Refine takeover code

The Securities and Exchange Board of India’s (SEBI) ongoing revision of the takeover code is welcome. There is a strong case for revising both the threshold of ownership when an acquirer has to make an open offer to other shareholders to buy up the shares they hold in the target company, and the scope of the open offer.

The point is not to kill, but promote a fair market for corporate control. If markets function properly, a company’s share price should reflect the worth of its assets and of its business model under the incumbent management. And, if the shares of a company trade at their optimal value, no acquirer would find it worthwhile to pay a higher price to take control of the business.

Takeovers happen only when an acquirer estimates the target company to be performing below its potential, either because of poor management or because it lacks synergy of the kind that the acquirer’s operations could bring to the table.

The latent threat of takeover in a well-functioning capital market can significantly improve corporate governance and managerial and allocative efficiency.

The Indian market lacks such a threat. SEBI must ask an acquirer to make open offer for 100% of the outstanding equity, instead of the 20% as prescribed now. Such an open offer is to ensure that all shareholders, and not just a privileged minority, get a chance to exit a company in the event of a management change, and get the same terms as of the transaction(s) leading to the management change.

If the mandatory open offer is for all outstanding stock, the acquisition decision would be costly enough to deter irrational bids and guerrilla raids that can sidetrack managerial attention without leading to takeover. Such a provision would be fair to both managements and shareholders.

It also makes sense for the regulator to raise the threshold for making an open offer from the current 15% to at least 25%. This would give investors such as private equity, whose primary aim is not control, a little more leeway to invest in companies without triggering the takeover code. SEBI also needs to simultaneously tighten other provisions to prevent covert takeovers by persons acting in concert.