Sell It or Keep It?

Posted: August 26th, 2021

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Sell It or Keep It?

Question

Suppose you own stock in a company. The current price per share is $25. Another company has just announced that it wants to buy your company and will pay $35 per share to acquire all of the outstanding stock. Your company’s management immediately begins fighting off this hostile bid. Is management acting in the shareholders’ best interests? Why or why not? What possible issues should you consider? Is this an example of an Agency problem?

Part 1

Answer 1

The offer to pay $35 per share, although the anticipated price was $25, is an attractive bid that is equally hostile. However, the reaction among company management is focused on protecting the interests of the company management instead of strategizing in the best way that befits the interests of shareholders. In my opinion, the management is not acting in the best interest of the client. More so, the conflict between them is a clear indication of agency problems. The possible issues evident in this case include the overtaking of the company, probably due to the realization of its profitability. The other company could have realized the benefit that comes with having control of the company. Besides, the company may be competitive on the market; hence having a high stake in its business would guarantee increased profits for the purchasing company. Accordingly, the management should act in disregard of the interest of the principal to avoid losing the company. Thus, although the management is expected to make decisions that maximize the wealth of the shareholders, the management appears focused on strategizing how best they would benefit from the offer. 

Part 2: Responses

Answer 2

I think this is an Agency problem.The hostile bid refers to an attempt to acquire or taking over a company without the acceptance of that particular firm’s management or board of directors, a specific firm’s control, or board of directors.The takeover defense mechanism set by the company’s current administration will not act in the shareholder’s interest. The bidder offers a substantial premium over the current market price of the share of the company to its existing shareholders.The action can be interpreted as the potential profits seen by the bidding company in the company that is being bid upon. Thus, the current management, when providing the takeover advances, does not serve the shareholders with the primary goal of maximizing shareholder wealth.

Response 1

Although the response highlights some of the issues that are a probable reason why the management is arguing amongst each other, it fails to indicate whether there is an agency problem. Besides, there are various reasons for the takeover. It is not only about being profitable. Probably, the purchasing company could be expanding, and through taking over other the company, it will help expand its market share. Thus, it is not conclusive to allude that the possible problem is only about the profitability of the company. 

Answer 2

In my opinion, the announcement of one company to acquire all of the outstanding stock of another company publicly represents a takeover, despite the higher price offered at $35 relative to the market price of $25. This statement stems from the fact that the company has not engaged in negotiations before making the announcement. Furthermore, since the management of the acquiring party has not engaged in any negotiations with the management or shareholders of the target company, the deal is a hostile takeover.

It is natural for the management of the target company to fight off the hostile takeover. Such action may stem from the higher estimated intrinsic value of the company determined by the management relative to the offer made in the hostile takeover.  These circumstances suggest that the management of the target company acts in the interests of the shareholders’ best interests. At the same time, it is necessary to consider that the estimated value of the company. In case it is substantially lower than the offered price, the management is not acting in the best interests of the shareholders.

The agency problem represents a conflict of interest when a particular party is acting against the best interests of another party. In the context of corporate finance, agency problem implies a conflict of interests between the management of a business entity and its shareholders. Thus, the situation of hostile takeover with the management of the target company opposing it does not represent the agency problem, unless the intrinsic value of the firm’s stock is substantially lower than the offer price. 

Response 2

The arguments raised in the response under answer 3 is reasonably exhaustive. The answer acknowledges the fact that the move was a hostile bid that was intentionally offered to facilitate the takeover. Further, the fact that the management is not convinced to continue with the offer indicates that there is an agency problem. The agency problem is exhibited in the fact that the management has to weigh between the shareholders’ interests and the interests of the company, who should both enjoy the rights of maximizing their profits. As such, the case requires pure preceding of one interest in place of the other. Thus, the management would prefer disregarding the shareholder’s interest in place of the company or management.