Public companies are structured in such a way that shareholder interests and management interests are seperated - at least that's the theory. Problems arise when management holds the position of Chairman, which often leads to their "friends" being appointed to fill the other seats. Shareholder interests are in great jeopardy when this happens because management has complete control and very little oversight. This type of situation can be particularly costly during mergers or acquisitions, when management interests can differ greatly from shareholder interests. Often times, management receives cash bonuses, severence packages, and other benefits that are not realized by shareholders. Occasionally, these benefits are offered by bidders who want to restrict the marketing done to sell the company in order to assure a lower cost of acquisition.

One such instance of this taking place is the Lone Star buyout by private equity firm Lone Star Funds. While the value of such a transaction should be over $40 (based on the analysis of a hedge fund), the company agreed to a buyout priced at only $27.10. Moreover, the company did not solicit any bids until after the company agreed to the $27.10 buyout with a contigency stating that Lone Star Funds would have the right to match any future bids! Combined with an $18 million breakup fee, the company is giving little chance for other bidders to make a higher offer. Why would a company do this? Well, management has a lot of money vested in stock options that will expire soon. If the buyout goes though, the CEO alone stands to make $80 million through the exercise of risk-free options. However, if the buyout fails (or if they would have had to consider other bids) he would have had to spend $14 million to exercise those options with no guarantee that a buyout would take place anytime soon.

Instances like this can cost shareholders a lot of money while management benefits. The problem can be traced back to the fact that management and the board are not adequately seperated - a problem which not only affects M&A decisions, but also executive compensation, performance metrics, capital allocation, and many other things that can cost shareholders. This is a growing problem that is currently policed by hedge funds, but should be addressed by Corporate America before it grows.

Mentioned Companies
Lone Star Steakhouse & Saloon Inc. (NDAQ:STAR)