Corporate Governance Solutions for Transition Economies: Representations and Warranties in Takeover Agreements

The decline of stoc k markets in the transition economies must make the phenomenon of ownership concentration go hand in hand with a more important due diligence and a search for solutions preserving the channel of external financing. In the absence of concrete formal pro- cedures that pay back the restructuring effort, majority owners decisively affect the allocation of companies' wealth in detrimental of small shareholders. When mandatory bid rule is effective, completing takeovers at high prices makes capital markets shrink, affecting on long term the mere capitalist conception of the economic regime of transition economies. Some new forms of en- forcement mechanisms have to be proposed in order to mitigate the classical corporate governance conflict between large and minority shareholders. Our approach aims to investigate an option asking for private law enforcement, which could encourage controlling shareholder to disclose the real status of the business being sold: representation and warranties in takeover agreements. In this respect, we propose a screening model, in the case of a cash—financing acquisition. The pur- pose of this formalization is to determine the features of the acquisition contract in equilibrium, defined by the amount of cash offered for control and by the fraction of liability assumed by the target in two different contexts: (i) when the buyer and the target have the same information; and (ii) when information asymmetry arises between the two parties. The model provides some theoretical predictions concerning the optimal amount of cash, the acquisition premium, and the overpayment of the target. It also contributes to the debate on the type of legal changes relevant for transition economies. JEL classification: G32; G34; L14