T.C.

MARMARA UNIVERSITY
INSTITUE OF SOCIAL SCIENCES
SCHOOL OF BUSINESS
ACCOUNTING-FINANCE (Ph. D)

STRATEGIC FINANCIAL PLANNING AND

MODELLING
Prof. Dr. ALİ OSMAN GÜRBÜZ

CORPORATE GOVERNANCE: AFFECTS OF TENDER

OFFERS AND CSR
GÖKBERK CAN
INTRODUCTION......................................................................................................................3
1. THE BASICS OF CORPORATE GOVERNANCE..............................................................3
2. SHAREHOLDERS' RIGHTS, VOTING AND CONTROL..................................................5
3. WHAT IS CORPORATE SOCIAL RESPONSIBILITY AND ITS AFFECT ON MARKET
VALUE.......................................................................................................................................6
4. TENDER OFFERS...............................................................................................................11
CONCLUSION.........................................................................................................................14
REFERENCES..........................................................................................................................14

2
INTRODUCTION

Corporate governance is not only a set of internal controls and policies for the public
companies. It affects companies’ way of doing business and on these days it is percieve as a
perspective part on social activities. Companies’ decisions on mergers and acquisitions,
recieved tender offers and responding to these actions are although decided in board of
directors, it takes a place in the companies’ governance. In this study, I did a research on three
respective parts of corporate governance application.

Corporate governance reforms are occurring in countries around the globe and potentially
impacting the population of the entire planet. In developing countries, such reforms occur in a
larger context that is primarily defined by previous attempts at promoting "development" and
recent processes of economic globalization. In this context, corporate governance reforms (in
combination with the liberalising reforms associated with economic globalization), in effect
represent a new development strategy for third world countries. (Reed, 2002, p. 223)

1. THE BASICS OF CORPORATE GOVERNANCE

The modern corporation is a complex organization of interlocking relationships. For

publicly held companies, one of the most important relationships is between the owners and
managers of the firm. This relationship is a classic example of the principal-agent relationship
and is characterized by a potential misalignment of goals where the agent may behave in his
own interest instead of acting in the principal’s interest. (Swanstrom, 2006, 115) The
financing decision is important from a corporate governance perspective because the financial
contracts written btween the company and the suppliers of capital establish who controls the
company and how this control changes if the corporation fails to honor its financial
obligations. Just as important, these contracts are used to mitigate conflicts of interests among
the stakeholders of the firm. (Kaen, 2003, 90)

The OECD Principles of Corporate Governance were originally developed in response

to a call by the OECD Council Meeting at Ministerial level on 27–28 April 1998, to develop,

3
in conjunction with national governments, other relevant international organisations and the
private sector, a set of corporate governance standards and guidelines. Since the Principles
were agreed in 1999, they have formed the basis for corporate governance initiatives in both
OECD and non-OECD countries alike.(OECD, 2004, 9)

A firm’s corporate governance structure can be used to reduce the total agency costs of
a firm through the monitoring of management actions and by aligning the managers’ self-
interests with those of shareholders. (Swanstrom, 115) The separation between ownership and
management opens the possibility of insider abuse. The use of rules, incentives (e.g. implicit
or explicit contracts), and monitoring is designed to align the interests of agents with the
desires of principals and thus minimize the potential for insider abuse and mismanagement.
Without effective control, decision-makers in the firm might be tempted to take actions that
deviate from the interests of residual claimants. (Manet, 2008, 14)

Corporate governance is about how the suppliers of capital make sure that they earn a
return on the funds placed under the control of managers and make sure that the managers and
other stakeholders don’t take the money and run. (Kaen, 2003, p. 90) In theory, corporate
governance is designed to play a major role in protecting the interests of the investors. In
fulfilling those interests (i.e., presumably realizing and sustaining share value), good
corporate governance uses two complementary mechanisms: monitoring and incentives. Both
mechanisms aim to prevent financial damage that can arise due to potential conflicts of
interest between managers and shareholders.(Adam and Schwartz, 2009, 226)

Corporate governance involves external and internal mechanisms. External

mechanisms essentially concern the market for corporate control in which, in theory,
underperforming management are disciplined and replaced following a successful hostile
takeover bid. Internal governance mechanisms relate to the panoply of incentive and control
mechanisms associated with board share ownership, board composition and external
blockholdings of shares. (Weir and Wright, 2006, 289)

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2. SHAREHOLDERS' RIGHTS, VOTING AND CONTROL

“To my mind there is no such thing as an innocent purchaser of stocks.” Supreme Court
Justice Louis D. Brandeis (Monks and Minow, 2004, 127)

One striking characteristic of the modern corporation is its widely distributed

ownership. According to the neoclassical theory of the firm, such ownership simply reflects
the efficient sharing of risk across a large number of individual shareholders. Through
shareholders hold control rights to the firm in addition to their financial claim, these control
rights have no value since there is no conflict regarding the production decision: profit
maximization is unanimously supported by all shareholders. (DeMarzo, 1993, 713)
Shareholders are the owners of a public corporation, a fictitiously created person which is run
by a hired manager to serve first and foremost the interests of the shareholders. The separation
of ownership (i.e., shareholders) and control (i.e., executives, managers, and directors)
weakens the owners’ ability to effectively monitor the firm. (Adam and Schwartz, 229)

The reality of the modern public corporation is much different from this neoclassical
picture, however. One important source of conflict within the firm is that managers, who
actively control the firm, may have different incentives than the shareholders. A large
literature has developed exploring this source of conflict and the agency costs inherent in the
relationship between owners and managers. (DeMarzo, 713) Stockholders are aware of these
conflicts of interest. Therefore, shareholders seek ways to limit managerial discretion over the
use of free cash flow and reduce agency costs. One way to remove managerial control over
free cash flow is to use debt financing. With debt financing, more cash is needed for interest
and principal payments; therefore, there is less cash available for growing the firm at the
expense of the shareholders. (Kaen, 98)

Managers can do two things with current year’s earnings: They can distribute them as
cash dividends, or they can retain them in the company. If the earnings are retained,
management can use them to make additional investments or to pay down debt. The decision
to pay down debt is part of the financing decision and is connected to the notion of an optimal

5
capital structure and solving governance problems through the financial structure decision.
(Kaen, 2003, 106)

The vote is a basic right of share ownership, and is particularly important given the
division of ownership (shareholders) and control (directors) in the modern corporation. The
right to vote can be seen as fundamental for some element of control by shareholders. (Mallin,
2001, 119) There are problems with the use of voting power indices in that they conflate
preference with power, and power with influence. The voting power of an individual is
measured in the power index literature in terms of the critical importance of that individual
for coalitions to form or survive. No account is taken about how much the person may wish to
be in one particular coalition rather than another. (Chakravarty, Goddard and Hodgkinson,
2004, 187)

3. WHAT IS CORPORATE SOCIAL RESPONSIBILITY AND

ITS AFFECT ON MARKET VALUE

CSR and CSR-related activities are becoming increasingly important for businesses,
especially those with global remits and those wishing to trade on international stock markets.
Corporate responsibility has become a differentiator and a type of licence to operate, not only
for industries with conventionally higher risk exposure—energy, utilities, heavy
manufacturing—but for all sectors. (Story and Price, 2006, 40) In the post-Enron years,
corporate governance has shifted from its traditional focus on agency conflicts to address
issues of ethics, accountability, transparency, and disclosure. Moreover, corporate social
responsibility (CSR) has increasingly focused on corporate governance as a vehicle for
incorporating social and environmental concerns into the business decision-making process,
benefiting not only financial investors but also employees, consumers, and communities.
(Gill, 2008, 452)

Simultaneously, the corporate social responsibility (CSR) movement has developed

the notion of corporate governance as a vehicle for pushing management to consider broader
ethical considerations, CSR has drawn on the dramatic progress made by companies in recent
decades in balancing shareholder goals with the need to reduce externalities that impact other

6
stakeholders. Thus, CSR has joined the political endeavors to make corporations more attuned
to public, environmental, and social needs by pursuing corporate governance as a framework
for boards and managers to treat employees, consumers, and communities similarly to, if not
the same as, stockholders. (Gill, p. 453)

CSR has various drivers, both external and internal. In many cases it is primarily a
response to the growing demands of citizens and NGOs, used by companies to maintain their
legitimacy and avoid bad publicity. There are also internal drivers for CSR, such as
shareholders or (potential) employees. (Runhaar and Lafferty, 2008, p. 479) Firms may be
said to have social strategy based on the importance given to: (1) defining a plan for social
action, (2) intensity of investment in social programs, (3) commitment of employees, (4)
perceived impact of social action on competitive position, and (5) measuring outcomes of
programs. Alternatively, social strategy may exist in a second sense when a firm positions
itself with respect to social issues. (Husted and Allen, 2007, p. 346)

CSR promoting initiatives have been implemented by international institutions, such

as the UN, ILO, and the OECD. Instead of regulations, these institutions increasingly rely on
voluntary initiatives. Many of these have demonstrated implementation problems regarding
monitoring, accountability, and enforcement. The Global Compact (GC) initiated by the
United Nations however seems to be more fruitful. The GC basically takes two approaches.
Firstly, it prescribes a set of 10 norms for CSR related to human rights, labour, the
environment, and anti-corruption, as guidelines for CSR (see Table I). (Runhaar and Lafferty,
2008, p. 480)

The 10 Global Compact principles (Runhaar and Lafferty, 2008, p. 480)

Area Principles
Human rights
• Businesses should support and respect the protection of internationally proclaimed
human rights; and
• make sure that they are not complicit in human rights abuses.

Labour conditions

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 • Businesses should uphold the freedom of association and the effective recognition of
the right to collective bargaining;
• the elimination of all forms of forced and compulsory labour;
• the effective abolition of child labour; and
• the elimination of discrimination in respect of employment and occupation.

Environment
• Businesses should support a precautionary approach to environmental challenges;
• undertake initiatives to promote greater environmental responsibility; and
• encourage the development and diffusion of environmentally friendly technologies.
Anti-corruption
• Businesses should work against all forms of corruption, including extortion and
bribery.

The GC is unique in several aspects. Firstly, it aims to overcome the weaknesses of

existing international conventions that aim to promote CSR. Secondly, it has a broad scope: it
not only aims to offer transparency by monitoring and publishing companies’ progress
regarding their CSR strategies, but offers a platform for learning as well. Thirdly, in the light
of other non-legal mechanisms for promoting and governing CSR, many consider it the
‘‘largest and most ambitious institution of this kind’’. This statement is supported by the large
number of actors participating in the GC. (Runhaar and Lafferty, 2008, p. 482)

Subsumed under the umbrella term Corporate Social Responsibility (CSR), the assumed
duties of business in society have been an increasingly debated topic in academic research,
business practice, politics and media. Especially within the scientific discussion, two
contradicting positions can be distinguished: on the one hand, there is the argument that
resources spent on other than economic goals are an illegitimate waste of resources, because
they are contradictory to a firm’s responsibility to its shareholders and therefore even to the
very function of business in modern societies. On the other hand, proponents of CSR try to
champion their idea by emphasising the so-called business case for CSR. Arguing that CSR
can come along with certain benefits that might outweigh its costs, they see CSR engagement

8
as a necessity for business, not least for the sake of its own economic interest. (Schreck, 2009,
p. 1)

This notion is of particular importance, because if CSR and profit maximising interests
could indeed be shown to go hand in hand, two conflicts could be resolved. First, on a
conceptual level, (economists’) arguments against CSR as an illegitimate expenditure would
lose their basis and two conflicting positions would eventually be united. Second, managers in
practice could justify CSR expenses to the shareholders not only due to their moral quality but
also with reference to their economic benefits. Similarly, investors would not have to worry
about a trade-off between their hope for a maximum return on their investment on the one
hand, and their ethical considerations on the other. However, as long as this parallelism of
societal engagement and private business interests lacks empirical support, it risks
corresponding to its advocates’ wishful thinking rather than to a reliable fact that canserve as
the ground for management decisions. Consequently, a profound understanding of CSR’s
economic impacts is highly relevant to both academic debate as well as practice. (Schreck,
2009, p. 2)

Community enterprise – an increasingly common form of social enterprise, which pursues

charitable objectives through business activities – may be the most effective mechanism for
building local capacity in a sustainable and accountable way. Traditionally, social investments
by MNCs have involved either donations to a charity, which then assumes responsibility for
delivering social outcomes, or direct management of social investment in-house. These
approaches have been criticized, however, for their limited contribution to local capacity
building, their focus on short-term outcomes, and the restricted role that they afford to
communities. Partnering with community enterprise, provided there is sufficient local
capacity to support it, is the most effective mode of governance through which MNCs can
manage social investments in developing countries. (Nwankwo, Phillips and Tracey, 2006, p.
91)

The neo-classical economists’ view of the role of professional management within a

company is that their decisions should be solely predicated on the objective of maximising the
corporation’s long-term market value and so the wealth of the company’s owners. In contrast,
stakeholder theory suggests that managements’ concern should extend to a much wider

9
spectrum of stakeholders (e.g., employees, customers, suppliers and the general community)
whose interests should all be taken into account in the decision processes of management.
There is clearly the potential for conflict between these two views in those instances where
maximising the wealth of owners is not the natural outcome of a process where the decisions
by management are influenced by the interests of a broad spectrum of stakeholders. (Bird et.
al, 2007, p. 189)

As corporate governance becomes increasingly driven by ethical norms and the need for
accountability, and corporate social responsibility adapts to prevailing business practices, a
potential convergence between them surfaces. Where there were once two separate sets of
mechanisms, one dealing with "hard core" corporate decision-making and the other with
"soft," people-friendly business strategies, scholars now point to a more hybridized,
synthesized body of laws and norms regulating corporate practices. (Gill, p. 463)

As the authority and power of the nation-state dramatically decline in the global era,
non-state actors and transnational bodies are increasingly engaged in creating regulatory
schemes and devices for businesses. Corporate self-regulation, as encouraged by intemational
agencies, social groups, and business-related entities has gained overwhelming attention as it
emerges as a complement to, if not a substitute for, formal governmental regulation. (Gill, p.
466) CSR has become an important element in the business strategy of a growing number of
companies worldwide. A large number of initiatives have been developed that aim to support
companies in developing, implementing, and communicating about CSR. (Runhaar and
Lafferty, 2008, p. 479)

Non-state actors and transnational agencies previously undertook regulaory efforts to

control corporate behavior under an umbrella of self-regulation. At present, however, there is
a common distinction between the mechanisms adopted by companies and financial
institutions to govern their intemal policies (e,g,, self-regulation) and those pursued by
extemal social actors to monitor self-regulation by looking at it from the outside, "Meta-
regulation," as the latter set of mechanisms is known, is characterized by three major features
deriving from the voluntary, private nature of business associations. (Gill, p. 468)

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4. TENDER OFFERS

A widely accepted motive for corporate takeovers is the elimination of inefficient target
management. As Brealey and Myers (2000, p. 945) contend, “There are always firms with
unexploited opportunities to cut costs and increase sales and earnings. Such firms are natural
candidates for acquisition by other firms with better management.”(KINI, KRACAW and
MIAn, 2004, p. 1549) Under conditions of private enterprise, the ultimate measure of
management success is the market price of the firm's common shares. A favourable trend of
net income and rate of return on invested capital are the primary forces affecting share price.
They reflect the net result of efforts in product planning, research and development,
purcha,sing, merchandising, personnel administration, operations, financing, and all other
phases of business management. (Gallinger, 1982, p. 179)

It is widely accepted that takeovers facilitate efficient resource allocation by disciplining

corporate management, thereby reducing the agency costs stemming from the separation of
ownership and control (Manne, 1965; Grossman and Hart, 1981; Shleifer and Vishny, 1986).
(Kumar and Ramchand, 2008, p. 850) Mergers involve a mutual accord or agreement whereas
some tender offers are typically instituted by an attacking corporation that views the
acquisition by merger unlikely. If managerial incompetence is the source of inefficient
utilization of the firm's assets, incumbent management may resist a take-over attempt that
results in the loss of their personal wealth position (i.e., power, salary, etc.). The ability of a
bidding firm to complete a take-over depends on resistance by incumbent management. This
resistance suggests two valuation consequences. (Kummer and Hoffmeister, 1978, 506)
1. Only a larger bid premium to the target's shareholders will insure the success of a
contested take-over.
2. A larger premium may only be offered in acticipation of large gains.

The traditional view of hostile takeovers is that they are tender offers which have been
resisted by the target's management, while friendly takeovers involve a more cooperative
response from the target management. Previous studies of hostile tender offers (e.g.. Walkling
and Long 1984; Morck, Shieifcr and Vishny 1988) have foeuscd, therefore, on explanations
for why target managers resist takeover attempts. These studies have identified several self-

11
serving reasons, such as personal compensation and career incentives, that motivate managers
to resist. Thus, this view implies that organizational action results from decisions based on the
personal and economic considerations of a target's managers (Jensen and Ruback 1983).
(D'aveni and Kesner, 1993, 123)

The basic arguments for resisting a tender offer are that the offer is inadequate relative
to the true value of the target and that a higher offer can likely be obtained in the future. These
arguments, however, provide a cover for target managements that seek to maintain control to
protect their jobs or perquisites. The central issue for investors is then to distinguish between
those firms that resist an offer because it is inadequate and those firms that make the same
claim but resist in an attempt to maintain their independence and control. (Baron, 1983, p .
331)

The valuation consequences of corporate tender offers can be hypothesized as follows:

(1) Target firms are expected to have abnormally low returns prior to take-over because of the
managerial inefficiency as well as other possible reasons; (2) More specifically, those firms
involved in target take-overs faced with management resistance will display poorer
performance (prior to take-over) relative to friendly take-overs; (3) The bid premium required
for unfriendly take-overs will be greater than for friendly take-overs; (4) Bidding firms will
increase their shareholder wealth in the event of a take-over. (Kummer and Hoffmeister,
1978, 506)

To resist an offer, a target may among other alternatives purchase its own shares to
prevent them from being tendered, file antitrust suits to block the acquisition, attempt to
acquire another firm to make itself less attractive to the offeror, and sell assets that the offeror
is seeking." The target may also attempt to obtain and use defensive or shark repellent charter
provisions that make it difficult to acquire a controlling interest or to obtain control of the
target if the tender offer is successful. (Baron, 1983, p. 332)

Since tender offers are made publicly and bidders have the opportunity to top
outstanding offers, competition for a target takes the form of a progressive auction. Auction
theory indicates that the highest bid will be made hy the investor with the highest valuation
for the target and that to be successful that investor will he forced to bid such that the

12
expected gain of the investor with the next highest valuation will be nonpositive. (Baron,
1983, p. 334)

The model of target resistance to tender offers developed here is based on the private
information of target management about the true value of the firm and about its own
preference for control. Target management may reject an offer for any of three reasons in the
context of this model. First, the offer may be inadequate compared to the true value of the
target. Second, the offer may be adequate in this sense, but target management may prefer to
await a possibly higher offer in the next period. Third, target management may reject an offer
in order to maintain its control over the target. (Baron, 1983, p. 342)

The model of target resistance to tender offers developed here is based on the private
information of target management about the true value of the firm and about its own
preference for control. Target management may reject an offer for any of three reasons in the
context of this model. First, the offer may be inadequate compared to the true value of the
target. Second, the offer may be adequate in this sense, but target management may prefer to
await a possibly higher offer in the next period. Third, target management may reject an offer
in order to maintain its control over the target. As offers are made and rejected, however,
some targets develop a reputation for having a preference for control and their market value
falls. The possibility of a preference for control reduces the initial market value of the firm
below what it would be if there were no such possibility. (Baron, 1983, p. 342)

A passivity rule can eliminate both the effect of a preference for control and the
externalities present in a value-maximizing resistance strategy. Furthermore, a passivity rule
results in the first-best market value. The model considered here suffers from three principal
weaknesses that need to be dealt with to clarify the resistance issue. First, resistance
undertaken to cause delay in order to provide adequate time to allow bidding competition to
develop needs to be incorporated into the analysis. Second, the development of information
about and the search for attractive targets should be endogenized. Third, the assumption of
symmetrically informed investors should be relaxed. (Baron, 1983, p. 342)

The findings of Kummer and Hoffmeister (1978, 514) support the contention that
firms subject to take-overs have experienced abnormally tow returns prior to a take-over

13
announcement. These retums are present in the 88 firm sample as well as the resist
subsamples. They suggest that the abnormally low returns are reflective of unrealized gains
subject to the replacement of incumbent management. The take-over of these firms is
consistent with a competitive marketplace for corporate control that leads to the efficient
utilization of corporate resources.

The study of D'Aveni and Kesner addressed the following research question: When
faced with a tender offer, do prestigious (well-connected) and powerful target managers resist
or cooperate? Their results indicated that targets were more likely to cooperate when: (I) the
target's managers were less prestigious than the bidder, or (2) when the target and the bidder
shared numerous ties to the same prestigious networks. In contrast, resistance was more likely
when: (1) a nonprestigious target faced a nonprestigious bidder, or (2) a prestigious target
faced a less prestigious bidder. This finding is, in turn, consistent with the predictions of the
resource dependence and social class models, which suggest that connections to elite political
and financial institutions should increase a bidder's influence over its environment.

CONCLUSION

Corporate social responsibility is percieved as two ways in the investors’ eyes; waste of
money for unnecessary advertisement or corporates’ payback to the public and nature for
what they take and used. Although the clear view is not decidable, it is known that society is
responding well to the social investments. On the other hand tender offers are subject to
managements’ ability and view to resistance and also company’s value against the offer.

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