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PROXY CONTESTS

Shareholders elect the board of directors to keep watch on management and replace unsatisfactory managers. If the board is lax, shareholders are free to elect a different board. In theory this ensures that the corporation is run in the best interests of shareholders.

In practice things are not so clear-cut. Ownership in large corporations is widely dispersed. Usually even the largest single shareholder holds only a small fraction of the shares. Most shareholders have little notion who is on the board or what the members stand for. Management, on the other hand, deals directly with the board and has a personal relationship with its members. In many corporations, management sits on the committee that nominates candidates for the board. It is not surprising that some boards seem less than aggressive in forcing managers to run a lean, efficient operation and to act primarily in the interests of shareholders.

When a group of investors believes that the board and its management team should be replaced, they can launch a proxy contest. A proxy is the right to vote another shareholder`s shares. In a proxy contest, the dissident shareholders attempt to obtain enough proxies to elect their own slate to the board of directors. Once the new board is in control, management can be replaced. A proxy fight is therefore a direct contest for control of the corporation.

But most proxy contests fail. Dissidents who engage in such fights must use their own money, while management can use the corporation`s funds and lines of communication with shareholders to defend itself. Such fights can cost millions of dollars.1

Institutional shareholders such as large pension funds have become more aggressive in pressing for managerial accountability. These funds have been able to gain concessions from firms without initiating proxy contests. For example, firms have agreed to split the jobs of chief executive officer and chairman of the board of directors. This ensures that an outsider is responsible for keeping watch over the company. Also, more firms now bar corporate insiders from serving on the committee that nominates candidates to the board. Perhaps as a result of shareholder pressure, boards also seem to be getting more aggressive. For example, outside directors were widely credited for hastening the recent replacement of top management at Coke and British Airwaves.

METHOD 2: MERGERS AND ACQUISITIONS

Proxy contests are rare, and successful ones are rarer still. Poorly performing managers face a greater risk from acquisition. If the management of one firm observes another firm underperforming, it can try to acquire the business and replace the poor managers with its own team. In practice, corporate takeovers are the arenas where contests for corporate control are usually fought.

There are three ways for one firm to acquire another. One possibility is to merge the two companies into one, in which case the acquiring company assumes all the assets and all the liabilities of the other. Such a merger must have the approval of at least 50 percent of the stockholders of each firm.2 The acquired firm ceases to exist, and its former shareholders receive cash and/or securities in the acquiring firm. In many mergers there is a clear acquiring company, whose management then runs the enlarged firm. However, a merger is often a combination of two equals with both managements having a major say in the running of the new company. For example, the $330 billion proposed merger between Time Warner and AOL is a merger of equals.

A second alternative is for the acquiring firm to buy the target firm`s stock in exchange for cash, shares, or other securities. The acquired firm may continue to exist as a separate entity, but it is now owned by the acquirer. The approval and cooperation of the target firm`s managers are generally sought, but even if they resist, the acquirer can attempt to purchase a majority of the outstanding shares. By offering to buy shares directly from shareholders, the acquiring firm can bypass the target firm`s management altogether. The offer to purchase stock is called a tender offer. If the tender offer is successful, the buyer obtains control and can, if it chooses, toss out incumbent management.

The third approach is to buy the target firm`s assets. In this case ownership of the assets needs to be transferred, and payment is made to the selling firm rather than directly to its stockholders. Usually, the target firm sells only some of its assets, but occasionally it sells all of them. In this case, the selling firm continues to exist as an independent entity, but it becomes an empty shellБІАААдa corporation engaged in no business activity.

The terminology of mergers and acquisitions (M&A) can be confusing. These phrases are used loosely to refer to any kind of corporate combination or takeover. But strictly speaking, merger means the combination of all the assets and liabilities of two firms. The purchase of the stock or assets of another firm is an acquisition.

PROXY CONTEST Takeover attempt in which outsiders compete with management for shareholders` votes. Also called proxy fight.

MERGER Combination of two firms into one, with the acquirer assuming assets and liabilities of the target firm.

1 J. H. Mulherin and A. B. Poulsen provide an analysis of proxy fights in БІАААмProxy Contests and Corporate Change: Implications for Shareholder Wealth,БІАААн Journal of Financial Economics 47 (1998), pp. 279 313. 2 Corporate charters and state laws sometimes specify a higher percentage.