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E-MailThe recent acquisition of Bear Stearns by J.P. Morgan has cast a spotlight on the reliability of fairness opinions. On March 16, when the board of Bear Stearns agreed to sell the company for $2 a share, the investment banking firm Lazard Ltd., who was acting as Bear Stearns’ main adviser, provided the board with a fairness opinion that $2 a share was a fair price for the company, which was then teetering on the brink of bankruptcy. Eight days later, on March 24, when J.P. Morgan agreed to raise its offer to $10 a share to address shareholder discontent, the same investment bank issued a fairness opinion indicating that $10 a share was a fair price. If $10 a share is a fair price, how could $2 be a fair price as well?
This turn of events vividly illustrates how little has changed in the world of fairness opinions since the publication in 1989 of the first critical academic study of fairness opinions, Fairness Opinions: How Fair Are They and What Can Be Done About It? by Lucian Bebchuk and Marcel Kahan. This study highlighted two issues that generate serious problems with fairness opinions. First, investment banks have significant discretion in arriving at the fair price. Second, investment banks do not have incentives to provide an accurate valuation and might have incentives to provide a fairness opinion supporting the position of the party inviting the opinion. The study went on to advocate a judicial approach that takes these issues into account.
The Bear Stearns event suggests that the problems identified by the academic critics of fairness opinions might well persist. It also highlights the limits on the ability of investors and courts to rely on such opinions.
3 Comments
I don’t dispute that serious questions can be raised about the value of fairness opinions, but it is not obvious to me that the Lazard opinions in this transaction demonstrate that a problem exists.
The first Lazard opinion would have been to the effect that $2 per share (or, more precisely, the exchange ration for JPM stock) was fair to the public stockholders of Bear Stearns. If nothing else changed, any higher price (no matter how much higher) should also be fair to those stockholders; the receipt of excessive consideration to not make a transaction unfair to the recipient.
Joel, I respectfully disagree. The Government (and not just Lazard) will face critical scrutiny whether it was actually involved in setting an unrealistically low stock price ceiling via intervention in the public interest (moral hazard and all that) at the expense of the Bear Stearns shareholders and in favour of just the Government’s preferred acquiror, when, in reality, the Bear Stearns net asset value was much higher than $2 dollars per share and an auction would have been warranted. My barefoot spies tell me that at least one well-managed major foreign bank looked into this and chose not to bid. Chances are that others chose not to bid either and an auction scenario was somewhat unrealistic as everyone was close to collective hysteria. The charge of arbitrary stock price valuation (by the Government and echoed by Lazard) could run in the opposite direction if Bear Stearns’ net asset value on Friday March 14 would actually have been lower than $2 dollars per share, because in such event it would have been the Bear bondholders who on March 14 should have become the principal stakeholders of the Bear. Who knows other than that insight is always predicated on hindsight? When Alan Schwarz disclosed on March 14 that the Bear faced insolvency, certain emergency provisions of federal and state financial institutions regulation entered center stage, while simultaneously the Bear directors’ Delaware duties were expanded by operation of the legal standard called “zone of insolvency” which prohibits favouring the equity over bondholders and clearly includes the rights of bondholders and other creditors. In furtherance of this argument, one of the ironclad consequences of such “zone of insolvency” standard is the absolute priority rule that will override any preferred treatment of the equity shareholders over and at the expense of the creditors. As far as the fairness opinion is concerned, Lazard was with the Government the first time around. But the Government wasn’t with Lazard the second time around when JPM upped the ante. They balked. There is a difference whether a windfall is agreeable to the shareholders because it’s nice to receive more money than you expected or whether a price is fair in terms of state of the art valuation techniques employed by Wall Street, i.e., a melange of DCF tempered by Capex, comparable company, comparable acquisition and the like. At least to the common senses, it appears as counterintuitive and a merger agreement cannot be considered fair by a fairness opinion at $2 dollars, only in order to be valued at $10 dollars as fair consideration a couple of days later with another fairness opinion by the same financial advisor, without leaving the impression of utter arbitrariness.
Price and value are very frequently used as synonyms, but could not be more different. I may value an asset at US$10, but if the best offer I can get for that asset at the time I want to sell is US$2, then, US$2 is a fair price. Bear was in a dire state – with a real threat to the firm’s existence as a going concern – which should the Board had rejected JP Morgan’s offer and the insolvency threat crystallized, the shares would have been worth much less.
Fairness under Bear’s circumstance should have really applied to the PROCESS and not the price (given there were no real alternatives).