The need for external mechanisms to address weak internal corporate governance, correct
suboptimal performance relative to competitors, and discipline ineffective or opportunistic
managers.
Types of External Corporate Governance Mechanism
Market for corporate control
Auditors
Banks and analysts
Regulatory bodies
Media and public activists
The theory of the market for corporate control was first put forward by Professor Henry G.
Manne of the Washington University Law School in 1965. He mainly analysed the market for
corporate control as having the role of mitigating problems of agency caused by the separation
of ownership and control in modern companies. Some scholars consider that the market for
corporate control can play a positive role and act as an external control mechanism, capable of
bringing down agency costs and mitigating contradictions between shareholders and
management. It can also optimise the allocation of resources.
The theory of the market for corporate control advocated by Manne et al. accepts the basic
hypothesis of the neoclassical capital market theory, that is to say it considers that enterprises
should adhere to the aim of maximising value. On the basis of this theory, if management
deviates from this single aim, causing the enterprise to be badly run, with reduced profits, the
share price is bound to fall. When it falls to a certain degree, the enterprise will be undervalued.
It is likely then that enterprise will become the target for acquisitions and mergers and after the
parties involved have obtained controlling shares, there are frequently changes to the board of
directors and managers. Such external pressure causes the enterprise to return to a maximised
value. Even if the bid is unsuccessful, the latent threat is a source of external pressure forcing
management not to deviate too much from the aim of maximised value. An unsuccessful
takeover is like a salutary kick for the managers in office (Keasy 1997). In this way, the market
for corporate control can bring down the costs incurred by the separation of ownership and
control to some extent.
Two conditions are required to make the above point of view tenable. (1) A company’s stock
market price has to reflect the actions and operational efficiency of the managers. A higher price
is an indication that the managers’ operational efficiency is higher, that is to say there is genuine
dependency between share price and the actions and operational efficiency of the managers.
(2) Takeovers have to occur because managers lack ability or their actions deviate from the
interests of the shareholders, that is to say there is genuine dependency between takeovers and
the ability and actions of managers.
there are many random elements which are not related to the managers. Sometimes, it is these
very random elements which determine a company’s basic value. On second thoughts, even if
we suppose that managers are the main or even the only factor determining the value of a
company, it is difficult for the market to fully observe the managers’ actions and evaluate them
correctly, since there is a lack of symmetry of information between managers and the market. In
this, the dependency between the conduct of managers and share price is much reduced.
Given its deep and liquid stock markets,5 India presents a favourable environment for public
takeovers. In order to develop and regulate takeover activity, India’s securities regulator the
Securities and Exchange Board of India (SEBI) has enacted specific regulations.
Due to the prevalence of concentrated shareholdings in Indian companies, the incidence of
hostile takeovers has been negligible. While SEBI’s takeover regulations do not confer much
power to the target’s board to set up takeover defences, the nature of concentration of
shareholdings and other factors offer sufficient protection to incumbent shareholders and
managements against corporate raiders. Hence, substantial attention in India is focused on the
mandatory bid rule (MBR), which operates to grant equality of treatment to minority
shareholders by conferring upon them an exit option in case of a change in control.6 India’s
takeover regulations are arguably stringent in implementing the MBR. This impedes value-
enhancing takeovers unless they are effected with the concurrence of the controlling
shareholders,7 who could potentially block them.
The MBR has become the mainstay of takeover regulation in India. 29 Rooted in the principle of
equal opportunity to shareholders, the rule requires control premium in case of a takeover to be
shared among all shareholders, including the minorities.30 In addition, it also provides an exit
opportunity to minority shareholders in the event of a change in control of the target. This is to
protect them against behaviour of the new acquirer that may be potentially abusive to the
interests of the minority who may then lack favourable exit opportunities.
