FTC Staff Comment to the Hon. Barbara Flynn Curie Concerning H.B. 165 to Regulate Certain Business Combinations

Suite 1~37
55 Easl Monroe SIr...,'
Chic•. ltIinois 60603
(312) 353-6156
UNITED STATES OF AMERICA
FEDERAL TRADE COMMISSION
CHICAGO REGIONAL OFFICE
May 	4, 	1989
COMMISSION AUTHORIZEDV890062
The Honorable 	Barbara 	Flynn 	Currie
House 	of 	Representatives
Illinois 	General 	Assembly
Springfield, 	IL
Dear Ms. 	Currie:
The 	staff 	of 	the 	Federal 	Trade 	Commission 	is 	pleased 	to
respond 	to 	your 	letter 	of April 	7, 	1989, 	inviting 	our 	comments
on House 	Bill 	165. 1 	The 	bill 	would 	add sections 	11.75 	to 	the
Business 	corporation 	Act 	regulating 	certain 	business 	combina-
tions 	and 	amend 	Section 	6.05 	of 	the 	Act 	specifically 	authorizing
"poison 	pills." 	We 	believe 	that 	these 	provisions 	are 	likely 	to
deter 	takeovers 	that 	may 	increase 	economic 	welfare.
If 	enacted, 	HB 	165's 	business 	combination 	provisions 	would
restrict 	the 	ability 	of 	acquirers 	to 	engage 	in 	business 	combina-
tions 	with 	target 	corporations 	for 	three 	years 	after acquiring 	15
percent 	of 	the 	target 	firms' 	shares. 	The 	bill 	would 	also 	amend
section 	6.05 	of 	the 	present 	Business 	Corporation Act 	by 	specific-
ally 	authorizing 	corporations 	to 	issue 	stock 	option 	rights 	with
limitations 	on 	their 	transferability, 	commonly 	referred 	to 	as
ttpoison 	pills."
We believe 	that 	takeover 	activity 	tends 	to 	enhance 	economic
efficiency 	and 	thus 	benefits 	consumers. 	For 	that 	reason, 	we
suggest 	that 	you 	consider whether 	the 	proposed 	legislation would
unduly 	interfere with 	the 	market 	for 	corporate 	control 	and 	harm
consumer welfare. 	If 	the 	General 	Assembly 	nevertheless 	decides
to 	enact 	any 	of 	the 	"business 	combination" 	provisions, 	we 	suggest
that 	it 	consider making 	this 	law 	applicable 	solely to 	corpora-
tions 	that 	affirmatively 	elect 	to 	be 	covered 	by 	them 	through
amendments 	to 	the 	corporations' 	articles 	of 	incorporation. 	An
affirmative 	"opting-in" 	provision would 	enable 	the 	shareholders
of 	each 	corporation 	to 	determine 	whether 	restraints 	on 	the
1 	These 	comments 	are 	the 	views 	of 	the 	staffs 	of 	the
Chicago Regional 	Office 	and 	of 	the 	Bureau 	of 	Competition 	of 	the
Federal 	Trade 	Commission. 	They 	are 	not 	necessarily 	the views 	of
the 	Commission 	or 	any 	individual 	Commissioner. 	since 	receiving
your 	invitation HB 	165 	has 	been 	amended. 	Our 	comments 	are
directed 	to 	HB 	165 	as 	amended. 	Similar 	legislation 	is 	pending 	in
the 	Illinois 	Senate 	in SB 	66. 	We 	shall 	confine 	our 	comments,
however, 	to 	HB 	165.

The 	Honorable 	Barbara 	Flynn 	Currie
Page 	2
transfer 	of 	corporate 	control 	are 	in 	the 	interests 	of 	the
corporation. 	We 	also 	suggest 	that 	the 	General 	Assembly 	consider
requiring 	shareholder 	approval 	of 	any 	"poison pill" 	proposed by
management.
A. 	Interest 	and 	Experience 	of 	the 	Federal 	Trade 	Commission
The 	Federal 	Trade 	Commission 	is 	charged 	by 	statute with
preventing 	unfair 	methods 	of 	competition 	and 	unfair 	or 	deceptive
practices 	in 	or 	affecting 	commerce. 	15 U.S.C. 	§ 	45. 	Pursuant
to 	this 	mandate, 	the 	Commission 	seeks 	to 	identify 	restrictions
that 	impede 	competition 	or 	increase 	costs without 	offering
countervailing 	benefits 	to 	consumers. 	Our 	efforts 	have 	included
providing 	comments 	to 	federal, 	state, 	and 	local 	legislatures 	and
administrative 	agencies 	on matters 	that 	raise 	issues 	of 	competi-
tion 	or 	consumer 	protection policy.
The 	Commission has 	substantial 	experience 	in 	the 	area 	of
mergers 	and 	acquisitions. 	The 	Commission 	enforces 	section 	7 	of
the 	Clayton 	Act, 	15 U.S.C. 	§ 	18, 	which 	prohibits 	acquisitions 	of
corporate 	assets 	or 	securities 	that 	may 	substantially 	lessen
competition 	or 	tend 	to 	create 	a 	monopoly. 	Under 	the 	Hart-Scott-
Rodino Antitrust 	Improvements 	Act 	of 	1976, 	15 U.S.C. 	§ 	18a, 	the
Commission 	reviews 	proposed 	acquisitions 	of 	corporate 	assets 	or
securities, 	including 	tender 	offers, 	to 	determine 	whether 	they
violate 	the 	antitrust 	laws.
The 	Commission's 	staff 	has 	addressed 	issues 	related 	to 	the
market 	for 	corporate 	control 	through 	scholarly 	studies 	and 	com-
ments 	to 	state 	governments. 	The 	Commission's 	Bureau 	of 	Economics
has 	published 	a 	study 	on 	the 	effects 	of 	takeover 	legislation
enacted 	by 	New 	York 	in 	1985. 2 	In 	the 	past 	three 	years, 	the
Commission's 	staff 	has 	provided 	comments 	on 	the 	corporate 	control
legislation 	of 	several 	states. 3
2 	L. 	Schumann, 	state 	Regulation 	of 	Takeovers 	and 	Share-
holder Wealth: 	The 	Effects 	of 	New 	York's 	1985 	Takeover Statutes
(Federal 	Trade 	Commission, 	Bureau 	of 	Economics, 	1987).
3 	E.g., 	Letter 	to 	Hon. 	Joseph 	D. 	Alviani, 	Exec. 	Office of
Economic Affairs 	of Massachusetts, 	September 	2, 	1988; 	Letter 	to
Hon. 	Steven 	D. 	Wolens, 	Texas 	House 	of 	Representatives, 	May 	5,
1988; 	Letter 	to 	Steven H. 	Armick, 	Delaware House 	of Repre-
sentatives, 	January 	15, 	1988.

The 	Honorable 	Barbara 	Flynn 	Currie
Page 	3
B. 	Effect 	of 	Takeovers 	on 	Economic Welfare
The 	corporate 	takeover 	is 	a 	mechanism 	for 	transferring
control 	of 	corporate 	assets. 	The 	transfer 	of 	corporate 	control
can 	serve a 	number 	of 	economic 	functions, 	such 	as 	facilitating
the 	redeployment 	of 	corporate 	assets 	to more 	efficient uses 	and
improving corporate management. 	Although 	not 	every 	takeover
ultimately 	produces 	such 	benefits, 	we 	believe 	that 	takeovers 	in
the 	aggregate 	are 	likely 	to 	enhance 	economic 	efficiency.
Some 	studies 	suggest 	that 	management-opposed 	corporate
acquisitions 	are 	most 	commonly 	carried 	out when 	outside 	bidders
have 	an 	opportunity 	to 	improve 	the 	performance 	and 	thereby
increase 	the 	value 	of 	target 	corporations. 4 	Such bidders 	pay
substantial 	premiums 	over 	the 	pre-offer market 	price 	of 	the
shares 	of 	target 	corporations 	because 	they 	believe 	that 	the
corporations 	will 	be worth more 	under 	their 	control. 5
There 	are 	a 	number 	of 	sources 	for 	the 	potential 	gain 	in 	an
acquired 	firm's 	performance. 	In 	some 	cases, 	bidders 	are 	able 	to
improve 	the 	management 	of 	the 	target 	firm. 	In 	other 	cases,
bidders 	may 	be 	able 	to 	combine 	firms 	with 	complementary
strengths, 	integrating 	production 	or 	distribution 	channels,
eliminating 	duplicative 	functions, 	or 	facilitating 	mutually
beneficial 	technology 	transfers. 	Takeovers 	may 	also 	permit 	firms
to 	shift 	corporate 	assets 	to 	more 	efficient 	uses 	by 	selling 	or
changing 	the 	use 	of 	underperforming 	facilities.
The 	transfer 	of 	corporate 	control 	in 	such 	circumstances 	is
likely 	to 	benefit 	shareholders, 	employees, 	and 	the 	economy 	as 	a
whole, 	as 	well 	as 	the 	successful 	bidder. 	Shareholders 	benefit 	in
two ways. 	First, 	because 	bidders 	for 	corporate 	control 	offer
substantial 	premiums 	over the 	pre-offer market 	price 	of 	corporate
shares, 	target 	company 	shareholders 	enjoy 	rapid 	appreciation 	of
the 	value 	of 	their 	shares. 	Second, 	the 	threat 	of 	takeovers 	may
motivate 	incumbent 	corporate 	managers 	to 	improve 	corporate
4 	~ 	Bradley, 	Desai 	& Kim, 	The 	Rationale 	Behind
Interfirm Tender Offers: 	Information 	or Synergy, 	11 	J. 	Fin. 	Econ.
183 	(1983); 	Gilson, 	A Structural 	Approach 	to 	Corporations: 	The
Case 	Against 	Defensive 	Tactics 	in 	Tender Offers, 	33 	Stan. 	L. 	Rev.
819 	(1981); 	Easterbrook 	& Fischel, 	The 	Proper Role 	of 	a 	Target's
Management 	in 	Responding 	to 	a 	Tender Offer, 	94 	Harv. 	L. 	Rev. 	1161
(1981).
5 	There 	is 	evidence 	that 	share 	prices 	of most 	target
companies 	significantly underperform the 	market 	in 	the 	pre-offer
period. 	See 	Gilson, 	supra 	note 	4, 	at 	852-53, 	and 	sources 	cited
therein.

The Honorable 	Barbara 	Flynn 	Currie
Page 	4
performance. 	Employees 	benefit 	from 	enhanced 	corporate
efficiencl 	and 	the 	accompanying gains 	in corporate competi-
tiveness. 	The 	economy 	can 	benefit both 	from 	the 	transfer 	of
corporate 	control 	to more 	efficient 	management 	and 	from 	the
incentives 	that 	takeovers 	create 	for 	improved managerial
performance.
Numerous 	scholarly 	studies 	have 	concluded 	that 	takeovers,
on 	average, 	lead 	to 	an 	increase 	in 	the 	stock market's 	valuation
of 	both 	the 	acquired 	and 	the 	acquiring 	firms. 	According 	to 	a
recent 	study, 	share 	prices 	of 	acquired 	firms 	increase 	by 	an
average 	of 	53.4 	percent. 7 	similarly, 	share 	prices 	of 	some
acquiring 	firms 	have 	increased, 	albeit 	by 	smaller amounts.
Various 	studies 	of 	share 	prices 	of 	acquiring 	firms 	have 	reported
increases 	that 	ranged 	from 	2 	to 	approximately 	7 	percent 	in 	the
past,8 	although 	other 	studies 	have 	found 	no 	gains 	for 	acquirers
in 	this 	decade. 9 	Even 	if 	the 	acquiring 	company's 	shares 	ex-
6 	Profitable 	firms 	provide 	the 	best 	opportunities 	for
wage qrowth, 	new employment, 	and 	the 	fulfillment 	of 	pension 	and
other 	contractual 	obligations 	to 	workers.
7 	Office 	of 	the 	Chief 	Economist, 	securities 	and 	Exchange
Commission, 	The 	Economics 	of 	Any-or-AII. 	Partial. 	and 	Two-Tier
Tender Offers, 	Table 	4A 	(1985).
8 	Those 	findings 	are 	summarized 	in Jensen 	, 	Ruback, 	The
Market 	for 	Corporate 	Control: 	The 	scientific 	Evidence, 	11 J. 	Fin.
Bcon. 	5, 	11 	(Table 	3), 	16-22 	(1983). 	See 	also Jarrell' 	Bradley,
The 	Economic 	Effects 	of 	Federal 	and 	state 	RegUlations 	of 	Cash
Tender 	Offers, 	23 	J. 	Law Econ. 	371, 	393-95 	(1980); 	Council 	of
Economic 	Advisers, 	Economic 	Report 	of 	the 	President 	197 	(1985).
9 	~ Jarrell, 	Brickley' 	Netter, 	The Market 	for 	Corporate
Control: 	The 	Empirical 	Evidence 	Since 	1980, 	2 J. 	Econ. 	Persp. 	49
(1988). 	A recent 	study 	of 	acquiring 	firms 	in 	78 	management
resisted 	takeovers 	between 	1976 	and 	1981 	concluded 	that 	those
firms 	lost 	42 	percent 	of 	the 	value 	of 	their 	stock prices 	over 	the
three 	years 	following 	their 	acquisitions. 	Magenheim' 	Mueller,
Are 	Acquiring-Firm 	Shareholders 	Better Off After An Acquisition?,
in 	Knights. 	Raiders. 	and 	Targets 	171 	(J. 	Coffee, 	L. 	Lowenstein'
s. 	Rose-Ackerman 	ed. 	1988). 	That 	study 	has 	been 	criticized 	for
using methodology 	that 	significantly overstates 	the 	losses 	of 	the
acquiring 	firms' 	value. 	See 	Bradley' 	Jarrell, 	COmment, 	~. 	at
254. 	Bradley and Jarrell, 	using 	the 	data 	from 	the 	Magenheim-
Mueller 	study 	and 	a 	different 	methodology, 	concluded that 	the
acquiring 	firms' 	three 	year 	losses 	were 	actually 	statistically
insignificant. 	Moreover, 	they 	note 	that 	even when 	"acquiring
(continued ... )

The 	Honorable 	Barbara 	Flynn 	Currie
Page 	5
perience 	no 	gains, 	these 	studies 	suggest 	that 	the 	market values
the 	combination 	of 	the 	acquirer and 	the 	target company more
highly 	than 	the 	individual 	firms 	absent 	a 	takeover. 10
These 	studies measure 	the 	stock market performance 	of 	the
companies 	involved during 	short 	periods 	of 	time 	surrounding
takeover 	bids. 	They may 	be viewed 	as 	offering 	the 	stock market's
valuation 	of 	the 	long-term 	effects 	of 	takeovers 	based 	on 	the
information 	available 	at 	the 	time 	the 	takeover 	is 	announced.
These 	valuations 	may change 	over time 	as more 	information 	is
gained. 	Thus, 	these 	studies 	serve 	only 	as 	indirect 	estimates 	of
long-term performance. 	Economic 	scholars 	largely 	agree, 	however,
that 	the 	increases 	in 	company 	valuations 	reported 	by 	these
studies 	represent 	efficiency gains. 	See 	note 	11, 	infra. 	Of
course, 	sharp 	fluctuations 	in 	market 	values, 	such 	as 	those 	ex-
perienced 	in 	the 	October 	1987 	stock market, 	may 	require 	a
cautious 	approach 	to 	long-term 	conclusions.
A substantial 	body 	of 	economic 	and 	legal 	literature 	supports
the 	view 	that 	these 	increases 	in 	the 	stock market's 	valuation 	of
firms 	following 	a 	takeover 	represent 	efficiency gains, 	and 	the
creation 	of 	new wealth, 	attributable 	solely 	to 	the 	takeover. 11
Participants 	in 	the 	stock market 	are 	not 	likely 	to 	bid up 	the
price 	of 	equity 	securities 	involved 	in 	takeovers 	unless 	prior
takeovers, 	on 	average, 	produced 	such 	gains. 	Other 	studies
quarrel 	with 	these 	conclusions, 	but many 	of these 	studies 	contain
9( ••• continued)
firms 	suffer 	capital 	losses, 	the 	gains 	to 	targets 	outweigh 	these
losses, 	and 	the 	net 	effect 	is 	a 	significant 	increase 	in 	the 	value
of 	the 	combined 	assets." 	.IQ. 	at 	256.
10 	Similarly, 	share 	prices 	of 	both 	bidding 	and 	target
firms 	usually decline 	after 	unsuccessful 	takeover bids 	to 	below
the 	pre-offer 	level. 	Bradley, 	Desai 	& Kim, 	supra 	note 	4, 	at 	189-
204; 	Jensen 	& RUback, 	supra 	note 	8, 	at 	8.
11 	~, 	~.g., 	Economic Report 	of 	the 	President, 	supra 	note
8, 	at 	187-216; 	Jensen 	& Ruback, 	supra 	note 	8; 	Jarrell, 	Brickley 	&
Netter, 	supra 	note 	9; 	Bradley, 	Desai 	& Kim, 	supra 	note 	4;
Gilson, 	supra 	note 	4; 	Easterbrook 	& Fischel, 	supra 	note 	4;
Easterbrook 	& Jarrell, 	Do 	Targets 	Benefit 	from 	Defeating Tender
Offers, 	59 	N.Y.U. 	L. 	Rev. 	277 	(1984); 	Pound, 	Lehn 	& Jarrell, 	Are
Takeovers 	Hostile 	to 	Economic 	Performance?, 	Regulation, 	Sept.-
Oct. 	1986, 	25.

13
The 	Honorable 	Barbara 	Flynn 	currie
Page 	6
methodological 	errors. 12 	Some 	scholars have 	also 	questioned 	the
overall 	effects 	of mergers 	and 	unsolicited 	takeovers 	on 	economic
efficiency. 13 	Another major 	scholarly 	study 	that 	relied 	on
accounting 	data 	took 	issue with 	the 	conclusions 	of 	the 	stock
market 	studies 	and 	concluded 	that 	takeovers 	neither 	improved nor
degraded 	the 	performance 	of 	the 	target 	firms. 14
12 	For example, 	Weidenbaum 	& Vogt, 	Takeovers 	and 	stock-
holders: 	Winners 	and 	Losers, 	19 	Cal. 	Mgmt. 	Rev. 	157 	(1987),
incorrectly 	relied 	on 	evidence 	concerning 	negotiated mergers 	to
conclude 	that 	management-opposed 	takeovers 	reduce 	efficiency.
When 	the 	evidence 	of management-opposed 	takeovers 	reviewed 	by 	the
authors 	is 	examined 	separately, 	it 	supports 	the 	conclusion that
takeovers 	enhance 	efficiency. 	Similarly, 	Lipton, 	Takeover 	Bids
in 	the 	Target's 	Boardroom, 	35 	Bus. 	Law. 	101 	(1979), 	offered
evidence 	purporting 	to 	show 	that 	stockholders 	benefited 	from
management 	resistance 	that 	resulted 	in 	the 	defeat 	of 	takeover
bids. 	Lipton's 	evidence 	showed 	that 	the 	share 	prices 	of 	some
firms 	that had defeated 	takeover 	bids 	increased 	above 	the 	tender
offer 	price 	a 	number 	of 	years 	later. 	His 	study 	did 	not 	compare
these 	share 	price movements 	to 	the 	overall 	market's 	movement
during 	the 	same 	period. 	More 	systematic 	stUdies, 	which 	examine
abnormal 	returns 	on 	shares 	of 	takeover 	targets 	compared 	to
overall 	market 	trends, 	show 	that 	stockholders 	incur 	significant
losses 	from 	the 	defeat 	of 	takeover 	bids. 	See 	generally 	Easter-
brook 	& Jarrell, 	supra 	note 	11, 	at 	282-84.
See 	Ravenscraft 	& Scherer, 	The 	Long-Run 	Performance 	of
Mergers and Takeovers, 	in 	Public 	Policy Toward 	Corporate
Takeovers 	34 	(M. 	Weidenbaum * K. 	Chilton 	ed. 	1988); 	Herman 	&
Lowenstein, 	The 	Efficiency 	Effects 	of 	Hostile Takeovers, 	in
Rnights, 	Raiders. 	and 	Targets, 	supra 	note 	9, 	at 	211.
14 	D. 	Ravenscraft 	& F. 	Scherer, 	Mergers, 	Sell-Offs. 	and
Economic 	Efficiency 	101-03 	(1987). 	The 	authors 	used 	accounting
data 	to measure 	economic 	rates 	of 	return. 	This methodology 	is
controversial 	because 	profits 	revealed 	by 	such 	data 	are 	SUbject
to wide variations 	reSUlting 	from 	the 	use 	of 	divergent 	accounting
conventions 	by different 	firms. 	See 	generally 	Benston, 	Ib§
Validity 	of 	Profits-structure 	studies 	with 	Particular Reference
to 	the 	FTC's 	Line 	of 	Business 	Data, 	75 	Am. 	Econ. 	Rev. 	37 	(1985);
Fisher 	& McGowan, 	On 	the Misuse 	of Accounting Rates 	of Return 	to
Infer Monopoly 	Profits, 	73 	Am. 	Econ. 	Rev. 	82 	(1983). 	In 	addi-
tion, 	because 	of 	constraints 	on 	the 	availability 	of data, 	the
study 	focuses 	largely 	on 	conglomerate mergers, 	and 	not manage-
ment-opposed 	takeovers. 	See 	Ravenscraft 	& Scherer, 	supra, 	at 	22.
As 	the 	authors 	observe, 	however, 	the 	incidence 	of 	horizontal
merger 	activity 	has 	increased markedly 	in 	this 	decade, 	and 	"[t]he
(continued .•• )

The Honorable 	Barbara 	Flynn 	Currie
Page 	7
Accordingly, 	no 	scholarly 	consensus 	on 	the 	economic 	effects
of 	takeovers 	supports 	changes 	in 	the 	law 	to make management-
opposed takeovers 	more 	costly 	and 	difficult. 	On 	the 	contrary, 	we
believe 	that 	the 	preponderance 	of 	scholarly 	opinion 	on 	the
sUbject 	supports 	the 	conclusion 	that 	management-opposed 	takeovers
produce 	economic 	benefits, 	and 	that 	new 	restrictions 	on takeovers
are 	likely 	to 	undermine 	economic 	efficiency.
C. 	Asserted 	Disadvantages 	of 	Takeover Actiyity
Purported 	disadvantages 	of 	takeover 	activity 	are 	often
asserted 	to 	justify 	restraining 	corporate 	acquisitions. 	Although
we 	know 	of 	no 	empirical 	research 	to 	substantiate 	these 	dis-
advantages, 	they 	are 	often 	cited by 	incumbent managers 	and 	other
takeover 	critics 	in testimony 	before 	Congressional 	committees 	and
in 	articles 	in 	the 	general 	press. 	In 	the 	absence 	of 	persuasive
SUbstantiating evidence, 	these 	claims do 	not 	support 	the
enactment 	of 	curbs 	on 	takeover 	activity.
Some 	takeover 	critics 	claim, 	for 	example, 	that 	acquirers
often take 	over well-managed 	corporations, 	oust 	good management,
and 	reduce 	corporate 	efficiency 	by 	installing 	less 	capable
management 	teams. 	This 	may 	happen 	in 	some 	cases. 	Corporate
acquirers, 	like 	all 	other 	businesspersons, 	may make 	mistakes.
This 	possibility, 	however, 	does 	not 	justify controls 	on 	takeover
activity 	any 	more 	than 	the 	possibility 	of 	poor 	investments 	in
plant 	or 	equipment 	justifies 	government 	controls 	on 	investment
decisions made by 	corporate 	managers. 	In 	a 	market 	economy,
investment decisions 	generally 	are 	best 	left 	to 	investors, 	who
stand to 	profit 	from 	correct 	decisions 	and 	lose 	from 	poor 	ones.
The 	critical 	fact 	is 	that 	takeover 	activity, 	in 	the 	aggregate,
has 	not 	been 	demonstrated 	to 	have 	adverse 	effects 	and 	in 	fact
appears 	to 	benefit 	society. 	Because 	the 	evidence 	suggests 	that
the 	benefits 	of 	takeovers 	outweigh 	their 	costs, 	restricting
takeovers 	in 	the 	hope 	of 	preventing unwise 	investments 	is 	likely
to 	harm 	societal 	welfare.
It 	also 	has 	been 	argued 	that 	management-opposed 	takeovers
result 	disproportionately 	in 	facility 	closings 	and 	lay-offs,
which 	impose 	great 	social 	costs 	on 	individuals 	and 	communities 	in
which 	plants 	are 	located. 	But 	factual 	support 	for 	the 	position
that 	takeovers 	lead 	to 	plant 	closings 	and 	lay-offs 	that would 	not
14( ••• continued)
shift 	toward 	large 	horizontal 	mergers 	is 	more 	difficult 	to
evaluate 	solely 	on 	the 	basis 	of 	our 	research." 	lQ. 	at 	219.

The Honorable 	Barbara 	Flynn 	Currie
Page 	8
have 	occurred 	otherwise 	is, 	at 	best, 	scanty.15 	Indeed, 	it 	is
difficult 	to 	assess 	whether 	or not 	closings 	or 	lay-offs 	that
occur 	after 	takeovers 	would 	have 	been 	carried 	out by 	the 	target's
management 	in 	any 	event 	to 	keep 	the 	firm 	competitive. 	Moreover,
most 	economic changes 	that 	increase 	efficiency
-- and 	thereby 	increase 	aggregate 	societal 	wealth 	-- 	create
dislocations 	that 	reduce 	the 	welfare 	of some 	individuals. 16
Virtually 	every major 	technological 	advance 	renders 	an 	earlier
technology 	obsolete 	and 	thus 	may disadvantage 	firms 	and 	indi-
viduals 	dependent 	on 	the 	earlier 	technologies.
Finally, 	it 	is 	argued 	that 	takeovers 	force 	corporate man-
agers 	to 	focus 	on 	short-term 	profits 	and 	forego 	long-term 	invest-
ments. 	The 	evidence 	shows, 	however, 	that 	foregoing 	long-term
investment makes 	companies 	more, 	not 	less, 	vulnerable 	to 	take-
overs. 	Takeover 	targets 	tend 	to 	have 	below-average 	research 	and
development 	budgets, 	showing 	a 	lesser 	commitment 	to 	long-term
investments 	than 	the 	average 	firm. 17
15 	See Jensen, 	Takeovers: 	Folklore 	and 	Science, 	Harv. 	Bus.
Rev. 	Nov.-Dec. 	1984, 	at 	114 	; 	£t. 	American 	Enterprise 	Institute,
Proposals Affecting 	Corporate 	Takeovers 	31 	(1985) 	(citing 	finding
that 	"very 	few 	jobs were 	affected" 	by 	6,000 	corporate 	acquisi-
tions 	in 	1970s). 	The 	AFL-CIO 	estimates 	that 	a 	total 	of 	80,000
jobs 	of 	members 	of 	its 	affiliated 	unions 	have 	been 	lost 	as 	a
"result 	of 	corporate 	restructuring" 	in 	recent 	years. 	Hostile
Takeovers, 	Hearings 	Before 	the 	Senate 	Committee 	on 	Banking,
Housing, 	and 	Urban Affairs, 	100th Cong., 	1st Sess. 	262 	(1987)
(statement 	of 	Thomas R. 	Donahue). 	Even 	assuming 	that 	this
estimate, 	for 	which 	the 	time 	frame 	is 	unspecified 	but presumably
spans 	a 	number 	of 	years, 	is 	correct, 	it 	is 	difficult 	to 	assess
how many 	of 	those 	jobs would 	have 	been 	abolished 	in 	any 	event 	to
improve 	the 	competitiveness 	of 	the 	affected 	companies. 	To 	put
the 	figure 	in 	perspective, 	a 	total 	of 	5.1 	million 	workers 	lost
their 	jobs 	because 	of 	plant 	closings 	or 	efficiency measures 	in
the 	years 	1979-1983. 	Bureau 	of 	Labor 	Statistics, 	Monthly 	Labor
Reyiew 	(June 	1985).
16 	It would 	seem 	preferable 	for 	government 	to 	respond 	to
these 	inevitable 	economic 	dislocations 	by 	initiating 	effective
remedial 	measures 	to 	assist 	displaced 	individuals 	rather 	than
severely 	restricting 	economic 	activity 	that 	benefits 	society.
Such measures 	may 	include, 	for 	example, 	programs 	to 	retrain
workers 	displaced 	from 	declining 	industries.
17 	This 	proposition 	is 	supported by 	a 	recent 	empirical
study 	of 	the 	investment 	patterns 	of 	takeover 	targets. 	The 	study,
which 	examined 	all 	217 	takeover 	targets 	that 	were 	acquired
(continued .•. )

The 	Honorable 	Barbara 	Flynn 	Currie
Page 	9
D. 	Empirical 	Evidence 	on 	Effects 	of Anti-Takeover Legislation
Three 	recent 	empirical 	studies 	concerning the 	effects 	of
anti-takeover 	legislation have 	concluded 	that 	anti-takeover 	laws
harm 	shareholders 	and 	undermine 	economic 	efficiency. 	A 1987
empirical 	study by 	the 	Commission's 	Bureau 	of 	Economics 	analyzed
the 	extent 	of 	the 	economic harm 	caused 	by 	a 	New 	York 	statute 18
restricting 	"business 	combinations."19 	This 	statute 	is very
similar to 	HB 	165's proposed 	business 	combination provisions.
The 	study 	found 	that 	the 	announcement 	by New 	York's 	governor 	of
the 	proposed 	legislation 	that 	ultimately became 	the 	New York 	law
resulted 	in 	a 	statistically 	significant decline 	in 	the 	average
value 	of 	shares 	of New 	York 	corporations. 	The 	decline was 	equal
to 	approximately 	one 	percent 	of 	the value 	of 	the 	shares, 	or 	$1.2
billion. 20 	As 	the 	study 	noted 	in 	conclusion:
[D]espite 	the 	political 	rhetoric 	advocating 	the
regUlation 	of 	takeovers 	on 	behalf 	of 	share-
holders, 	the 	evidence 	• 	• 	• 	indicates 	that 	this
very 	strong 	statute does 	not 	protect 	share-
holders; 	rather, 	the 	law 	protects managers 	at 	the
expense 	of 	shareholders. 	• 	•• 	[In 	addition, 	the
statute] 	may 	promote 	the 	inefficient management
of 	society's 	assets 	by 	lessening 	the 	ability 	of
17( ••• continued)
between 	1980 	and 	1984, 	found 	that 	takeover 	targets 	had 	below
average 	ratios 	of 	(i) 	research and development 	expenditures 	to
total 	expenditures 	and 	(ii) 	capital 	investment 	to 	earnings.
Office 	of 	the 	Chief 	Economist, 	securities 	and 	Exchange 	Commis-
sion, 	Institutional 	Ownership, 	Tender Offers, 	and 	Long-Term
Investment 	8-10 	(1985).
18 	N. 	Y. 	Bus. 	Corp. 	Law 	§ 	912.
19 	Schumann, 	supra 	note 	2. 	"Business 	combination"
statutes 	restrict 	the 	ability 	of 	acquiring 	firms 	to merge 	or
engage 	in other 	specified business 	activity 	with 	unsolicited
takeover 	targets 	for 	a 	specified 	period 	of 	time 	following 	the
acquisition 	of 	target 	company 	shares.
20 	IQ. 	at 	41, 	46-47. 	Continuing 	research by 	the 	same
author 	suggests 	that 	the 	decline 	in 	the 	value 	of New York
corporations 	caused by 	the 	enactment 	of 	the 	legislation may 	have
been 	significantly greater than 	reported 	in 	this 	study. 	Measured
over 	the 	entire 	205-day 	course 	of 	the 	legislative process, 	the
decline was 	9.7 	percent, 	net 	of market. 	L. 	Schumann, 	State
RegUlation 	of Takeovers 	and 	Shareholder Wealth: 	The 	Case 	of 	New
York's 	1985 	Takeover Statutes 	(mimeo April 	1988).

The 	Honorable 	Barbara 	Flynn 	Currie
Page 	10
capital 	markets 	to 	efficiently 	reallocate 	assets.
Consequently, 	the 	real 	cost 	of 	the 	goods 	and 	services
produced 	by 	the 	firms 	affected 	by 	[the 	statute] 	may
increase~ 	injuring 	consumers 	as 	well 	as 	share-
holders.~l
Another 	study, 	conducted by 	the 	Office 	of the 	Chief 	Econo-
mist 	of 	the 	Securities 	and 	Exchange 	Commission, 	also 	concludes
that 	anti-takeover 	legislation 	is 	harmful 	to 	the 	interests 	of
shareholders. 	The 	study 	examined 	the 	effects 	of 	a 	recent 	Ohio
law that, 	among 	other things, 	authorized 	corporate 	directors 	to
consider 	the 	interests 	of 	persons 	other 	than 	the 	shareholders 	in
assessing 	takeover 	bids. 22 	The 	SEC 	study 	found 	that 	enactment 	of
the 	Ohio 	law 	caused 	an 	immediate 	two 	percent 	decline 	in 	the
equity value 	of 	corporations 	insulated 	from 	takeovers. 	Finally,
a 	1987 	study 	on 	the 	effects 	of 	Indiana's 	anti-takeover 	statute,
which 	contains a 	"business 	combination" 	provision 	similar to
that 	in 	the 	proposed 	legislation, 	found 	that 	the 	enactment 	of
Indiana's 	law 	caused 	a 	4.2 	to 	6.1 	percent 	decline 	in 	the 	value 	of
shares 	of 	Indiana 	corporations. 23
E. 	Effect 	of 	"Business 	Combination" 	Restrictions
The 	proposed legislation 	governs 	"business 	combinations"
between any 	interested 	"shareholder" 	and 	a 	takeover 	target 	firm.
An 	-interested shareholder" 	is 	defined 	as 	the 	owner 	of 	15 	percent
or more 	of 	the voting 	shares 	in 	a 	corporation. 	The 	proposed
legislation would 	prohibit 	such 	shareholders 	from 	merging 	with 	or
conducting 	other 	specified 	business 	activities 	with 	target
corporations 	for 	three 	years 	following 	the 	interested 	share-
21 	Schumann, 	supra 	note 	2, 	at 	47.
22 	Office 	of 	the 	Chief 	Economist, 	Securities 	and 	Exchange
Commission, 	Shareholder Wealth 	Effects 	of 	Ohio 	Legislation
Affecting 	Takeovers 	(1987). 	The 	Ohio 	law 	is 	codified 	in Ohio
Rev. 	Code Ann. 	§ 	1701.01 	et 	seg. 	(Page 	1986 	Supp.). 	A similar
provision 	is 	found 	in 	Section 	8.85 	of 	the 	Illinois 	Business
corporation Act. 	HB 	165 	has 	proposed 	some 	changes 	in 	that
provision. 	We 	have 	no 	comment 	on 	those 	changes.
23 	Sidak 	& Woodward, 	corporate 	Takeovers. 	The 	COmmerce
Clause. 	and 	the 	Efficient Anonymity 	of 	Shareholders 	(mimeo March
1987). 	The 	4.2 	percent 	decline 	represents 	a 	portfolio 	in which
equal 	weight 	is 	given 	to 	all 	Indiana 	firms. 	The 	6.1 	decline
represents 	a 	value-weighted 	portfolio.

The 	Honorable 	Barbara 	Flynn 	Currie
Page 	11
holder's 	share 	acquisition date, 	unless 	certain conditions 	are
met. 24
The 	proposed 	legislation 	is 	likely 	to 	deter 	takeovers whose
profitability depends 	on 	the 	ability 	of 	the 	acquirer 	to merge
with 	the 	target 	corporation. 	The 	successful 	bidder 	for 	corporate
control 	commonly 	seeks 	to 	consolidate 	the 	target 	into 	its
operations 	by means 	of 	a 	merger. 25 	A three-year merger 	prohibi-
tion 	will 	likely 	require 	many 	acquirers 	to maintain 	inefficient
forms 	of 	business 	organization 	and 	thus 	would 	undercut 	their
ability 	to 	improve 	the 	efficiency 	of 	target 	corporations. 	This,
in 	turn, 	may 	deter 	some 	takeover 	bids 	that 	would 	benefit 	the
economy.
The 	bill 	would 	also 	prohibit 	the 	sale 	or 	other disposition
of 	substantial 	target 	company 	assets 	to 	an 	interested 	shareholder
for 	three 	years 	after 	the 	shareholder becomes 	an 	interested
24 	The 	business 	combination may 	be 	carried 	out 	under
three 	conditions:
1. 	if 	before 	the 	acquirer 	became 	an 	interested 	party
the 	target 	corporation's 	board 	of 	directors
approved 	the 	business 	combination 	or 	transaction
which 	resulted 	in 	the 	shareholder becoming 	an
interested 	shareholder;
2. 	if 	the 	interested 	shareholder became 	beneficial
owner of 85 percent 	of 	those 	shares 	not 	owned 	at
the 	time 	the 	transaction 	commenced 	by 	certain
employee's 	stock plans 	or 	directors 	who 	are 	also
officers; 	or
3. 	if 	it 	is 	approved 	by 	the 	board 	of 	directors 	and
authorized 	at 	an 	annual 	or 	special 	meeting 	of
shareholders 	by 	the 	affirmative 	vote 	of 	at 	least
66 	2/3 	percent 	of 	the 	outstanding voting 	shares
that 	are 	not 	owned by 	the 	interested 	shareholder.
Conditions 	one 	and 	three 	leave 	a 	great 	deal 	of 	dis-
cretion with management, 	whose 	interests may 	not 	always 	be
consistent with 	economic 	efficiency 	or the 	best 	interests 	of
shareholders. 	Condition 	two 	requires 	an 	acquisition of 	an 	over-
whelming 	percentage 	of 	a 	company's 	shares. 	Because 	this 	may 	be
so 	costly 	and 	tie 	up 	so much 	capital 	it may 	deter mergers 	that
would 	be, 	on 	the 	whole, 	beneficial.
25 	~ R. 	Gilson, 	The 	Law 	and 	Finance 	of 	Corporate
Acquisitions 	854 	(1986).

The 	Honorable 	Barbara 	Flynn 	currie
Page 	12
shareholder. 	This 	prohibition would 	increase 	the 	cost 	of
financing, 	and 	in many 	cases 	may 	deter, 	takeovers 	designed 	to
redeploy 	assets 	to more 	efficient 	uses.
The 	proposed 	legislation would 	restrict 	the 	freedom 	of
shareholders 	to 	control 	and 	dispose 	of 	their 	property 	without
government 	scrutiny. 	Owners 	of 	assets 	should be 	free 	to 	sell
property without 	having 	the 	state 	examine 	the 	merits 	of 	the
transaction, 	absent 	a 	compelling 	justification. 	When 	share-
holders 	determine, 	for 	whatever 	reason, 	to 	transfer 	control 	of 	a
corporation, 	the 	state 	should 	not 	frustrate 	their will 	and
require 	them to 	retain 	managers 	they 	wish 	to 	displace.
F. 	Consideration 	of 	an 	"Opting-In" 	Mechanism
If 	the 	legislature 	decides 	to 	enact 	the 	"business 	combina-
tion" 	restrictions 	despite 	the 	concerns 	discussed 	above, 	we
suggest 	that 	the 	relevant 	provisions 	be modified 	to 	make 	them
applicable 	only 	to 	corporations 	whose 	shareholders 	affirmatively
elect 	to be 	covered by 	them 	through 	amendments 	to 	the 	corpora-
tions' 	articles 	of 	organization. 	To 	the 	extent 	that 	the
"business 	combination" 	provisions 	of 	HB 	165 	are 	motivated 	by 	a
concern 	for 	shareholders, 	their 	purposes 	would 	be 	better served
by 	a 	requirement 	that 	shareholders 	approve 	a 	decision 	to 	opt 	into
coverage. 	Corporate 	by-laws 	generally may 	be 	amended 	b~ the 	board
of 	directors 	without 	the 	approval 	of 	the 	shareholders. 	6 	The
votes 	of directors 	to 	amend 	the 	by-laws 	to 	opt 	into 	coverage 	by
business 	combination 	restrictions 	may 	be 	influenced by 	the
directors' 	loyalty 	to 	existing 	management, 	whose 	jobs may 	be
threatened 	by 	a 	takeover. 27 	The 	result 	may 	be 	to 	discourage
takeovers 	that 	would 	benefit 	the 	shareholders. 	Therefore, 	we
recommend 	that 	a 	corporation's 	decision 	to 	opt 	into 	the 	proposed
"business 	combination" 	provisions 	be made 	solely through 	a
shareholder vote 	amending 	the 	articles 	of 	organization.
G. 	Effect 	of 	"Poison 	pill" 	Restrictions
UB 	165 	also would 	amend 	Sec. 	605(e) 	of 	the 	Business
Corporation Act, 	Ill. 	Rev. 	Stat. 	ch. 	32, 	para. 	6.05(e), 	by
explicitly granting 	corporations 	authority 	to 	issue 	rights 	or
options 	that 	cannot be 	transferred 	to 	persons 	owning 	or offering
26 	~ 	Ill. 	Rev. 	Stat. 	ch. 	32, 	para. 	2.25 	(1987).
27 	Indeed, 	the 	senior managers whose 	jobs may 	be most
threatened by a 	takeover 	often 	sit 	on 	their 	corporation's 	board
of 	directors.

The 	Honorable 	Barbara 	Flynn 	Currie
Page 	13
to 	acquire 	a 	certain 	number 	or 	percentage 	of 	outstanding 	shares.
These 	rights 	or 	options 	are 	often 	called 	a 	"poison 	pill."
The 	term 	"poison pill" 	refers 	to 	a 	family 	of 	shareholder
rights 	plans 	that, 	when 	triggered 	by 	a 	tender 	offer or the
accumulation 	of 	a 	specified 	percentage 	of 	shares 	by 	an 	acquirer,
provide 	other 	shareholders 	with 	rights 	to 	purchase 	additional
shares 	or 	to 	sell 	shares 	to 	the 	target 	at 	very 	attractive
prices. 	These 	rights, 	when 	triggered, 	may 	significantly 	reduce
the 	value 	of 	the 	target 	to 	a 	hostile 	bidder 	and 	may 	sUbstantially
lower 	the 	value 	of 	the 	target's 	shares 	that 	a 	hostile 	bidder has
already 	acquired. 	According 	to 	a 	1986 	study by 	the 	SEC's 	Office
of 	the 	Chief 	Economist, 	"poison pills" 	are very 	effective
deterrents 	against 	hostile 	takeovers 	due 	to 	two 	important
features: 	1) 	when 	they 	can 	be 	cheaply 	and 	quickly 	redeemed 	by
target 	management, 	they 	force 	potential 	acquirers 	to 	negotiate
directly with 	the 	target's 	board 	if 	they 	wish 	to 	have 	the 	pill
removed: 	and 	2) 	if 	not 	redeemed, 	they 	make 	hostile 	acquisitions
exorbitantly 	expensive. 28
The 	1986 	SEC study 	examined 	the 	effects 	of 	"poison pills" 	on
the 	wealth 	of 	target 	shareholders. 	The 	study 	reports 	on 	the
effects 	of 	245 	"poison 	pills" 	announced 	between 	1983 	and 	July 	4,
1986, 	and 	focuses 	on 	the 	effects 	of 	pills 	that 	appeared 	in 	37
firms 	subject 	to 	takeover 	speculation. 	The 	authors 	find 	that
"poison pills" 	are 	associated 	with 	gains 	to 	target 	shareholders
following 	an 	auction 	for 	the 	firm. 	In 	such 	cases 	the 	target
shareholders 	gained 	14 	percent 	on 	average. 	However, 	in 	other
cases 	the 	pills 	led 	to 	the 	defeat 	of 	the 	takeover 	and 	the 	target
shareholders' 	stock 	fell 	17 percent 	in value 	over the 	next 	6
months. 	On 	net, 	the 	authors 	find 	that 	"poison pill" 	announce-
ments 	are 	generally 	associated 	with 	a 	loss 	of 	shareholder value
of 	.66 	percent.
"Poison 	pills" 	may 	result 	from 	market 	failure 	with 	respect
to 	corporate 	governance 	that 	enables managers 	to 	thwart 	takeovers
and 	protect 	their own 	interests 	at 	the 	expense 	of 	shareholders.
Nevertheless, 	shareholders 	of 	some 	firms 	may 	have 	legitimate
objections 	to 	hostile 	takeovers 	and 	desire 	long-term 	contracts
with 	incumbent 	managers. 	Shareholders may 	also 	desire 	"poison
pills" 	in 	order 	to 	provide 	managers 	greater 	leverage 	in 	negotia-
tions 	with potential 	bidders.
28 	Office 	of 	the 	Chief 	Economist, 	Securities 	and 	Exchange
Commission, 	The 	Effects 	of 	Poison 	Pills 	on 	the 	Wealth 	of Target
Shareholders, 	October 	1986.
-. 	-)~. 	.. .;;,:~ " 	... .

The 	Honorable 	Barbara 	Flynn 	Currie
Page 	14
To 	correct 	any market 	failure 	that 	enables managers 	to 	use
·poison pills" 	to 	protect their 	own 	interests 	at 	the 	expense 	of
shareholders, 	legislation that 	allows 	for 	the 	adoption 	of 	"poison
pills" 	should 	stipulate 	that 	such 	shareholder 	rights 	plans 	can be
adopted 	only upon 	approval 	of 	a 	majority 	of 	outstanding share-
holders. 	By 	requiring 	shareholder 	approval, 	legislation
permitting 	the 	adoption 	of 	"poison 	pills" 	would 	prevent 	the 	abuse
of 	"poison pills" 	by management, 	while 	allowing 	for 	their 	use
when 	shareholders believe 	them 	to 	be 	in 	the 	shareholders' 	best
interest.
Conclusion
On 	the whole, 	we 	believe 	that 	vigorous 	takeover 	activity
enhances 	economic 	efficiency 	and 	thus 	benefits 	consumers,
workers, 	and 	shareholders. 	We 	believe 	that HB 	165 	is 	likely 	to
impede many 	of 	the 	beneficial 	consequences 	of 	takeovers 	without
offering 	countervailing benefits. 	The 	legislature 	therefore 	may
wish to 	consider whether 	this 	legislation unduly 	interferes 	with
the 	market 	for 	corporate 	control 	to 	the 	detriment 	of 	the 	economy
and 	consumer welfare 	generally.
SiS~ , 	~c. 	.. 	. 	\1-\<v-'
C. 	steven 	Baker
Regional 	Director