Do Mandatory ‘Auctions’ Increase Gains of Target Shareholders in M&A?

The following post comes to us from Fernan Restrepo of Stanford Law School. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Several years ago, the Delaware Supreme Court held, in Revlon v. MacAndrews & Forbes Holdings, that when a “sale” or “break-up” of a company becomes “inevitable,” the duty of the board of directors is not to maintain the independence of the company or otherwise give priority to long-term considerations, but rather to obtain the highest price possible for the shareholders in the transaction (that is, to maximize short-term value). To satisfy that duty, when confronted with these situations, the board is generally supposed to conduct an auction (or, as clarified in subsequent decisions, a “market check”) that ensures that the final buyer is, in fact, the best bidder available. In the words of the court, in this “inevitable” “break-up” or “sale” scenario (which, however, the court did not precisely define), the directors’ duties shift from “defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders.”

Even before Revlon, the literature was divided on whether takeover transactions should involve “auctioneering” duties. One strand of the literature supports auctions in general because they increase competition among bidders and thus lead to better prices for the target shareholders. For another strand, auctioneering duties do not necessarily increase prices because the directors of the target company will anyway seek to obtain the best price available in the market in order to satisfy their ordinary duty of care to the shareholders. From that perspective, mandatory auctions are actually a friction in the takeover market that can have the unintended effect of deterring potential bidders. The effects of Revlon duties, however, have remained empirically untested. Although some works have analyzed related aspects, they do not formally evaluate the effect of mandatory market checks on target returns and deal incidence. The purpose of this work is therefore to make a first step to fill this gap in the literature.

To examine the effect of market checks on shareholder returns, this work focuses on the impact of Paramount Communications, Inc. v. Time, Inc. (hereinafter Time Warner) on the cumulative abnormal returns (CARs) and buy-and-hold abnormal returns (BHARs) for the target corporation around the announcement of the transaction. The analysis focuses on this decision because prior literature has considered that it created a safe harbor from Revlon for stock-for-stock transactions, particularly when ownership of the corporation remains in a “large and fluid aggregation of shareholders.” As a result, returns in those deals should experience a statistically significant decrease after the date of the decision if Revlon actually exerts an upward pressure on prices. In alternative specifications, however, the analysis is repeated for Revlon itself.

To evaluate the effect of Time Warner, in turn, this work employs two baseline methodologies: difference-in-differences and propensity score matching with difference-in-differences. The treatment group in these analyses is the set of transactions that received the exemption from Revlon in Time Warner and the control group is a set of all-cash deals involving the acquisition of a controlling block of shares in the target company, which generally trigger Revlon. Sensitivity analyses, however, repeat the regressions using narrower definitions for this group in order to avoid over-inclusiveness. In addition, due to potential self-selection, the regressions are also run with an alternative control group of transactions involving California targets, which were clearly not subject to Revlon when Time Warner was decided.

To test the hypothesis that Revlon duties deter potential bidders, the analysis uses again a difference-in-difference methodology, this time in a logit framework with Norton-Wang-Ai adjustments to the difference-in-differences estimator. The treatment group in this specification is the entire set of transactions (all-cash and all-stock) involving Delaware targets and the control group is the entire set of transactions involving California targets. If mandatory market checks in fact have a deterrent effect, the incidence of all-stock deals relative to all-cash transactions should increase in Delaware after Time Warner, and this increase should be statistically significant when compared with the control group.

As discussed in the paper, the results indicate that, after Time Warner, CARs and BHARs did not decrease in all-stock deals (or narrower definitions of the treatment group) relative to all-cash deals (or alternative benchmarks). In addition, the results also indicate that Time Warner does not seem to have caused an increase in the relative incidence of stock deals. One possible interpretation of these results is that, even in the absence of mandatory market checks, the target board will generally seek to maximize shareholder value when the company confronts a “sale” or “breakup” scenario. This, in turn, provides support for moves toward greater flexibility in more recent case law.

The full paper is available for download here.

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