On November 30 2022, the Belgian federal government and the governments of the federated entities adopted the cooperation agreement on the Belgian foreign direct investment screening mechanism. The draft text has now been submitted to the various parliaments for approval and should enter into force on June 1, 2023. This adds Belgium to the list of EU Member States that have recently tightened their rules on foreign direct investment (FDI). Similarly, in mid-2022, the Dutch Chamber of Representatives adopted the Wet Vifo, establishing the new Dutch general (F)DI screening mechanism. Its entry into force is scheduled for early summer 2023.
As many have pointed out, the practical implications of these new FDI rules for mergers and acquisitions (M&A) in the Benelux can hardly be overstated. For one thing, FDI screening will affect the timetable of transactions. As with merger control, the deal will not be able to close prior to the green light from the respective screening authorities (i.e. the Interfederal Screening Committee for Belgium and the Investment Screening Office for the Netherlands). As important as these practical implications are, the tightening of FDI rules also raises more theoretical questions, that is, from a Law and Economics perspective.
The impact on the market of corporate control
First, one may wonder what the impact of these two brand-new FDI screening mechanisms will be on the Benelux market for corporate control.[1] The (negative) impact of the tightened FDI rules on takeover activity in the Benelux will not be known from the outset and only become clear once the two screening mechanisms have been in place for a number of years. However, other countries, such as the US and France, have had operating FDI screening mechanisms for some time now, which has led to an extensive body of empirical research.
As to the US market for corporate control, Godsell, Lel and Miller studied the impact of the Foreign Investment and National Security Act of 2007 (FINSA) on takeover activity in the US. They compared the cross-border takeover probability of companies specifically identified by the Committee on Foreign Investment in the United States (CFIUS) as critical to national security with that of companies not so identified. Their empirical research demonstrated that the cross-border takeover probability of listed firms affected by FINSA decreased by 68% compared to those not affected by FINSA.[2] In the same vein, turning to the French market for corporate control, a study found that the entry into force in 2014 of the Alstom Decree, which significantly extended the list of sectors to which the French screening mechanism applies, led to a 40% drop in the overalltakeover probability of listed and privately held companies affected compared to those not affected by the reform.[3]
It is not inconceivable that the Belgian and Dutch FDI screening rules will have similar effects on the takeover probability of affected Benelux companies. Differences in the scope of application of the different regimes should, however, be borne in mind. For instance, the French screening mechanism, both in its current form and under the Alstom Decree, applies both to EU and non-EU investors.[4] In contrast, the Belgian screening mechanism will apply solely to non-EU investors. On the other side of the spectrum, the Dutch screening mechanism will not only apply to non-EU and EU investors but also to Dutch investors. In short, one could assume that the broader the personal scope, the greater the negative effect on takeover probability will be, and, conversely, the narrower the personal scope, the more limited the negative effect.
The impact on the performance of the firms affected
The finding above prompts another question: what does such a reduced takeover probability mean in the light of the disciplining function of hostile takeovers? According to this theory, hostile takeovers serve as a device for discipling the target company’s incumbent management.[5] If the target company performs poorly, its shares will be priced lower than those of its peers. Hostile bidders will consider the underperforming company as an “easy prey” and be willing to pay a premium above the shares’ market price, because they believe that, under superior management, the target company’s assets would yield higher returns. The incumbent management will therefore be incentivised to improve their performance and thus that of the target, as this would increase the target’s stock price, and hence stave off hostile bids.[6]
In all this, it is important to note that the disciplining function of hostile takeovers rests on two premises. First, that the target company’s shares are listed on a stock-exchange, and secondly, that the capital markets are efficient, meaning that the target’s share price fully reflects all available information about the target, including information about the performance of the target’s incumbent management[7] If those two conditions are not satisfied, the target’s (in)efficiency will not be reflected in the share price, and the hostile bidder will not be able to be guided by it in its takeover decision.
In keeping with this idea, regulatory takeover regimes that reduce takeover probability could result in reduced management discipline and poorer company performance. This is an assumption that has first gained traction in the context of takeover defences (such as poison pills, staggered boards and golden parachutes), which allocate the decision-making power in takeover situations to the target’s incumbent management, enabling the latter to entrench itself. Indeed, in order to consolidate its own position within the firm, management, fearing to be replaced after the takeover, might propose to the target’s board and shareholders to adopt takeover defences. These would lower the takeover probability of the target, weaken the incentive for incumbent management to improve the target’s performance, and can therefore be considered inefficient.[8]
A similar assumption could be made as regards to FDI screening mechanisms: stricter rules on FDI may make it less likely that the inefficient management of firms falling within the FDI regime’s scope will be replaced by more efficient management. Despite the fact that such takeover barriers are erected by the legislator and not by the incumbent management itself, it is still the latter that indirectly would benefit from the negative effects of FDI screening on the market for corporate control.
However, this assertion needs to be qualified. There is an ongoing debate on the question whether or not takeover defences, and by analogy FDI screening mechanisms, do indeed negatively affect the performance of listed companies. According to the Principal Cost Theory of Goshen and Squire, the answer to this question is nuanced and firm-specific. The two authors argue that takeover defences and the allocation of decision-making power to management can prove efficient in some situations. For example, when shareholders fail to recognize the true value of the incumbent management’s strategy, they might sell their shares at a too low a price, giving away the firm’s hidden value. This may be due to the fact that the activities of the company concerned or the sector in which the company operates are difficult for the shareholders to understand.[9] Where, on the other hand, in addition to the fact that the firm’s business is easy to grasp, the inefficient target’s managers acts in bad faith (i.e. out of self-preservation), takeover defences and the allocation of decision-making power to management should be considered inefficient.[10] In these circumstances, as the traditional view rightly asserts, takeover defences do indeed result in poorer performance by the target.
In short, depending on the characteristics of the company concerned, the provision of takeover defences by the target’s shareholders to the target’s management may prove efficient or inefficient.[11] This is all the more true for mandatory FDI filing requirements. Other than in the case of takeover defences, companies do not choose whether or not they are subjected to FDI screening. In some situations, FDI screening will prove efficient “by accident” (see by analogy, the example described by Goshen and Squire regarding takeover defences). In other situations, however, it will only help mala fide management to remain in power. FDI screening mechanisms should therefore be regarded as inefficient, as they apply regardless the specificities of both the firm and the situation, and in other words lead to hostile takeovers being successfully staved off even when this proves inefficient.
Admittingly, the considerations above regarding the negative impact of FDI screening mechanisms on the performance of listed companies are of slightly lesser relevance for the Benelux, as hostile bids are (already) relatively rare. One reason is that Belgian and Dutch companies are typically characterised by a highly concentrated (family) shareholder structure. Hostile bids are therefore unlikely to succeed without the support of the controlling shareholders. Dutch law also allows target’s management to deploy strong takeover defences, such as the “anti-takeover foundation”.[12] By way of contrast, the detrimental effect of the National Security and Investment Act 2021 on the performance of UK listed firms will likely be more noticeable, as takeover defences are generally prohibited under the no frustration rule in the UK.[13]
Conclusion
The considerations above result in two findings. First, the Belgian and Dutch FDI screening mechanisms will most likely negatively impact the takeover probability of listed and privately held firms in the Benelux. Because of the larger personal scope of the Wet Vifo compared to the Belgian cooperation agreement, this negative impact is expected to be greater under the Dutch FDI rules than under the Belgian FDI rules.
In addition, applying the Principal Cost Theory of Goshen and Squire, it is not inconceivable that the two Benelux FDI screening mechanisms will have a detrimental effect on the firm performance of the listed target companies falling within their scope.[14] However, it should be noted in this regard that the market for hostile bids in the Benelux is (already) relatively inactive compared for instance to the UK’s. Therefore, this negative impact will most likely be rather limited.
As the above are ultimately no more than assumptions, we should welcome empirical research that studies the impact of these two FDI screening regimes on the Benelux market for corporate control and the firm performance of Belgian and Dutch listed companies. In the meantime, however, their potential drawbacks should be mitigated as much as possible. Making the screening procedures shorter and less cumbersome, would be a good start.
Thomas Van Gerven
Student master of laws (KU Leuven)
[1] The market for corporate control, a concept and term first developed and coined by Henry G. Manne, can be defined as the market place in which listed and private held companies are bought and sold in whole or in part. See Henry G. Manne, ‘Mergers and the Market for Corporate Control’ (1965) 73 Journal for Political Economy 110.
[2] David Godsell, Ugur Lel and Darius Miller, ‘Financial Protectionism, M&A Activity, and Shareholder Wealth’ (2018), 34. Available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3218001.
[3] Marc Frattaroli, ‘Does protectionist anti-takeover legislation lead to managerial entrenchment?’ (2020) 136 Journal of Financial Economics 106, 116-117.
[4] Code monétaire et financier, Article R151-2. Available at https://www.legifrance.gouv.fr/codes/article_lc/LEGIARTI000041461628/.
[5] David Scharfstein, ‘The Disciplinary Role of Takeovers’ (1988) 55 The Review of Economic Studies 185, 185. More recently: Andrew Johnston, ‘Takeover regulation: historical and theoretical perspectives on the City Code’ (2007) 66 Cambridge Law Journal 422, 450.
[6] Simon Deakin and Giles Slinger, ‘Hostile Takeover, Corporate Law and the Theory of the Firm’ (1997) 24 Journal of Law and Society 124, 127. More recently: Albert O Saulsbury, ‘The Availability of Takeover Defenses and Deal Protection Devices for Anglo-American Target Companies’ (2012) 37 Delaware Journal of Corporate Law 115, 142.
[7] Deakin and Slinger (n 6) 127.
[8] Johnston (n 5) 450.
[9] Zohar Goshen and Richard Squire, ‘Principal Costs: A New Theory for Corporate Law and Governance’ (2017) 117 Columbia Law School 767, 817.
[10] Idem.
[11] Idem.
[12] For more on the Dutch “anti-takeover foundation”, see Leonard Chazen and Peter Werdmuller, ‘The Dutch Poison Pill: How it is Different from an American Rights Plan?’, Harvard Law School Forum on Corporate Governance, December 11, 2015, https://corpgov.law.harvard.edu/2015/12/01/the-dutch-poison-pill-how-is-it-different-, from-an-american-rights-plan/.
[13] According to the no frustration rule, the target’s management may not ‘frustrate’ an unsolicited offer once it has been made, nor once the management has reasons to believe that it will be made (i.e. an imminent offer). See Takeover Code, Rule 21. Available at https://www.thetakeoverpanel.org.uk/wp-content/uploads/2008/11/code.pdf.
[14] That is, provided that the Benelux capital markets are at least semi-strongly efficient. See Eugene F Fama, ‘Efficient Capital Markets: A Review of Theory and Empirical Work’ (1977) 25(2) The Journal of Finance 383. Fama distinguishes three forms of capital market efficiency: weakly, semi-strongly and strongly efficient capital markets. Stock prices in semi-strongly efficient markets reflect not only historical information but also all current publicly available information about the firm (e.g. stock splits, dividend payments and takeover bids).
Corporate Finance Lab 