Friday, April 10, 2009

Change of Control Provisions

Business Week has an article today about change of control provisions enacted by various companies. Here's an excerpt from the article:

The tactic might well be called "the banker made me do it" defense. Amylin (a biotech firm) has in place a "change of control" debt covenant that requires it to pay back an outstanding loan if investors buy a large stake in the company or elect a block of board members. Amylin says it would be forced to pay back a $125 million Bank of America (BAC) loan if outsiders wrested control of its board, which in turn could force it to default on up to $900 million in debt. That could make Amylin unpalatable as a takeover target.

In my view, these takeover defense tactics do not serve shareholders well. A company should be capable of defending itself against a hostile takeover by performing at a high level, not through such gimmickry. If a firm isn't performing well, then perhaps a hostile takeover (or the credible threat of one) is the right medicine. After all, even the threat of a hostile takeover puts management on its toes, and it insures that management will not drag its feet on necessary restructuring moves when performance lags. That threat also insures that companies will not horde excess cash during and after a period of high performance.

One other type of change of control provision also proves troublesome. Some CEOs have change of control provisions in their compensation contracts. They stand to gain a huge windfall if the company is sold. These provisions clearly do not enhance shareholder value, nor do they help employees or customers of the firm. If the firm is performing well, and the CEO engineers the sale of the firm to another company, the CEO will benefit greatly anyway because he or she often holds a high number of shares and options (which will be purchased at a substantial premium). Why the need for an additional change of control "bonus"? If the firm is not performing well, then the CEO doesn't deserve any type of special added bonus because of a takeover. In fact, if the CEO loses his or her job in such a hostile takeover, he or she probably deserves it and certainly doesn't deserve a large bonus since the firm has underperformed.