In business generally the way that one company takes over another is through negotiations, contracts, and payment. Look at it like this: Company A wants to obtain Company B. Company A and B begin having discussions where Company A outlines all of the advantages of being acquired by Company A (e.g. easier access to resources, streamlined processes, a stronger legal department to protect against lawsuits, etc.) until eventually an agreement is made and Company A takes over Company B.
A Hostile Takeover is not like that. In a Hostile Takeover members of Company A insert themselves into the workings of Company B, the most common form is through the stock-market. Essentially members of Company A buy out shares of Company B on the stock market until they hold the majority of shares making them the de-facto leaders of the board, at this point they can basically force Company B to turn over all assets (not directly mind you, they don’t have absolute authority, but they have enough that anyone who will not cooperate will have things turn out worse rather than better).
How is that legal?
By going public, a company is saying that it has ceded ownership of the company to their shareholders. (It is simply the fact that many founder/CEOs prefer to think of it as a financing scheme – perhaps due to their egos believing that their destiny is to control “their” company)
So it isn’t illegal for someone to buy a large enough stake in the company to demand more control over it. There are takeover laws of course so not all actions are permitted.
What is more prevalent is for CEOs and their handpicked boards to ignore the demands of their shareholders (ie owners) and this is where things like poison pill provisions, golden shares etc are put in place to restrict the ownership rights of shareholders. These could be seen as more self serving and invidious. (ie they may own 10% of the company but want to act as though they own 100%)
Hostile takeovers have a pretty bad reputation because the group or company taking over typically resorts to short term loans to raise money for the takeover. To pay back these short term loans, they break apart the company they bought in the hopes that pieces of it will have higher value in the market and/or resort to drastic cost cutting measures (usually involving mass layoffs)
So the frenzy is not attractive but mostly not illegal either.
Why were hostile takeovers so popular in the 1980s and why do we hear less about them now?
There’s a specific kind of “hostile takeover,” the so-called “corporate raid” which has very much fallen out of favor since approximately the 1990s. This involves the buyer acquiring a significant stake in a target company (usually not a majority!) and employing a variety of tactics to temporarily boost the share price at the cost of hollowing out the target company’s core assets.
This kind of “hostile takeover” has largely disappeared. One reason is that publicly-traded companies have mostly adopted various legal devices that prevent the kind of tactics employed by corporate raiders. There are a variety of moves here, but the specifics aren’t important. Suffice it to say that the management and boards of large companies have various ways of making corporate raids very difficult, and that most companies who perceive some risk that they might be the target of a hostile takeover have adopted a number of these tactics,
But a really important reason for the decline in corporate raids may well be that stock market prices have gone up significantly, across the board, since the early 1990s. This one is a little more technical, but I’ll try to explain as simply as possible.
If you want to understand how corporate raids work, you need to understand what a company’s “price-to-book ratio” (“P/B”) is. P/B is the comparison of the total value of all a company’s outstanding shares (“market capitalization”) to the value of its current assets (“book value”). Share prices are thought to be based on the market’s expectation as to a particular company’s future profitability, over time, so the P/B ratio is usually quite a bit higher than one. Google currently has a price-to-book ratio of about 4.4:1, while Amazon’s is in excess of 21:1. After all, if I could make $100 by selling an asset now, but that asset could produce $20/year in profit, indefinitely, it is a better long-term investment to hang on to it, yes? But if that same asset could be sold for $1,000, while still only producing $20/year in profit. . . maybe I should take the $2,000 and find some place else to invest my money.
What corporate raiders do is target companies perceived to have an unusually or unreasonably low P/B ratio. Such a situation suggests that it’s possible to make a pretty penny doing either of two things: either making management changes (sometimes highly dodgy ones) to temporarily boost the share price, or simply sell off the company’s major assets for their book value, gutting it as a going concern. That is why this particular type of hostile takeover is characterized as a “raid”: the hostile investor is actually hollowing out the business rather than merely taking it away from the existing management/board.
In any case, the fact of the matter is that stock prices have risen, pretty much across the board, since the early 1990s. I don’t have the specific figures in front of me, but the aggregate P/B ratio of the market as a whole has gone way up. This means that there are fewer and fewer companies out there that are attractive targets for corporate raids. Acquiring an equity stake large enough to deploy raider tactics is so expensive now that there’s no real point.
Theodore Lee is the editor of Caveman Circus. He strives for self-improvement in all areas of his life, except his candy consumption, where he remains a champion gummy worm enthusiast. When not writing about mindfulness or living in integrity, you can find him hiding giant bags of sour patch kids under the bed.