If the Delaware Court of Chancery Got Airgas Right, Professor Bebchuk’s Op-Ed Got it Wrong

I wrote my comment “Delaware Court of Chancery Gets Airgas Right” (posted on the HLS Forum on March 1, 2011) before reading Professor Lucian Bebchuk’s op-ed “An Antidote for the Corporate Poison Pill” that was published in The Wall Street Journal on February 24, 2011. As such, my comment did not address Professor Bebchuk’s op-ed directly, but rather served as a counterpoint, providing another point of view. In this comment, I offer a more direct response to Professor Bebchuk’s op-ed.

The fundamental difference between Professor Bebchuk and me stems from Professor Bebchuk’s applying Athenian democracy principles to corporate governance (or, if you will, the French Revolution approach) while I favor a more Platonic representative structure (the American Revolution approach). My approach recognizes the central role of directors in corporate change-of-control transactions, regardless of their form, balanced by imposition of fiduciary duty obligations that are subject to court review. No such balance exists if unfettered power is given to shareholders, who have no such fiduciary duties as a check, whose access to information, no matter how robust the disclosure, is likely to be more limited than the board’s, and whose actions often can be controlled by a subset of shareholders with a short-term perspective.

Professor Bebchuk sets up a false dichotomy by characterizing the Airgas decision as allowing maintenance of a “poison pill” to block shareholder consideration of a takeover bid “for as long a period of time as the board deems warranted” and of giving incumbent directors “the right to use the poison pill indefinitely.” As Chancellor Chandler made clear, the decision did no such thing but rather reaffirms the controlling principle that Delaware courts will scrutinize the board’s decisions intensely in these situations to ensure compliance with fiduciary duty principles and existence of a clear justification for a board to prevent shareholders from making a decision on the takeover bid. As I said in my previous comment, while the Airgas board was able to satisfy the court’s enhanced scrutiny in this particular circumstance, “[a]nother board (and for that matter, the Airgas board on another occasion) might not.” All that Airgas holds is that a takeover offer that, in the board’s reasonable judgment after a thorough evaluation process, is materially inadequate can be a threat to the corporation justifying maintenance of the poison pill even in the face of an all cash, fully disclosed, non-coercive offer that has been pending for sufficient time for the board to explore alternatives.

The main thrust of Professor Bebchuk’s op-ed is to decry the use of staggered boards and to promote their elimination. There can be legitimate debate over the value of staggered boards. However, in my judgment, it is a legitimate corporate governance alternative that has benefits, such as continuity and promotion of a longer-term outlook, and each corporation should be free to decide what board structure works best for it.

Airgas provides an informative case study on the significance of the role of directors in change-of-control transactions and the value of staggered boards. The Airgas board, when Air Products’ $70 a share offer was made, found that offer to be inadequate, concluding, with the benefit of expert financial advice, that the shares were worth at least $78 a share, more than an 11% difference. In the face of rejection of its offer, Air Products ran a proxy contest and succeeded in electing its three nominees for the three slots up for election to the nine-member board. Following their election, the three directors nominated by Air Products, with the benefit of advice from their own counsel and financial advisers, joined the other directors in unanimously voting to keep the poison pill in place, finding the Air Products’ offer to be inadequate. This course of events demonstrates several things: the ability of directors operating under fiduciary duty principles to make independent decisions; the significance of directors having full access to all relevant information to inform their decision making; and the need for directors to have a role in evaluating change-of-control transactions. Moreover, the Airgas experience shows the value of staggered boards so that incumbent directors are in a position to provide context and background to new directors that assist them in the performance of their duties. It is by no means clear what the outcome would have been if Air Products had been able to replace the entire board, but it is clear that shareholders with a long-term focus would have been put in greater jeopardy of losing significant value.

The choice posed between Professor Bebchuk’s approach and my approach to corporate governance in tender offer change-of-control transactions is between unfettered decision making by shareholders, on the one hand, and decision making in which directors have a role, subject to judicial review under an enhanced scrutiny standard, on the other. I submit that the latter provides a more balanced approach that is consistent with the policy underlying the Delaware corporate statute and is accompanied by appropriate checks and balances to protect the interests of all shareholders so that long-term corporate value can be taken into account.