2. STATUS QUO AND THE NATURE OF THE PROBLEM

Takeovers: the market for corporate control

9. The market for company shares can be thought of as containing two segments: a market for corporate control and a market for risk-return spread.
10. The threat of attempts to purchase assets that bidders judge to be underperforming is a critical factor in overcoming the agency problems that stem from the separation of ownership (i.e., by the shareholders) and management (i.e., by the company's executive and Board) in companies. The activity of assessing the value of companies and buying and selling controlling stakes contributes to efficiency.
11. Those selling and buying controlling stakes (or shares more generally) are assumed to want to maximise their own welfare. On the basis of the available information, bidders have convinced themselves (and often their financers and other backers) that by taking a risk they can improve the earnings of the assets. If they are right the improved performance would benefit them and any other shareholders. Current shareholders can go along for the ride (if the bid is for partial control). Or they can sell their shares if they are happy to accept the offer, for example if they want to realise their investment at the offer price, or if they believe the successful bidder would do worse than the incumbents. The ability to freely buy and sell shares and the availability of good information (a competitive market) are thus important safeguards to efficiency.
12. It is important to understand the significance of the issues canvassed in this paper and the context in which they are made. Cameron Partners, in a submission dated 31 July 2006 in response to the Panel's June 2006 discussion paper, said:
    
    The market for corporate control is a vital element in ensuring the resources of the economy are maximised for the benefit of all New Zealanders. Harvard economist Michael C Jensen put it this way:

"The market for corporate control that has arisen in the last two decades is generating large benefits for shareholders and for the economy as a whole. The corporate control market generates these gains by loosening the control over vast amounts of resources and making it possible for those resources to move more quickly to their highest value use...The market for corporate control is best viewed as a major component of the managerial labour market. It is an arena in which alternative management competes for the rights to manage corporate resources." Jensen, The Efficiency of Takeovers, The Corporate Board, September/October 1985, pp 16-22.

In the absence of a strong market for corporate control, sub-performing management teams become entrenched, key assets of the economy are poorly managed and all New Zealanders as well as shareholders suffer.

13. The market for shares includes the participation of those who are primarily interested in maximising investment returns and achieving the best risk-earnings portfolio. These participants tend to rely on remote strategies, such as tracking market announcements and the ability to buy and sell freely to manage their returns. The Panel, guided by the statutory objectives underlying the formulation of the Code, sees a change of corporate control as a significant event in which all shareholders should have the opportunity to participate.
14. Bids can proceed using various strategies. The bidders seeking control can offer an appropriate price to all, or can seek out those with a controlling holding and negotiate a price with them. In either case the share price offered may be different from that previously prevailing. Other strategies are possible.
15. The shareholders of a target company may include many small investors. Acquiring the shares of this group may prove to be an expensive exercise as it can be difficult to locate and negotiate with them individually. A takeover bidder may economise by confining the offer to those holding a controlling stake. That offer may be significantly above the prevailing price, as it is motivated by a belief that the bidder can make better returns than the current management team or direction.
16. As this document sets out, problems can arise when, during or following a change in corporate control, shareholders have no opportunity for an alternative exit when their shares are compulsorily acquired, or when they are not given the opportunity to participate in decisions about a change in control.

Background to the Takeovers Panel and Takeovers Code

17. At various times concerns have been raised about the use of different procedures that regulate the change in control of companies. Before the Takeovers Code was introduced, there was considerable concern about how this impacted on shareholders' and local and international investors' confidence in the integrity of the New Zealand market.
18. Prior to the introduction of the Code, with some exceptions for listed companies, control of companies could pass, through the sale of the shares of one controlling shareholder to another. This could occur without the knowledge or participation of the minority shareholders.
19. The Takeovers Act was passed in 1993. The provisions of the Code were introduced in 2000 and came into force in July 2001.
20. The functions of the Takeovers Panel, established under the Takeovers Act, are:
    1. to keep under review the law relating to takeovers of specified companies and to recommend to the Minister any changes to that law it considers necessary
    2. to keep under review practices relating to takeovers of specified companies
    3. to investigate any act or omission or practice for the purpose of exercising its powers under the enforcement provisions of the Act
    4. to make determinations and orders and make applications to the Court under the enforcement provisions of the Act
    5. to co-operate with any overseas regulator
    6. to promote public understanding of the law and practice relating to takeovers.
21. The Panel routinely monitors the takeovers market, in the performance of the Panel's statutory functions, in order to determine whether to exercise its powers. The powers of the Panel, set out in Part 3 of the Takeovers Act 1993 are:
    1. to issue summonses and to take evidence on oath
    2. to carry out inspections and obtain evidence at the request of overseas regulators
    3. to make confidentiality orders
    4. to accept undertakings that are enforceable by the Courts
    5. to inspect documents, and to authorise the Registrar of Companies or any other person to undertake inspections
    6. to grant exemptions from the Code
    7. to enforce the Takeovers Code by making determinations, issuing restraining orders, and applying for Court orders.
22. More information about the Code and the Panel can be found at www.takeovers.govt.nz, in its Statement of Intent and in its Annual Reports.

Status quo

23. Companies that have voting securities listed with a registered exchange or have 50 or more shareholders are 'Code companies' which are subject to the specific protections, provisions and procedures of the Takeovers Code. The fundamental rule of the Code (rule 6) prohibits changes in control arising from the increase in the holding or controlling (together with associates) of more than 20% of the voting rights in a Code Company. The fundamental rule is subject to a limited number of exceptions set out in rule 7. These exceptions have the effect of permitting changes of control which may arise from the increase in the holding or control of voting rights above the 20% level. These exceptions may take the form of Code compliant offers (which may be partial or full offers), selective acquisitions or allotments.
24. The reconstruction provisions of the Companies Act also provide mechanisms which can be used to effect a change of control of a company.
25. An amalgamation under Part 13 of the Companies Act permits two or more companies to combine to form one company, following a meeting of shareholders in each amalgamating company. Combining of the companies may effect a simple pro rata merger of all the shareholding interests. Alternatively, it may be structured to effect a change in the control of the shareholding interests, resulting in a non-pro rata outcome where one or more shareholders increase their control position in the amalgamated company, resulting in the rest having their control positions reduced or even the complete exit of the company by the other shareholders. The amalgamation may be structured so that the Code company will be removed from the Companies Office Register and the "acquiring" shareholder will continue as the holder of shares in an entity that is not a Code company. Such changes of control do not appear to have consequences under the Code.¹ Recent examples of such amalgamations include the amalgamation of Waste Management New Zealand Limited (Waste Management) and Transpacific Industries Group (Transpacific), and the amalgamation of Humanware Limited (Humanware) and Jolimont Capital (Jolimont).
26. An amalgamation, or some other restructuring of a group of companies, can also be undertaken under the "scheme" provisions of Part 15 of the Companies Act. Under a Part 15 scheme, the succeeding company effectively acquires one or more other companies. Schemes are approved by the Court. A scheme of arrangement under Part 15 of the Companies Act, as with an amalgamation under Part 13, will only have Code consequences if it results in a person becoming the holder or controller of more than 20% of the voting rights in a Code company during the reconstruction process or after the scheme has taken effect. If a scheme is structured so that no person becomes the holder or controller of voting rights in the Code company, the Code will not apply. An example of such a scheme was the merger of Independent Newspapers Limited and Sky Network Television Limited, through a new company that was formed to effect the scheme.
27. The Panel may grant an exemption from the Code's requirements in relation to the elements of a scheme which may be captured by the Code and in respect of which an exception under rule 7 is not available. A focus of concern for the Panel in granting such exemptions (which will be reflected in the conditions attached to the granting of the exemption) relates to the information to be provided to shareholders and to the shareholder voting approval thresholds. The Panel's policy on exemptions for schemes is available at www.takeovers.govt.nz .
28. An additional layer of regulation is also involved for companies listed on registered exchanges such as New Zealand Exchange Limited (NZX). Listed companies also have to comply with the Securities Markets Act's continuous disclosure requirements and the Securities Act's prospectus and investment statement disclosure requirements for offers of securities.
29. When listed companies are involved in takeovers, schemes or amalgamations, the NZX:
    1. reviews meeting notices for schemes and amalgamations to ensure that shareholders have information in a readable and understandable form
    2. monitors the disclosures required to be made under the Listing Rules
    3. suspends trading in the stock 5 days after a compulsory acquisition notice has been sent to outstanding shareholders
    4. deals with applications for waivers and with complaints of breaches of the Listing Rules.
30. In addition, the Securities Commission (which is established under the Securities Act) has an oversight role in respect of offer documents and market practices that might mislead securities markets participants.
31. The following table compares the key features concerning changes in control under the Code, and Parts 13 and 15 of the Companies Act.

Footnote

1. Such changes of control will only have Code consequences if the amalgamated company becomes a Code company (i.e., it will be listed or will have 50 or more shareholders) and the manner in which amalgamation is structured results in a person becoming the holder or controller of more than 20% of the voting rights in the amalgamated company.