The Hidden Virtue of Antitakeover Defenses

Although corporate takeover literature discusses the pros and cons of takeover defenses quite thoroughly, it fails to explain the wide divergence in actual takeover practices. Recent empirical studies reveal that while some IPO stage firms do not adopt defenses, a significant number use a variety of antitakeover strategies (Daines & Klausner 2001, Coates 2000 and Field & Karpoff 2000). Moreover, none of the tests conducted in these studies revealed any relevant difference between adopting and non-adopting firms. The purpose of this paper is to shed light on the findings of these empirical studies, while demonstrating that there may even be rational divergence of antitakeover practices among similar firms. The potential advantage in antitakeover charter provisions, which can guarantee higher premiums to shareholders in the event of a takeover, is eroded by the adoption of defenses by multiple targets. The reason for this is that bidders prefer to buy unshielded targets, if all other factors are equal, since they are less expensive. Like the increased risk of burglary to one's apartment when a neighbor installs bars on his windows, the greater the likelihood that unshielded targets will enjoy takeover events as the ratio of shielded targets in a market increases. The diversion of takeover activity toward unshielded firms, which seemingly is a hidden virtue of takeover defenses, provokes an evolutionary process that could explain the divergence of antitakeover practices among firms.