What are we protecting? - A study of the Swedish regulation of deal protection arrangements
Abstract: The thesis evaluates and examines the effects of the Swedish regulation of deal protection arrangements by looking to the impact of the provision on the Swedish capital market and target shareholders. The foundations of the Swedish takeover regulation are examined by presenting and arguing the relevant provisions in, and relationship between, stock exchange law, corporate law and EU law. Fiduciary duties of target board directors in Sweden, the U.S. and the U.K. are examined. When takeover regulation apply, Swedish target boards are to exclusively observe the collective interest of the shareholders in any action in response to a takeover offer. The shareholders’ interest in a takeover context is determined to be that of maximum return on their investment in relation to the offer and the opportunity to decide on the merits of a bid. Directors of U.S. companies are assigned fiduciary duties and must act in an informed and good faith manner in the interest of the company and its shareholders. These duties apply in a takeover situation and any action in response to an offer must be rational and constitute a reasonable response. Directors of U.K. companies must act in the interest of the company. The duties of U.K. directors in a takeover is to act in the interest of the company vis-à-vis the shareholders, maximize shareholder returns and not deny shareholders the opportunity to decide on the merits of a bid. As for the relationship between fiduciary duties and deal protection arrangements, rule II.17a of the Takeover Rules prohibits Swedish offeree company boards from committing to any offer-related arrangements vis-à-vis an offeror. Although one may be granted an exemption from the provision, that possibility appears severely limited. In the U.S., deal protection arrangements are reviewed under the business judgement rule and ostensibly permissible. However, deal protections may be analogized to defensive measures and subject to an enhanced scrutiny only allowed within certain parameters. The U.K. regime is very similar to the Swedish and Rule 21.2(a) of the Takeover Code prohibits offeree companies to enter into any offer-related arrangements. The rule is a product of a significant legal reform in 2011. This reform provided a unique opportunity to properly examine the effects of deal protection arrangements on target shareholders. Research shows a substantial and economically significant decline in deal volume in the U.K. after the prohibition was introduced. Moreover, there seems to have been no obvious equipoising benefits to target shareholders. The implications of the U.K. research are supported by research on break fees in the U.S. and Australia. The research on break fees suggests that such arrangements positively affect shareholder wealth by improving deal completion rate and facilitating larger premiums. However, it also shows that the beneficial properties of break fees are dependent on the size thereof. Rule II.17a of the Swedish Takeover Rules is analyzed on the background of the economic research and regulation in the U.S. and U.K. The conclusion is drawn that deal protection arrangements appear to benefit target shareholders by promoting ex ante deal initiation and competing bids to a larger extent than it deters ex post competitive bidding. Prohibiting deal protection arrangements does not seem to yield higher premiums for target shareholders. Absolute prohibitions of deal protection arrangements appear to obstruct effective competition in the market and subsequent efficient allocation of resources, causing welfare losses. It is consequently doubtful if the Swedish prohibition strengthens target boards’ negotiating position, is beneficial to shareholders or promotes a competitive takeover market. The adoption of a U.K. style of takeover regulation appears misguided as takeovers of Swedish listed companies appear more difficult than in the U.K. due to a larger presence of controlling shareholders. A U.K. style of regulation in Sweden may therefore have unforeseen detrimental effects when taking into account differences in ownership structures and market resiliency. Prohibiting deal protection arrangements may also promote a quantitative increase in irrevocables which may contribute to agency problems between minority and majority shareholders in Swedish companies. Such an increase may prove detrimental to the competitiveness of, and increase transaction costs on, the Swedish market. The possibility of being granted an exemption to rule II.17a of the Takeover Rules does seemingly little to mitigate the potential detrimental effects. All things considered, the analysis suggests that rule II.17a of the Takeover Rules does not improve competitive conditions, promote target shareholder value or strengthen target boards. The prohibition is therefore unwarranted as overall economic welfare would be improved under a less intrusive regulatory regime. It is suggested that a reversion to the previous regime where deal protection arrangements are allowed if they are in the interest of the shareholders may prove more beneficial for Swedish shareholders. In circumstances where market regulation is necessary, regulation that promotes the efficient allocation of resources should be favored, unless otherwise justified with regards to protective interests. As the prohibition does not seem to fulfill the outlined purposes, it should be evaluated on the basis of its actual effects. The provision therefore appears sub-optimal. Although a reversion would create new problems, these appear insignificant compared to the negative economic effects of the current regime.
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