Disgorgement Provisions

Discussion

Disgorgement provisions require that an acquirer or potential acquirer of more than a certain percentage of a company's stock pay back, or disgorge to the company any profits realized from the sale of that company's stock purchased 24 months before achieving control status. All sales of company stock by the acquirer occurring within a certain period of time (between 18 months and 24 months) prior to the investor's gaining control status are subject to these recapture-of-profits provisions. Ohio and Pennsylvania are the only states that currently have disgorgement provisions.

Impact of Disgorgement Provisions

Disgorgement provisions prevent a hostile acquirer from profiting by purchasing a large stake in a company, announcing a battle for control of that company, and then selling out at the higher market price resulting from news of the potential acquisition. To the extent that this provision protects shareholders from profiteers desiring to put the company in play solely to reap the benefits of a temporarily higher stock price, disgorgement provisions protect shareholder wealth.

However, these provisions are not without an antitakeover effect, in that they eliminate a source of revenue for legitimate acquirers. Often, acquirers may rely on the possibility of selling shares to cover their costs, especially if the bid is unsuccessful. Increasing the risk of substantial losses through the adoption of disgorgement provisions may discourage beneficial takeover attempts. Because disgorgement provisions may provide benefits to shareholders in certain cases, evaluate proposals to opt out of such provisions on a case-by-case basis.

Impact of Antitakeover Statutes on Shareholder Returns

Antitakeover statutes generally increase management's potential for insulating itself and warding off hostile takeovers that may be beneficial to shareholders. While it may be true that some boards use such devices to obtain higher bids and to enhance shareholder value, it is more likely that such provisions are used to entrench management.

The majority of available evidence on individual corporate Antitakeover measures indicates that heavily insulated companies generally realize lower returns than those having managements that are more accountable to shareholders and the market. The evidence also suggests that when states adopt their own antitakeover devices, or endorse those employed by firms, shareholder returns are harmed.

For instance, a 1990 study completed by Jonathan M. Karpoff and Paul H. Malatesta investigated the effect of 40 state takeover bills between 1982 and 1987 and found that the "announcement of takeover legislation corresponded with a small but statistically significant decrease in the stock values of the firms incorporated in the state considering the law."[1] In addition, Karpoff and Malatesta discovered that firms headquartered, but not necessarily incorporated, in the state adopting takeover legislation realized negative stock price effects. The negative economic impact of such provisions on all firms listed on the New York and American stock exchanges for the period in question was estimated at $6 billion.[2]

Studies focusing on individual cases also support the position that state antitakeover amendments harm shareholder value. Pennsylvania, in particular, has passed antitakeover provisions (contained in Pennsylvania Senate Bill 1310) that appear to have seriously harmed those firms incorporated there. Karpoff and Malatesta conclude that, from the time the proposed legislation was first announced on Oct. 13, 1989, through Jan. 2, 1990, when the bill was introduced in the state's House of Representatives, the average Pennsylvania firm's cumulated abnormal stock return was negative 6.9 percent.[3]

Other studies have also examined the effect of Pennsylvania's antitakeover legislation. For instance, a Wilshire Associates study dated Aug. 27, 1990, concluded that the share prices of Pennsylvania companies were an average of four percent lower than what could have been expected had the antitakeover legislation not been passed.[4] The total value attached to this decrease was estimated at $3.6 billion. Wilshire determined the findings to be all the more significant in light of the fact that: (1) the loss represented the present value of uncertain future opportunity losses, and (2) the bill was signed at a time when the takeover market was at a virtual standstill. Further supporting the idea that Pennsylvania's legislation did not enhance shareholder value was the fact that, when companies opted out of one or two of the law's provisions, they experienced a return of 2.3 percent above the S&P 500.[5]

While Pennsylvania is one of those states sponsoring the strongest takeover defenses, studies have concluded that the adoption of takeover provisions in other states has also depressed shareholder value. For instance, the losses suffered by shareholders because of Indiana's control share acquisition over a 14-day period surrounding the legislation's introduction were estimated at $2.7 billion.[6] Other states, such as Ohio and Massachusetts have been criticized for the potential negative economic effects of their antitakeover statutes.[7] The body of evidence seems to indicate that companies in states with antitakeover legislation experience lower returns than they would absent such statutes.