Investing in the Competition

Abstract:     
We expect competitors to act as each other's foes. Yet some companies own equity stakes in their competitors. The Article explores this phenomenon of companies owning about 5-15% of the competition and conjectures a few explanations for this investment strategy. The focus of the Article is on the 'barrier to team formation' motivation; investment in the competition that amounts to an anti-takeover mechanism. The Article suggests that companies invest in the competition to deter a third competitor from joining forces with the competition. This anti-takeover mechanism is unique, it is initiated and controlled by a person who is not a fiduciary of the company and who owes no duties to the company's shareholders, but rather is controlled by a competitor (who owns fiduciary duties to its own shareholders). While the managers enjoy the entrenchment provided by the anti-takeover mechanism, they do not control it. And unlike the customary anti-takeover mechanisms, the shareholders cannot bring a derivative suit to restrict it, there is no judicial review of the mechanism, and shareholder pressure cannot relieve it. Thus, the shareholders are vulnerable and are exposed to agency costs, while management is entrenched by this anti-takeover mechanism installed by the competitor. In order to prevent the anti-takeover effect of investing in the competition, the article proposes to amend the bidding rules and allow a special split bid that will level the playing field for potential bidders.

Keywords: Competitors, Microsoft, Yahoo, Google, anti-takeover, takeover, mergers and acquisitions, tender offers, takeover bids, takeover defense, corporate governance, entrenchment.

JEL Classifications: G30, G34, G38, K20, K22

Working Paper Series