Takeover Code The Other Side

The Bhagwati Committee has fixed a low ceiling for both the threshold, when the mandatory public offer is triggered and worse still the scale to which the target company's shares have to be purchased. Thus a mandatory public offer has to be made on crossing 10 per cent of the target company and the public offer need only be for 30 per cent of the target company's shares.

By drawing up such guidelines, the authors of the takeover code have violated one of the most fundamental principles of any system of justice, namely, equality of treatment for all persons, whether they be citizens or shareholders of the same class. A mandatory public offer should not be discriminatory. It must be available to every shareholder and not just to those 30 per cent holders who can get to the offeror's merchant bank first. Clearly, the Bhagwati Committee has designed a takeover code to help those who live in Mumbai. For the citizens of that fair city will certainly be able to offer their shares quicker than citizens of Jodhpur or Jaisalmer, however much the telephone system improves after Mr Sukh Ram's departure. Indeed it must be questionable, in spite of the great judicial authority that any committee chaired by Justice Bhagwati must carry, whether the takeover provisions are constitutional. For under Article 14 of the Indian Constitution, the State is required to provide every person equal protection of the laws within the territory of India. Now under the Bhagwati Committee's guidelines, as a matter of public policy, the offeror has the right to discriminate in its treatment of the same class of shareholders. He can in effect say that for 30 per cent of the shares I will pay 'x' price, which may be twice the market price, but for the rest you must fend for yourself and take your chance in the markets.

I am aware of no country, with similar provisions, where a public offer can be so restricted to a certain percentage. As soon as a mandatory offer is triggered, the offeror is required to make and is bound to accept the same offer to and from all. The Bhagwati Committee must have been aware of the rules applying to both England and America. It, therefore, must have been influenced in its deliberations by the wrongful belief that a takeover requires cash offers and given the difficulty of adequate liquidity in India, any code requiring to make a public offer to the entire class of shareholders, would make hostile takeover extremely unlikely.

In actual practice, however, most takeovers are carried out by means of a combination of cash and shares in the offeror's company. And the cash offer is invariably less valuable than the more attractive offer of shares. This even enables smaller companies to bid for much larger ones because the small company will need only to increase its capital. To give an example, when in the United Kingdom, Guinness bid for Distillers, the market capitalisation of Guinness was only £600 million, while that of Distillers was at least six times that amount. In effect Guinness was only able to bid for Distillers, by making an offer that could be paid by issuing more Guinness stock. Guinness shareholders in effect held a smaller percentage of stock in a much larger company. Guinness shareholders agreed to substantial dilution of their holdings to take over Distillers.

Of course, the takeover code does not make it mandatory to make a cash offer. Indeed, it specifically permits an offer through stock. But that is where the authors got themselves befuddled. For if you can make an offer through stock, there is no liquidity consideration to prevent the mandatory public offer to be made for the entire 100 per cent of the target company's shareholding.

Let us take an absurd hypothetical example to drive home the point. Suppose, I floated a small shell company "" Mulji Incorporated, and let us suppose that my company shares were quoted on the stock exchange at Rs 100. Now let us assume that I launched a takeover for Tisco (I warned you that the example was ludicrous) and I offered every shareholder of Tisco five new shares of Mulji Inc for every one share of Tisco. Now suppose shareholders of Tisco are avid readers of this column and therefore, improbably conclude that I was a business genius. They may well decide we prefer five shares of Mulji Inc to one share of Tisco. At present, Tisco shares are quoted at Rs 200, so a calculating shareholder may say that he will receive shares worth Rs 500 of Mulji Inc, for sacrificing Rs 200 of Tisco stock. After all, the assets of Tisco will now become the assets of Mulji Inc and if in their opinion I can manage Tisco better than its existing managers they will vote for the change.

The only point I make is that it is not necessary to have cash to take over a company. It is therefore imperative that the rule of equality between the same class of shareholders must be preserved. The only logical solution is that any public offer cannot be restricted to a lower percentage than 100. It is perfectly reasonable for the offeror to state that his offer is conditional upon his acquisition of a 50 per cent stake in the target company, but whatever offer is made, it must be available to all shareholders.

In other respects too the takeover code is hopelessly muddled. The Committee could not resist the temptation of interfering with free markets. My frivolous example would never come about because Sebi would want me to show cash, securities etc, before I could proceed. The nanny principle is ever present in the hearts and minds of regulators; and the Bhagwati Committee has played into their hands.

There is one matter where the code has clearly gone too far. It has proposed some unknown test of control for triggering a mandatory offer. But no definition of control has been offered. Suppose, the CEO of a company dies and another takes over, there is a change of control so does that require a mandatory offer?

There are a great many editors and commentators who have been eager to encourage hostile takeovers. I would urge fellow economists not to be deceived into believing that the new guidelines that the Bhagwati Committee has proposed are a great surge forward to freedom of the markets. It has been designed by regulators to give them a greater opportunity to meddle in corporate affairs. It is an illogical and confused draft. Unless it is substantially altered, it is likely to do as much damage to Indian business as Sebi has done to the capital markets of this country.