a special interest. In this context, it would be appropriate to single out several groups:

The first group of specific features is related to differences in causes of the noted processes. Though traditionally ‘waves’ of mergers and takeovers accompany stages of economic growth, in the conditions of the post-communist Russia, regardless of the stages, such factors as post-privatization property redistribution, expansion and reorganization of large groups, and financial crises have a very substantial impact on the national economy. A spontaneous process of consolidation of equity and capture of control in corporations in the wake of the 1998 crisis form an unquestionable proof to that.

A direct influence of public regulation in Russia (in contrast to, for instance, the USA wh ere the modification of forms and methods of mergers and takeovers was related to the introduction of new government regulation measures, among others) is insignificant. As long as specific forms and paths of integration are concerned, mergers and takeovers mostly take a spontaneous way. At the same time, these processes (integration, consolidation) indirectly appear a protecting reaction to privatization consequences (costs) and the exposure of property rights to outside threats, and tax policy.

The second group is determined by the specifics of the national stock market. From its outset, Russia’s securities market has been developing as a market for corporate control. At present, it is characterized by a declining volume of operations that form portfolio investment and a rising scale of buyouts for the sake of property redistribution. Nonetheless, mergers and takeovers practically do not concern the organized stock market, and stock prices in the secondary market have no substantial significance. It is the largest blue chips with the respective relatively liquid market for them that to the least extent can become an object for a takeover, even providing their market price is far lower than potential.

The third group of specific features is associated with the specificity of the property structure inherent in many Russian companies and participants in operations:

  • minority stockholders in the target company play a passive role, and they cannot play the role of regular participants in the market for corporate control;
  • it is company heads’ personal considerations that matter (though  they do not confess about such motives in public, and the motives are perceived very negatively as conflicting with economic efficiency). Practically a total identity of managers and owners of enterprises (apart from regular ambitions cherished by the former, which is also typical of them in other countries) leads to the situation in which a merger with a larger competitor is conceived as a defeat to him;
  • the companies’ complex and non-transparent  (property) structure ensures a minimum level of openness in the course of concluding these deals;
  • the organization of corporations as a ‘group of companies’  makes a buyout of an already existing enterprise’s assets a far greater technological and less risky deal compared with conduct of a reorganization of two merging companies;
  • relatively high requirements to  the share in the given enterprise’s equity to exercise control over it (ideally, up to 100% of the equity);
  • a minimal and relatively inefficient legal regulation of relationship between companies, including groups in the frame of the same structure;
  • it often happens that an informal control (through ‘contract groups’, control over cash flow, tolling mechanisms, agreements on the use of ‘cash surrogates’, etc.) appear more preferable than the legal merger or takeover arrangements;
  • regional governments do not have a possibility to exercise a direct legal regulation of integration processes (as they do in the USA), however, they usually take part in such deals favoring either party;
  • while private creditors may enjoy certain benefits from the acquiring company’s buyouts of their demands, creditors representing government institutions are often used to initiate bankruptcy procedures;
  • absolutely any entity (be that a ‘friendly’ buyer of stock, a federal body, regional administration, a bank-creditor, the court of law, a criminal group that obviously do not need to acquire the target company’s stock) can be used as the ‘white knight’.

The fourth group of specific features concerns the most typical forms of mergers and takeovers:

  • there are no equitable mergers, which can also be attributed to the underdeveloped state of the stock market (consequently, payments are often effected in the form of cash or promissory notes rather than stock);
  • the aggressive acquisition of companies undervalued on the stock market for the purpose of a short-term increase in their market price and a consequent re-selling, which often is accompanied by their fragmentation, use of LBO and issuing junk bonds (the raider business known in the US since the 1980’s) practically has not received any outspread in Russia;
  • despite the above fact, voluntary ‘friendly’ mergers  and takeovers (typical of the continental Europe at least until the 1990’s) happen fairly rarely, too;
  • there are financial constraints to an aggressive takeover of companies through offering their stockholders premiums to the cost of their stock;
  • the prevalence (since 1998) of the aggressive takeovers through bankruptcy and various debt schemes;
  • an exchange of shares so far practically has not been used in Russian takeover practices;
  • the deals on acquisition of stock chiefly are financed at the expense of the given company’s stockholders;
  • the group of defense measures is prevailed by administrative-enforcement and legal ones (activated prior to and after the takeover), though to the equal extent it can also be attributed  to aggressor’s tactics;
  • the establishment of conglomerates is a relatively outspread practice, though this particular type of mergers has lost its significance worldwide38.

In Russia, the key specific features are the prevalence of tough hostile takeovers (essentially ‘captures’, as a number of experts put it) with the use of the so-called ‘administrative resource’. In their most general form, the practical takeover methods have not undergone any notable changes through the past 10 years, though accents, of course, changed over time, By their essence, the takeover methods can be split into 6 main groups: buying up various stock packages on the secondary market; lobbying privatization (trust) deals with government stock packages; an introduction to holdings or other groups by administrative means; buying up and transformation of debts into participation in property and shares; capturing control through bankruptcy procedures; initiation of court’s rulings. The usage of issuer’s mistakes made in the course of registration of results of security issues is a very popular device (see the Table below).

Let us highlight on just a few examples of capture strategies carried out by large Russian holdings (groups) basing on an elementary discrediting of the former management and use of the administrative resource.

The car-making sector. The logic of action pursued by FIG ‘Sibal’ in the course of taking over car-making enterprises can be described as follows: a mass PR-campaign to discredit an enterprise and its managers, in order to lower the price of the future deal; negotiations with local governments on ‘strategic cooperation and investment’ involving top federal bureaucrats, an offer to pay off debts and support an election campaign; an acquisition of a control block with a consequent reshuffle in the company management and board of directors; ‘cleaning up’ debts and withdrawing liquid assets to a new company in the holding  frame.

The sector for chemicals: While taking over, for instance AO ‘Nevinnomysky Azot’ (Stavropol Krai), ‘MDM’ group also practiced standard (for Russia) methods: the general takeover plan provided: an acquisition of some 30% of stock on the secondary market; the change of the director general; an acquisition of the 21.8% enterprise stake remained in public property. The implementation of this strategic plan was accompanied by complementary measures: discrediting the company’s Director General and his consequent arrest by Tax Police39, convening an early shareholder meeting in the group’s ‘territory’ in Murmansk Oblast, with police blocking the way to ‘alien’ shareholders (both private ones and those representing the government) due to their alleged breach of ‘passport control procedures’.

Trade. In this area, it is particularly interesting to track down the background of the takeovers of 23 large department stores in Moscow (‘Krasnopresnensky, ‘Veshnyaki’, etc.) by using artificial bankruptcy technologies. The supplier – ‘capturer’ – OOO ‘AN ‘ROSbuilding’- delivered to them on credit goods worth a total of Rb. 50-60 Thos. (i.e. the amount coming within the purview of the law ‘On bankruptcy’) with a deferral of payment. Consequently, a false firm ‘paid off’ the store’s debt to the supplier and ‘vanished’ (closed its accounts and changed the address), thus automatically making the store its debtor. Three months later, the firm filed a bankruptcy lawsuit on the grounds of the payment overdue. In a number of cases the court of law ruled to launch bankruptcy procedures that resulted in the dismissal of the store’s director and the transfer of property rights for business (‘Krasnopresnensky’ department store) to ‘aggressor’.

In this respect one can refer to a conflict between Alfa-group and Taganrog metallurgical plant in Rostov oblast. Though the local management and affiliated structures’ aggregate control share had accounted for 51%, ‘Alfa-Eco’ applied already well-tried takeover methods that suggest an acquisition of a minority stock (with a consequent increase of it) and the use of the notorious federal - level ‘administrative resource’ (filing lawsuits under any pretext, inspection raids by the Attorney General office, the Accounting Chamber of RF, Ministry of Interior, FSB, FSC, tax and antitrust authorities), while in the period prior to the governor elections the regional administration took a neutral stand. As a result, two representatives of Alfa-Eco were introduced to the Board of Directors of the plant (and such a decision can be consider legitimate, if 10 of 11 members of the Board voted for it), while the plant committed itself to transfer the major part of its annual profit on dividends. In the context of the present paper, it is particularly interesting that the conflict revitalized the local Oblast securities market: many enterprises whose classical control block has been long completed began to acquire shares to increase it up to 75% and more.

Some comparative characteristics of foreign and Russian variants of ‘hostile takeover’ deals

Charateristic features Western ‘hostile takeover’* Russian ‘hostile takeover
Form Building up a package 9up to 10%) of the target company; open tender against its managers’ will Latent buying up; an open offer; acquisition liabilities
The attack is initiated by Aggressor (its daughter company or an authorized investment bank) Aggressor’s offshore companies; a company specialized on takeovers (jointly with the aggressor)
Instrument for gaining control The target company’s stock 1) Stock (the aggressor’s governing bodies should pass a formal decision; the corporate law framework formally provide a mature antitrust regulation and methods of defense; tax regime – corporate profit tax; the possibility to acquire by the target company of up to 10% of its stock; the price of acquisition – market or contract one);
2) Liabilities (no need in passing a formal ruling; there are no restrictions set by  antitrust  law; tax regime – corporate profit tax, with VAT not excluded; the possibility of acquisition by the target company itself – there are no direct restrictions; the price of acquisition- contract, except for a part of promissory notes
Forms of payment Cash; the aggressor’s stock; other securities (owned by the aggressor and the third parties) Cash; the aggressor’s promissory notes or those accepted  by the market; PRIN=s and IAN=s
Cost of the operation Market quotations of the stock plus premium Market quotations of the stock or direct agreements with creditors (the cost may vary between 6.5 up to 90% of the value of cash liabilities without regard of fines, etc.)
Initiators Management of the aggressor; investment banks (far seldom) Actual owners of the aggressor
Main beneficiary Stockholders of the target company; executives of the aggressor; executives of the target company Actual owners of the aggressor; some stockholders of the target company; some creditors of the target company
Prospects for the target company Joining the aggressor; alienation of the most of non-profile assets; a consequent sales Restructuring, fragmentation of  assets; mitigation of financial positions; a possible discontinuation of operations
Impact of the third persons Possible only on the part of courts (should a trial start) antitrust bodies, key creditors of the target company; the government’s influence is minimal; the investment banks’ impact rises sharply Extremely high, including the account of ‘commercialization’ of government and other public institutions.

* Western ‘hostile takeover’ implies primarily practices adopted in the US market for corporate control
Sources: Leonov R. “Vrazhdebnye pogloschenia” v Rossii: opyt, tekhnika provedenia I otlichie ot mezhdunarodnoy praktiki; the author’s estimates.

The general belief is that the Russian law provides an owner of an enterprise with unlimited possibilities to defend his business from takeover. Because of this, first, it is the structures that possess the resource of political pressure on the owner that primarily have an access to practically any takeover technique. Secondly, Russia demonstrates a relatively unique phenomenon – that is, the existence of companies that ensure mergers and takeovers. Their operational pattern is the following: they create, together with the ‘client’ (‘aggressor) a joint company, restructure the whole group that participates in profits and assets of the joint company, or it sells its part of stock to the ‘client’40.

The Western experiences provide well known main defensive tools applied by managers (stockholders) of the target company: they are divided into two groups: preventive (‘shark - frightening’, ‘poisoned pills’, various ‘parachutes’, employees’ participation in the capital, defense of the register and change of the place of registration of the corporation, creation of a strategic alliance, etc.); and those effective after a tender offer was announced (a trial, an invitation of the ‘white knight’, an agreement on non-takeover, a reverse buyout with premium, a counterattack on the aggressor’s stock, assets/liability restructuring, PR-defense, etc.)41.

The list of resistance means used in Russia by management (stockholders) of a target company against a potential aggressor comprises almost all those tools used internationally (adjusted to the specificity of the national market). Nonetheless, there is a relatively narrow outspread of preventive defenses (except such means as control over register, a maximal concentration of equity ownership or a ‘dispersion’ of assets in the frame of a group). In the event of a direct threat it is the role played by administrative resources (federal and regional governments, local courts, enforcement agencies, and employees at an enterprise), a counter ‘black PR’, assets and liabilities restructuring, counterattacks at the enemy’s stock and filing counter-claims (‘trial’) that appear most significant, among others.

While considering the specificity of Russian takeover techniques, one should note a very important issue related to Russian enterprises’ alternative sources of financing42.  Essentially, there is a direct link between the most actively used takeover methods and possibilities for financing. The problem is that nowadays an attraction of a really outside financing (equity and borrowed alike) sharply increases the risk of a hostile takeover (through buy-ups of stock, accounts payable, promissory notes and/or bankruptcy). Such takeovers have formed a regular phenomenon between 1998 through 2002. Consequently, the self-buyout of stock and an artificial creation of accounts payable (along with the concentration of stock or all the liabilities with an affiliated company) turned out to be a widespread way to prevent an enterprise takeover. This, of course, leads both to undermining possibilities for self-financing and decreasing the enterprise’s attractiveness in the potential outsider investors’ eyes.

Though so far it has been hard to evaluate the efficiency of completed mergers and takeovers in the country, primarily because of the absence of adequate statistical data, however, there are some negative examples in this respect.

More specifically, in the late 80’s a number of the largest national oil companies would fail to negotiate their mergers. In December 1997, a group of Russian companies that dealt with computer production and distribution of computer equipment under the single trademark ‘DVM Group’ began to merge with ‘Bely Veter’ retail computer equipment store network43. Because of their specialization, both companies were faced by substantially limited prospects for their development - that is why such a vertical integration would have appeared quite logical to them. However, a serious conflict in February 1999 has resulted in the comeback to the market of the two independent companies and a complete mess in the area of their customer services.

The market for takeovers is considered one of key outsider corporate governance mechanisms. At the same time it is noted that it becomes most efficient when the need arise in overcoming a conservative board’s resistance, as they are not keen to have the company especially a highly diversified one44, rationalized (fragmented). At the same time, the efficiency of this particular mechanism judged from the perspective of further improvement of corporate governance is under increasing critique. More specifically, some experts believe that the threat of takeover drives managers to implement just short-term projects, as they are concerned about a decline in quotations of their company stock, while some other researchers think that takeovers serve to interests of stockholders only rather than all ‘stakeholders’. Finally, there always is a risk of destabilization of both the acquiring and the target companies’ operations.

The stabilization in the property interest area (in a certain sense, the post-crisis fixation of property interest spheres) by 2003 has created prerequisites for a new stage of hostile takeovers. Both the shortage of ‘free’ objects for takeover and a gradual exhaustion of available financial resources (they would be considerable after the 1998 depreciation in the mining sector) allow to assume  that over the upcoming years the takeover fashion should imply the administrative resource, with the use of debt schemes, lawsuits on invalidity of earlier conducted deals, etc. In this respect, there arises a serious challenge: that is, efficiency of regulation of mergers and takeovers by legal means, special regulators and law enforcement apparatus.

Legal regulation of mergers and takeovers

As international practices show, from the government regulation perspective, the problem of mergers and takeovers suggests considering several areas: its consistency with an industrial policy and a general strategy of reorganization in the frame of the respective sectors and industries; supporting an active functioning of competition mechanisms in an economy; ensuring transparency of operations in the market for corporate control; protection of shareholder (including minority) rights; regulation  of social conflicts caused by mergers and takeovers.

Apart from general provisions stipulated in the Civil Code of RF, the current Russian law is focused primarily on anti-trust aspects (economic concentration) and single matters associated with transparency and protection of stockholder rights. The consideration of problems of consistency of requirements of laws on mergers and acquisitions with industrial policy is hardly an urgent issue, because of the absence of any concept for industrial policy in RF. Social conflicts arising in the course of reorganization are well known in practice, however they lack a special regulation.

The term ‘reorganization’ used in the Civil Code of RF (Art. 57) concerns only legal aspects of enterprises’ operations in the part of regulation of possible intermediary transformations of legal entities within the range from their establishment to liquidation (however, as far as the respective content is concerned, it comprises them both, as reorganization is also a way of both discontinuation of legal entities’ operations and establishment of new such entities. The list of reorganization forms set by the law comprises: merger, accession, splitting off (fragmentation), separation, transformation. At the same time, the law lacks any definition of reorganization itself.

So, clearly, the forms of reorganization of a legal entity set by the Civil Code of RF do not mirror the whole variety of economic forms of restructuring. At the same time, different by economic motivations and resulting property structures, the economic forms of restructuring often fall under the single form of reorganization of legal entity45.

Meanwhile, there arose an evident need in revising the effective basic laws. The ideology of the respective bills46 suggests that the current law both blocks reorganization and even leads (because of its imperfection, lack of clarity and self-contradictory nature) to the situation when any reorganization bears a high risk to be recognized as void. The law on reorganization and liquidation of commercial organizations should be aimed at tackling two main challenges: that is, securing transparency and cheapness of the process, as well as the balance between owners’ an creditors’ interests. From the perspective of general approaches, the effective law needs to be amended along the following avenues:

  • expanding reorganization forms, establishment of conditions for combination and use of various organizational and legal forms;
  • a more developed legal regulation of transformational options available for open-end joint-stock companies established compulsorily in the course of mass privatization;
  • securing protection of interests of participants in reorganized commercial enterprises basing on toughening requirements to the information on a reorganization (takeover);
  • the introduction of a mandatory condition to attract  an independent appraiser  to identify the market value of stock (shares) basing on which a coefficient of exchange of stock (shares) and amounts of compensation payable under the reorganization should be identified;
  • the exclusion of the possibility of a compulsory reorganization otherwise than following the respective  ruling of  the court of law;
  • securing conditions of current operations of commercial organizations from the moment of making the decision on reorganization (liquidation) and until the moment of  its completion.

From the perspective of regulation of economic concentration in the frame of antitrust law, there remain numerous unsolved challenges that should be regulated by legal means and in the process of regulative activities. As the current practice and research outcomes47 in this particular area show, the emphasis should be placed on the following problems:

  • a possible revision of the concept for the law ‘On competition and restriction of monopolistic operations on product markets’ (with account of problems that arose in the course of receipt of EC legal provisions);
  • an adoption of amendments to the law on competition that  would simplify anti-monopoly control proced



Russian version published in: Voprosy Ekonomiki, N 12, December 2002.

The present paper was prepared basing on materials of the research: Radygin A., Entov R., Shmeleva N. Problemy sliyaniy i poglosheniy v korporativnom sektore (Problems of merges and acquisitions in the corporate sector). M.: IET, 2002.

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