The Inefficiency of Hostile Takeovers as a Disciplinary Mechanism: A Theoretical Analysis

Traditionally, takeovers are seen as a mechanism to improve societal efficiency by acquiring low-value firms at low costs, thereby eliminating poorly managed companies. However, this article challenges this view, demonstrating that certain market infrastructure issues can cause pricing distortions in capital markets. These market infrastructure issues include information asymmetry, imperfect industrial organizations, subsidies and support by the government or other entities, and capital-market imperfections. Such capital-market pricing distortions from market infrastructure issues can keep the value of bad-quality companies high. Conversely, high-quality companies may be undervalued, making them unintended targets. In either case, the disciplinary role of takeovers is undermined. Therefore, countries with serious corporate governance problems should address market infrastructure issues before encouraging hostile takeovers and relaxing related rules that previously restrict bidders’ activities. In addition, this article argues that in countries with certain market infrastructure issues, hostile takeovers are not necessarily effective in enhancing the general quality of management competitiveness, corporate efficiency, or improving corporate governance. It also contends that the efficiency of hostile takeovers depends on the soundness of market infrastructure, a factor often overlooked by academia and policymakers.