Stock corporations

András K ecskés • Vendel Halász

Stock Corporations A Guide to Initial Public Offerings, Corporate Governance and Hostile Takeovers

András Kecskés • Vendel Halász

Stock Corporations A Guide to Initial Public Offerings, Corporate Governance and Hostile Takeovers

© Dr. PhD András K ecskés, 2013 © Dr. Vendel Halász, 2013 © HVG-ORAC Publishing House, 2013 © LexisNexis Austria Publishing House, 2013

Published jointly by HVG-ORAC Lap- és Könyvkiadó Kft., Budapest and LexisNexis Verlag ARD Orac GmbH & Co Kg, Wien

www.hvgorac.eu www.lexisnexis.at

ISBN 978-963-258-205-4 Hungary ISBN 978-3-7007-5672-9 Austria All rights reserved.

No part of this publication may be reproduced or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or by any information storage and retrieval system, without the prior written permission of the publisher.

Responsible editor: Zsolt Gábor Typesetting and technical editing by Éva Harkai Printed by Multiszolg Bt.

’Falsa tempore ac spatio vanescunt’ (Tacitus)

Contents

Foreword . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Acknowledgements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 I. Initial public offering 1. Introduction to initial public offering . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.1. Definition of initial public offering . . . . . . . . . . . . . . . . . . . . . . . . . .

1.2. Advantages of going public . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.2.1. Increase of the share capital . . . . . . . . . . . . . . . . . . . . . . . . .

1.2.2. Access to alternative sources of capital . . . . . . . . . . . . . . . .

1.2.3. Reliability and increased prestige . . . . . . . . . . . . . . . . . . . .

1.2.4.

Liquidity and the effect on the evaluation of the shares . . . .

1.2.5.

Management and the motivation of employees . . . . . . . . . .

1.2.6. Additional advantages . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.3. Disadvantages of going public . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.3.1. Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.3.2. Increased disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.3.3.

Compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.3.4. Potential loss of flexibility and control over the company . .

1.3.5.

Investor relations, PR . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.3.6.

Short-term approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.3.7. Increase of agency costs . . . . . . . . . . . . . . . . . . . . . . . . . . . .

25 25 27 27 28 29 30 31 31 31 31 33 33 34 35 35 36

37 37 37 39

2. Arrangements for initial public offering . . . . . . . . . . . . . . . . . . . . . . . . . .

2.1. Having a minority investor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.2. Preliminary (legal) due diligence . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.3. Differences between public and private companies . . . . . . . . . . . .

2.4. Decision of the shareholders’ meeting on going public

and on the capital increase by issuing new shares . . . . . . . . . . . . . .

40

3.

Preparations for initial public offering . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.2. Issues related to the structure and management of the company . . .

3.3. Is the company ready for initial public offering? . . . . . . . . . . . . . . .

3.4. Selecting the participants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

44 44 44 48 48

8

Contents

3.5. Investment service providers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.6. Aspects of selecting the investment service provider

coordinating the transaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.6.1. Experience with the company and the respective industry .

3.6.2. Experienced analysts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.6.3. Reputation and attention . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.6.4. Distribution abilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.6.5.

Aftermarket support . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.6.6. Conflict of interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.6.7. Services and attention . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.7. Letter of intent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.8. Compliance with rules of corporate governance . . . . . . . . . . . . . . .

3.9. Setting up an investor relations/public relations department . . . . .

3.10. Optimal remuneration system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

50 53 53 53 54 55 55 55 55 56 56 61 62

4. Due diligence and documentation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 4.1. Due diligence investigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 4.1.1. Due diligence and prospectus liability . . . . . . . . . . . . . . . . . 63

4.1.2. Purpose of the due diligence . . . . . . . . . . . . . . . . . . . . . . . . 66

4.1.3. Subject matter of the due diligence . . . . . . . . . . . . . . . . . . . 67 4.2. The prospectus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69

4.2.1. The significance of the prospectus . . . . . . . . . . . . . . . . . . . . 69

4.2.2. Development of the European capital markets . . . . . . . . . . 71

4.2.3. The road to the Prospectus Directive . . . . . . . . . . . . . . . . . . 72

4.2.4. Effective EU and national regulation . . . . . . . . . . . . . . . . . 73 4.2.5.

The Prospectus Directive and an overview of its regulation 74

4.2.6. The scope of the EU regulation . . . . . . . . . . . . . . . . . . . . . . 77

4.2.7. The prospectus in the Capital Markets Act . . . . . . . . . . . . . 78

4.2.8. Provisions on prospectus . . . . . . . . . . . . . . . . . . . . . . . . . . . 81

4.2.9. The contents of the prospectus pursuant to the

Prospectus Directive . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

4.2.10. Provisions of Regulation 809/2004/EC on the contents

of the prospectus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86 4.2.11.

Share Registration Document . . . . . . . . . . . . . . . . . . . . . . . . 87

4.2.12. Share Securities Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92

4.2.13. The regulation of the summary in Regulation 809/2004/EC . . 96

4.2.14. Language requirements regarding the prospectus . . . . . . . . 97

4.2.15. The omission of some information from the prospectus . . . . 98

4.2.16. Incorporating information by reference . . . . . . . . . . . . . . . . 99

4.2.17. The validity of the prospectus and registration document . 100

4.2.18. The frustration of the offering in Hungarian law . . . . . . . . . 102 4.2.19. The evaluation of the regulation on preparing the prospectus 102 4.2.20.

Competent authorities, professional secrecy and cooperation 103

4.2.21. The approval of the prospectus . . . . . . . . . . . . . . . . . . . . . . . 104

Contents

9

4.2.22. Single European passport, mutual recognition,

and EU and Hungarian rules regarding issuers

registered in a third country . . . . . . . . . . . . . . . . . . . . . . . .

4.2.23. Authorising the disclosure of the prospectus in Hungary . .

4.2.24. Means of disclosing the prospectus . . . . . . . . . . . . . . . . . . .

4.2.25. EU regulation of advertising in connection with

the public offering of securities . . . . . . . . . . . . . . . . . . . . . .

107 109 110

5.

Analyst and marketing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5.1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5.2. Investment case (equity story) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5.3. Presentations to research analysts . . . . . . . . . . . . . . . . . . . . . . . . . .

5.4. Preparation of traders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5.5. Pilot fishing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5.6. Function and position of research analysts . . . . . . . . . . . . . . . . . . . .

5.7. Investor education (pre-marketing) . . . . . . . . . . . . . . . . . . . . . . . . .

5.8. Formal marketing activity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5.9. Company roadshow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

113 113 113 114 115 115 115 116 117 117

6. Offer structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6.1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6.2. Share distribution plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6.3. Allocation of shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6.4. Spinning (preferential allocation of shares) . . . . . . . . . . . . . . . . . . .

6.5. Private offering in the United States pursuant to Securities

and Exchange Commission Rule 144a . . . . . . . . . . . . . . . . . . . . . . .

119 119 119 120 121

7. Listing on the stock exchange – conditions and aspects . . . . . . . . . . . . . .

7.1. Aspects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

7.1.1. The minimum size of the company or of the series

of shares to be listed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

7.1.2. The minimum free float and liquidity . . . . . . . . . . . . . . . . . .

7.1.3. Relevant rules of corporate governance . . . . . . . . . . . . . . . .

7.1.4. Number of audited years required . . . . . . . . . . . . . . . . . . . .

7.1.5. Market prestige . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

7.2. The provisions of Directive 2001/34/EC on the admission of

securities to official stock exchange listing and on information

to be published on those securities . . . . . . . . . . . . . . . . . . . . . . . . . .

7.2.1. General provisions concerning the official listing of

securities and the competent authorities . . . . . . . . . . . . . . .

7.2.2. Specific conditions for the admission of shares . . . . . . . . . .

7.3. Listing on the Budapest Stock Exchange . . . . . . . . . . . . . . . . . . . . .

125 125

111

122

126 127 128 129 130 130 130 133 134

8. Pricing and issuing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 138 8.1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 138

10

Contents

8.2. The evaluation of the company – a starting point of pricing . . . . . .

8.3. General rules of issuing in Hungary . . . . . . . . . . . . . . . . . . . . . . . . .

8.4. Marketing models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8.5. Fixed price offer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8.6. Book building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8.7. Firm commitment or best effort offering? . . . . . . . . . . . . . . . . . . . .

8.8. Auctions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8.9. Provisions on auction in the Hungarian act on capital markets . . . .

8.10. Oversubscription and allocation . . . . . . . . . . . . . . . . . . . . . . . . . . . .

138 139 140 141 142 147 148 153 153

9. Secondary market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9.1. Stabilisation on the secondary market . . . . . . . . . . . . . . . . . . . . . . .

9.2. Greenshoe option (the option to buy securities for the

original price beyond the quantity stipulated in the prospectus) . . .

9.3. Regulations on stabilisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9.4. Motivations of stabilisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9.5. Short term underpricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9.6. The possible reasons for underpricing . . . . . . . . . . . . . . . . . . . . . . .

9.7. Long-term overpricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9.8. Flipping (quick resale of shares) . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9.9. Lock-up (a period of share lock-up) . . . . . . . . . . . . . . . . . . . . . . . . .

9.10. Laddering (pushing up the price) . . . . . . . . . . . . . . . . . . . . . . . . . . .

9.11. Regulation related to the activity of the analysts . . . . . . . . . . . . . . .

155 155

II. Corporate governance 1. Corporate governance and its system of terms . . . . . . . . . . . . . . . . . . . . .

1.1. Corporate governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.1.1. The definition of corporate governance . . . . . . . . . . . . . . . .

1.1.2. The corporate governance system of companies . . . . . . . . .

1.1.3. Relations between management, owners, employees

and other persons concerned . . . . . . . . . . . . . . . . . . . . . . . .

1.1.4. Lawful, ethical, reasonable, efficient and socially useful

solutions for profit oriented operation . . . . . . . . . . . . . . . . .

1.1.5. The role of laws and the self-regulating mechanisms

of the market and the business sphere . . . . . . . . . . . . . . . . .

1.2. Fundamental concepts and terms related to the field of

corporate governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.2.1. Managing body . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.2.2.

CEO (Chief Executive Officer) . . . . . . . . . . . . . . . . . . . . . . .

1.2.3. Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.2.4. Hostile takeover . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.2.5. Other technical terms of the business sphere . . . . . . . . . . . .

156 157 160 161 162 166 168 170 171 171 179 179 179 180 182 184 185 186 186 187 187 188 188

2. Interests and stakeholders in the world of public corporations . . . . . . . . . 189 2.1. Defining the circle of stakeholders . . . . . . . . . . . . . . . . . . . . . . . . . . 189

Contents

11

2.2. Theory on the priority of the interests of the shareholders . . . . . . . . 190 2.3. Theory emphasising the interests of stakeholders . . . . . . . . . . . . . . 195

3. The role of corporate governance in the United States . . . . . . . . . . . . . . . 198 3.1. New challenges of corporate governance in the new millennium . 198 3.2. Regulatory reform in the United States: the Sarbanes-Oxley Act . 200

3.2.1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200

3.2.2. The adoption of the Sarbanes-Oxley Act . . . . . . . . . . . . . . . . 202

3.2.3. The persons the Sarbanes-Oxley Act is named after . . . . . . . 202

3.2.4. Summary of the contents of the Sarbanes-Oxley Act . . . . . . 203

3.2.5. Overview of the introductory provisions of the

Sarbanes-Oxley Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204 3.2.6.

The Public Company Accounting Oversight Board (PCAOB) 205

3.2.7. The provisions of the Sarbanes-Oxley Act on the

independence of auditors . . . . . . . . . . . . . . . . . . . . . . . . . . . 209

3.2.8. Provisions regarding more severe liability . . . . . . . . . . . . . 210

3.2.9. Increasing the transparency of financial information . . . . . 211

3.2.10. Other relevant provisions of the Sarbanes-Oxley Act . . . . . 212

3.2.11. Critical remarks regarding the Sarbanes-Oxley Act . . . . . . 213 3.3. The global financial crisis and the United States . . . . . . . . . . . . . . . . 214 4. The role of the European Union in the fields of corporate governance and company law legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 218 4.1. The features of European regulation on corporate governance . . . 218 4.2. The methods of regulating corporate governance in the EU . . . . . . 219 4.3. Sources of law in the field of corporate governance . . . . . . . . . . . . . 219 4.4. ‘Soft law’ regulation achieved by corporate governance codes . . . 220 4.5. Issues of self-regulation in the European Union . . . . . . . . . . . . . . . . 221 4.6. The concept of community regulation on corporate governance

in the report of the Winter group . . . . . . . . . . . . . . . . . . . . . . . . . . . 223 4.7. Recommendations in the report of the Highlevel Group

regarding the most important fields of corporate governance . . . . . 224

4.7.1. View on disclosure obligations . . . . . . . . . . . . . . . . . . . . . . . 225

4.7.2. Objectives regarding the exercise of shareholders’ rights . 226

4.7.3. Recommendations regarding the operation of the

management board (board of directors) . . . . . . . . . . . . . . . . 227

4.7.4. Issues related to auditing in the report of the Highlevel Group . 230 4.8. The Action Plan of the European Commission in 2003 and the

sources of law on corporate governance in the European Union . . . 231 4.9. Regulation on disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 235

4.9.1. Disclosure obligations in the Action Plan . . . . . . . . . . . . . . 235

4.9.2. Provisions of Directive 2006/43/EC . . . . . . . . . . . . . . . . . . . 238 4.9.3.

Directive 2006/46/EC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 239

4.9.4. Harmonisation of transparency requirements for issuers

(Directive 2004/109/EC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240

12

Contents

4.10. Shareholder rights and their exercise . . . . . . . . . . . . . . . . . . . . . . . .

4.10.1. Shareholder rights in the Action Plan . . . . . . . . . . . . . . . . .

4.10.2. Directive 2007/36/EC on the exercise of certain rights

of shareholders in listed companies . . . . . . . . . . . . . . . . . . .

4.11. Community concept regarding the managing bodies

of public corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4.11.1. Targets of the Commission’s Action Plan regarding

the managing bodies of public corporations . . . . . . . . . . . .

4.11.2. Provisions of Recommendation 2005/162/EC . . . . . . . . . . . .

4.11.3. Recommendation on the remuneration of the management

board/board of directors . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4.12. The effects of regulatory solutions applied in the United States

on the legislation of the European Union . . . . . . . . . . . . . . . . . . . . .

4.13. The future ways of corporate governance development in the

European Union . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4.14. The 2012 Company Law and Corporate Governance Action Plan

of the European Commission . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

241 241 245 252 252 257 260 261 263 264

5. Corporate governance in the United Kingdom . . . . . . . . . . . . . . . . . . . . . 269 5.1. The characteristics of the corporate governance regulations of the

United Kingdom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 269 5.2. Cadbury Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 270 5.3. Director Remuneration Report (Greenbury Report) . . . . . . . . . . . . 272 5.4. Hampel Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 273 5.5. Combined Code on Corporate Governance . . . . . . . . . . . . . . . . . . . 273 5.6. The UK Corporate Governance Code . . . . . . . . . . . . . . . . . . . . . . . 276

5.6.1. Establishment of the code and the principles of regulation . . 276

5.6.2. Main Principles of the Code . . . . . . . . . . . . . . . . . . . . . . . . . 277

5.6.3. Using the comply or explain model in the Code . . . . . . . . . . 278 6. Sources of law regarding corporate governance in Germany . . . . . . . . . . 280 6.1. The characteristics of corporate governance regulations in Germany 280 6.2. Relevant sources of law regarding corporate governance in Germany 281 6.2.1. Legislation on capital markets . . . . . . . . . . . . . . . . . . . . . . . 281

6.2.2. Act on corporate transformation

(Umwandlungsgesetz – UmwG) . . . . . . . . . . . . . . . . . . . . . . 281 6.2.3.

Competition Act (Gesetz gegen Wettbewerbsbeschränkungen) 282

6.2.4. The third Act on the development of capital markets

(Drittes Finanzmarktförderungsgesetz) . . . . . . . . . . . . . . . . 282

6.2.5. Act on the supervision of corporations and on

transparency (Gesetz zur Kontrolle und Transparenz

im Unternehmensbereich – KonTraG) . . . . . . . . . . . . . . . . . 282

6.2.6. Act on the simplification of capital increase

(Kapitalaufnahmeerleichterungsgesetz) . . . . . . . . . . . . . . . . 283

6.2.7. German regulation on takeovers . . . . . . . . . . . . . . . . . . . . . 283

Contents

6.2.8.

Tax reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6.2.9. The fourth Act on the development of capital markets

(Vierte FinanzmarktfĂśrderungsgesetz) . . . . . . . . . . . . . . . . .

6.2.10. Transparenz- und Publizitätsgesetz (TransPuG) . . . . . . . . .

6.3. Deutscher Corporate Governance Kodex . . . . . . . . . . . . . . . . . . . . . .

13 284 285 285 286

7. The development of corporate governance in France . . . . . . . . . . . . . . . . 288 7.1. The characteristics of the corporate governance regulations

in France . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 288 7.2. The self-regulatory elements of corporate governance in France . . 290 8. The management structures of public corporations . . . . . . . . . . . . . . . . . 292 8.1. The distinction between the one-tier and two-tier board systems . 292 8.2. The relevant questions of the comparison of corporate

governance systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294 8.3. The different characteristics of the one-tier and two-tier board

systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 295 8.3.1. The development of Rhine capitalism and the dualist model . . 295

8.3.2. The Anglo-Saxon model based on capital concentration

and the primacy of capital market relations . . . . . . . . . . . . . 298 8.4. The main features of the one-tier and the two-tier board systems . 302 8.4.1. The main features of the dualist model . . . . . . . . . . . . . . . . . 302

8.4.2. The effect of the obligatory representation of employees . . . 305

8.4.3. The main features of the one-tier system . . . . . . . . . . . . . . . 307 8.5. The future of the management structures of public corporations . . 310 8.5.1. The development tendencies of the two-tier board system . 310

8.5.2. The development tendencies of the one-tier board system . 314 9. Executive Remuneration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 317 9.1. The theoretical background of executive remuneration . . . . . . . . . . 317

9.1.1. The business law theory of the remuneration . . . . . . . . . . . . 317

9.1.2. Determining the remuneration, remuneration committees . 323 9.1.3. The Enron scandal and the criticism of remuneration

committees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 326

9.1.4. On the growing tendencies of remuneration . . . . . . . . . . . . 327

9.1.5. The features of executive remuneration in European

corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 329

9.1.6. The purpose of executive remuneration . . . . . . . . . . . . . . . . 331 9.2. The practical questions of the optimal remuneration of executives . . 332

9.2.1. Remuneration tools . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 332

9.2.2. Regulation regarding the application of remuneration tools . 332 9.2.3.

Financial incentive . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 333

9.2.4. Career orientation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 335 9.2.5. Performance-based remuneration and performance

indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 335

14

Contents

9.2.6. Stock option remuneration and its risks . . . . . . . . . . . . . . . .

9.2.7. Indexed share options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9.2.8. The optimal share option agreements . . . . . . . . . . . . . . . . .

9.2.9. Decision-making regarding share option remuneration . . .

9.2.10. Shares under transfer restraint as a remuneration tool . . . .

9.2.11. The role of the public and the regulation of disclosure

obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

338 341 342 344 345 346

10. Governance and Ownership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 348 10.1. Research results of La Porta and his team and further relevant

theoretical approaches . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 348

10.1.1. The La-Porta analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 348

10.1.2. Interpretation of differences in capital market structures

from the perspective of 20th century history and politics . 350

10.1.3. The theory emphasizing the importance of the autonomy

of the private sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 354

10.1.4. Diverse corporate governance systems as the explanation

for dispersed ownership and liquid markets . . . . . . . . . . . . 355 10.2. Analysis of Hungarian economic law from the perspective

of the enforcement of shareholder rights, based on the

La Porta method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 357

10.2.1. The one share-one vote principle . . . . . . . . . . . . . . . . . . . . 357

10.2.2. The possibility of proxy by mail . . . . . . . . . . . . . . . . . . . . . . 361

10.2.3. Shares not blocked before the general meeting . . . . . . . . . . 363

10.2.4. Cumulative voting or proportional representation . . . . . . . 363

10.2.5. Oppressed minorities mechanism . . . . . . . . . . . . . . . . . . . . . 364

10.2.6. Preemptive rights to buy new issues of stock . . . . . . . . . . . . 366

10.2.7. Percentage of share capital to call an extraordinary

shareholders’ meeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 367

10.2.8. Mandatory dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 368

10.2.9. Enforcement of shareholders’ rights in Hungary . . . . . . . . 369 10.2.10. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 370 11. The ownership structure of listed corporations . . . . . . . . . . . . . . . . . . . .

11.1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

11.2. Concentrated shareholder structure . . . . . . . . . . . . . . . . . . . . . . . . .

11.3. The connection between the shareholder structure of corporations

and the protection of minority shareholders . . . . . . . . . . . . . . . . . . .

11.4. The level of protection for shareholders and the control

over the management of the company . . . . . . . . . . . . . . . . . . . . . . .

11.5. Participation of employees in corporate governance . . . . . . . . . . . .

11.6. Dispersed shareholder structure . . . . . . . . . . . . . . . . . . . . . . . . . . . .

11.7. The connection between dispersed shareholder structure

and the purposes of takeover regulations . . . . . . . . . . . . . . . . . . . . .

11.8. Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

371 371 372 374 377 378 380 383 384

Contents

15

III. The takeover of public corporations 1. Exercising voting power in public corporations . . . . . . . . . . . . . . . . . . . .

1.1. The issue of voting power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.2. Questions of corporate governance originating in the separation

of cash flow rights and voting rights . . . . . . . . . . . . . . . . . . . . . . . . .

1.3. The reasons of the formation of the controlling minority shareholder structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.4. Cross-ownership of shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.5. Shares with multiple voting rights . . . . . . . . . . . . . . . . . . . . . . . . . .

1.6. Indirect ownership structures (pyramid structures) . . . . . . . . . . . . .

1.7. Disclosure obligations related to acquisition . . . . . . . . . . . . . . . . . .

391 392 393 394 395

2. The theoretical background of regulations of takeover . . . . . . . . . . . . . . .

2.1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.2. Grounds of takeover . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.2.1. Review of related theories . . . . . . . . . . . . . . . . . . . . . . . . . .

2.2.2. Disciplinary theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.2.3.

Synergy theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.2.4. Theory of increasing efficiency . . . . . . . . . . . . . . . . . . . . . . .

2.2.5. The exploitation theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.2.6. Theories based on the approach of behavioural studies . . .

2.3. Adopting the decision about a takeover bid . . . . . . . . . . . . . . . . . . .

2.3.1. The possible alternatives of regulation . . . . . . . . . . . . . . . . . .

2.3.2. The theory of maximising shareholders’ wealth . . . . . . . . . . .

2.3.3. Distributional approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.3.4. Long-term shareholder and social welfare theory . . . . . . . . .

2.3.5. Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.4. The main aspects of adopting the regulation . . . . . . . . . . . . . . . . . .

398 398 399 399 399 402 402 403 404 405 405 407 409 411 414 416

3. The takeover regulation of the United States of America . . . . . . . . . . . . .

3.1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.2. The provisions of the Williams Act . . . . . . . . . . . . . . . . . . . . . . . . .

3.3. The takeover regulation of the states . . . . . . . . . . . . . . . . . . . . . . . .

3.4. Court practice – the resolutions of principal significance of the

Delaware courts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

417 417 418 421

389 389 390

423

4. Review of the takeover regulation of the European Union and Hungary . . 429 4.1. The history of community regulation . . . . . . . . . . . . . . . . . . . . . . . . 429 4.1.1. The reasons for adopting a community level takeover

regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 429

4.1.2. The short history of the adoption of the Takeover Directive 431 4.2. The history of the Hungarian takeover regulation . . . . . . . . . . . . . . 438 4.3. The provisions of the Takeover Directive and the Hungarian law . 440

4.3.1. The supervisory authority and the applicable law . . . . . . . . 440

4.3.2. The introduction of the mandatory bid in community

legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 444

16

Contents

4.3.3. The regulation on voluntary bid . . . . . . . . . . . . . . . . . . . . . . 452

4.3.4. Equal treatment of shareholders . . . . . . . . . . . . . . . . . . . . . 453

4.3.5. Mandatory bid in the Hungarian legislation . . . . . . . . . . . . 454

4.3.6. The period available for accepting the offer . . . . . . . . . . . . 456 4.3.7. The offer price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 458

4.3.8. Conflicts of interest with regard to the purchase offer

and the information gap . . . . . . . . . . . . . . . . . . . . . . . . . . . . 462

4.3.9. The information regarding the offers and the approval

by the supervisory authority . . . . . . . . . . . . . . . . . . . . . . . . . 463

4.3.10. The approval by the Supervisory Authority of

Financial Institutions in Hungary . . . . . . . . . . . . . . . . . . . . 468

4.3.11. Providing information on the target company . . . . . . . . . . . 469

4.3.12. Neutrality rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 472

4.3.13. Breakthrough rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 475

4.3.14. Optional rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 480

4.3.15. Optional breakthrough rule in the Hungarian legislation . 481

4.3.16. Reciprocity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 482

4.3.17. Squeeze-out and sell-out in community legislation . . . . . . . 483

4.3.18. Squeeze-out and sell-out in the Hungarian Capital

Markets Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 486

4.3.19. The future of squeeze-out and sell-out type of rights . . . . . 487

4.3.20. Conclusions regarding the European takeover regulation . 487 5. Defence against hostile takeovers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 489 5.1. Countermeasures in case of hostile takeovers . . . . . . . . . . . . . . . . . 489 5.1.1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 489

5.1.2. Countermeasures in case of hostile takeovers . . . . . . . . . . . 491 5.2. Standpoints in connection with anti-takeover defence measures,

the approval of defence measures . . . . . . . . . . . . . . . . . . . . . . . . . . . 495

5.2.1. The related theoretical approaches . . . . . . . . . . . . . . . . . . . 495

5.2.2. Decision-making on defence measures in the

European Union . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 497

5.2.3. The timing of the approval of anti-takeover defence measures . 499 5.3. Defence measures against hostile takeovers . . . . . . . . . . . . . . . . . . . 500 5.3.1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 5.3.2.

Defence measures incorporated in the articles of association . 500

5.3.3. Issuing new shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 502

5.3.4. Poison pills . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 504

5.3.5. White squire . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 508

5.3.6. Forming cross-ownership structures . . . . . . . . . . . . . . . . . . 509

5.3.7. White knight . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 510

5.3.8. Acquisition of treasury shares . . . . . . . . . . . . . . . . . . . . . . . 510

5.3.9. Golden parachute – tin parachute . . . . . . . . . . . . . . . . . . . . 513

5.3.10. Standstill Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 514 5.3.11.

Greenmail . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515

Contents

17

5.3.12. PR (public relations) activities . . . . . . . . . . . . . . . . . . . . . . .

5.3.13. Crown jewels . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5.3.14. Pac-man defence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5.3.15.

Stock-split . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5.3.16. Offeree’s Takeover of or Merger with Another Company . . .

5.3.17. Bringing forward the unlawfulness of the offer or the

violation the rules of competition law . . . . . . . . . . . . . . . . .

5.3.18. Leveraged recapitalisation . . . . . . . . . . . . . . . . . . . . . . . . . .

5.3.19. Leveraged buy-out . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

520 520 521

6.

522 522 523 524 525 525 526 526

The effects of takeovers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6.1. The effects on the debt level of companies . . . . . . . . . . . . . . . . . . . .

6.2. The effects on creditors and bondholders . . . . . . . . . . . . . . . . . . . . .

6.3. The effects on employees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6.4. The effects on executives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6.5. The effects on shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6.6. The effects on business strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6.7. The adverse effects of high-leverage buy-outs . . . . . . . . . . . . . . . . .

516 517 518 519 519

Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 527 Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 555

Foreword

András Kecskés – Vendel Halász, ‘Stock Corporations: A Guide to Initial Public Offerings, Corporate Governance and Hostile Takeovers’ This book is being published about a quarter of a century after the fall of the Berlin Wall, by two young Hungarian authors. It is well known that the years before the fall of the Berlin Wall were marked by a strong ideological pressure. This pressure was not without opposition; yet it left a mark on the opposition as well. There were, indeed, scholars in Hungary – and other communist countries as well – who adopted a dissident spirit, and who espoused ideas that were pro market economy. But it was difficult to defy a ruling (communist) system of values, and to be at the same time sufficiently critical towards the juxtaposed system. After the end of communism dissidents were joined by more and more people who were waving the flag of market economy, and at the same time they were exercising the same uncritical attitude towards ‘the right thing’ (this time a new ‘right thing’) as the attitude that prevailed under communism.

András Kecskés and Vendel Halász belong to a new generation for which reality begins after communism, and who have a better chance to be pro-market economy, but at the same time to take a critical attitude towards real problems and shortcomings. In other words, they have a better chance to take market economy seriously, rather than just to believe in it. The book shows that this opportunity was seized. The focus of the book is on stock markets, and three consequential issues have been analyzed: initial public offerings, corporate governance, and takeover of public corporations. The scrutiny is directed towards Hungarian law, and Hungarian market reality, but it also offers a thorough analysis of EU law, various legal systems in Europe, and of U.S. law as well.

The analysis is often centered on problems that are marking contemporary business reality. Attention has been devoted to best practices (and dilemmas in choosing between models of best practices). The book focuses on structural characteristics, but also on patterns of responsible (and irresponsible) behavior, juxtaposition between ethics and short term gains, on the role of transparency, just as and on the impact of expertise.

The book reminds us that we have a new generation of scholars, for whom economic and legal phenomena are not just a matter of transition, but an established reality in which orientation is not charted by slogans – and that could be improved as well.

Tibor Várady, S.J.D. Harvard Professor of Law at the Central European University in Budapest

Acknowledgements

Even in the age of infocommunication the authors of this volume honestly believe that books do have spirits. Therefore, the authors consider it extremely important to publish their book with good conscience, representing the concept of integrity in science, education and practice. After two years of comprehensive research the authors present their book to legal and economic professionals, students and to all involved in getting a deeper insight in the world of corporations and markets.

Nevertheless, the authors could not do this with good conscience if they remained in debt by failing to acknowledge the help and support of all those friends and colleagues without whom this book would never have materialized.

We would like to thank the persistent guidance and support provided by Professor Dr. László Kecskés, corresponding member of the Hungarian Academy of Science and dean of the Faculty of Law – University of Pécs, as well as the inspiring original points of view offered by Dr. habil Tibor Nochta PhD. We owe special thanks to our colleagues working at the University of Pécs and other institutions of higher education as well as to those working as legal and business practitioners.

We wish to express appreciation to Professor Dr. Lajos Vékás, ordinary member of the Hungarian Academy of Science, Professor Dr. András Kisfaludi CSc, Professor Dr. Péter Hardi CSc and Dr. habil Tekla Papp PhD for supporting our conferences and events, with special regard to the ‘Business & Law’ conference series. We also thank the generous support from Professor Dr. József Veress Dsc and Dr. habil Gyula Zeller PhD economists who always provided guidance on professional matters whenever we turned to them. We would also like to express our gratitude to all those members of the leadership and staff of the University of Pécs and the Faculty of Law who proved to be supportive towards us and our initiatives.

We also gratefully acknowledge business practitioners and representatives of the business sphere for sharing their experience with us. Thus we wish to express our sincere gratitude to the American Chamber of Commerce in Hungary and the members of the Chamber’s Governance and Transparency Committee for the opportunity to gain lots of experience and knowledge while working together or attending their events. Special thanks are due to president László Czirják, attorney Dr. András Hanák and adviser Dr. Péter Kazár.

We would like to thank Professor Dr. Tibor Várady, ordinary member of the Serbian Academy of Science for finding our volume worthy of recommendation. We also thank him for providing his foreword to our book.

22

Acknowledgements

Finally, an honorable mention goes to Marietta Pókay, Zsófia Zelnik and Péterné Hortobágyi for their generous support on the linguistic maintenance of our manuscripts.

The manuscript of the book was closed on 30th of April 2013.

9th of September 2013

The Authors

I. Initial public offering

1.

Introduction to initial public offering

1.1. Definition of initial public offering In case of initial public offering (IPO) the shares of the company are publicly offered1 for the first time2. This can happen by selling newly issued shares (primary shares) or by the public selling of the shares that previously have been privately offered (secondary shares). In Hungary, public offering is a sale offer of securities aimed at investors not specified previously, which includes sufficient information on the conditions of the offer and on the securities in order to facilitate the decisionmaking of the investors.3 As in case of initial public offerings, the company offers its shares to the investors publicly for the first time, it is rather simple to tell it apart from the subsequent secondary public offering.

The type of shares offered to the public is an important issue in case of initial public offerings. One of the purposes of initial public offerings is that the company acquires more capital in order to finance its operation4. In such instances the publicly offered shares are newly issued and the share capital of the company is concurrently increased. This is the so-called primary offering5. By this solution the company makes income, its capital structure is strengthened as it results in a preferable debt to equity ratio. The increase of the share capital cannot be the sole reason for initial public offerings, as companies often carry out such transaction without a capital increase. The necessary capital can be acquired in other ways as well, for example by obtaining venture capital or taking out a loan. One cannot neglect the transaction costs of issuing shares. Furthermore the potential underpricing of the securities, the increased agency costs originating in being a public corporation and the costs of being on the stock market all produce a significant burden to the corporation planning to go public. In addition a public company must guarantee a significant market return

1 See GRIFFITH, Sean J.: Spinning and Underpricing – A Legal and Economic Analysis of the Preferential Allocation of Shares in Initial Public Offerings, Brooklyn Law Review, Vol. 69. Issue 2. (2004) p. 585.

2 See UTSET, Manuel A.: Producing Information: Initial Public Offerings, Production Costs, and the Producing Lawyer, Oregon Law Review, Vol. 74. Issue 1. (1995) p. 280.

3 See DR. TOMORI, Erika: Értékpapírjog és a tőkepiac szabályozása (Közép-európai Brókerképző Alapítvány, Budapest, 2008) p. 168; Article 5 paragraph (1) point 94. of Act CXX of 2001 on capital markets 4 See BOOTH, Richard A.: Going Public, Selling Stock, and Buying Liquidity, Entrepreneurial Business Law Journal Vol. 2. Issue 2. (2008) p. 661.

5 See DR. TOMORI, Erika: Értékpapírjog és a tőkepiac szabályozása (Közép-európai Brókerképző Alapítvány, Budapest, 2008) p. 163.

26

1. Introduction to initial public offering

to the shareholders,6 in order to perform well in the competition of the market and to preserve the trust of the investors.

Another reason for initial public offering may be that it enables the current owners to get out of the company or to diversify their investments by selling a part of their share7. The sale of the previously privately offered shares by way of public offering is also called a secondary offering (or secondary placement in some markets8).

Having offered the previously privately offered security to the public and having it listed on the regulated market, it shall qualify as a publicly offered security thereafter.9 The income of the sale shall go to the pre-IPO shareholders, whose shares in the company shall consequently decrease. This method offers the possibility to get out of the company, but it has no effect on the balance sheet and the capital structure of the company. However, presumably the market does not prefer such conducts. We can raise two arguments to support this statement. On one hand it is the personal purpose of the investors wishing to get out of the company to sell the shares for the highest possible price. Other viewpoints are of little relevance to them.10 On the other hand it is an obviously wrong message to the market if the existing shareholders decide to leave the company by selling their (all of their) shares. Clearly this investors and the management know the realistic situation of the company. Them leaving the company qualifies as a significant warning regarding the risks and the future profitability of the company.11 Therefore if the existing investors in fact wish to sell their shares, it is inexpedient to do so concurrently in one round. It is advisable to offer only a part of their existing shares during the course of the initial public offering and following a successful transaction sell the remaining shares gradually on the open market.

As primary offering (offering of primary shares) provides the company the possibility to grow, it is the most popular method. As a general rule a significant part of the shares offered in an initial public offering must be newly issued shares – even if the existing shareholders concurrently sell a part of their shares (secondary offering, offering of existing, so-called secondary shares). In such cases two types of shares participate in the initial public offering: in the primary component there are the newly issued shares, and the income of their sale goes to the company. The shares owned by the existing owners of the company, which have been issued before, are the secondary 6 See BOOTH, Richard A.: Going Public, Selling Stock, and Buying Liquidity, Entrepreneurial Business Law Journal Vol. 2. Issue 2. (2008) p. 661.

7 See DRAHO, Jason: The IPO Decision – Why and How Companies Go Public (Edward Elgar Publishing, Northampton, 2005) p. 41 However empirical studies show little justification for the importance of the diversification of portfolios in case of initial public offerings. A research carried out by Marco Pagano, Fabio Panetta and Luigi Zingales in 1998 with respect to Italian companies shows that the founders of a company sold only 6% of their securities during the initial public offering and another 1.3% in the next 3 years.

8 See LAHMANN, Dirk: Germany: The Investment Banker’s View, International Legal Practitioner Vol. 22. Issue 2. (1997) p. 60.

9 See DR. TOMORI, Erika: Értékpapírjog és a tőkepiac szabályozása (Közép-európai Brókerképző Alapítvány, Budapest, 2008) p. 163.

10 See BOOTH, Richard A.: Going Public, Selling Stock, and Buying Liquidity, Entrepreneurial Business Law Journal Vol. 2. Issue 2. (2008) p. 661–662.; See LAHMANN, Dirk: Germany: The Investment Banker’s View, International Legal Practitioner Vol. 22. Issue 2. (1997) p. 60.

11 See DRAHO, Jason: The IPO Decision – Why and How Companies Go Public (Edward Elgar Publishing, Northampton, 2005) p. 186.

I. Initial public offering

27

component. These shares shall be offered continuously and shall be listed on the regulated market. The income of their sale shall flow to the previous owners.12 It is possible that the market is willing to take a larger number of secondary shares as part of the total IPO volume, if special circumstances justify that.13 Many companies choose to become public corporations because they simply have no other options. Its investors, for example the venture capital funds, expect the company to get listed on the stock market, create the liquidity of its securities and this way ensure the possibility of the sale of the shares obtained by the investment.14 Initial public offerings are certainly not only governed by these reasons and obviously not motivated by one single cause.

1.2. Advantages of going public 1.2.1. Increase of the share capital In an initial public offering a private corporation offers shares for sale to the public for the first time and subsequently its securities are sold publicly on the open market.

The initial public offering plays a major role in corporate financing.15 This role can also be considered extraordinary because the public market can provide unlimited funds for the companies.16 Public offering is an important method of increasing the share capital. The company may sell its newly issued shares – and thus a specific portion of ownership – and receive money for it. The company receives this money without any restrictions regarding its use, without any interest and without the obligation to pay it back.17 Paying dividends is only an option, it is not a duty.18 Therefore public offering can draw new capital to the company.19 Such new capital has two purposes: on one hand it is used to expand the business activities of the company20 (so it is used for growth)21,

12 See DRAHO, Jason: The IPO Decision – Why and How Companies Go Public (Edward Elgar Publishing, Northampton, 2005) pp. 186–187.

13 See LAHMANN, Dirk: Germany: The Investment Banker’s View, International Legal Practitioner Vol. 22. Issue 2. (1997) p. 60.

14 See BOOTH, Richard A.: Going Public, Selling Stock, and Buying Liquidity, Entrepreneurial Business Law Journal, Vol. 2. Issue 2. (2008) p. 663.

15 See GANOR, Mira: Manipulative Behavior in Auction IPO’s, DePaul Business & Commercial Law Journal, Vol. 6. Issue 1. (2007) p. 3.

16 See REDNER, Stephen J.: Thinking of Going Public? Think Twice, Then Read the Sarbanes-Oxley Act of 2002, The Journal of Small and Emerging Business Law, Vol. 6. Issue 3. (2002) p. 522.

17 See SJOSTROM, William K. Jr.: Going Public Through an Internet Direct Public Offering: A Sensible Alternative for Small Companies?, Florida Law Review, Vol. 53. Issue 3. (2001) p. 572.

18 See GEDDES, Ross: IPOs and Equity Offerings (Butterworth-Heinemann, 2008) p. 8.

19 See DRAHO, Jason: The IPO Decision – Why and How Companies Go Public (Edward Elgar Publishing, Northampton, 2005) p. 36.

20 See DRAHO, Jason: The IPO Decision – Why and How Companies Go Public (Edward Elgar Publishing, Northampton, 2005) p. 1.

21 See CHOO, Eugene: Going Dutch: The Google IPO, Berkeley Technology Law Journal, Vol. 20. Issue 1. (2005) p. 411.

28

1. Introduction to initial public offering

on the other hand it serves to reduce the company’s debts.22 The company may also increase it’s working capital. When expanding the business activities of the company, the new capital may be used also for research and development23, for creating new production capacities or to diversify the activities of the company.24 If the company admittedly wishes to increase the share capital for its own investment purposes, a cautious investor immediately reviews the chapter on the ‘Use of Proceeds’ of the prospectus and considers how the company could create value for its new shareholders. The clearer a company can explain the use of the income deriving from the offering and its contribution to the future growth, the more successful its initial public offering will be.25 1.2.2. Access to alternative sources of capital Initial public offering does not only give the company an immediate capital injection, but also the chance to satisfy future capital needs by way of subsequent issuing of shares.26 A well-performing and liquid public market that developed following the public offering and listing on the stock exchange may result in a wholesome possibility to draw in more capital.27 Initial public offering therefore provides access to capital markets and expands the range of applicable financing methods28 (for example: convertible bonds, bonds, warrants, etc.). This way the company does not depend so much on bank financing. By being listed on the stock exchange, its reliability with regard to loans is increased as well, so it will have cheaper bank financing options too.29 Based on the above, following the initial public offering, the company will be able to obtain other, alternative sources of capital, as being public assumes compliance with stricter regulations and the expectations of the investors, which reduces the creditors’ risk.30 Initial public offering generally increases the net value of the company due to the newly obtained capital and improves the debt to equity ratio as well. This can also contribute to the company’s financing 22 See GEDDES, Ross: IPOs and Equity Offerings (Butterworth-Heinemann, 2008) p. 8; FORST, Bradley: Going Public and the Implications of Corporate Control: the Modern Lawyer’s Role as Counselor, South Texas Law Journal, Volume 23. Issue 1. (1982) pp. 74–75.

23 See TURKI, Adel L., BARRY, Christopher B.: Initial Public Offerings by Development Stage Companies, The Journal of Small & Emerging Business Law, Vol. 2. Issue 1. (1998) p. 121.

24 See SCHNEIDER, Carl W. and MANKO, Joseph M.: Going Public – Practice, Procedure and Consequences, Villanova Law Review, Vol. 15. Issue 2. (1970) p. 283; REDNER, Stephen J.: Thinking of Going Public? Think Twice, Then Read the Sarbanes-Oxley Act of 2002, The Journal of Small and Emerging Business Law, Vol. 6. Issue 3. (2002) p. 522.

25 See GEDDES, Ross: IPOs and Equity Offerings (Butterworth-Heinemann, 2008) p. 9.

26 See LAHMANN, Dirk: Germany: The Investment Banker’s View, International Legal Practitioner, Vol. 22. Issue 2. (1997) p. 59.

27 See SCHNEIDER, Carl W. and MANKO, Joseph M.: Going Public – Practice, Procedure and Consequences, Villanova Law Review, Vol. 15. Issue 2. (1970) p. 284.

28 See CHOO, Eugene: Going Dutch: The Google IPO, Berkeley Technology Law Journal, Vol. 20. Issue 1.(2005) p. 411.

29 See LAHMANN, Dirk: Germany: The Investment Banker’s View, International Legal Practitioner, Vol. 22. Issue 2. (1997) p. 59.

30 See REDNER, Stephen J.: Thinking of Going Public? Think Twice, Then Read the Sarbanes-Oxley Act of 2002, The Journal of Small and Emerging Business Law, Vol. 6. Issue 3. (2002) p. 522.

I. Initial public offering

29

under better conditions. Usually listed corporations can acquire capital for their future expansion more easily and under better terms than private corporations.31 Furthermore if investment service providers work on these transactions, it may be even more beneficial for the company to make contact with such a firm, as it will have a stake in obtaining the necessary capital for the business activities of the company. Subsequent, secondary public offerings will also be a lot easier as the company will already have the documents that are necessary for the transaction, it will only have to update and amend those.32 Additionally the requirements of a subsequent secondary public offering are more simple and it may even be carried out without a prospectus.33 1.2.3. Reliability and increased prestige Being public increases the reliability and good-will of a company and it is also the investors’ consideration – either well-founded or not – that public companies are more prestigious.34 Being listed on the stock exchange and having a wide range of shareholders gives respect and reputation to the company.35 The customers and suppliers often become shareholders, which motivates them even more to maintain their loyalty towards the company.36 The above and the increased prestige may have a beneficial effect on the company’s relationship with suppliers, customers and creditors.37 Due to the public offering the number of shareholders multiplies and the attention of the analysts and the business press increases concurrently. As the investors and the supervisory authorities monitor the company’s financial performance, the important pieces of information regarding the company shall be accessible to the public, therefore the customers and traders will be more willing to cooperate with the company.38, 39 Being in contact with the investors gives listed companies a more significant attention from the media and the public with regard to a good investment opportunity than private corporations. The continuous obligation to publish specific information also provides a constant opportunity to appear in front of the public.40 See GEDDES, Ross: IPOs and Equity Offerings (Butterworth-Heinemann, 2008) p. 25.

See SJOSTROM, William K. Jr.: Going Public Through an Internet Direct Public Offering: A Sensible Alternative for Small Companies?, Florida Law Review, Vol. 53. Issue 3. (2001) pp. 572–573.

33 Article 22 paragraph (4) point a) of Act CXX of 2001 on capital markets 34 See FORST, Bradley: Going Public and the Implications of Corporate Control: the Modern Lawyer’s Role as Counselor, South Texas Law Journal, Volume 23. Issue 1. (1982) p. 75.

35 See DRAHO, Jason: The IPO Decision – Why and How Companies Go Public (Edward Elgar Publishing, Northampton, 2005) p. 39.

36 See SCHNEIDER, Carl W. and MANKO, Joseph M.: Going Public – Practice, Procedure and Consequences, Villanova Law Review, Vol. 15. Issue 2. (1970) pp. 283–284.

37 See BILL, Arthur H.: On Your Mark, Get Set… – Positioning a Company for a Future Initial Public Offering, Business Law Today, Vol. 2. Issue 3. (1993) p. 61.

38 See SJOSTROM, William K. Jr.: Going Public Through an Internet Direct Public Offering: A Sensible Alternative for Small Companies?, Florida Law Review, Vol. 53. Issue 3. (2001) p. 575.

39 Offerings carried out via the internet (electronically), without the active contribution of investment service providers do not necessarily ensure these advantages. This is highly dependent on the level of attention of the analysts and the business press.

40 See GEDDES, Ross: IPOs and Equity Offerings (Butterworth-Heinemann, 2008) p. 25.; SJOSTROM, William K. Jr.: Going Public Through an Internet Direct Public Offering: A Sensible Alternative for Small Companies?, Florida Law Review, Vol. 53. Issue 3. (2001) p. 575.

31

32

30

1. Introduction to initial public offering

1.2.4. Liquidity41 and the effect on the evaluation of the shares Securities of public corporations are usually sold at a higher price than the ones of the private corporations. In the case of the former the shares are usually sold on a regulated market42, which facilitates a more efficient pricing and an optimal encounter for supply and demand. The prospectus required for the public offering and the subsequent annual reports can ease the anxiety about the performance of the company. Therefore public corporations usually have a higher value than comparable private ones43, not a little bit due to the higher level of transparency.

This can be also justified with the fact that the trading of shares on the stock exchange mentally gives the investors a feeling of significant success as they will enjoy the advantages of the liquidity of the securities from then on.44 The investors are willing to pay a premium for such liquidity, so that they can easily buy or sell the securities of the company. The scope of the liquidity premium may vary from time to time pursuant to the current economic circumstances, and it may even reach 30%.45 A share can be considered liquid if it has an efficient market that ensures public trading and facilitates selling and buying with a minimal price difference. In order to ensure liquidity, the securities are often listed on a leading stock exchange following the public offering and the investment service providers taking part in the transaction often provide an initial price support (stabilisation) on the secondary market. This support often means that they shall act as market makers46 on the market47 and publish analyses and recommendations in order to maintain the interest of the investors. Liquidity enables investors (and the founders of the company)48 to sell their securities and realise their profit. It also provides the founders the option to diversify their portfolios49 without adversely affecting the price of the shares.

41 See DRAHO, Jason: The IPO Decision – Why and How Companies Go Public (Edward Elgar Publishing, Northampton, 2005) p. 1.

42 See REDNER, Stephen J.: Thinking of Going Public? Think Twice, Then Read the Sarbanes-Oxley Act of 2002, The Journal of Small and Emerging Business Law, Vol. 6. Issue 3. (2002) p. 522.

43 See GEDDES, Ross: IPOs and Equity Offerings (Butterworth-Heinemann, 2008) p. 24.

44 See SCHNEIDER, Carl W. and MANKO, Joseph M.: Going Public – Practice, Procedure and Consequences, Villanova Law Review, Vol. 15. Issue 2. (1970) p. 284.

45 See GEDDES, Ross: IPOs and Equity Offerings (Butterworth-Heinemann, 2008) p. 24.

46 According to Article 4 paragraph (2) point 3 of Act CXXXVIII of 2007 on investment service providers, stock exchange service providers and the rules of their activities, a market maker is an investment service provider that does proprietary trading and undertakes a continuous obligation to buy and sell at the prices it previously set.

47 See SHER, Noam: Negligence versus Strict Liability: The Case of Underwriter Liability of IPO’s, DePaul Business & Commercial Law Journal, Vol. 4. Issue 3. (2006) p. 479.

48 See DRAHO, Jason: The IPO Decision – Why and How Companies Go Public (Edward Elgar Publishing, Northampton, 2005) p. 41.

49 See SPINDLER, James C.: IPO Liability and Entrepreneurial Response, University of Pennsylvania Law Review, Vol. 155. Issue 5. (2007) pp. 1205–1207.