498 17 Duties of the Board in the Context of Takeovers
agent hypothesis) and its managers who only want to remain in control (the management
entrenchment hypothesis).^43
17.4 Takeover Defences and the Interests of the Firm
The share ownership structure of the firm belongs to the strategic choices the
firm’s survival depends on. In addition, managing the firm’s debt-to-equity ratio is
one of the most important ways to manage the firm’s risk level. A takeover can
change both. A takeover results in a new share ownership structure. Takeovers
tend to result in high leverage, because takeovers like LBOs are typically financed
from the cash-flow of the target (Chapter 20).
From the perspective of the firm, the use of takeover defences is a legitimate
way to manage its share ownership structure and leverage, and to protect its corpo-
rate strategy. In short, it is a legitimate form of corporate risk management.
The target’s board can weigh the costs and benefits of the potential takeover,
the costs and benefits of using takeover defences (for takeover defences, see
Chapter 18), and the costs and benefits of permitted financial assistance (for fi-
nancial assistance, see section 20.4). (a) For example, the firm might benefit from
having a certain controlling shareholder in some respects (for the function of
shareholders, see Volume I). On the other hand, the benefits do not necessarily
outweigh the cost of increased indebtedness (in an LBO, the target will end up re-
paying the loans) and the increased cost of equity capital (some acquirers like pri-
vate-equity funds require large distributions). (b) It is also possible that the firm
can achieve the same benefits without changing its existing share ownership struc-
ture. For example, the firm can choose its optimal debt-to-equity level. (c) The
target’s board can also choose to reduce the cost of the takeover by causing the
company to give permitted financial assistance when the board believes that it is
in the interests of the firm to do so (section 20.4).
The legitimacy of the firm’s interest to use takeover defences has been recog-
nised not only in Delaware where the Unocal standard applies, but also in Com-
munity law (but neither in the London market nor in legal science).
As explained above (section 17.2 and Volume I), the duty to further the inter-
ests of the firm belongs to the most important duties of the board. The corporate
bodies of the firm are expected to decide what to organise internally and when to
rely on the markets.^44 Possibly apart from the situation when the Revlon test ap-
plies,^45 there is no reason to disapply the general rules on directors’ duties just be-
cause somebody wants to take over the company or its business.^46 The board
(^43) See, for example, Barboutis GO, Takeover Defence Tactics: Part I: The General Legal
Framework on Takeovers, Comp Lawyer 20(1) (1999) pp 14–22.
(^44) Coase R, The Nature of the Firm, Economica, New Series, Vol. 4, No. 16 (Nov. 1937)
pp 386–405.
(^45) Revlon Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d at 173 (Del. 1986).
(^46) See also Merkt H, Verhaltenspflichten des Vorstands der Zielgesellschaft bei feindlichen
Übernahmen, ZHR 165 (2001) pp 225 and 245.