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What Is A Hostile Takeover Of A Company?

In a takeover, an outside or inside investor acquires managerial control of a corporation by acquiring enough common stock and stockholder votes to control the board of directors, and thereby control management. The adjective hostile (as opposed to friendly) indicates that the takeover is not welcomed by management and frequently indicates that one objective of the takeover is to replace management.

Raider is a pejorative term used to describe a firm or individual who specializes in hostile takeovers. Raiders commonly identify firms as takeover targets when those firms are believed to be undervalued because managers are not acting in the stockholders’ best interests. For example, managers of some conglomerates could increase stockholder value by selling pieces of the conglomerate that are not synergistic with other pieces.

Takeovers can have either positive or negative effects on existing shareholders and employees, depending on the acquiring firm’s objectives and the actions taken by the management of the target firm. A takeover can represent an attempt to steal value from the existing managers and workers; alternatively, it can represent an effective mechanism to revitalize an organization plagued by ineffective management. In either case, managers have often been permitted to include certain elements in their compensation packages that allow a retention of power in the face of a hostile takeover.

One compensation device that has helped discourage takeover attempts and protect managers is the golden parachute, which is a benefits package payable to incumbent managers if those managers are terminated following a successful hostile takeover (or in some cases a friendly merger). Both the ethical and incentive effects of golden parachutes are difficult to assess. Some proponents argue that golden parachutes serve stockholder interests because “top managers are free to devote their attention to serving the interests of existing stockholders in the face of a takeover threat. These parachutes are viewed as providing managers with financial protection that will keep them unbiased in their actions, regardless of the outcome. However, critics view the golden parachute as a means for entrenched managers to protect themselves in the event they are ousted. Proponents of this perspective are offended by the notion that managers who mismanage and create the conditions that originally attracted a takeover effort should profit by a takeover designed to remove those same managers for inept performance.

Golden parachutes also have taxation issues. When these devices were first introduced, corporations were allowed to deduct the payments as normal business expenses. Such deductibility was affected significantly by the 1984 Deficit Reduction Act, which added a 20 percent excise tax on amounts received by an executive that are in excess of three times a five-year average salary. Although many companies have agreed to pay this tax as part of a manager’s severance package, a corporate deduction is disallowed for the excess payment.

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