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Mandatory Bids in China: You Can Lead a Horse to Water, but You Can’t Make It Drink

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Abstract

This paper studies mandatory bids in China against an institutional backdrop of restrictive IPO requisites. We find that virtually no shares held by external shareholders are tendered in mandatory bids for all the remaining shares. Mandatory bidders’ tactics to avoid tendering by public investors include pressing down their bid prices, and the potential manipulation of target stock prices. In relation to the economic impacts of mandatory bids, we document that the market responds favourably to their announcements, and that targets’ operational performance improves in their wake, consistent with the theoretical prediction that mandatory bids induce efficient transfers of corporate control. Our research is among the earliest empirical works on the mandatory bid rule in a particular jurisdiction. It not only yields interesting results pertaining to the unique Chinese regulatory environment, but also generates useful insights into mandatory bids beyond China.

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Notes

  1. The mandatory bid rule first appeared in Art. 48 of The Temporary Rules for Regulating the Issuance and Exchange of Stocks (Gupiao Faxing Yu Jiaoyi Guanli Zanxing Guiding, 股票发行与交易管理暂行条例) of 1993.

  2. See Ma (2009), p 52.

  3. See Cai (2011); Xi (2015). In addition, Tang and Kanda (2019), published in Chinese after earlier drafts of our paper were made publicly available, includes some descriptive data on the prices and outcomes from the tender offers in China, including the percentage of exemptions. However, it is primarily a doctrinal study of the mandatory bid rules in China and Japan.

  4. See Bebchuk (1994).

  5. See Lüttmann (1992).

  6. See Kahan (1993); Bebchuk (1994).

  7. See Bergström et al. (1997).

  8. See Burkart et al. (2000).

  9. Enriques (2004) and Papadopoulos (2007) critically assessed the proposed EU takeover directive on the mandatory bid rule. Directive 2004/25/EC of the European Parliament and of the Council of 21 April 2004 on takeover bids [2004] OJ L 142/12. Papadopoulos (2013) analyzed a decision by the Court of Justice of the European Free Trade Association States to clarify the criteria for the adjustment of mandatory bid prices. Schuster (2013) applied an economic model to advocate the efficiency of the mandatory bid rule in the presence of competing bids.

  10. See Enriques (2004); Xi (2015).

  11. See Barclay and Holderness (1991); Barclay and Holderness (1992).

  12. See Burkart et al. (2000).

  13. See Carvalhal da Silva and Subrahmanyam (2007).

  14. See Xi (2015).

  15. See Grant et al. (2009).

  16. See Cai (2011).

  17. See Kahan (1993); Bebchuk (1994); Schuster (2013).

  18. See Bebchuk (1994).

  19. See Burkart et al. (2000).

  20. See Cai (2011).

  21. See Grant et al. (2009); Cai (2011).

  22. See Clarke et al. (2008).

  23. The general requirement for mandatory bids is stipulated in Art. 65 of the PRC Securities Law as amended in 2019, and the regulatory details are detailed in Chapter 3 of RLTC. Xi (2015) provides an interesting discussion on the potential reasons for the reform to mandatory bid rules in 2006.

  24. See Ma (2009), pp 57–58.

  25. As treasury stock was not permitted in China during the study period, the number of outstanding shares in a listed company is essentially identical to the number of issued shares.

  26. See Ma (2009), pp 59–60.

  27. See Ma (2009).

  28. In this paper, transfer (or change) of control represents a change in the largest shareholder of the target, or a change in the absolute controller who holds above 50% shares of the largest shareholder of the target. In China, the largest shareholder almost always controls the board of directors.

  29. A shareholder must disclose the number of shares they hold in the company and cease trading within three days of accumulating an additional 5% of the target shares on the open market (RTLC, Art. 13).

  30. All four bids (for stocks of 000048, 000893, 600246, 600280) were triggered as a result of the incumbent controlling shareholders’ acquisition of additional stocks in target companies. Besides, four other mandatory bids resulted from a change of ownership, from with to without a controller, in the controlling shareholder of the listed companies. These offers are based on a recent CSRC internal policy to deal uniquely with the latest mixed ownership reform of State-Owned Enterprises (SOEs). The four listed companies (000538, 600664, 600729, 600829) in our sample are all controlled by SOEs going through such reforms. We do not count these cases as either involving or not involving a transfer of control.

  31. Four of these six transactions employed a two-step strategy to seize the control of target companies. In the first step, the new controller purchased exactly, or slightly less than, 30% of the stocks in the target company, either from the incumbent controller in a lump-sum transfer (002032, 002552, 600265) or gradually from the public market (660774). Then a partial offer was made in the second step by the purchaser to acquire additional stocks. The other two partial offers were made by bidders with zero, or a small, toehold position to take control of the targets. One of them represents the first hostile public bid in China for control of a listed company (000403). The remaining one established a controlling position in a target (000008) without a controller therebefore. Both bids would give the bidders below 30% shareholding even after their bids were successful, hence partial offers being allowed.

  32. RTLC, Arts. 62 and 63. In particular, exemptions based on the following reasons require CSRC approval ex ante: (1) transfer of shares between subsidiaries of the controlling shareholder of a listed company; (2) stock acquisitions to restructure financially distressed companies; (3) increase in shareholding by SOEs due to a reallocation of state assets by the government; (4) passive increase in shareholding due to stock buybacks by a listed company from specific investors; or (5) other situations where the CSRC deems it necessary to adapt to market development and protect lawful interests of investors. On the other hand, automatic exemptions occur in the case of: (1) private placement of new shares with particular purchasers based on shareholder approval and 3-year lockups; (2) purchases of no more than 2% of the outstanding shares within every 12 months by shareholders with 30–50% of the shares; (3) stock purchase by absolute controllers holding more than 50% of the shares; (4) financial institutions trading stocks in the ordinary course of business without an intention of control; (5) acquisition of stocks due to inheritance; (6) execution of securities repurchase agreements; or (7) revival of voting rights by preferred shareholders. The basic framework of the exemption system was established in 2006, with minor procedural changes made through the 2014 amendments to RTLC. However, the latest revision of RTLC, promulgated on 20 March 2020, removes the requirement of CSRC approval regarding all the above 12 reasons for exemptions.

  33. For example, see Wan and Varottil (2013) for exemptions from mandatory bids in Singapore.

  34. See Enriques (2004), p 777 for a similar exemption in France.

  35. These are financing agreements secured by share pledges where, in essence, borrowers sell their shares in listed companies to lenders with the promise of repurchasing these shares at a different price in the future. Voting rights, however, usually remain with the borrowers.

  36. In China, preferred shareholders of listed companies do not have voting rights in regular situations, and instead their voting rights are revived when shareholders vote on issues relating to a fundamental change in the company or in the terms of preferred shares, and when dividends of preferred shares are outstanding for an extended period of time.

  37. See Ma (2009), p 89.

  38. See Tang and Kanda (2019).

  39. RTLC, Art. 37. The offer period can be extended if there are competing bids issued subsequently.

  40. RTLC, Art. 35.

  41. More details can be found in Huang (2011).

  42. See Liu et al. (2013).

  43. See Wang and Ban (2016).

  44. See Robyn Mak, Xiaomi IPO Escalates China’s Battle of the Bourses, Reuters (15 June 2018), https://www.reuters.com/article/us-xiaomi-china-breakingviews/breakingviews-xiaomi-ipo-escalates-chinas-battle-of-the-bourses-idUSKBN1JB0K8.

  45. See the report on Sina.com, http://news.sina.com.cn/c/2017-12-16/doc-ifypsvkp3731363.shtml.

  46. PRC Securities Law as amended in 2014, Art. 50(3).

  47. See Peng (2012).

  48. RTLC, Art. 42.

  49. Inequality (7) in Bebchuk (1994) presents the condition for a transfer of control under the mandatory bid rule assuming that the purchase price of control, hence the bid price, is greater than the share value to non-controlling shareholders after the transfer. We extend this model to our case where this price is below the post-transfer share value to non-controlling shareholders. Using the original notations in Bebchuk (1994), we write out the conditions under which non-controlling shareholders do not choose to tender their shares in a mandatory bid as the market price exceeds the bid price upon bid announcement.

    $${\text{W}}_{{\text{e}}} + \, \left( {{\text{n}} - {\text{k}}} \right){\text{B}}_{{\text{e}}} /{\text{k }} < {\text{ W}}_{{\text{n}}} + \, \left( {{\text{n}} - {\text{k}}} \right){\text{B}}_{{\text{n}}} /{\text{k}}$$
    (1)
    $${\text{W}}_{{\text{e}}} {-}{\text{B}}_{{\text{e}}} < {\text{ W}}_{{\text{n}}} {-}{\text{B}}_{{\text{n}}}$$
    (2)
    $${\text{W}}_{{\text{e}}} + \, \left( {{\text{n}} - {\text{k}}} \right){\text{B}}_{{\text{e}}} /{\text{k }} < {\text{ W}}_{{\text{n}}} {-}{\text{B}}_{{\text{n}}}$$
    (3)

    where We and Wn are the per share total value flowing to shareholders when the company is under the control of, respectively, the incumbent and new controllers, Be and Bn are the per share private benefits of control going, respectively, to the incumbent and new controllers, n denotes the total number of outstanding shares, and k stands for the number of shares owned by the incumbent and available for transfer to the new controller.

    Inequality (1) ensures that the new controller enjoys enhanced company value as compared to the original controller when non-controlling shareholders do not exit following the transfer of corporate control, so that the new controller does have an incentive to pay for the control. Inequality (2) reflects the condition that the value of shares held by non-controlling shareholders embodied in the market price rises in the wake of the transfer of control. Finally, inequality (3) imposes the condition that the mandatory bid price, p, which cannot be below the negotiated purchase price for control, is lower than the share value to non-controlling shareholders following the transfer of control. This last inequality is derived from We + (n − k)Be/k < p < Wn – Bn.

    As all of the parameters are positive and n > k, we can rearrange (1) as We – Wn < (Bn – Be)(n − k)/k, and (2) as We – Wn < Be – Bn. Therefore, for both (1) and (2) to be satisfied, We – Wn has to be negative since both (Bn – Be) and (Be – Bn) cannot be positive at the same time, and if both equal zero, We – Wn still needs to be smaller than zero. Alternatively, rearranging (3), we get We – Wn < – [(n − k)Be/k + Bn] which also means We – Wn is negative. Therefore, the company’s overall value should be greater under the control of the new controller.

  50. The model in Bebchuk (1994) foreshadows this conclusion as well. Again, using the notations in Bebchuk (1994), the value the incumbent controller enjoys per share can be written as

    $${\text{W}}_{{\text{e}}} + \, \left( {{\text{n}} - {\text{k}}} \right){\text{B}}_{{\text{e}}} /{\text{k}}.$$
    (4)

    The first term in (4) is the per share total value of the firm under the incumbent’s control and the second term represents the per share private benefit of control, which is diverted from non-controlling shareholders. As the controller increases their number of shares, k rises, which renders the value of the second term smaller. Hence, in order to maintain the value of their shares, the controller gets an extra incentive to raise We, all other things being equal. Moreover, Burkart et al. (2000) also hypothesizes an increase in firm value following ownership concentration due to an enhanced alignment of interests between controlling and non-controlling shareholders, despite the fact that their discussion surrounds the degree of concentration generated as a result of successful full bids.

  51. The target stock ticker symbols of these eight cases are 000586, 000759, 002662, 002711, 600093, 600525, 600664 and 600829.

  52. This is the bid by Rongsheng Heavy Industries for Quanchai Engine (600218). It appears that the stock purchase agreement between the incumbent controller and the purported acquirer of control was terminated due to the effect of a changed conditions clause allowing the acquirer to quit in case of a material shift in economic positioning. Indeed, the acquirer exercised their rights according to this clause, alleging that the deterioration of the European debt crisis had activated its right to withdraw (Lei 2014). Since listed companies in China are not required to file their material deal agreements, we have limited information on the details of this case. In theory, incumbent and intended controllers of other companies may also insert similar clauses into their negotiated stock purchase agreements so as to reserve the right to terminate the agreements, as well as the ensuing mandatory bids, when they find it in their benefit to do so. In practice, however, no other bidders have replicated the Rongsheng and Quanchai case, probably due to Chinese regulators’ cautious attitude regarding voluntary withdrawals of announced bids.

  53. The two bids referenced are Golden Horse Tourism (000602) and Erzhong Group (Deyang) Heavy Industries (601268).

  54. Two of the three are the partial offers made by bidders with zero, or a small, toehold position to take control of the targets mentioned in supra n. 31. The other is a strategic investment solicited by the existing controller of Beingmate Baby and Child Food (002570). The bidder, therefore, is essentially an ally of the controller.

  55. We get the stock price and target financial information for 2019 from Wind as CSMAR only contains data up to 2018 at the time of our data collection.

  56. For target industrial sectors, we follow the 2012 version of the Guidelines for the Industry Classification of Listed Companies issued by CSRC (Shangshi Gongsi Hangye Fenlei Zhiyin, 上市公司行业分类指引, hereinafter as Guidelines). Considering the small size of our sample, however, we code target industries only using the initial Latin letters in the Guidelines which represent industrial categories (menlei, 门类).

  57. See Varottil (2017); Wan (2017).

  58. When we look at the average shareholding by the top three shareholders, companies listed on SZSE mainboard rises slightly from 44.85% in 2012 to 46% in 2017. However, for those listed on both SZSE SME board and ChiNex, this percentage drops by more than six percentage points during the same period.

  59. E.g. Restrepo and Subramanian (2015); Cain et al. (2019).

  60. Two reports do not have the 30-day VWAP for unknown reasons.

  61. E.g. Krishnan and Masulis (2013).

  62. We do not calculate offer premiums based on the price 6 months prior to the offer announcement although the law requires that offer prices cannot be lower than the highest price the offeror has acquired the target stocks at within this period of time. It is an unconventional practice in the literature to calculate offer premiums based on stock prices more than 2 months prior to announcements. Theoretically, offer premiums should indicate the extra price paid by offerors relative to the current value of targets when offers are being made. Given that targets’ stock prices tend to fluctuate with various information, the farther away the benchmark day is chosen from the offer announcement day, the less likely prices tied to that day would accurately reflect the current value of targets at the time of the offer. Six months means there are two quarterly reports, which seem to be too far away from the offer announcement.

  63. See Subramanian (2016), p 628.

  64. The coefficient of the full offer dummy is significant at the 10% level in only one model, and in all the rest, it is significant at the 5% level.

  65. The coefficient of the full offer dummy loses statistical significance only in model V when the 30-day VWAP is used to measure the premium.

  66. See Wu (2005).

  67. See Xu et al. (2017).

  68. Bris (2005).

  69. Jiang et al. (2005).

  70. If the offer closing day is not a trading day, then it is up to the last trading day before the offer closing day.

  71. dROA1 = target’s ROA in the quarter of the offer announcement – target’s ROA in the quarter one year before the offer announcement.

  72. dROA2 = target’s ROA in the quarter one year after offer closing – target’s ROA in the quarter of the offer announcement.

  73. didROA = dROA2 – dROA1.

  74. For the definition of transfer of control, see supra n. 28.

  75. Bebchuk (1994); Kahan (1993).

  76. See proof of this point in supra n. 49.

  77. This second standard is apparently overinclusive as firms beginning major asset restructuring may not complete it within the first year after closing the offer. For the purposes of our study, however, this should not be an issue as the overinclusive standard ensures that our ascertained improvement in operational performance is even less likely due to asset alteration if the interaction between the full offer and the new dummy variable has no effect on target performance.

  78. See supra n. 49.

  79. We are aware of only one quantitative study written in Chinese on the transfer of public corporate control in China (Xu and Fu 2017), which does not look into tender offers in particular or apply multivariate regressions.

  80. La Porta et al. (1998).

  81. The extent of extortion risk is based on Dyck and Zingales (2004).

  82. Aside from China, Italy, Japan and India are other jurisdictions where partial offers are permitted under the mandatory bid scheme (Davies and Hopt 2009; Varottil 2017; Tang and Kanda 2019).

  83. Burkart et al. (2000) postulate that the incumbent will sell part of their controlling block at a discount in pursuit of post-bid benefits from unsold shares when the new controller can create value for non-controlling shareholders that is even greater than the pre-bid value enjoyed by the incumbent shareholder as a controller. In the context of our study, however, it seems that incumbent shareholders often sell the entirety of their controlling blocks to mandatory bidders.

  84. One case concerning this point is the sale of Sichuan Shuangma Cement Co. (000935) shares by its former controller Lafarge after setbacks experienced in the Chinese cement market. It is reported that Lafarge holds an option to purchase Sichuan Shuangma’s assets related to cement production after selling its shares. See Wen (2017).

  85. However, two-step acquisitions seem have increased in recent years. Each year of 2017, 2018 and 2019 saw one such transaction, while this appeared only once in China some 11 years before 2017, see supra n. 31 for details of these four two-step deals.

  86. See Tang and Kanda (2019) for the surge of partial offers in 2018. Apart from stimulation by the first successful hostile bid, a more favourable regulatory position may have also facilitated hostile bids. Most noticeably, the regulation on voluntary trading halts has been gradually tightened since 2017 and trading halts can exert severe deterring effects on hostile bids.

  87. Xu and Fu (2017) is the only study, to our knowledge, that touches on this issue and apparently shows no improvements in target operational performance for these types of transactions.

  88. See Wan and Varottil (2013).

  89. Based on inequality (7) in Bebchuk (1994), an incumbent should never start a mandatory bid except when confronted with a hostile bidder. In a competitive bidding scenario, a challenger cannot win unless its offer price is no lower than the per share total value of the firm under the incumbent’s control (Burkart et al. 2000), which is denoted by We in Bebchuk (1994). In the presence of the mandatory bidding requirement that allows all the external shareholders to sell their shares, however, the challenger is only willing to make such a bid if the per share total value of the firm under their control, Wn, is greater than We. Therefore, if the incumbent wins, the firm value at least remains unchanged. In contrast, if the challenger wins, i.e. Wn > We, then the firm value will increase under the new controller. However, some scholars have argued recently that allowing for partial bids in hostile takeovers, similar to the Chinese rule, could increase overall welfare by enlarging the chance for a listed company to become the target of a bid (Fedderke and Ventoruzzo 2017).

  90. See Clarke et al. (2008); Allen et al. (2005).

  91. See Zhang and Li (2017).

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Acknowledgements

We thank Zilin Chen and Mengyao Kang for helpful research assistance, and Mingyu Chen, Wai Yee Wan, Chao Xi, Wenming Xu, the anonymous reviewers and participants at the 2nd Conference on Empirical Legal Studies in China for invaluable comments. All errors are ours, as always.

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Authors and Affiliations

  1. Associate Professor, School of Law, Singapore Management University, 55 Armenian Street, Singapore, 179943, Singapore

    Wei Zhang

  2. Assistant Manager, Department of Compliance Inspection, Shenzhen Stock Exchange, Shenzhen, China

    Weiran Lin

  3. Senior Manager, Legal Department, Shenzhen Stock Exchange, Shenzhen, China

    Bin Zeng

  4. Legal Counsel, Myanmar Fiber Optic Communication Network Co. Ltd., Yagon, Myanmar

    Wenxiu Zhang

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  1. Wei Zhang
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Zhang, W., Lin, W., Zeng, B. et al. Mandatory Bids in China: You Can Lead a Horse to Water, but You Can’t Make It Drink. Eur Bus Org Law Rev 22, 351–394 (2021). https://doi.org/10.1007/s40804-021-00210-6

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  • DOI: https://doi.org/10.1007/s40804-021-00210-6

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