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How Often Do “Conflicts of Interests” in the Investment Banking Industry Arise During Hostile Takeovers
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Conflicts of interests in the investment banking industry Arise During Hostile Takeovers
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This article seeks to examine conflicts of interests in the investment banking industry. The first question we address is: How common is it for a given investment bank to advise client A in a meaningful capacity while, at the same time, assisting client B in the hostile takeover of client A? The article also seeks to determine whether specific information obtained from client A could be used to the advantage of client B in a hostile takeover of client A. The concentrated industrial organization of the investment banking industry and the sharing of risks among investment banks implies that every large U.S. firm should, in theory, have a relationship of some kind with a substantial proportion of the investment banking industry. Hence, we are not surprised to find that potential “conflicts of interest” related to the flow of private information are routine in the investment banking industry, and such “conflicts” are dealt with through the use of “Chinese walls.”
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Although economists have written extensively on conflicts of interest within investment banking, they have not focused on conflicts between an investment bank and a client that is the target of a hostile takeover. Articles on conflicts in investment banking have tended to focus on the conflict that arises from a bank both underwriting stocks or bonds and providing investment management services to individual clients.1 For example, Womack and Kent, after studying the performance of stock recommendations from firms with an underwriting business and those without, found that the recommendations of those with an underwriting
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1. Michaely Roni & Kent Womack, Conflict of Interest and the Credibility of Underwriter Analyst Recommendations, 12 REV. OF FIN. STUDIES 653 (1999)
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February 2004] Conflicts of Interest in Banking 3
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connection performed significantly worse than those of the analysts without an underwriting connection, indicating a conflict of interest within investment institutions that both underwrite financial instruments and provide investor services.2 Although some articles have focused on potential conflicts of interest between an investment bank and the target it represents, these articles have examined the incentives of the investment bank to complete the merger to gain higher fees, even if the merger is not in the best interests of the investment bank’s client.3 In their article on friendly acquisitions, Kessner and Shapiro found that investment banks generally received larger compensation for acquisitions where the bidder paid a higher premium, indicating that although the interests of the bank and the target coincided, the interests of the bank and the acquirer were at odds .4
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The determination of how often an investment bank is asked to assist in a hostile takeover of a current or recent client, and the potential incentive problems faced by such a bank, are topics that remain unexplored. This paper examines the potential for conflict of interest in light of evidence from past hostile takeover attempts in which private information could have created a potential conflict. We restrict ourselves to hostile takeovers, as targets in friendly acquisitions and mergers would be unlikely to have reason to complain about the actions of the investment bank assisting the acquirer. Examining the hostile takeover attempts in the United States since 1993 that involved a price exceeding one billion dollars, we determined that the majority of cases had a potential for an investment bank conflict of interest involving the advisor of the acquirer and the target. Only two cases resulted in a lawsuit alleging that the acquirer’s advisor had acted improperly: Computer Science Corporation’s suit against Bear Stearns and Computer Associates, and the Dana Corporation’s suit against UBS Warburg.5
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Of these two cases, the UBS Warburg case seems more relevant to our investigation than the Bear Stearns case. In the Bear Stearns case, the target had never been a client of the investment bank.6 Bear Stearns was accused of misusing trade secrets that it had gained through contact with another client, not through direct contact with the target itself.7 Furthermore, the Bear Stearns’ suit involved accusations that the investment bank had misused another investment bank’s assessment of the company, unlike the situation with UBS, in which the target worried about the misuse of the information it had provided to UBS.8 Thus, we focus on Dana’s suit against UBS Warburg, as it involved a more direct contact between the target and the acquirer’s investment advisor than did the Bear Stearns case.
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3. Idalene F. Kesner & Debra L. Shapiro & Anurag Sharma, Brokering Mergers: An Agency Theory Perspective on the Role of Representatives, 37 ACAD. MGMT. J. 703 (1994).
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5. Gabrielle Jonas, Tech Issues Hit Midday Mark As Mixed Lot, Dow Loses its Edge, CMP
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6. Computer Sci. Corp. v. Computer Assoc. Int’l, Inc., Nos. CV 98-1374-WMB SHX, 1999 WL 675446, at *4 (C.D. Cal Aug. 19, 1999).
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In Part III, we analyze all hostile takeovers in the past ten years where the market capitalization of the target firm exceeded $1 billion and the identity of the financial advisor of the acquirer is known. Our analysis reveals that, in the majority of cases, at least one of the advisors for the acquirer previously represented the takeover target in some way. The existence of overlapping relationships provides incentives for clients and investment banks to limit flows of private information about clients. If clients believe that material secret information about their business that is to be revealed to an investment bank would be of interest to a competitor, then the clients may obtain assurances or a written agreement about disclosure from the investment bank to ensure the confidentiality of the information. Similarly, if banks believe that there is potential for a conflict to arise among clients relating to private information, they will often decide that it is appropriate to restrict access to that information within the investment bank by constructing a Chinese wall. Banks may have an incentive to do so, even if the client has not requested such action, as doing so may preserve “option value” for future business for the bank.
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In Part IV, we test whether acquisition premia are significantly different for the acquisitions in our sample where there is potential conflict. We find no significant differences in means-the mean premia of deals with and without conflicts are 30 and 32 percent, respectively. We find, however, that the standard deviation of acquisition premia is greater in deals with a potential conflict of interest. That finding could be interpreted as evidence that private information made available to acquirers helped them to distinguish the true value of targets. Examining differences in the standard deviations of acquisition premia, however, is not helpful for identifying whether abuse of private information has occurred in a particular case.
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In Part V, we propose an economic test to determine whether private information is material to the price or probability of a hostile takeover. In particular, if the information in question is material to the takeover, then it follows that the public revelation of that information should affect the abnormal returns of the target’s stock price in a significant way. As a case study, we perform an analysis of the Dana Corporation’s (“Dana”) abnormal returns surrounding announcements about an attempted joint venture with DaimlerChrysler (“Chrysler”) during the attempted hostile takeover over Dana by ArvinMeritor. The potential for a conflict of interest arose because of UBS’ simultaneous representation of Dana and ArvinMeritor. In particular, UBS was retained by Dana to negotiate a potential joint venture between Dana and Chrysler involving Detroit Axle, an axle production facility, and served as a participant in a loan syndicate for Dana. During this existing relationship with Dana, UBS assisted ArvinMeritor in an attempted takeover of Dana. The abnormal returns around the announcement of the attempted joint venture with Chrysler imply that the financial market did not perceive the planned purchase of Detroit Axle from Chrysler to be a significant contributor to the probability of a successful takeover by ArvinMeritor, or to the price at which such a takeover would take place. If the prospect of the joint venture had been material to the takeover,
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February 2004] Conflicts of Interest in Banking 5
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announcements related to it would have affected the current price of Dana’s stock through one or the other channel, or both. The market spoke clearly about the lack of materiality of the joint venture to the takeover: The market’s view was that the prospect of the joint venture was not of any material relevance.
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II. WHAT ARE THE STANDARDS FOR CONFLICTS OF INTERESTS IN THE
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INVESTMENT BANKING INDUSTRY?
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The standards of conflicts in the investment banking industry are different than those in the legal profession, where law firms often refuse to represent clients if they are involved in an adversarial position with respect to a former or current client. As we demonstrate below, in contrast, it is common for an investment bank to work for client A while assisting client B in the acquisition of client A. Although the academic literature has not covered this specific issue, news stories indicate that such behavior does occur and does not violate laws or regulations so long as the investment bank does not pass confidential information from the target to the acquirer. Larger investment banks engage in this behavior more frequently than smaller investment banks because of the paucity of banks that can handle large deals.
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A. The Economics of the Investment Banking Industry Necessitates
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Representation of Firms That Could Have Adverse Interests
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Because the supply of investment banking exhibits economies of scale, the industry is prone to concentration.9 Companies contemplating takeovers gravitate towards those investment banks with more capital, information, and experience, thus making entry difficult.10 The few investment banks that can take on large projects will tend to merge with each other to obtain more capital and share risk. 11
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The concentrated industrial organization of the investment banking industry and the sharing of risks among investment banks imply that virtually every large U.S. firm has relationships of some kind with a substantial proportion of the investment banking industry. Representation in an investment banking transaction entails enormous risks for the investment bank. Even for the largest U.S. investment banks, the associated risk is so large that many deals are shared across multiple banks. Without dispersion of the risk, the collapse of a large deal could pose significant difficulties for the
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9. Hear no evil, see no evil, speak no evil, USBANKER, May 1, 2002, at 10 (available at 2002 WL 5644685)
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10. Bharat Anand & Alexander Galetovic, Information, Nonexcludability, and Financial Market Structure, 73 J. OF BUSINESS 357, 358 (Jul. 2000)
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11. Citigroup makes the most of a bad year, SAIGON TIMES DAILY, Dec. 31, 2002 (available at 2002 WL 101161743).
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bank. Thus, any bank organizing a large transaction will need to array multiple financial institutions to support it.12
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The need to disperse the risk of large deals combined with the tendency towards concentration means that in a large takeover or merger there is a significant likelihood that any investment bank representing the acquirer would have had prior dealings with the target.
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B. Potential “Conflicts of Interest” Related to the Transmission of Private Information
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Potential “conflicts of interest”-that is, situations where two corporations in an adversarial position both have some relationship with a particular investment bank-are routine in the investment banking industry and often are dealt with through the use of “Chinese walls.”13 There has been no ruling of which we are aware that such overlapping relationships constitute a breach by the investment bank. In other cases, where there is no potential for conflict via the flow of material secret information-for example, as in a passive role as a member of a loan syndicate-there may be no need to even create a Chinese wall.
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Several investment banks have been known to represent potentially adverse interests on two separate transactions or even on a single transaction. For example, Goldman Sachs faced pressure in 2001 from its decision to help Montedison, an Italian energy company, fend off a takeover from EDF, a French energy company, and Fiat.14 Goldman Sachs had longstanding relationships with all three of the companies and had started advising Montedison on its takeover defense a few weeks before the announcement of the offer.15 Despite the possibility of losing future business from Fiat and EDF, Goldman Sachs decided to stay as Montedison’s advisor rather than to drop out of the defense.16
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In 1999, Goldman Sachs arranged the hostile takeover attempt of Mannesmann by Vodafone Airtouch, PLC. Mannesmann, which had previously used Goldman Sachs to acquire Orange Ltd., filed suit, arguing that Goldman Sachs had assured Mannesmann that it would not assist another client in a hostile bid against Mannesmann and that this assurance
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12. For example, the five-year revolving line of credit issued to the Dana Corporation in this case had over twenty banks participating in the loan. See also William L. Megginson & Annette B. Poulsen & Joseph F. Sinkey, Jr., Syndicated Loan Announcements and the Market Value of the
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Banking Firm, 27 J. OF MONEY, CREDIT & BANKING 457, 458 (May 1995)
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13. A “Chinese wall” is a name for procedures instituted within a securities firm to separate various departments or project teams so as to prevent general access to non-public information provided by clients.
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14. Deborah Ball, Marcus Walker
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February 2004] Conflicts of Interest in Banking 7
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prompted Mannesmann to hand over confidential information to Goldman.17 Although the British court granted a temporary injunction against Goldman Sachs’ acting as the advisor for the deal, one week later the court dismissed the case because Kurt Kinzius, the managing director of Mannesmann, changed his testimony about whether he was present when Goldman Sachs had made the assurances.18 In court filings, Goldman Sachs asserted that while it would not assist a hostile bid against a current client, it would do so against a former client provided that it could keep the former client’s sensitive information confidential.19 Goldman Sachs, one of three investment banks initially retained by Vodafone, withdrew its services from the deal after the judgment, prompting concern over Vodafone’s ability to line up an alternative investment bank large enough to handle the deal.20 There are fewer investment banks in Europe than in the United States, and commentators have noted that initiators of takeovers in Europe often have had difficulty finding backing from an investment bank that did not already have a relationship with the target of the takeover.21
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NatWest faced a similar situation to that of Goldman Sachs in 1985 when it provided $200 million to The Icahn Group to launch a hostile takeover of TWA. TWA, citing its banking relationship with NatWest’s parent, National Westminster Bank, PLC, challenged the participation of NatWest in the attempted takeover, prompting NatWest to end its participation in the attempted takeover.22 The practical significance of NatWest’s action was small, however, as The Icahn Group had already withdrawn the entirety of the $200 million loan .23
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Murray Ohio Manufacturing Company filed suit against Sullivan & Cromwell in 1988 seeking to enjoin the law firm from assisting AB Electrolux in its hostile bid against Murray .24 Murray had retained Goldman Sachs to devise its anti-takeover strategy and Goldman Sachs had in turn used Sullivan & Cromwell to assist in its preparation.25 Murray claimed that Goldman Sachs might have passed confidential information to Sullivan & Cromwell during the course of its consultations, thus giving Electrox an advantage in its bid .26 The federal judge refused to issue the injunction,
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17. Erik Portanger, Mannesmann can’t block Goldman’s Vodafone Role, WALL ST. J., Nov. 19, 1999, at * 1
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21. David Lascelles, Atmosphere is Rather Close as Sisters Crowd in, FIN. MAIL, Nov. 26,
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22. Mike Carroll, Nat West backs of Icahn ‘s bid for TWA after parent cites Conflict of
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Interest, AMER. BANKER, May 28, 1985, at 1.
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24. Laurie Cohen & Ed Bean, AB Electrolux Gets Permission For Murray Bid-Sullivan &
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Cromwell Cleared As Judge Lifts Hurdle
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stating that Murray had failed to produce any evidence that confidential information had passed between Sullivan and Goldman.27
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III. ANALYSIS OF LARGE HOSTILE TAKEOVERS SINCE 1993
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In the majority of hostile takeovers since 1993, at least one of the advisors for the acquirer previously represented the takeover target in some way. Using SDC Platinum from Thomson Financial Securities Data, we identified every unsolicited or hostile transaction with a U.S.-based target firm announced from November 1, 1993 to November 6, 2003 in which the target of the transaction’s market capitalization was greater than $1 billion four weeks preceding the date on which the transaction attempt was announced. These proposed transactions include mergers, acquisitions of partial interests in the target, and acquisitions of remaining interests in the target. Of the 72 hostile and unsolicited transaction proposals contained in the database that met these criteria, 55 contain a list of the acquiring firm’s financial advisors in the takeover attempt. Two of these transactions are duplicates of other transactions (in terms of announcement dates, target firms, and acquirer advisors). Table 1 (presented in the Appendix) shows a list of the 72 attempted takeovers that met our criteria.
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February 2004] Conflicts of Interest in Banking 9
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For each of the 52 takeover attempts in our sample, we searched for any relationship between the takeover target and the acquirer’s financial advisor in the five calendar years preceding the unsolicited offer that might entail a transfer of relevant private information. We find that many of these unsolicited offers feature relationships where information of some kind was exchanged between the target and the acquirer’s financial advisor before the unsolicited offer was announced. These relationships are of several types: a financial advisor in a transaction, a member of a loan syndicate, an underwriter of a new issue, and a financial advisor of a poison pill.
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Thirteen of the 52 transactions in our sample featured an acquirer’s financial advisor that served as an advisor for the target in a transaction that preceded the unsolicited offer by no more than five calendar years. Six of these thirteen transactions featured an acquirer’s financial advisor that served as an advisor for the target in a transaction that preceded the unsolicited offer by no more than two calendar years. These previous transactions included mergers and acquisitions of assets in which the acquirer’s financial advisor would have obtained detailed information about the target company.
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Five of the 52 transactions in the sample featured an acquirer’s financial advisor with a role in a loan syndicate for the target that was established no more than five calendar years preceding the unsolicited offer. Four of the five transactions featured an acquirer’s financial advisor with a role in a loan syndicate for the target that was established no more than two calendar years preceding the unsolicited offer. Two of the acquirers’ financial advisors served only as participants in loan syndicates for the target, just as UBS is with Dana, whereas the others had even more significant roles, including agent, administrative agent, syndications agent, and arranger.
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At least 29 of the transactions featured an acquirer’s financial advisor that served some role as an underwriter, such as agent, book runner, or comanager in underwriting a new issue (such as stock, bonds, or notes) for the target no more than five calendar years before the unsolicited offer was announced. Twelve of these 29 transactions featured an acquirer’s financial advisor that served a role in underwriting a new issue for the target no more than two calendar years before the unsolicited offer was announced.
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Finally, in one transaction, Newmont Mining’s hostile takeover of Santa Fe Pacific Gold, the acquirer’s financial advisor, Goldman Sachs, was the target’s financial advisor in designing its poison pill -the very instrument a company uses to prevent a hostile takeover. In that case, Santa Fe Pacific Gold adopted the poison pill less than two years before Newmont launched its hostile takeover.
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In summary, we found that at least 33 of the 52 transactions featured situations where some private information could have flowed from the target to the acquirer’s financial advisor, based on relationships that occurred no more than five calendar years before the unsolicited offer was announced, and seventeen transactions featured a potential flow of information from the target to the acquirer’s financial advisor no more than two calendar years before the unsolicited offer was announced. Table 2 shows the number of
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transactions in our sample that feature each type of relationship in the five calendar years and two calendar years preceding the unsolicited offer.
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TABLE 2: RELATIONSHIPS BETWEEN TARGETS OF UNSOLICITED OR HOSTILE
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TRANSACTION OFFERS AND THE ACQUIRER’S FINANCIAL ADVISOR
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Relationship Transactions Featuring
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Unsolicited Offer Transactions Featuring the
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Relationship Two Calendar
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Note: The “Total” row does not equal the sum of the columns because some transactions feature multiple types of relationships between the target and the acquirer’s financial advisor.
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Sources: Thomson Financial Securities Data
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Co. Re Public Offerings, REGULATORY NEWS SERVICE, Oct. 11, 1993
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Completion of Public Offering, Pennzoil Co. Re Disposal of Subsid, etc.,
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REGULATORY NEWS SERVICE, Oct. 28, 1992.
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Based on Tables 1 and 2, it is reasonable to conclude that potential “conflicts of interests” are common in the investment banking industry. Table 3 (presented in the Appendix) describes the relationships that existed between the target firm and the acquirer’s financial advisor in each of the 52 transactions in our sample.
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IV. COMPARISON OF ACQUISITION PREMIA IN DEALS WITH AND WITHOUT A
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POTENTIAL CONFLICT OF INTEREST
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Using Tables 2 and 3, we compared acquisition premia associated with 34 takeovers where a potential conflict of interest existed to acquisition premia associated with 32 takeovers without a potential conflict of interest. The analysis was intended to determine if the average announced premia was different when the acquirer may have had inside information about the target from its investment advisor. We generated the initial premiums by subtracting the stock price the day before the announcement from the
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February 2004] Conflicts of Interest in Banking 11
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announced offer price and then dividing it by the pre-announcement stock price.
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We tested the equality of the means of the initial stock offers for those companies with potential inside information and those without potential inside information. The average initial premium for those targets without a potential conflict of interest was 30.0 percent with a sample variance of 0.0295, while the average initial premium for those targets with a potential conflict of interest was 32.7 percent with a sample variance of 0.0493. Table 4 summarizes the results.
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TABLE 4: SUMMARY STATISTICS OF ACQUISITION PREMIA
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Sample with Potential Conflict
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For mean differences, we calculated a t statistic of -0.57 with 64 degrees of freedom, which was not significant at the 10 percent confidence interval. We then tested whether acquisitions with potential private information tended to have more variation in their premia than those without insider information. Our hypothesis is that bidders with inside information do not need to pay the “average” premium if those bidders can discriminate between “good” and “bad” targets. To the extent that private information helps bidders to sort targets according to their true values, we expect to see greater variation in the premia paid by acquirers. We calculated an F statistic of 1.67 with 31 and 33 degrees of freedom, which was significant at the 10 percent confidence interval. Figure 1 presents the density plots of the acquisition premium for the two samples.
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FIGURE 1: DENSITY PLOTS OF ACQUISITION PREMIUM
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No Conflict of Interest Potential Conflict of Interest
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As Figure 1 shows, the upper tail of the distribution of premium for deals with a potential for conflict (represented by triangles) is fatter, indicating a larger proportion of targets attracting very high premia. The lower tail of the distribution is smaller for deals with a potential conflict. One possible explanation for the smaller lower tail is that private information may help acquirers to avoid targeting some lower-quality targets.
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Given the differences in the two distributions, we conclude that it is possible that some information may be transferred from some of the conflicted banks to acquirers. Nevertheless, the evidence in favor of that view is weak. Furthermore, even if one accepts the differences in the two distributions as evidence for some “abuse” of private information, it is not possible to determine with any confidence whether private information affected the offered acquisition premium in any particular case. Finally, this evidence is of little use for gauging the damage from the transmission of private information. Indeed, the evidence suggests that private information may often be used to benefit acquirers (by raising the acquisition premium they receive). As we argued, the small relative size of the lower tail for deals with a potential conflict may indicate that when the private information communicated to the acquirer is unfavorable, the target may not receive a bid at all. If that is the case, however, it may be impossible to determine damages, since the “damaged” firms did not become the targets of hostile takeovers. In the next section, we develop an approach for identifying whether private information has been transferred to acquirers by investment banks, and for measuring the damages from such information flow in individual hostile takeovers.
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February 2004] Conflicts of Interest in Banking 13
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V. AN ECONOMIC TEST FOR MATERIALITY OF PRIVATE INFORMATION: A CASE STUDY OF THE PROPOSED TAKEOVER OF DANA BY ARVINMERITOR
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Suppose an investment bank obtains private information about client A during the course of its representation of client A. Suppose further that the investment bank shares that private information with client B while representing client B in the hostile takeover of client A. If the private information that breached the “Chinese Wall” is material to the takeover, then it follows that the public revelation of that information should affect the abnormal returns of the target’s stock price in a significant way.
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For an application of this test, we examine the attempted hostile takeover of Dana by ArvinMeritor in the winter of 2003. The relevant details of the case are as follows: UBS was retained by Dana, an automobile equipment manufacturer, to negotiate a potential joint venture between Dana and Chrysler involving Detroit Axle, an axle production facility. During its representation of Dana, UBS assisted ArvinMeritor, a rival automobile equipment manufacturer, in an attempted takeover of Dana. Dana sued UBS shortly after the announcement of ArvinMeritor’s hostile takeover attempt, alleging that UBS obtained material information about Dana and shared that information with ArvinMeritor.
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An analysis of Dana’s abnormal returns surrounding announcements about the joint venture -that is, the announcement of the transaction, and the subsequent announcement that it would not take place-reveals that the market did not perceive the planned joint venture to be a significant contributor to the probability of a successful takeover by ArvinMeritor, or to the price at which such a takeover would take place. If the joint venture had been material to the takeover, its announcement would have affected the current price of Dana’s stock through one or the other channel, or both. We use an event study to estimate the impact of these events on Dana’s stock price.
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The first step in the event study is estimating the market model for Dana’s stock returns, adjusted for dividends. The market model is given by the following equation:
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[ 1 ] Rt = á + ßRmt + eit,
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where Rt represents the return to Dana on day t, Rmt represents the return to the S&P 500 Index on day t, and eit represents an error.28 The estimate of á, or “alpha,” is the average rate of return Dana’s stock would expect on a day when the S&P 500 index realized a zero return. The estimate of ß, or “beta,” represents the sensitivity of Dana’s returns to general market movements, or its “systematic risk.” We estimate an alpha of -0.00247 and a beta of 1.3679 using the ordinary least squares method for Equation 1 over a 200-tradingday estimation period (which is t = -250 to -50, where t = 0 is July 8, 2003,
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the date of the announcement of ArvinMeritor’s tender offer). The “expected return” of a stock is defined as the stock’s estimated alpha plus the product of the actual daily return of the S&P 500 Index and the stock’s estimated beta. We calculate the “abnormal returns” for Dana by subtracting the expected returns from the actual returns. That is, the daily abnormal returns are the residuals for each observation in the regression analysis.
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Consider now an unexpected announcement on an event day. We consider three windows in which to measure the market’s reaction to the announcement. The first is a one-day window that considers the abnormal returns solely on the event day itself. The second is a window of three days, from one day before the announcement to a day after the announcement. The third is a window of eleven days, from five days before the announcement to five days after the announcement. For each window, we compute the cumulative abnormal returns for that period. Finally, for each window, we compute the standard errors of the abnormal returns (for each company and each portfolio) by using information covering the 200-day estimation period.
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ArvinMeritor first announced its tender offer for Dana on July 8, 2003 .29 The previous day, Dana’s stock closed at $12.02. At the end of trading on July 8, Dana’s stock closed at $16.20-an increase of 35 percent. After the markets closed on July 22, 2003, Dana announced that it was rejecting ArvinMeritor’s tender offer.30 Dana’s stock closed at $15.60 on July 23, up 2 percent from its closing price of $15.28 on July 22. However, because Dana reported its quarterly earnings at the same time that it announced its rejection of the tender offer,31 the market was responding to multiple events on that date, and so it is not possible to measure the specific effect of Dana’s rejection of the tender offer with precision.
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On September 15, 2003, Automotive News published an article on Dana’s negotiations with Chrysler to buy Detroit Axle.32 On September 15, 2003, Dana’s stock price closed at $15.62-0.9 percent higher than its previous closing price. Detroit Axle was one of several factories that Chrysler was attempting to sell or close at the time, and Chrysler was the only Big Three automobile manufacturer that still produced axles.33 When the talks between Dana and Chrysler were announced, Chrysler was also negotiating a new labor contract with the United Auto Workers (“UAW”), which represented the Detroit Axle employees. The UAW typically had veto power over any plant sale or shutdown in its labor agreements.34 On September 26, 2003, the UAW announced a new labor agreement between
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29. Press Release, ArvinMeritor, ArvinMeritor to Commence Tender Offer to Acquire Dana for $15 Per Share in Cash (Jul. 8, 2003) (this document can be accessed at http://www.arvinmeritor.com/media_room/press_releases_2003.asp).
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30. Press Release, Dana Corp., Dana Corporation’s Board of Directors Rejects Unsolicited
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Offer From ArvinMeritor (July 22, 2003) (available at http://www.dana.com/news/pressreleases/).
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31. Sholnn Freeman, Dana Board Rejects ArvinMeritor Takeover Bid, WALL ST. J., July 23,
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32. Robert Sherefkin, Dana Wants To Buy DCX Axle Plant, AUTOMOTIVE NEWS, Sept. 15, 2003, at 1.
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33. Mark Truby & Mike Hudson, DaimlerChrysler deal may sell, close 7 plants, DETROIT NEWS, Sept. 16, 2003, at 1.
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34. Sherefkin, supra note 32.
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February 2004] Conflicts of Interest in Banking 15
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Chrysler and Detroit Axle’s workers in which the workers would “retain their right to remain DaimlerChrysler employees.”35 On October 6, 2003, Automotive News elaborated on the implication of UAW’s press release and reported that this labor agreement would prevent Chrysler from selling Detroit Axle in the near future.36 Dana’s stock price closed at $15.50 and $15.55 on September 26 and October 6-a decrease of 1.0 and 0.3 percent from the previous day’s close, respectively. These slight movements were not out of the ordinary for Dana’s stock after ArvinMeritor’s tender offer had been announced. Between July 9 and October 28, Dana’s stock price closed within a narrow trading range of $14.96 to $15.96. As Figure 2 shows, the movements in Dana’s stock price flattened significantly after the announcement of ArvinMeritor’s tender offer.
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FIGURE 2: DANA’S CLOSING STOCK PRICE
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Note: Stock prices are adjusted for dividends.
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Source: Yahoo! Finance, available at http://finance.yahoo.com/q/hp?s=DCN.
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Figure 2 shows that movements in Dana’s stock price were flat during the three months following the tender offer announcement on July 8 relative to movements before announcement.
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35. Press Release, United Auto Workers, UAW members at DaimlerChrysler ratify new labor pact (Sept. 26, 2003) (available at http://www.uaw.org/news/index.cfm).
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36. Robert Sherefkin, UAW Deal Unravels Dana’s Plan for DCX Plant, AUTOMOTIVE NEWS, Oct. 6, 2003, at 50.
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TABLE 5: CUMULATIVE ABNORMAL RETURNS FOR DANA FOR EVENT DATES
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RELATED TO TENDER OFFER AND NEGOTIATIONS WITH CHRYSLER ON
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Returns July 8, 2003 July 23, 2003 Sept. 15, 2003 Sept. 26, 2003 Oct. 6, 2003
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1-Day 34.6%** 2.3% 1.7% 0.2% -0.6%
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3-Day 33.5%** 1.1% 0.4% 0.6% 0.5%
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11-Day 35.3%** -0.2% 3.6% 3.1% -2.7%
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1-Day 12.74 0.84 0.61 0.06 -0.22
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3-Day 7.04 0.24 0.10 0.14 0.11
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11-Day 3.56 0.03 0.40 0.36 -0.22
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|
Note: * Significant at 10 percent level
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As Table 5 shows, none of the cumulative abnormal returns were significant other than the returns in the windows around the initial announcement of the tender offer. The evidence shows that Dana’s planned purchase of Detroit Axle did not significantly affect the market value of Dana and did not change in investors’ minds the probability that the tender offer would be accepted or altered.
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The existence of overlapping relationships often leads to precautionary measures by both clients and investment banks. Investment banks may choose, in their own self-interest, to erect Chinese walls to limit information flows. Doing so reduces the possibility that private information may become abused (for example, through insider trading). Furthermore, investment banks that limit information flow will be better able to attract clients that might otherwise be concerned about potential conflicts with adversarial firms.
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Clients should also take precautions, and should ask the investment bank to agree not to divulge confidential information without assurances or a written agreement about disclosure if they believe that material secret information about their business of interest to a competitor is going to be revealed to the investment bank. Hiring investment banks as a means to protect against their involvement in a hostile takeover does not generally work, since there is no legal obligation on the bank not to advise the acquirer. In recognition of that fact, the dean of Tuck Business School remarked that “[t]oday nobody in his right mind would show his investment banker sensitive information without assurances or a written agreement about disclosure.”37 Concerns about possible conflicts of interest have influenced some companies to demand written assurances about the confidentiality of the information they give over to the investment bank. It is the client’s responsibility to secure confidentiality agreements before providing
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37. John A. Byrn, Corporate Clients feel Seduced and Abandonned, BUS. WK., Mar. 2, 1987,
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|
February 2004] Conflicts of Interest in Banking 17
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confidential information. Conditional on such agreements being secured, it is the banks’ responsibility to protect confidential information.
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We show that the potential for conflict in investment banking is extremely common, and by itself, the presence of a potential conflict is neither unusual, nor a reasonable grounds for presuming that private information has been transmitted by the bank. Our comparison of the acquisition premia for hostile takeovers in cases with and without a potential for private information transmission does not indicate significant harm, on average, to targets, conditional on an ofer being made. If anything, targets receiving offers seem to enjoy a greater possibility of very high offers. Finally, we develop an approach for identifying the transmission of private information in individual cases, and for measuring the extent of damages that could be used to assess a specific case of a hostile takeover.
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Conflicts in banking_005 2/23/04 11:30 am EDT
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TABLE 1: UNSOLICITED OR HOSTILE OFFERS MADE FROM NOVEMBER 1993 TO NOVEMBER 2003 TO U.S.-BASED TARGETS WITH MARKET
|
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CAPITALIZATIONS EXCEEDING $1 BILLION
|
|
Announced Target Name Acquirer Name Target
|
|
3/14/1994 Kemper Corp General Electric
|
|
Capital Corp 1,380.70 Goldman
|
|
Sachs & Co Kidder Peabody
|
|
Co LLC Hostile Hostile No Merger
|
|
Cyanamid Co American Home
|
|
Products Corp 5,126.90 Morgan
|
|
First Boston Gleacher & Co Hostile Hostile Yes Merger
|
|
8/2/1994 Unitrin Inc American General
|
|
Corp 2,060.60 5,889.30 Morgan
|
|
Stanley & Co Merrill Lynch &
|
|
Kelton Hostile Hostile No Merger
|
|
System Inc Investor Group 1,999.20 Smith Barney
|
|
Brothers Unsolic. Agreed No Acq. Part.
|
|
9/21/1994 Borden Inc Japonica Partners LP 1,750.10 Lazard Freres
|
|
Boston Corp Hostile Unsolic. No Acq. Part.
|
|
Announced Target Name Acquirer Name Target
|
|
10/19/1995 Cordis Corp Johnson & Johnson 1,381.20 Morgan
|
|
Securities Inc Hostile Hostile Yes Merger
|
|
1/24/1996 Hasbro Inc Mattel Inc 2,674.60 8,240.10 Bear Stearns
|
|
Corp Hostile Hostile No Merger
|
|
3/5/1996 WR Grace & Co Hercules Inc 6,810.90 Merrill Lynch
|
|
& Co Inc Hostile Hostile No Merger
|
|
4/12/1996 Kansas City Power
|
|
& Light Co Western Resources
|
|
Inc 1,617.20 2,100.40 Merrill Lynch
|
|
Brothers Hostile Hostile No Merger
|
|
Corp JC Penney Co 6,022.60 11,214.20 Goldman
|
|
Sachs & Co CS First Boston
|
|
Corp Hostile Hostile No Merger
|
|
10/23/1996 Conrail Inc Norfolk Southern
|
|
Corp 5,901.00 11,480.60 Hostile Unsolic. Yes Acq. Part.
|
|
10/23/1996 Conrail Inc Norfolk Southern
|
|
C orp 5,901.00 Lazard Freres
|
|
Co Inc Hostile Hostile Yes Merger
|
|
10/28/1996 Loctite Corp Henkel KGaA 1,448.90 Dillon, Read
|
|
& Co Inc Rothschild Inc. Hostile Hostile Yes Merger
|
|
12/5/1996 Santa Fe Pacific
|
|
Corp 1,528.30 4,776.90 SBC Warburg
|
|
Securities Inc Goldman Sachs
|
|
& Co Hostile Hostile No Merger
|
|
1/27/1997 ITT Corp Hilton Hotels Corp 5,073.70 Goldman
|
|
Jenrette Hostile Hostile Yes Merger
|
|
2/18/1997 Great Western Finl
|
|
Co,Irwindale,CA 4,337.90 3,837.40 Merrill Lynch
|
|
Montgomery Hostile Hostile No Merger
|
|
Announced Target Name Acquirer Name Target
|
|
4/22/1998 Mellon Bank Corp,
|
|
Pittsburgh,PA Bank of New York
|
|
Co Inc 13,198.20 17,532.00 Morgan
|
|
Sachs & Co Merrill Lynch &
|
|
Co Inc Hostile Hostile No Merger
|
|
5/21/1998 Excite Inc Zapata Corp 1,409.30 267.3 Unsolic. Unsolic. No Merger
|
|
8/4/1998 AMP Inc AlliedSignal Inc 7,459.80 Credit Suisse
|
|
& Co Hostile Hostile No Merger
|
|
8/4/1998 AMP Inc AlliedSignal Inc 7,459.80 25,298.10 Credit Suisse
|
|
& Co Hostile Hostile Yes Acq. Part.
|
|
8/18/1998 Adobe Systems Inc Quark Inc 2,662.70 Goldman
|
|
JP Morgan Unsolic. Unsolic. No Merger
|
|
12/15/1998 Coltec Industries
|
|
Inc Crane Co 1,004.90 1,955.80 Credit Suisse
|
|
Barney Unsolic. Unsolic. No Merger
|
|
Shipbuilding Inc Litton Industries Inc 1,052.00 2,496.40 Credit Suisse
|
|
Lazard Houses Merrill Lynch,
|
|
Pierce, Fenner Unsolic. Unsolic. No Merger
|
|
Group NiSource Inc 4,212.10 3,364.10 Morgan
|
|
Inc Hostile Hostile Yes Merger
|
|
6/14/1999 Frontier Corp Qwest Commun Int
|
|
Inc 5,963.60 18,040.00 Morgan
|
|
Jenrette Unsolic. Unsolic. No Merger
|
|
Announced Target Name Acquirer Name Target
|
|
Holdings Corp Carl Icahn 2,751.90 Warburg
|
|
Stanley & Co Unsolic. Hostile Yes Merger
|
|
5/2/2000 Bestfoods Unilever PLC 13,185.90 Merrill Lynch
|
|
Smith Barney Goldman Sachs
|
|
Warburg Hostile Hostile No Merger
|
|
10/16/2000 Hercules Inc International
|
|
Specialty Prods 1,342.90 381.1 Donaldson
|
|
Sachs & Co Unsolic. Unsolic. No Acq. Part.
|
|
Industries Inc Weyerhaeuser Co 2,941.80 8,034.40 Goldman
|
|
Sachs & Co Morgan Stanley
|
|
& Co Hostile Hostile Yes Merger
|
|
3/7/2001 Barrett Resources
|
|
Corp Shell Oil Co 1,634.60 Goldman
|
|
Brothers Hostile Unsolic. Yes Merger
|
|
Shipbuilding Inc Northrop Grumman
|
|
Corp 1,830.00 6,657.30 Credit Suisse
|
|
Morgan Hostile Unsolic. Yes Merger
|
|
Inc,Atlanta,GA 12,446.30 19,248.50 Credit Suisse
|
|
Sachs & Co Morgan Stanley Hostile Unsolic. No Merger
|
|
Holdings Inc Arpine Investments
|
|
Inc 2,770.50 Unsolic. Unsolic. No Acq. Part.
|
|
8/1/2001 Cooper Industries
|
|
Inc Danaher Corp 3,815.60 8,320.50 Credit Suisse
|
|
Merrill Lynch & Unsolic. Unsolic. No Merger
|
|
Target Acquirer Attitude of
|
|
Market Market Management Initial
|
|
Date Cap ($ Cap ($ Target’s Acquirer’s Towards the Offer Tender
|
|
Announced Target Name Acquirer Name mil) mil) Advisors Advisors Transaction Price Offer? Form of Deal
|
|
7/8/2003 Dana Corp ArvinMeritor Inc 1,617.00 1,426.40 Credit Suisse
|
|
7/11/2003 Clayton Homes Inc Cerberus Capital 1,723.10 Bear Stearns Unsolic. N/A No
|
|
Management LP & Co Inc Merger
|
|
Source: Thomson Financial Securities Data.
|
|
Conflicts in banking_005 2/23/04 11:30 am EDT
|
|
TABLE 3: DESCRIPTIONS OF RELATIONSHIPS BETWEEN TARGETS OF UNSOLICITED OR HOSTILE TRANSACTION OFFERS AND THE ACQUIRER’S
|
|
Announcement Target Acquirer’s Financial Advisors Previous Relationship Between Acquirer’s Financial Advisor and Target
|
|
3/14/1994 Kemper Corp Kidder Peabody & Co Inc
|
|
8/2/1994 American Cyanamid Co Gleacher & Co
|
|
8/2/1994 Unitrin Inc Merrill Lynch & Co Inc
|
|
3/27/1995 Wellpoint Health Networks Inc Credit Suisse First Boston Int
|
|
6/5/1995 Lotus Development Corp CS First Boston Corp Lotus Development used CS First Boston as its financial advisor when it acquired SoftSwitch in 1994. Lotus Development used First Boston (a predecessor to CS First
|
|
Boston) as its financial advisor when it acquired Samna in 1990 and when it attempted to merge with Novell in 1990. Credit Suisse First Boston was an arranger of
|
|
three $50 million revolving lines of credit for Lotus Development, the latest of which Credit Suisse First Boston had a 16.67 percent share and was active in July 1991
|
|
with maturity in June 1994. Credit Suisse First Boston was also an agent on a $50 million line of credit active in June 1992 and a $75 million line of credit active in
|
|
May 1993. First Boston was the lead placement agent of Lotus Development senior notes issued in 1990.
|
|
6/20/1995 LILCO Bear Stearns & Co Inc Bear Stearns was an underwriter for numerous LILCO bonds, common stock, and preferred stock issued in every year from 1991 through 1994.
|
|
Corp,Boston,MA UBS Securities Inc
|
|
8/14/1995 PP&L Resources Inc Salomon Brothers Salomon Brothers was a co-manager of multiple PP&L first mortgage bonds issued from 1991 through 1994.
|
|
10/18/1995 First Interstate Bancorp,CA CS First Boston Corp
|
|
Montgomery Securities First Interstate Bancorp used Montgomery Securities as its advisor in its merger with Cal Rep Bancorp in 1993. Credit Suisse (predecessor to CS First Boston) was a
|
|
participant in a $500 million revolving line of credit for First Interstate Bancorp (active in May 1994 with maturity in May 1997). Montgomery Securities was a co
|
|
manager of First Interstate Bancorp common stock issued in 1990.
|
|
10/19/1995 Cordis Corp JP Morgan Securities Inc
|
|
1/24/1996 Hasbro Inc CS First Boston Corp Tonka used First Boston (a predecessor to CS First Boston) as a financial advisor when it merged with Hasbro in 1991. First Boston was the book runner of Hasbro
|
|
convertible subordinated notes issued in 1991.
|
|
4/12/1996 Kansas City Power & Light Co Salomon Brothers
|
|
4/25/1996 Dayton Hudson Corp CS First Boston Corp CS First Boston was the book runner for Dayton Hudson asset-backed certificates issued in September 1995.
|
|
10/23/1996 Conrail Inc JP Morgan
|
|
Co Inc Morgan Guaranty Trust, a subsidiary of JP Morgan, was an administrative agent with a 16 percent share on a $500 million term loan for Conrail, active in April 1995
|
|
with maturity in April 2000. Merrill Lynch was an agent of Conrail medium-term notes issued in 1994. Merrill Lynch was also the book runner, lead placement agent,
|
|
and co-manager of various certificates and debentures issued from 1991 to 1994.
|
|
10/28/1996 Loctite Corp Rothschild Inc.
|
|
12/5/1996 Santa Fe Pacific Gold Corp Goldman Sachs & Co Goldman Sachs advised Santa Fe Pacific Gold on a poison pill adopted in 1995 with an expiration date in 2005. Goldman Sachs acted as a co-manager, global
|
|
coordinator, book runner of Santa Fe Pacific Gold common shares issued in 1991, 1992, and 1994. Goldman Sachs was a co-manager of Santa Fe Pacific Gold senior
|
|
notes and senior debentures issued in 1994 and 1995.
|
|
December 2003] Conflicts of Interest 3
|
|
Announcement Target Acquirer’s Financial Advisors Previous Relationship Between Acquirer’s Financial Advisor and Target
|
|
1998, and was the book runner of guaranteed notes issued in 1996.
|
|
3/2/2000 Shared Medical Systems Corp Warburg Dillon Read Inc
|
|
3/6/2000 Dime Bancorp Inc,New
|
|
York,NY Salomon Smith Barney
|
|
Sandler O’Neill Partners Dime Bancorp used Salomon Brothers as its advisor in a merger with North American Mortgage in 1997. Lakeview Financial Corp used Sandler O’Neill Partners as
|
|
its advisor when it was acquired by Dime Bancorp in 1999. Anchor Bancorp used Salomon Brothers as its advisor when it was acquired by Dime Bancorp in 1995.
|
|
Smith Barney was a syndicate member in underwriting Dime Bancorp common shares issued in 1996, and Salomon Smith Barney was a co-manager of Dime Bancorp
|
|
3/14/2000 Howmet International Inc Salomon Smith Barney Salomon Brothers and Smith Barney were syndicate members in underwriting Howmet International common shares issued in 1997.
|
|
5/2/2000 Bestfoods Goldman Sachs & Co
|
|
Warburg Arisco Produtos Alimenticios used Goldman Sachs when it was acquired by Bestfoods in February 2000.
|
|
11/13/2000 Willamette Industries Inc Morgan Stanley & Co
|
|
3/7/2001 Barrett Resources Corp Lehman Brothers Lehman Brothers was a co-manager for a $150 million note for Barrett Resources, active in February 1997 with maturity in February 2007.
|
|
5/8/2001 Newport News Shipbuilding Inc Salomon Smith Barney
|
|
Morgan JP Morgan was used as an advisor when Tenneco spunoff Newport News Shipbuilding to shareholders as a new company in 1996. JP Morgan was the lead placement
|
|
agent of Newport News Shipbuilding senior notes and senior subordinated notes issued in 1996.
|
|
5/14/2001 Wachovia Corp,Winston-
|
|
Salem,NC Morgan Stanley Morgan Stanley acted in various roles, including agent, co-manager, and book runner, of multiple Wachovia securities, notes, CDs, and certificates from 1996 through
|
|
8/1/2001 Cooper Industries Inc Lehman Brothers
|
|
Lynch & Co Inc Climate System, a unit of Wynn’s International, used Lehman Brothers as its advisor when it was acquired by Moog Automotive, a unit of Cooper Industries in 1996.
|
|
Eagle Electric Manufacturing Co Inc used Lehman Brothers as its advisor when it was acquired by Cooper Industries in 2000. Cooper Industries used Merrill Lynch as
|
|
its advisor when Federal-Mogul Corp purchased Cooper’s Cooper Automotive unit in 1998. Lehman Brothers was the book runner of Cooper medium-term notes
|
|
issued in 1998, and was an agent of Cooper medium-term notes issued in 1996.
|
|
8/14/2001 CenturyTel Inc Merrill Lynch & Co Inc
|
|
Stephens Inc Merrill Lynch was an agent of Pacific Telecom (acquired by CenturyTel in 1997) medium-term notes issued in 1996, was a co-manager of CenturyTel notes and
|
|
debentures issued in 1998, and was the book runner of Pacific Telecom medium-term notes issued in 1999. Stephens Inc was a syndicate member of CenturyTel
|
|
remarkable or redeemable securities (ROARS) and global notes issued in 2000 and a co-manager of debentures and notes issued in 1998.
|
|
2/15/2002 NRG Energy Inc Lehman Brothers Lehman Brothers was the joint-lead placement agent of NRG senior secured bonds issued in 2000 and was a co-manager of NRG common stock issued in 2000.
|
|
2/22/2002 TRW Inc Salomon Smith Barney
|
|
Stephens Financial Group Salomon Smith Barney was a syndications agent for a $3.3 billion 364-day facility (active in January 2000 with maturity in January 2001), a $1.5 billion 364-day
|
|
facility active in January 2002 with maturity in January 2003, and a $1.5 billion term loan active in January 2002 with maturity in January 2005. Salomon Smith
|
|
Barney had a 14 percent share in both the latter 364-day facility and the term loan. Salomon Smith Barney was a co-manager of TRW notes issued in 2001, the joint
|
|
book runner of TRW senior unsecured notes issued in 2000, the book runner of TRW medium-term floating rate notes issued in 2000, and the joint lead placement
|
|
agent and global coordinator of TRW global bonds issued in 1999. Salomon Brothers was the book runner of TRW medium term notes issued in 1997
|
|
9/23/2002 Dole Food Co Inc Deutsche Bank AG Dole Food used Deutsche Bank as an advisor when it sold a majority interest in Cerveceria Hondurena SA to South African Breweries PLC in 2001. Flexi-Van
|
|
Leasing Inc, a unit of Dole Foods, used Deutsche Bank AG as its advisor in its merger with Castle & Cooke Inc in 2000 and in its acquisition of the marine chasis
|
|
division of Transport International Pool in 2002. Deutsche Bank was also a participant in a $200 million 364-day facility with Dole Food (August 2001 – August
|
|
2002) and held a 7.5 percent share of the facility. Deutsche Bank was a co-manager of Dole Food notes issued in 1998.
|
|
11/13/2002 Taubman Centers Inc Merrill Lynch & Co Inc Merrill Lynch was a co-manager of Taubman Centers cumulative perpetual preferred stock issued in 1997, and the book runner of Taubman Centers common stock
|
|
1/15/2003 Taubman Centers Inc Merrill Lynch & Co Inc
|
|
Citigroup Merrill Lynch was the book runner of Taubman Centers common stock issued in 1998.
|
|
6/6/2003 PeopleSoft Inc Credit Suisse First Boston Int Vantive Corp used Credit Suisse First Boston when it was acquired by PeopleSoft in 1999.
|
|
Sources: Thomson Financial Securities Data
|
|
