Variety of studies shown that hostile takeovers actually are efficient

By Alla Gul (MBA) – Our Contributor

“Hostile takeover usually involves a public offer of a specific price, usually at a substantial premium over the prevailing market price, for a substantial percentage of the target firm’s stock” (Jarrell, n.d.).  This type of takeover is called hostile because it goes against the wishes of the target company’s management and board of directors.  Hostile takeovers are often seen as inefficient and undesirable. On the other hand, as Lee and McKenzie (2006) stated, there is plenty of evidence that the shareholders of the target company in a hostile takeover realize large gain.

Constant fear of takeover can hinder growth and stifle innovation, as well as generating fears among employees about job security.

Who Benefits from a Hostile Takeover?

Critics of takeovers state that these gains ignore the economic loses that takeovers impose on other groups connected with the target firms (Jarrell, n.d.). However it has been shown in a variety of studies that hostile takeovers actually are efficient. At the same time, even if it is accepted that hostile takeovers are generally efficient, there still should be corporate defenses against such takeovers (Lee & McKenzie, 2006). Among the most common reasons for defense are the desire to retain autonomy or management control, the preference for an alternative partner, and the desire to negotiate a more favorable financial takeover (Pearce & Robinson, 2004). Opposing hostile takeovers, managers of target companies have access to a variety of anti-takeover defensive strategies. The efficiency of hostile takeovers and several anti-takeover defensive strategies are discussed in the sections below.

The efficiency of takeovers

Takeover bids increase the wealth of the corporation’s stockholders significantly (Lee & McKenzie, 2006). But what about other parties involved?

First, critics of hostile takeovers argue that the acquiring corporation often bids too much and loses in the deal. However, Lee and McKenzie (2006) have shown that for the acquiring corporation’s stockholders, their wealth is not greatly affected since “the winning bid for the stock of a corporation targeted for a takeover will fairly accurately reflect the value of that corporation to the winner” (p.510).

Second, also unsupported is the charge that losses to bondholders finance the shareholder gains from takeovers (Jarrell, n.d.). According to several studies mentioned by Lee and McKenzie, takeovers do not impose losses on bondholders, and “…any losses to bondholders do not come anywhere close to offsetting the gains to stockholders” (2006, p. 511). Considering shareholders of bidding firms, “…the studies that find net losses from bidders also show that these losses – at 1 to 3 percent of the stock price – are minuscule compared with the enormous gains to target shareholders” (Jarrell, n.d.).

Next, there is also an opinion that the constant threat of hostile takeover forces corporate managers to stress short-term policies at the expense of more valuable long-term plans, “thereby impairing the economic health and competitive vigor of their companies and the nation” (Jarrell, n.d.). However, the research has shown that the threat of a hostile takeover is not a reason for managers to become short-sighted. Moreover, making decisions that increase the long-term profitability of the firm even if those decisions temporarily reduce profits is the best protection against a takeover (Lee & McKenzie, 2006).

What Yahoo has, Microsoft wants, but Yahoo continues to play hard to get. Even as talks start, stop, and sputter, the two companies still face a formidable foe in Google--and many questions about what they'll do next.

Microsoft’s hostile bid for Yahoo

Also, after a corporation is taken over, often it is broken up as the acquiring firm sells off divisions, often ones that have been profitable. And, therefore, as critics of takeovers state, takeover is disruptive and inefficient. However, multiple examples have proven that by spinning off some of the acquired firm divisions, its total value often increases (Lee & McKenzie, 2006).

To continue, there is a claim made that although stockholders gain from takeovers, they do it at the expense of workers being laid off. But the fact that workers are laid off after hostile takeovers is consistent with the view that these takeovers promote efficiency (Lee & McKenzie, 2006). Lee and McKenzie (2006) further argued that one of the advantages of the market for corporate control is the increased pressure on managers to keep the size of their workforce under control. In addition, most of the harmed workers are not necessarily made worse off by the system that encourages takeovers. “Workers harmed in the case of their firm’s takeover can receive offsetting benefits from the efficiency improvements they, the workers, realize through the lower price of the goods they buy” (Lee & McKenzie, 2006, p.515).

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Takeover defenses



They can be classified into two categories: preventive and reactive. Preventive strategies are taken by executives to make the firm less attractive as an acquisition target. Reactive strategies are used when a hostile takeover has begun because the particular suitor is not wanted (Pearce & Robinson, 2004). Poison pills and golden parachutes are examples of preventive defenses’ forms, and greenmail and litigation are the forms of reactive anti-takeover defenses.

A poison pill is a very effective way for managers of a corporation to defend against a takeover. It is a defensive strategy that allows shareholders of the target firm to acquire additional shares at attractive prices to dilute the stockholdings of the acquiring corporation causing attacking firms to lose money on its investment (Lee & McKenzie, 2006). Based on results of several studies, the poison pill is a highly popular and effective defensive strategy and may be beneficial to the target firms (Pearce & Robinson, 2004). However, as Lee and McKenzie (2006) have stated, studies indicate that they are in general harmful to the wealth of the target corporation’s shareholders.

Golden parachutes are another form of defensive strategy. Golden parachutes are special, valuable compensation packages that are distributed to a selected group of executives ‘if a pre-specified threshold of outside stock ownership is acquired in a takeover bid” (Pearse & Robinson, 2004, p. 19). Lee and McKenzie (2006) have pointed out that golden parachutes reduce management opposition to takeover bids that benefit shareholders. They can also encourage executives to take greater risks, “given that they know that they will receive a significant severance-pay package if the risks they take result in losses and they lose their jobs” (Lee & McKenzie, 2006, p.517). However, as Lee and McKenzie (2006) continued, ” There is at least tentative support for the proposition that that golden parachutes, across a range of companies, tend to promote the interest of shareholders… by bringing the interests of top managers more in line with those of their shareholders ” (p. 517). Moreover, according to Pearce and Robinson (2004), many studies have indicated that golden parachutes have low effectiveness as a defense strategy and have negligible effects on stockholder wealth.

The next strategy, greenmail, involves repurchasing the shares of stock that have been acquired by the aggressor at a premium in exchange for an agreement that the aggressor will no longer target the company for a takeover (Pearse & Robinson, 2004). Some studies suggest that greenmail can result in small gains for the repurchasing firm’s shareholders. However, any gain to shareholders may encourage others to attempt a takeover (Lee & McKenzie, 2006). Other studies indicate that greenmail has medium effectiveness as a defense strategy and that the effect of greenmail payments on shareholder wealth is generally negative (Pearce & Robinson, 2004, p.21). In addition, Lee and McKenzie (2006) concluded that paying greenmail consistently does not promote the long-run profitability of a firm.

Finally, litigation is a defensive strategy that involves pursuing a legal sanction and restraining order against a pursuer to block that company from acquiring additional stock until the pursuer can prove that that justification for the injunction is unfounded. Litigation is often undertaken to extend the negotiation period so that more attractive offers can be solicited and/or to insure a higher probability of a successful takeover (Pearce & Robinson, 2004). In general, according to a number of studies, the strategy has low effectiveness as a defense mechanism against takeover but has a positive wealth effect for stockholders (Pearce & Robinson, 2004)

To summarize, some individuals and groups do lose in any takeover. However, “The empirical studies offer little or no support for the notion that the huge gains to shareholders reflect similarly large loses to related parties…On average, takeovers reflect wealth-enhancing and socially valuable redeployment of corporate recourses…  Huge gains to target shareholders created large net economic gains”( Jarrell, n.d.).

At the same time, even if it is accepted that hostile takeovers are generally efficient, there still should be corporate defenses against such takeovers (Lee & McKenzie, 2006). It is difficult to define what the best means to protect a corporation against hostile takeover are. Strategies vary in their efficiency and effectiveness. However, “The best defense is efficient management that provides shareholders with a competitive return on their investment” (Lee & McKenzie, 2006, p.516).

The main consequence of a bid being considered hostile is practical rather than legal. If the board of the target cooperates, the bidder can conduct extensive due diligence into the affairs of the target company. It can find out exactly what it is taking on before it makes a commitment. But a hostile bidder knows only publicly-available information about the target, and so takes a greater risk. Also, banks are less willing to back hostile bids with the loans that are usually needed to finance the takeover. However, some investors may proceed with hostile takeovers because they are aware of mismanagement by the board and are trying to force the issue into public and potentially legal scrutiny


Jarrell G. Takeovers and leveraged buyouts. The Concise Encyclopedia of Economics. Retrieved on November 5, 2007 from

Lee, D.R. & McKenzie, R. B. (2006). Microeconomics for MBAs. New York.

Cambridge University Press

Pearce. J & Robinson. R. (2004). Hostile takeover defenses that maximize shareholder wealth. Business Horizons. 47/5, pp.15-24

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What Is the Prisoner’s Dilemma? What is Game of Strategy?

What Is the Prisoner’s Dilemma?

Game of Strategy in Social Science. Prisoner dilemma: a study in conflict and cooperation.
Game theory is a branch of applied mathematics that is used in the social sciences, most notably in economics, as well as in biology, engineering, political science, international relations, computer science, and philosophy.

Game theory attempts to mathematically capture behavior in strategic situations, in which an individual’s success in making choices depends on the choices of others. While initially developed to analyze competitions in which one individual does better at another expense (zero sum games), it has been expanded to treat a wide class of interactions, which are classified according to several criteria. Today, “game theory is a sort of umbrella or ‘unified field’ theory for the rational side of social science, where ‘social’ is interpreted broadly, to include human as well as non-human players (computers, animals, plants)” (Aumann 1987).

Traditional applications of game theory attempt to find equilibrium in these games. In an equilibrium, each player of the game has adopted a strategy that they are unlikely to change. Many equilibrium concepts have been developed (most famously the Nash equilibrium) in an attempt to capture this idea. These equilibrium concepts are motivated differently depending on the field of application, although they often overlap or coincide. This methodology is not without criticism, and debates continue over the appropriateness of particular equilibrium concepts, the appropriateness of equilibria altogether, and the usefulness of mathematical models more generally.

Nash equilibrium

Nash equilibrium

In game theory, Nash equilibrium (named after John Forbes Nash, who proposed it) is a solution concept of a game involving two or more players, in which each player is assumed to know the equilibrium strategies of the other players, and no player has anything to gain by changing only his or her own strategy unilaterally. If each player has chosen a strategy and no player can benefit by changing his or her strategy while the other players keep theirs unchanged, then the current set of strategy choices and the corresponding payoffs constitute a Nash equilibrium.

Prisoner’s dilemma: a study in conflict and cooperation.

The Prisoner’s Dilemma is the best-known game of strategy in social science (Dixit & Nalebuff, n.d.). This dilemma represents a common problem in achieving cooperation in any number of social settings. The dilemma “illustrates the tendency toward noncooperative behavior, despite general advantage from cooperation” (Lee & McKenzie, 2006, p.233). The Prisoner’s Dilemma classic game scenario as well as several related real world situations is presented below.

The prisoners’ dilemma is a well-known problem in game theory.

The prisoners’ dilemma is a well-known problem in game theory.

In a classical game, two people are apprehended as suspects for a major crime. They are separated from each other and interrogated. There are two options available to each of the two suspects. Each can either confess, thereby implicating the other, or keep silent. No matter what the other suspect does, each can improve his own position by confessing. If the other confesses, then one had better do the same to avoid the especially harsh sentence that awaits a recalcitrant holdout. If the other keeps silent, then one can obtain the favorable treatment accorded a state’s witness by confessing. Thus, confession is the dominant strategy for each. But when both confess, the outcome is worse for both than when both keep silent (Dixit & Nalebuff). However, each prisoner chooses to defect even though both would be better off by cooperating, hence the dilemma. In the classic form of this game, no matter what the other player does, one player will always gain a greater payoff by playing defect. Since in any situation playing defect is more beneficial than cooperating, all players will play defect, all things being equal .However, it should be noted that multiple repetition of the game will lead to different results (“Prisoner’s Dilemma”, n.d.).

The Prisoner’s Dilemma has applications in business and economics.

Example 1

Suppose there are two firms, A and B, selling similar products. Each has to decide on a pricing strategy. Both firms are better off when they both charge a high price; each makes a profit of $10 million per month. However, if one firm cheats and sells its product for lower price, it wins a lot of customers from the competitor. Assume its profit rises to $12 million, and the competitor’s profit fall to $7 million. If both set low prices, the profit of each is 9 million. In this situation, the low price strategy is like the prisoner’s confession, and the high price strategy equals to keeping silent. If we call the low price strategy cheating, and the latter cooperation, then cheating is each firm’s dominant strategy. However, the result when both cheat is worse for each than if both firms were to cooperate (Dixit & Nalebuff, n.d.).

Example 2

Lee and McKenzie (2006) gave an example of a Prisoner’s Dilemma game with respect to the healthcare decisions we make. An employer typically buys insurance policies with low deductibles. This feature of insurance policy has encouraged excessive use of healthcare services. This, in turn, drives employee’s insurance premium up. As a result, some workers can not afford to have the insurance anymore. We are in a Prisoner’s Dilemma with respect to our healthcare decisions. Collectively, we would be better off if we all moderated the amount of health care services. But because of insurance and government subsidies, it is in the interest of each of us to ignore most of the cost when we choose how much healthcare to demand (Lee & McKenzie, 2006).

Example 3

An example of a real world situation we have been observing for a number of years is the use of performance-drugs in professional sports, particularly those that are forbidden by the organizations that regulate competitions. For example, the 2007 Tour de France was rocked by a series of doping scandals.

  • Pre-race favorite Alexander Vinokourov (Kazakhstan) tested positive for blood doping after winning the Stage 13 .The incident led his  Astana Team  to quit the Tour after Stage 15.
  • Cristian Moreni (Italy) tested positive for testosterone after Stage 11. When his positive test was announced after Stage 16, his entire  Cofidis (cycling team) team pulled out of the Tour. Moreni acknowledged his offense, choosing not to have his B sample tested. He was detained by French police, who searched the hotel rooms where the Cofidis team was to spend the evening after Stage 16.
  • After the end of the Tour, it was revealed that Spanish rider Iban Mayo  tested positive for EPO late in the race. (“Doping in Sport”)

Doping is considered to be unethical by most international sports organizations and especially the International Olympic Committee “…because of the health threat of performance-enhancing drugs, the equality of opportunity of the athletes and the exemplary effect of “clean” (doping-free) sports in the public” (“Doping in Sport”). Moreover, there are disciplinary actions employed against athletes tested positively on the doping drugs usage. However, using drugs in professional sports continues because of the strong incentive. It is a classic Prisoner’s Dilemma (Scheiree n.d.). To illustrate, Schneier (2006) gives the following example:

Suppose there are two competing athletes: Alice and Bob. Both Alice and Bob have to individually decide if they are going to take drugs or not. Imagine Alice evaluating her two options: “If Bob doesn’t take any drugs,” she thinks, “then it will be in my best interest to take them. They will give me a performance edge against Bob. I have a better chance of winning. Similarly, if Bob takes drugs, it’s also in my interest to agree to take them. At least that way Bob won’t have an advantage over me. So even though I have no control over what Bob chooses to do, taking drugs gives me the better outcome, regardless of his action.” Unfortunately, Bob goes through exactly the same analysis.

As a result, both athletes cheat, taking performance-enhancing drugs and neither has the advantage over the other. If they could trust each other, they could abstain from taking the drugs and maintain the same non-advantage status. They both would be better off since they would escape any legal or physical danger. But competing athletes can’t trust each other, and everyone feels he has to dope in order to compete (Schneier, 2006).

As Lee and McKenzie (2006) have pointed out, “Overcoming Prisoner’s Dilemmas is a pervasive problem in the development of social and management policies” (p.41). Studying principles of the game theory and its application to business will assist managers in choosing the most effective business solutions.

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Dixit, A. & Nalebuff, B. Prisoners’ dilemma. The Library of Economics and Liberty. Retrieved November 8, 2007 from

Doping in sport. Wikipedia. Retrieved November 7, 2007 from

Lee, D.R. & McKenzie, R. B. (2006). Microeconomics for MBAs. New York.

Cambridge University Press.

Prisoner’s dilemma. Wikipedia. Retrieved November 8, 2007 from’s_dilemma

Schneier, B. (2006). Drugs: Sports’ Prisoner’s Dilemma. Retrieved November 8, 2007 from

Related article:

Mike Shor’s lecture notes for a course in Game Theory taught at the Owen Graduate School of Management at Vanderbilt University. Page contains links to lecture notes and supporting materials


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